The GM & Chrysler Success

During the State of the Union address, the President crowed about the success of the GM/Chrysler bailouts, noting that these companies were thriving again. An NPR program this evening was holding up GM/Chrysler as a beacon of hope for Kodak, as if bankruptcy were now the fountain of corporate youth.  

But this just begs the question of why did the GM/Chrysler bankruptcies work? What made these bankruptcies success stories? NPR raised the question, but had some lame answers, namely that it forced management to make decisions it hadn't wanted to do like cutting loser brands (Saturn, Pontiac). It might have helped focus management decision-making, but that alone can't be the answer, I think. I'm curious to hear readers' thoughts. A few thoughts of my own below the break.

Vee Haf Vays Uf Making You Pay!

Anna Gelpern's Gunboat Diplomacy post pretty much sums out the leaked German term sheet on Greece. I would only note one other thing--the highly idiosyncratic use of "absolute priority." The Germans seem to have taken the language of Chapter 11 and repurposed it, with absolute priority meaning foreign unsecured creditors get paid in full before anyone else sees a cent. Of course, maybe the Germans really do know how to get blood out of a stone.  But in the meantime, I think this is best referred to as Teutonic priority.  

Kudos to Jean Braucher and Bob Lawless!

A new study by Credit Slips own Jean Braucher and Bob Lawless (with Dov Cohen) on race and bankruptcy filings received very prominent and well-deserved page A1 coverage in the New York Times.  It's a fabulous study, and it's wonderful to see it getting such great media attention. 

Bankruptcy, Backwards

Credit Slips Own Anna Gelpern has a great new article in the Yale Law Journal that very much deserves a plug. It's called "Bankruptcy, Backwards:  The Problem of Quasi-Sovereign Debt." The article deals with the problems of financial distress for quasi-sovereigns, like US states or even to some degree EU member states. As Anna points out, bankruptcy seems to mean all things to all people, and as a result framing discussions of how to deal with quasi-sovereign debt---where there is no bankruptcy regime of any sort--quickly devolves into debates about existing bankruptcy systems, like US Chapter 9, rather than starting from the unique problems of quasi-sovereign debtors and then figuring out what sort of financial restructuring system might make sense.

I highly recommend the article, particularly for those of us who don't regularly deal with sovereign debt issues. There's a strange divide in practice and scholarship between domestic bankruptcy and sovereign debt restructuring. A few people (David Skeel, Steven Schwarcz, Bob Rasmussen, e.g.) have written in both areas, but they remain pretty separate fields. Anna's insights from the sovereign debt field are very useful for domestic bankruptcy scholars, as they help us step back and see the larger picture of what is going on.  

American Capitalism: Profit, But Fairly

Adam Davidson wrote up an interesting apologia for Wall Street in the NY Times last week, which I think is ultimately a call for better regulation, rather than bank-hating.  I missed the piece originally, but Yves Smith found it and has nothing good to say about it. I think Yves is a little too harsh on Davidson. I've got issues with parts of the piece, but on different grounds, namely that it efuses to engage on the real issue. The problem isn't financial intermediation.  That's a perfectly fine thing that plays a useful role in society.  

Instead, the problem is when financial intermediaries do not treat the intermediating parties (meaning consumer and investors) fairly. The history of US financial services is nothing short of a history of scandals involving financial institutions variously ripping off investors and consumers. I'm not just talking about those scandals we remember, like Milken or Madoff or the recent slew or even the second tier ones like the Salad Oil scam or all of 1920s mortgage bonds. The history of US financial services is largely a history of unregulated innovation resulting in abuse and then follow-up regulatory reform. Lather, rinse, wash, repeat. 

Davidson argues that the reason to "hate the banks" is that 

Wall Street firms enforce the cold rules of capitalism: hostile takeovers, foreclosures, fee increases, defaults. But those rules clearly do not apply to the largest banks themselves. 

Davidson misses the mark here a bit. It's not just that the banks get bailed out, meaning that the rules of market discipline don't apply to them. It's that the banks frequently break the rules when applied to others.  It's fine to do foreclosures or hostile takeovers or sell consumers speculative securities. But it's not ok to foreclose without following the law or to profit on insider knowledge on hostile takeovers or or to sell investors "safe" assets when you know they are junk.

The fundamental rule of American capitalism is "profit, but fairly." Whatever one thinks is "fair", I don't think there should be much disagreement that Wall Street too often disregards the second part of this dictum to focus on the first. But take away the "but fairly" and society quickly becomes a Gilded Age baronial kleptocracy, a post-Soviet (or pre-Soviet) Russia. If we want capitalism to work--meaning that there is social stability, pace OWS--market players must play by the rules. This is where the debate needs to be focused:  ensuring that our financial intermediaries play by the rules. 

The Consumer Finance Pantheon?

In putting together a revised syllabus for my consumer finance course this semester, I was struck with how different this nascent field is from established courses like Contracts.  No matter what Contracts casebook one uses to teach, there are a bunch of well-established chestnuts that everyone knows:  Hadley v. Baxendale, for example, or Williams v. Walker-Thomas Furniture, Raffles v. Wichelhaus, Frigaliment, Lucy Lady Duff Gordon, Hawkins v. McGee, or Jacobs & Young v. Kent (and one could go on and on).  It's hard to say the same for Consumer Finance; indeed, I've got very few cases on my syllabus. 

I'm curious what Credit Slips readers think are the leading cases in the consumer finance area.

The Fed on Mortgage Servicing

I had the privilege today of hearing Federal Reserve Board Governor Sarah Bloom Raskin deliver the keynote address to the Section on Financial Institutions at the American Association of Law Schools Annual Meeting.  Governor Bloom Raskin's topic: mortgage servicing, which is not something the Fed has previously addressed.  I strongly commend her speech to you. It's rare to see a bank regulator invoke Shakespeare to great effect, as she does, but it's much more important for some of the other things she says:

This wave of foreclosures is one of the factors hindering a rapid recovery in the economy. Traditionally, the housing sector, buoyed by low interest rates and pent-up demand, has played an important role in propelling economic recoveries. The increase in housing sales and construction often is accompanied by purchases of complementary goods, like furniture and appliances, which magnify the effect of the housing recovery.

However, six years after house prices first began to fall, the pace of the economic recovery remains slow. Nationally, house prices have fallen by nearly one-third since their peak in the first quarter of 2006, and total homeowners' equity in the United States has shrunk by more than one-half--a loss of more than $7 trillion. The drop in house prices has had far-reaching effects on families, neighborhoods, small businesses, and the economy, in part because so many American families--more than 65 percent--own their homes. The fall in house prices has caused families to cut back on their spending and has prevented them from using their home equity to fund education expenses or start small businesses. The decline in house prices has also impeded families from benefiting from the historically low level of interest rates, as perhaps only half of homeowners who could profitably refinance have the equity and creditworthiness needed to qualify for traditional refinancing.

This is a really important set of points. They shouldn't sound new to Credit Slips readers, but it's really important to have a Fed Governor saying them.  

The Restatement of Property and the Road to Mortgagocracy

I recently did a string of blog posts of the Permanent Editorial Board for the UCC's Report on the enforcement of negotiable mortgage notes. I'm still planning a final installment there, but I came across another document that just floored me in showing how across another American Law Institute product that just floored me in how deeply captured and compromised part of the legal elite is.  

The document in quest is section 5.4(c) from the Restatement (2d) of Property.  The Restatements are an ALI-only product (unlike the UCC, which is jointly done with NCCUSL), and they are the ALI's signature product.  They are meant to "restate" the law, meaning summarize and improve it, sort of the way Yiddish versions of Shakespeare plays were unironically advertised as farbesert un fartaytsht (improved and translated).  That is to say the restatements are meant to be positive summaries of the law, but they often have normative spins.  

Section 5.4(c) appears to stand for a very simple and uncontroversial principle (pace FNMA v. Eaton), that only the obligee of a mortgage note has the right to foreclose on the note:  

A mortgage may be enforced only by, or in behalf of, a person who is entitled to enforce the obligation the mortgage secures.

In other words, a naked mortgage's got nothin' (are you listening AZ Supreme Court?).  But then the comments and illustration go off the deep-end. Here's Comment (e):  

Mortgage may not be enforced except by a person having the right to enforce the obligation or one acting on behalf of such a person...[including an agent or a trustee for the noteholder.]  The trust or agency relationship may arise from the terms of the assignment, from a separate agreement, or from other circumstances. Courts should be vigorous in seeking to find such a relationship, since the result is otherwise likely to be a windfall for the mortgagor and the frustration of [the noteholder]'s expectation of security. See Illustration 10.

MBIA v. Countrywide Ruling

There's been a lot of media coverage of the recent ruling of the NY Supreme Court (that's the trial court, not the final Court of Appeals) in MBIA v. Countrywide, a suit by the monoline bond insurer against Countrywide for fraud, negligent misrepresentation, etc. that induced it to insure Countrywide's mortgage-backed securities. This and Syncora's similar suit are being carefully watched because they are the MBS litigation that is the farthest along and thus seen as a belleweather for other rep and warranty suits.  While the monolines are in a somewhat different position than MBS investors, they provide a good indicator of what to expect from investor suits.  

For all the discussion of the opinion, no one seems to have actually read the damn thing, so here it is.

The CFPB Gets a Director

The CFPB is finally getting a Director, which enables it to exercise its full range of powers. It's good to see this Administration show some backbone. Better late than never, I guess, and Rich Cordray is a great pick.

While this is a step forward, I worry that the CFPB and Director Cordray will feel that they have to walk on eggshells so as not to rile Congressional Republicans and draw continued scrutiny. There's a fine line that the CFPB will have to navigate in terms of what fights to pick--there are some fights it needs to have and some that are better to avoid to live to fight another day, but I'm happy to see this as the new problem for the CFPB.        

A New Theory of the Role of the GSEs in the Housing Bubble

Bill Black has an interesting new take on the role of Fannie and Freddie in the housing bubble. He sees their investment in non-prime mortgages as being driven by executive compensation, rather than a fight for market share against investment bank securitization conduits or govt affordable housing policy. The government affordable housing policy point has been repeatedly debunked (and Susan Wachter and I have a new paper that adds to this debunking via an examination of the commercial real estate bubble, where there was no government involvement whatsoever). Black is not, however, able to disprove the market share theory. What he does point to is that the GSE's involvement with nonprime mortgages was as whole loans kept in portfolio, rather than securitized (and also via purchases of MBS), which he says was a move to increase the short-term yield for the GSEs and thus maximize short-term executive compensation.

I think this is an interesting theory, but there are a few data points necessary to make it work, and I'm skeptical that they all support Black. 

More Rot in the OCC Foreclosure Reviews

Michael Olenick, Gretchen Morgenson, and Yves Smith have all written pretty damning things about the foreclosure reviews persuant to the OCC consent orders with major mortgage servicers. (For my own previous thoughts, see here and here.) I've just started to peruse some of the engagement letters with the firms conducting the reviews, and the rot is even worse that these other critics portray.

What follows is in no way a comprehensive cataloging of the problems in the OCC foreclosure review process--this is just what I spotted from the briefest of perusals.  Yet it is clear that there are two types of serious problems:  conflicts of interest and flawed substance of the review process. I'll lay both out below and then give some thoughts as to what could and should be done to remedy this farcical process in order to ensure some accountability to the public and justice for homeowners. The post concludes with some thoughts about the core problem--the OCC--and what can be done to remedy it.   

Occupy Bank of America?

Who knew that Mitt Romney had outflanked Obama on the left? Well, it took Nixon to go to China, but I expect we'll see a lot of backpedaling here. 

It's a bit troublesome, though, that a Harvard Law grad like Romney would believe that small claims court would possibly be the venue for resolving a wrongful foreclosure. Leaving aside jurisdictional issues, small claims courts are basically debt collection courts:  they're used by debt collectors, not by homeowners who can't afford legal counsel and are seeking injunctive relief. It explains a lot about the state of our legal system if the Romneys of the world honestly believe that small claims court is a the way middle class folks can receive justice. 

Robbing Peter to Pay Paul: US Economy Edition

The Administration seems to have cut a deal to extend the payroll tax cut, which is a smart economic move in terms of trying to support demand. But it's being paid for by an increase in the "G-fee" (guarantee fee) charged by FHA and Fannie Mae and Freddie Mac on the loans they purchase. In other words, anyone refinancing or taking out a mortgage now will be subsidizing reduced payroll taxes.  The result is robbing Peter to pay Paul, which means the economic benefits from extending the payroll tax cut are going to be muted by the chill this puts on the struggling housing market.  

The argument that it will encourage homeowners to look for non-GSE/FHA loans is pretty silly and hides the foolishness of using housing to pay for payroll tax cuts. Homeowners don't choose whether they have a GSE loan or not. They choose whether to do FHA or not, but if it's not an FHA loan, the homeowner doesn't know if the loan is going to stay in the lender's portfolio, be sold to another lender, be sold to a GSE (and maybe securitized by the GSE) or be privately securitized. Raising the costs of the GSE execution might encourage more portfolio lending, but it's hard to believe that a few basis point change in GSE execution costs is going to suddenly make the private-label securitization market revive.  The problems in that market aren't just the economics--particularly of servicing--but the utter lack of trust investors have in the underwriting, documentation, and servicing. For the private-label market to revive, there will need to be a much more significant difference in execution costs between private-label and the GSEs. The increased G-fee doesn't do it. 

It's painfully apparent that this Administration doesn't have a housing policy, and that's a serious problem when housing is the anchor weighing down the economy.  Consider, on the one hand, the Administration tries to make refinancing easier via the expansion of HARP.  Then it raises the "G-fee" that Fannie Mae and Freddie Mac charge on every loan they purchase, which gets passed on the homeowner in the form of a higher mortgage rate.  (I'm not sure of the pass-through rate, but I'd guess it's pretty high.)  If the Administration is trying to fix the housing market, this sure isn't the way to do it.

Lies and Denial: the 2012 GOP Strategy

The last 24 hours have witnessed some remarkable historical revisionism on financial regulation coming out of the GOP.

First, we had one of the most bizarre and simply untrue attack ads I've ever seen, courtesy of Karl Rove's Crossroads GPS outfit. The ad calumnies Elizabeth Warren, claiming that first she was responsible for the TARP bailout and then set out to butter up bankers. Is this man on drugs? Rove seems to be confusing Elizabeth Warren with George W. Bush. 

Let's set the record straight.  Elizabeth Warren involvement with TARP was as chair of the Congressional Oversight Panel.  That was a body created by Congress to monitor and report on the effectiveness of TARP bailout.  The Oversight Panel did not create the bailout.  Congress did at the urging of the Bush Administration. The Oversight Panel had absolutely no authority to direct the use of the bailout. Its sole authority was to act as a watchdog.

And what a watchdog it was! It was Elizabeth Warren's trenchant criticism of the bailout that catapulted her to the national stage. The reason she started being invited to appear on the Daily Show and the like was because there was no better and more articulate critic of the bailout than Elizabeth Warren. The Oversight Panel could easily have been a sleepy, impotent backwater. Elizabeth Warren turned it into a ferocious bully pulpit for the interests of middle class Americans who were confused and angry over what was happening to their country. To blame Elizabeth Warren for the bailout is like calling Larry Bird the greatest New York Knick ever. It's so ridiculous that it's insulting. (And fighting words in Boston.) 

Then there's a hooter of a claim that Elizabeth Warren was courting bankers. Let's put that in some context to show how silly the charge is.  Elizabeth Warren left the Oversight Panel to help push for the creation of the Consumer Financial Protection Bureau, and for a long time it was thought that she would be nominated as the Bureau's Director. One reason she wasn't nominated was because the banks took an "over our dead [but now rescusitated via bailouts thank you very much] bodies" approach to Warren, claiming that she was "anti-bank."

Now, some might think that's a compliment, but Warren tried to show that she's not anti-bank. She just wants fair, transparent markets.  (Apparently, that's a problem for banks.  Heck, apparently, if you want market to be fair, and transparent and work as they are supposed to that makes one anti-bank, a socialist, a communist, or worse.  Capitalism, it turns out has nothing to do with markets.) To show that she wasn't anti-bank, Warren took great pains to reach out to banks and to show them that she's open-minded and willing to listen to their concerns, especially the concerns of small community banks and credit unions.  So now Elizabeth Warren is being damned for having been gracious and fair and open-minded. 

For more commentary on this lunacy, see here and here. 

"The Wikipedia of Land Registration Systems"

Pretty amazing opinion in Culhane v Aurora Loan Services of Nebraska byJudge Young of the US District Court for the District of Massachusetts. Judge Young breaks out a fresh can of whoop-ass on MERS, which wasn't even a litigant. How are these choice lines:  "MERS is the Wikipedia of Land Registration Systems."  Now I like Wikipedia, but property title isn't do-it-yourself. Or this gem: "a MERS certifying officer is more akin to an Admiral in the Georgia navy or a Kentucky Colonel with benefits than he is to any genuine financial officer." Well, at least he didn't call them an "Admiral in the Great Navy of the State of Nebraska".  You gotta love a landlocked navy. 

That said, for all of his misgivings about MERS supplying "the thinnest possible veneer of formality and legality to the wholesale marketing of home mortgages to large institutional investors," Judge Young still says that it's kosher, if unseemly. 

The issue here was whether there could be a foreclosure by a naked mortgagee--that is a mortgagee who is not the noteholder.  (That's the issue before the Supreme Judicial Court of Massachusetts currently in Eaton v. Fannie Mae.)  Judge Young say no:  the note and mortgage need to be reunited before foreclosure; a naked mortgagee can't foreclose.  In this case, however, Judge Young found that the mortgage and note were reunited before the foreclosure was brought.  

I think Judge Young is right on the law, and wrong on the facts here. I don't know how this case was lawyered, but it seems to me that there are two factual problems that indicate that the mortgage and note were not in fact reunited prior to foreclosure.  Here's Judge Young's explanation of how the reunification happened: 

Aurora, as Deutsche's loan servicer, has an interest in the underlying debt; Aurora also physically possesses the collateral file, including the note. With the assignment of legal title to the mortgage from MERS, Aurora became the mortgagee of record as well, thusperfecting its standing to bring a foreclosure action against Culhane.

Culhane makes much of the fact that the endorsement to Deutsche on the note and attached allonge is undated. While this Court agrees as matter of law that the mortgagee must hold the note or be the servicing agent of the note holder before initiating foreclosure proceedings, here Aurora did. Regardless of the date that Deutsche became the note holder,whether it was before or after the cut-off date for loans to be transferred into the RALI Series 2006–QO5 Trust, as of April 1, 2008, Aurora was servicing Culhane's loan for Deutsche. Aurora caused legal title to the mortgage to be assigned to it over a year after becoming the servicing agent, and it did not send the notice of sale to be published until September 21, 2009.

First, Judge Young seems to assume the note is negotiable. Otherwise it doesn't matter who holds the note. If it's not negotiable, then it's just a plain old contract, and physical possession is irrelevant. Just because I hold the original loan contract between Karl and Soia doesn't mean that I have any right to enforce it if it isn't a negotiable instrument. But it doesn't look like negotiablity was raised by the parties; I would think it is in the purview of judicial notice as it is obvious from the face of the instrument, but if the issue isn't flagged for a judge, it is often missed. 

Second, it isn't clear whether the trust law argument was ever put firmly before the court. If the note was transferred to the trust after the trust's closing date, that transfer is void under New York trust law. That means that the trust doesn't own the note, which means Aurora doesn't have an interest in it, which means that the note and mortgage have not been reunited prior to the foreclosure, so under Judge Young's analysis, then, the foreclosure should not be permitted. The reason the closing date matters is because if the transfer is after the closing date, it cannot happen as a matter of law. The fact that Aurora was servicing the loan for Deutsche as trustee isn't enough if Deutsche as trustee doesn't have an interest in the note. I don't know how this issue was lawyered, but this is a critical point. 

So it seems to me that this is a good opinion, but that it needed to go further into the factual question of whether Deutsche as trustee had any interest in the note. That might be a function of lawyering rather than anything else. I don't think this case presents a clear victory for the mortgage industry--it just focuses the issue on the question of who can enforce the note, and I'm not sure that's where the industry really wants things to go. 

HARP's Dirty Little Secret: Most HARP Refis are of Positive Equity Mortgages

So the Administration has announced that it is expanding the HARP refinancing program to help underwater borrowers.  Originally, HARP enabled borrowers with up to 125% loan-to-value (LTV) ratios to refinance (105% for adjustable rate loans).  The revised program removes the LTV cap for fixed-rate loans, reduces some refi fees, permits refis of loans that have been mildly delinquent recently, and extends the eligibility date.  All the news accounts have stated that the number of HARP refinancings is expected to roughly double, from about 900,000 refinancings to perhaps 1.8 million refinancings. This is trumpeted as a boon for underwater homeowners.  

The revised program may well help some underwater homeowners lower their monthly payments. Unfortunately, the 900,000 and 1.8 million numbers are seriously deceptive.  Most of the HARP refinancings to date have been for borrowers with positive equity.  HARP has refinanced very few underwater borrowers.  As of 2Q 2011, 92% of HARP refinancings (776,009 of 838,441) were of loans between 80% LTV and 105% LTV. Only 62,432 refis were between 105% and 125% LTV.  In other words, HARP has provided very little help for underwater borrowers.

Ironies of the Legal Profession?

Funny to see the juxtaposition in the New York Times of a piece berating law schools for the irrelevance of their curriculum and then a piece about our former co-blogger Elizabeth Warren, a law professor whose work can be called anything but irrelevant (unless you think conceiving and standing up a new government agency that some think is the Leviathan itself is irrelevant). 

There's lots to say about what's right and what's wrong in the NYT piece on law schools--maybe for a future post--but for now let's just say that it paints with too broad of a brush. There are certainly real problems with the law school curriculum and legal scholarship, but the NYT didn't quite capture them.  The bigger problem with the piece, I think was that it accepted the idea that law schools should be preparing students with practice knowledge like where to file a certificate of merger. Baked into this critique is an acceptance of the beleagured economics of the legal profession, where billing is usually by the hour, rather than by the service, so clients often pay premium rates for non-premium services (that frankly don't require a legal education). This is what clients are increasingly pushing against--why pay laywers for work that doesn't really involve much training or knowledge? If law schools aren't succeeding in training their graduates to perform the non-premium services, is that really a failing? Or are law schools actually training students in the critical thinking skills-- statutory interpretation skills and policy argument skills--that can sustain premium billing rates?  

Soured on Saurman

Elected justice moves swiftly. The Michigan Supreme Court handed down its opinion in Residential Funding Co. v. Saurman on Wednesday, a couple of weeks after oral argument. They were in a rush to get the opinion out, it seems. Unfortunately, it's a terrible opinion. The Michigan Supreme Court reversed the appellate court to hold that MERS has the power to conduct non-judicial foreclosures (foreclosure by advertisement) in Michigan.

To reach this conclusion, the Michigan Supreme Court had to conclude that MERS had an interest in the indebtedness--that is an interest in the note.  MERS, however, expressly disclaims any interest in the note. So it took some acrobatics and legerdemain and outright tautology to get no to mean yes. Here's how they did it:

The Heirs of Karl Lleywellyn: the PEB Report, Green Cheese, and the Hijacking of American Law (Part III)

As I noted in the previous posts on this thread (here and here), I think the Permanent Editorial Board for the UCC's report on the enforceability of mortgage notes is simply irrelevant because it deals with negotiable notes, and virtually all mortgage notes today are not negotiable. But even if the notes were negotiable, there are still some further flaws in the report itself.

I'm not going to attempt a complete catalogue. But I will point out some two highlights:  the failure to address the interaction of the UCC with other law, such as real property law and trust law and agency law; and the failure to address the evidentiary issues that are at the heart of the foreclosure documentation problems.  

The Heirs of Karl Lleywellyn: the PEB Report, Green Cheese, and the Hijacking of American Law (Part II)

Why the PEB Report? 

What motivated the Permanent Editorial Board for the Uniform Commercial Code to issue its ridiculous report on the enforceability of negotiable mortgage notes (discussed in the previous post in some detail) when virtually no mortgage notes are negotiable? Why go to all the effort and fuss to issue an irrelevant report?  

The report is an attempt to paper over all of the legal and paperwork snafus that have gummed up the foreclosure system. The report is an attempt to put a finger on the scale of justice in favor of the banks in foreclosure litigation. (I hope ALI members who read this understand just what a rogue body the PEB has become; I don’t think this is a policy that the ALI membership as a whole would support.)   

To understand what’s going on here, think of the scene in Star Wars when the rebels are attacking the Death Star and the imperial officer says to Grand Moff Tarkin:

We’ve analyzed their attack, sir, and there is a danger. Should I have your ship standing by?  

The Heirs of Karl Lleywellyn: the PEB Report, Green Cheese, and the Hijacking of American Law (Part I)

This last week the Permanent Editorial Board of the Uniform Commercial Code came out with a report bering the none-too-thrilling title of "Report on Application of the Uniform Commercial Code to Selected Issues Related to Mortgage Notes". There's an awful lot to say about this awful document, and I'm not going to attempt to cover it all in a single blog post. This post is going to cover what the report is, what authority it has, and why it is completely irrelevant (namely that it deals with negotiable notes, when virtually all mortgage notes are non-negotiable). Subsequent posts will deal with the substantive flaws in the report and with the motivation behind the report and with the way the uniform law making process has become completely hijacked by monied interests.

There are two critical takeaways from this post. First, it is important to understand that the PEB report is not law. It is not authoritative or binding. The PEB does not determine what the law is or what the Uniform Commercial Code means or does not mean. The report is merely dicta on dicta from a completely nonrepresentative, politically unresponsive body that includes some patently conflicted members.

Second, it is important to understand that the PEB report is utterly irrelevant because by its own terms it only addresses the enforceability of "negotiable" mortgage notes, and virtually all mortgage notes are non-negotiable. Therefore, even if everything in the PEB report were correct (which it ain't), it would have as much real world application as a report on the enforceability of mortgage notes made of green cheese. (This raises the question, of course, why there would be so much energy spent on an irrelevant document. I'll address that in a later blog post, but basically this report is a desperate attempt to put a finger on the scales of justice in favor of the banks).

Is Bank of America Gambling on Resurrection (or Is BoA Holding the US Hostage)?

What would you do if you were running an insolvent company? The smart thing is to bet big:  go with a high-risk/high-return strategy.  If the gamble pays off, you're solvent, and if not, well, you're already insolvent.  You're playing with the creditors' money. (And without a tort of deepening insolvency, there really isn't a clear downside for management.)  This is gambling on resurrection.  

We've seen the disastrous results of banks gambling on resurrection.  That was the S&L crisis. Rising interest rates in the late '70s decapitalized the S&Ls as the S&Ls' assets were long-term, fixed rate mortgages that paid lower rates than the S&Ls had to pay depositors.  The S&Ls, however, got a pliant Congress to agree to massive deregulation that allowed them to expand into all sorts of new business lines, like commercial real estate and race horses and junk bonds. Insolvent S&Ls went chasing high risk/high return projects.  The result was that the tab for taxpayers to fix the S&L mess was significantly greater.

Today, it looks like Bank of America is repeating the S&Ls' gamble on resurrection and using this gamble to hold the US government hostage.  

Corzine's $12 million

I know this is a bit tardy, but I've been meaning to post on this. A couple weeks ago, the media were making a big deal about Jon Corzine renouncing the $12 million in severance he is owed by MF Global. But he isn't. He's walking away from a $12 million general unsecured bankruptcy claim (as far as I can tell he's not secured) against an entity that looks to be deeply insolvent. Heck, his claim might be subject to equitable subordination. In any case, his bankruptcy claim for the severance isn't worth anything close to $12 million. If it pays out $1 million, I'd be surprised. The difference between the face and bankrutpcy value of the claim was universally missed in the reporting.

Is Fraudulent Transfer in Joe Paterno's Playbook?

No, fraudulent transfer isn't a fancy football term for a fake handoff.  That's a bootleg.  Instead, it's what you call a bs transfer of an asset to avoid creditors or when you are or are about to be rendered insolvent. And it looks like it might be part of Joe Paterno's playbook.  Whatever one thinks about Paterno's conduct at Penn State, it sure looks like he's trying out the fraudulent transfer play by selling his house to his wife for $1 plus love and affection.

The only reason I can see for the transfer is that JoePa thinks he's going to get the bejezus sued out of him, and he wants to be as judgment proof as possible. But maybe the love and affection are really worth $594,483.40.  

The Multistate Foreclosure Settlement

The New York Times came out with a strong editorial urging state AGs and the Administration not to rush into the proposed multi-state settlement deal. I think it's worthwhile reviewing what we know about the deal and the arguments for and against it.  Let's start with the facts that we know.  There aren't many that are publicly confirmed; the Administration, the AGs leading the multi-state settlement, and the banks very much want to avoid public comment on the deal--they want to present it as a fait accompli.  As a result, there hasn't been definitive reporting on the contents of the term sheet currently circulating among AGs.  It appears, however, the the deal has the following features.

Some 16 banks that do mortgage servicing will:

1. contribute a total of $5 billion in cash;
2. contribute total of mortgage assets with a face value of $20 billion, but a market value considerably lower; 
3. agree to uniform servicing standards.

In exchange, the state and federal authorities signing on would give the banks:

1. a release of all servicing claims;
2. a release of all origination claims, including discriminatory lending claims;
3. a release of all MERS claims against the banks, leaving MERS Inc. as a potential defendant for MERS related issues (MERS Inc. has no financial assets of note.)  

Perhaps $20B of the money would be used for principal write-downs and for interest rate reductions (via refinancings, which have the added benefit of relieving the banks of rep and warranty problems on the old loan) on the loans owned by these banks, which is less than 10% of the first lien loans in the U.S. 

Let's start with the argument for this deal and then consider why it is wrong.  

The US's Missing Housing Policy

The United States has no housing policy. And there's none on the horizon either. That's a scary thing, given the centrality of housing to domestic economic woes.  

Once upon a time, the US had a housing policy. It was focused on increasing homeownership. It might have been a misguided policy or at least a policy taken too far, but it was a policy and everyone understood that. It meant that programs were designed to work toward that goal.

Today, 4 years into a housing crisis, we still have no housing policy. There's no plan to clean up the legacy of the housing bubble and no plan to build the future of housing finance. This sad state reflects a singular failure of political leadership.  It also reflects a deeply fragmented housing finance world in which no one is in a position to call the shots. 

The Multistate Settlement Lottery: Bupkis

The NY Times had some details today about the multi-state attorney general mortgage servicing settlement in the works. It looks every bit as awful as one might have feared. Here's the criticial take-away:  this is bupkis. It gives meaningless relief to a meaningless number of randomly or adversely selected homeowners.  It doesn't do justice, even by halves. 

First, though, there's a detail reported in Gretchen Morgenson's otherwise insightful piece that I have on good source is incorrect.  The piece states that the banks would be doing principal write-downs on loans they own or service.  That's gotta be incorrect.  The banks can do principal write-downs only on loans that they own.  They have no legal authority to pledge write-downs on loans that they service on behalf of investors.  (Remember the Greenwich Financial suit against Countrywide for doing just that?)  

There's a critical implication here, then about the scope of the multi-state settlement:  at best 20% of the population of underwater mortgagees will be helped by this settlement, say 2.2 million homeowners.  The other 8.8 million (and probably 10 million by my reckoning) are SOL.  How do you think they're going to feel about their AGs?  About their President?  Too many times have American homeowners been promised help without receiving any.  It's getting old. 

Make the Banks Pay

I have a post up on Salon.com.  Credit Slips readers will recognize it as based on a prior post here.

Nemo Dat Trumps Bona Fide Purchaser

The Massachusetts Supreme Judicial Court just handed down a second major mortgage foreclosure ruling, Bevilacqua v. Rodriguez.  The case was an Ibanez follow-up dealing with the rights of a purchaser at an invalid foreclosure sale. I thought this was a no brainer case and said so in an amicus brief co-authored with some of the Credit Slips crew. As the trial court noted, the foreclosure sale purchaser has to lose otherwise I could actually sell you the Brooklyn Bridge or some other property I don't own.

What was cool about this case from an academic perspective was that it pitted two heavyweight, Latin-inscribed principles of commercial law against each other:  the nemo dat quod non habet principle (you can't give what you don't have) and the bona fide purchaser principle (one who takes in good faith for value and without notice of defect will get legal protection against claims). While these are both venerable principles of commercial law, there should have been no question that nemo dat prevails. It is arguably the foundational principle of commercial law:  the most one party can transfer to another are the rights it has.  

The Sweep-It-Under-the-Rug Housing Plan (updated)

There is $700 billion in negative equity in the US. That is the critical figure. Any housing plan that doesn’t take a serious bite out of that $700 billion isn’t worth discussing. It’s just window dressing. And that’s exactly what the latest iteration of the Tom Miller-led AG mortgage servicing settlement is. Sure it’s been sweetened by the addition of some interest rate reductions for underwater, but current homeowners (discussed at the end of this post), but that’s small potatoes. The latest settlement proposal is an exercise in rearranging deck chairs on the Titanic.

It’s time that we recognize that negative equity is the critical problem in the US economy. Fix negative equity and you will fix the US economy. That is because negative equity is the key for repairing household balance sheets, and that is the catalyst for getting consumers spending again, getting banks lending again, and getting businesses hiring again. If we're serious about dealing with negative equity, we need to address it directly and not engage in an extend and pretend dance. 

It's also time that we recognize that negative equity didn't just appear by itself.  This wasn't a freak weather event.  It was a man-made disaster.  We ended up with negative equity because of a housing bubble inflated by very deliberate acts by a limited number of financial institutions that profitted greatly from bloating the economy with cheap and unsustainable mortgage financing. We witnessed a macro-economic crime and are living with the consequences of it. 

The Way Forward: Going in Circles?

The latest proposal for dealing with the mortgage crisis comes from The Way Forward by Daniel Alpert, Robert Hockett and Nouriel Roubini (AHR), a policy paper sponsored by the New America Foundation.  AHR present is an incredibly wide-ranging proposal covering all sectors of the economy, not just housing, but I'm going to limit my comments to their mortgage crisis proposal. 

I was really hoping that there's be something innovative in the paper in terms of dealing with the mortgage crisis. There isn't.  Instead, AHR cobble together a variety of existing proposals.  The problem is that many of the existing proposals are grossly impractical (such as turning homeowners into renters en masse) and for the more practical proposals, such as principal reductions, AHR haven't figured out the catalyst for adoption, which is key. 

I don't like yucking on somebody's yum; this is a proposal that tries to grapple seriously with the mortgage problem in the US.  I wish there were more of this going on. (Hey, where's your proposal Levitin?) That said, I don't think this proposal is going anywhere. The one really novel move in AHR is its approach to loss recognition. It's also the scariest part of the proposal as it proposes taking us back into the "regulatory goodwill" accounting days of the S&Ls. 

More on Foreclosure File Reviewers

A simple google search for "foreclosure file reviewer" turns up a bunch of interesting things, including who is searching, what Level 2 means (as opposed to Level 1 or Level 3) and the involvement of Promontory, a financial services consulting firm headed by a former Comptroller of the Currency:

Robosigning 2.0: Mortgage Foreclosure File Reviewers

Do you have what it takes to be a Mortgage Foreclosure File Reviewer Level 2?  An intrepid researcher forwarded to me a job ad for a mortgage foreclosure reviewer who will be reviewing bank foreclosures per the OCC/Fed servicing fraud consent orders. I have seldom seen a document that says more about the bullshit malarkey that the OCC and Fed are trying to pass off to cover for the banks than this job ad. I think it demolishes even the thin fiction that the OCC/Fed servicing consent orders are anything more than Potemkin villages. Instead, what we have here is nothing less than a federally-blessed Robosigning 2.0.

Occupy Wall Street, "Fringe Banking" and Public Options

I happened to walk by Zuccoti Park in Manhattan yesterday, where the Occupy Wall Street protest is centered. I picked up a few pieces of protester literature. I can't say that I was in any way comprehensive in my collection. Some of the literature was just nuts, e.g., a flier blathering about admiralty law usurping the common law and the Trading with the Enemies Act. This flier could just as easily have been found at a Tea Party gathering. It gave new meaning to the term "fringe banking." 

But I also picked up a thoughtful and intelligent, for example a flier about public banking and the Bank of North Dakota (the only state-owned bank in the United States).  Hmmm.  That sounds like a public option for banking. If the financial system is broken, maybe it needs some better competition. It's not such a crazy idea. We actually already do that quite a bit in the mortgage market-FHA, VA, RHS, Ginnie Mae, and historically the FHLBs, HOLC and Fannie Mae (Susan Wachter and I have a forthcoming book chapter on this, to be posted to SSRN soon). We've even done it in straight banking--most people forget that we used to have a U.S. Post Office Bank. We have an FDIC that used to compete with private bank insurance funds (see the opening chapters of Kathleen Day's S&L Hell for a description of the private Maryland S&L insurance fund that failed). And we have federal (public) currency that used to compete with and has now supplanted private bank notes.  My point here is not to endorse public options or not, but merely to note that historically they were a response to failed private markets and should be part of the policy discussion. 

OCC Servicing Settlement--Will Homeowners Get Screwed (Again)?

The WSJ reports on the latest development in the implementation of the OCC's mortgage servicing fraud consent orders.  It seems that the banks will have OCC approved "independent" foreclosure review consultants (chosen and paid by the banks) review foreclosure files from 2009-2010 and pay homeowners damages if there are any problems found.  

This proposal really worries me.  It's hard to imagine that the banks will part with any money unless they receive releases--broad releases--from the homeowners.  The homeowners, however, will not typically have legal representation and will lack the ability adequately value their claims against the banks. $100 for a complete release?  Why not?  

Bully for BofA: New Debit Card Fees!

Bully for you, Bank of America.  Bank of America's starting charging monthly fees for debit card usage to some customers. This is being taken as an "I told you so" by opponents of the Durbin Amendment, who argued that it would only result in higher costs for consumers. Actually, the BoA move is exactly what we might expect:  consumers are having to pay for their rewards. That's how it should be. They might be paying too much, but that's another matter.  So what does Bank of America's move tell us?

Housing Finance: Role of the Government Guarantee

I'm testifying before the Senate Banking Committee on Tuesday about the role of the government guarantee in housing finance (a/k/a wtf do we do with Fannie and Freddie). My testimony is here. I expect it will manage to piss off people left, right, and center, but that's the nature of this GSE reform debate. 

I'm not thrilled with the prospect of a government guarantee, but I just don't think that there's sufficient the market demand for credit risk on U.S. mortgages for a non-guaranteed system to function. Do we really think that $6 trillion dollars of interest risk investors are suddenly going to decide they want credit risk as well?

Realistically, if it gets hairy enough, the government will bail out the system, Dodd-Frank, Tea Party, and all that jazz aside. We'll keep chanting no more bailouts until we do the next bailout. (Remember the War to End All Wars?) That means that it's better to have an explicit guarantee and price for it.  

Put differently, the choice we face is not guarantee or no guarantee. That's just a false dichotomy. The choice instead is between an explicit and an implicit guarantee. The implicit guarantee is a guarantee of moral hazard. The government will bail, but won't price for it. The explicit one certainly has its own problems, but at least it means we are being candid about the risks the government is assuming and trying to price for them and structure the guarantee to mitigate the risk that it will be used.   

First to File--Patent Thoughts

Congress just passed a bill overhauling the US patent system.  The most significant change appears to be shift from a first-to-invent to a first-to-file system.  Now, I am not a patent scholar and am wading into unfamiliar waters by opinining in any way on this shift, but it's rather fascinating to consider from a comparative perspective with security interests in personalty and realty, where first-to-file is generally the rule (with important exceptions like relation back for purchase money security interests and priority by possession or control).  

So, as I understand it, a key problem with first-to-invent was that it was rather time-consuming to determine who actually invented something first. Administratively, that seems like a cumbersome system, even if it does help protect original thinking. 

At first glance, first-to-file seems like a much easier system administratively, which will speed up the patent process and create more certainty in property rights--and certainty is the major goal of any property title system. It should eliminate litigation over priority of invention.  (Put differently, we're going to a pure race system, not even race-notice.) But I suspect that first-to-file will just put more weight on the question of whether A's filing covers the same property as B's filing. If A and B have filed for patents on separate ideas, then there's no competition in rights and no problem. The danger, it would seem, is that first-to-file might encourage prophylactic filings. I'm not sure how easy that is to do, but encouraging a race could undercut the efficiency gains by not having to adjudicate who was first to invent.  

Chapter 11 Bankruptcy Venue Reform

This Thursday, the House Judiciary will be holding a hearing on H.R. 2533, which would reform Chapter 11 venue and require corporations (which includes more than true corporations under the Bankruptcy Code) to file in the district in which they are headquartered or in the district in which a controlling affiliate has filed.  So no more bootstrapping of Eastern Airlines, Enron, or GM via tiny affiliates.  And no more Los Angeles Dodgers of Delaware.  

Nevada AG: Securitization Fail

The Nevada AG is looking to reopen the 2008 AG settlement with BoA:  the AG alleges rampant and immediate non-compliance with the settlement.  The NYT coverage missed what is arguably the bigger story:  the Nevada AG came out and alleged a securitization fail.  The NY AG moved in this direction in his BNYM settlement action intervention, but was a little more oblique on that point. The Nevada AG minced no words: 

Bank of America misrepresented, both in communications with Nevada consumers and in documents they recorded and filed, that they had authority to foreclose upon consumers' homes as servicer for the trusts that held these mortgages.  Defendants knew (and were on notice) that they had never properly transferred [text redacted] these mortgage to those trusts, failing to deliver properly endorsed or assigned mortgage notes as required by the relevant legal contracts and state law. Because the trusts never became holders of these mortgages, Defendants lacked authority to collect or foreclose on their behalf and never should have represented they could.   

See also paragraphs 53 and 137-149. Amazing how the federal regulators missed all of this. Realize that it's been less than a year since the robosigning scandal broke and the chain of title issues started getting some attention. I expect we will see a lot more action on this front over the next year. Prosecutors, investors, and consumer attorneys are getting a lot more savvy about these issues, and it's getting harder and harder for the banks to dance around the problem.      

More on Refinancing Plan

Chris Mayer, one of the authors of the refinancing plan, a version of which is currently being considered by the administration, wrote in to the comments on an earlier post, protesting my characterization of his proposal. I have no argument with Chris about there being too many frictions in the refinancing process. I'm not sure that this is the best way to fix them, however, and I'm also puzzled by what problem the proposal aims to solve.  Is the goal to stabilize the housing market or to provide economic stimulus?  

Refinancing Malarkey

It looks like the Obama Administration is about to endorse some version of the Hubbard-Mayer plan of letting everyone (or at least everyone with an agency mortgage) refinance at today's low rates, regardless of whether they are delinquent or underwater.  (Gotta love how the administration picks up a 3-year old Republican plan with obvious deficiencies and acts like it's fresh meat.) I fail to see how such a plan will accomplish much.  

The ability to refinance depends heavily on whether a homeowner is current and has equity. Consider, then, the impact on the 4 categories of homeowners under this rubric:   

Conflicts on the New York Fed Board

The regional federal reserve banks are weird, hybrid creatures, both private bankers' banks and public governmental agents. This hybrid existence means that they have conflicts baked into their DNA--they are both supposed to serve and regulate their member banks. These conflicts have been most patent with the New York Fed. During the AIG bailout, it was represented by the very lawyer who minutes before had been representing the private bank consortium that was trying to arrange a bailout of AIG and which benefitted from the public bailout. Yes, a client can waive conflicts and the lawyer probably knew the deal constraints better than anyone else, but that doesn't mean that the conflicts always should be waived.

The latest manifestation of this problem is FRBNY Director Kathryn Wylde criticizing NYAG Eric Schneiderman for having the chutzpah to sue the hometeam over fraud with MBS and mortgage servicing: 

“It is of concern to the industry that instead of trying to facilitate resolving these issues, you seem to be throwing a wrench into it. Wall Street is our Main Street — love ’em or hate ’em. They are important and we have to make sure we are doing everything we can to support them unless they are doing something indefensible."

Gee, some might just think that what's going on with servicing fraud is indefensible. What does Wylde want? A trail of corpses? Apparently it's not ok to be hating on the hometeam.     

Wylde, of course, is a woman whose salary is paid by the banks. She heads the Partnership for New York City, an influential NYC business booster club. I haven't tracked down their finances, but it's hard to imagine that a fair portion of PFNYC's funding doesn't come from its "partners," which include all of NY's major financial institutions and the law firms that handle their legal work. 

Yves has previously riffed about the way in which Wylde is compromised by PFNYC's ties to the financial services industry, but it strikes me that the problem is by no means limited to Wylde, even if her public statements were pretty revealing. Instead, the problem is with all the selections of the Board of Governors of the Federal Reserve (Bernanke et al.) for the Class C directors, who are appointed by the Board of Governors of the Federal Reserve to represent the "public".  All three Class C directors have a serious conflict of interest because of their day jobs involve hitting up the banks for donations.  

Feds to AGs: Can't Touch This

As this NYT story notes, the administration has been putting pressure on the AGs, particularly NY AG Schneiderman, for several weeks now, urging them to fall in line with the administration's hear-no-evil, see-no-evil position on MBS and servicing fraud.  The NYT story makes it sound as if the feds were jolted into intervening because of pleas from the banks.  It's enough to make one think that we're back in 2005.   

There are three things that particularly bother me about what's happening.  

Any Bright Ideas?

Jean Braucher has noted the FHFA's RFI on foreclosure prevention. A huge problem with any proposal is the time to implementation for anything. It took months to develop flops like FHASecure, Hope4Homeowners, and FHAShortRefi. Any program where the government and/or private parties have to do much gets a major ding in my book because by the time its rolled out and the kinks are worked out, it'll be too late.

So here are some thoughts. First, the government needs to settle on its policy goal. Why are we trying to prevent foreclosures? Is it a macroeconomic goal of stabilizing the housing market? Is it a macroeconomic goal of deleveraging consumer balance sheets? Is it a moral goal of helping unfortunates? Is it an electoral goal of making people feel that the government is doing something/is on their side?

Second, there are obvious limitations on what the administration can do. Anything involving legislation is a non-starter with this dysfunctional Congress. Rule-making too might be problematic. But there's plenty the administration can do without legislation or rule-making. What's upsetting is that the adminsitration doesn't seem to be giving any consideration to these options because it will involve some tussling with the financial sector. It's easier to pretend that its hands are tied by Congressional acrimony and that ideas don't exist. 

So let me throw out an idea: why not have FHFA order the GSEs as a safety-and-soundness measure to write-down the principal on all underwater mortgages?  Or to offer all underwater homeowners with GSE loans a shared equity refinancing? At the very least, this could be done no question on GSE portfolio loans, and with some smart lawyering probably also on GSE securitized loans. (And if there is securitizaiton fail with the GSEs, then they're all portfolio loans!) That deals with (1) strategic default/negative equity, and (2) consumer balance sheet deleveraging. It doesn't take much to expand that move to FHA/VA, bank portfolio loans, and to private-label (ah, what a squandered opportunity the servicing consent orders were...).  

Now this won't help with unemployment, but deleveraging consumers is the key to increasing consumer credit and increasing consumer spending, which is the key to increasing job growth. It's all connected.  It probably won't kick in until 2013-2014 (Maybe just in time for it to be known as the Bachman or Romney or Perry recovery?  If so, the GOP can thank the bank regulators), but it's the right thing to do. 

Are Corporations People Too?

The "corporations are people, my friend" line was quite the momement. But as bad as it sounded, Mitt had a theoretical point. People (as well as other corporations) own corporations and people work for corporations.  The problem isn't that there aren't people at the end of the line behind corporations. The problem is that it's a minority of (primarily wealthier)people.  

According to the Federal Reserve's 2007 Survey of Consumer Finances, only 17.9% of families held stocks, 11.4% hold mutual funds, and 52.6% hold retirement accounts that likely hold a lot of stocks and mutual fund assets.   

I haven't been able to find data on the percentage of people employed by corporations, but it's assuredly large. That said, it's hard to imagine that corporate tax breaks would generally result in higher salaries for most employees rather than higher dividends for shareholders. The competition to attract capital is likely fiercer than the competition to attract labor (and certainly for semi-skilled or unskilled labor), which would mean that corporate tax breaks would benefit shareholders (a minority of people) and highly skilled labor (again a minority that probably doesn't need a lot of help).  So maybe a more accurate phrase for Mitt is "corporations are wealthy people, my friend". 

The Systemic Risk Industry

There seems to be a cottage industry now in proposals to solve and/or mitigate systemic risk. I'm myself somewhat of a guilty party. The producers here are law profs and economists (and probably some other disciplines as well). These proposals fall into three buckets. One focuses on executive compensation as the key area for reform, a second on activity and/or size limitations, and the third on changing banks' capital structures. Strangely there seems to be little integration of these three approaches, although they would seem to be complements, rather than alternatives. But we scholars tend to see every problem as a nail for our particular hammer. 

It'll be interesting to see if this industry has a half-life longer than a couple of years; I suspect not, as many of the producers in the industry are not particularly interested in financial institutions per se and are likely to migrate to the next hot application of their tool box. Among existing proposals, the most intellectual activity has focused on capital structures as key. We've seen myraid co-co bond proposals, living wills, holding company structures, alternative capital risk-weighting, leverage limits, liquidity requirements, expanded shareholder liability, and all sorts of other variations on contingent capital. (I'm pointedly not linking any of these because my point isn't to pick on any single proposal, but to note a phenomenon.)  Some of these ideas are quite creative; some reinvent the wheel (it's astonishing how many proposals are blissfully unaware that similar devices have been tried and rejected by the market in US banking history).  Some are realistic that they can at best mitigate risk; others seem to truly believe that they will make the world safe for banking and eliminate risk.  

I'm rather conflicted regarding how to view this industry. On the one hand, I'm thrilled to see this level of scholarly attention to financial regulatory issues. Would that had been the case pre-crisis. On the other hand, I get the eerie sense from reading some of these proposals that I'm witnessing a redux of structured finance, in which a lot of excellent brain power was spent on trying to develop capital structures that eliminated risk, only to find out that it had been shifted and concentrated, rather than removed. (This might be because of the prominence of co-co bond proposals, which, like securitization, are automated bankruptcy systems.) 

I've argued elsewhere that at best we can reduce risk--akin to building higher levees or flood walls--but that doing so has its own costs.  The key point is that we cannot eliminate it from the system and need to learn to live with it and allocate losses more efficiently, fairly, and transparently ex-post.  Even this, I'm not sure will hold up. Credit Slips' Own Anna Gelpern has wisely pointed out that rules are inevitably tossed overboard during financial crises as soon as they become inconvenient. I have to think that this would apply both to capital structure rules (would co-cos really convert if it affected other financial institutions' holdings?) and to ex-post loss allocation rules (again, co-cos being in effect an automated loss allocation). I hate to take such a nihilistic position, but I think we risk deluding ourselves if we think we can seriously contain, much less eliminate risk by solely by adopting new capital structures.

Bankruptcy Politics and State Bankruptcy

I have a new paper out, Bankrupt Politics and the Politics of Bankruptcy, that examines state bankruptcy proposals and then uses them as a jumping-off point for sketching out a political theory of bankruptcy as a "creditor's armistice," an unstable political bargain, rather than an economic bargain ala Jackson & Baird's "creditor's bargain."  

The paper argues that bankruptcy is unlikely to do much good for the states because states' fiscal woes are akin to business model problems, rather than simple overleverage, and bankruptcy cannot fix business models.  States' business model--US fiscal federalism--is an inherently procyclical business model that is exacerbated by a moral hazard problem in state politics. Bankruptcy can no more fix this bad business model than it can make a buggy whip manufacturer (or a brick-and-mortar bookstore or video store) a viable operation.  

The intensely and patently political nature of the issues raised by state bankruptcy show a major set of deficiencies in contractarian theories of bankruptcy law, which have been developed primarily in the business bankruptcy context.  While others (such as our former co-blogger Elizabeth Warren) have criticized the creditors' bargain for failing to account for all of the stakeholders in bankruptcies, I argue that the inclusion or exclusion of various interests in bankruptcy is itself an essential part of a dynamic system of competing rent-seeking interests.

I don't attempt a formal exposition of an alternative political theory of bankruptcy in this paper--that's for another day--instead, I use this paper to lay out the idea and start linking the sovereign debt, subnational debt, business debt, and consumer debt literatures into a "unified theory" (yeah, I'm going to aim big, why not?) of debt restructuring (as in bankruptcy with a small "b").  The abstract is below the break:

Credit Card Securitization and Skin-in-the-Game

I have a new paper on credit card securitization and what it teaches us about the likely effectiveness of the Dodd-Frank Act's skin-in-the-game risk retention requirements. Credit card securitization has long required 4%-7% credit risk retention (cf. 5% under Dodd-Frank).  

I argue that when combined with other features of credit card securitization it was actually counterproductive at aligning issuer/securitizer and investor incentives and likely contributed to rate-jacking. Instead, credit card securitization didn't go off the rails like mortgage securitization because of the existence of implied recourse, effectively 100% skin-in-the-game. This suggests that skin-in-the-game cannot be relied upon as a one-size-fits-all cure. Its effectiveness will instead depend on the other securitization features with which it is combined.  

If you're interested in going into the sausauge factory of credit card securitization, there's plenty of gore and detail here for you. If you're interested in the connections between credit card securitization and rate-jacking, there's something here for you. And if you're interested in whether Dodd-Frank's risk retention requirements will be effective, there's something here for you too.  

The (overly long) abstract is below the break: