Student Loan Servicing Fail (continued)

The U.S. Education Department is doing a lousy job of overseeing the private companies servicing $1.1 TRILLION of federal student loans. That is the gist of the Inspector General's findings in a new report. Among other problems, the IG found that servicers were not telling borrowers about available repayment options, and were miscalculating income-based repayment amounts. When USED found these problems, they did not use contractual remedies to force servicers to improve their performance. To quote the report: "by not holding servicers accountable, [USED] could give its servicers the impression that it is not concerned with servicer noncompliance with Federal loan servicing requirements, including protecting borrowers' rights."

Meanwhile, borrowers with 49,669 loans have applied for Public Service Loan Forgiveness as of 9/30/2018. 206 borrowers with 423 loans have been approved. So, 99% denial rate.

More Data, Please!

Effective reform requires detailed knowledge of exactly what's being reformed. This is especially true of complex systems like corporate and individual insolvency regimes, with numerous inputs and outputs and carefully counterbalanced policy objectives. Two recent papers accentuate an acute weakness in global insolvency reform development--a lack of reliable and comprehensive data on the operation of existing systems, which will of course infect future planned procedures, as well. The global insolvency team at the IMF notes this problem in the context of its current advisory operations, and Adam Feibelman anticipates this problem with respect to India's developing insolvency and bankruptcy law. Both suggest a solution in more careful attention to data production and tracking. Both papers are interesting reading for those concerned with a more responsible approach to global insolvency policy-making, where for far too long it seems the old joke about empirical analysis has rung true: anecdote is not the singular of data.

New (From the Archives) Paper on Determinants of Personal Bankruptcy

This working paper is a longitudinal empirical study of lower-income homeowners, including a subset of bankruptcy filers, produced with an interdisciplinary team of cross-campus colleagues, including Professor Roberto Quercia, director of UNC's Center for Community Capital. We just posted this version on SSRN for the first time yesterday in light of continued interest in its questions and findings. The abstract does not give too much detail (see the paper for that), but here it is:

Personal Bankruptcy Decisions Before and After Bankruptcy Reform

Abstract

We examine the personal bankruptcy decisions of lower-income homeowners before and after the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Econometric studies suggest that personal bankruptcy is explained by financial gain rather than adverse events, but data constraints have hindered tests of the adverse events hypothesis. Using household level panel data and controlling for the financial benefit of filing, we find that stressors related to cash flow, unexpected expenses, unemployment, health insurance coverage, medical bills, and mortgage delinquencies predict bankruptcy filings a year later. At the federal level, the 2005 Bankruptcy Reform explains a decrease in filings over time in counties that experienced lower filing rates.

New Paper: Consumer Protection After the Global Financial Crisis

Historian Ed Balleisen and I have just posted a paper of interest to Credit Slips readers who are interested in consumer protection, financial crises, and inputs into post-crisis policymaking more generally. I will let the abstract speak for itself:

Consumer Protection After the Global Financial Crisis

Edward J. Balleisen & Melissa B. Jacoby

Abstract

Like other major events, the Global Financial Crisis generated a large and diffuse body of academic analysis. As part of a broader call for operationalizing the study of crises as policy shocks and resulting responses, which inevitably derail from elegant theories, we examine how regulatory protagonists approached consumer protection after the GFC, guided by six elements that should be considered in any policy shock context. After reviewing the introduction and philosophy of the Bureau of Consumer Financial Protection, created as part of the Dodd-Frank Act of 2010, we consider four examples of how consumer protection unfolded in the crises’ aftermath that have received less attention. Our case studies investigate a common set of queries. We sought to identify the parties who cared sufficiently about a given issue to engage with it and try to shape policy, as well as the evolving nature of the relevant policy agenda. We also looked for key changes in policy, which could be reflected in various forms—whether establishing an entirely new regulatory agency, formulating novel enforcement strategies, or deflecting policy reforms.

The first of our case studies focuses on operations of the Federal Trade Commission in the GFC’s aftermath. Although the Dodd-Frank Act shifted some obligations toward the CFPB, we find that the FTC continued to worry about and seek to address fraud against consumers. But it tended to focus on shady practices that arose in response to the GFC rather than those that facilitated it. Our second case study examines the Congressional adoption of a carveout from CFPB authority for auto dealers, which resulted from strong lobbying by car companies worried about a cratering sales environment, and the aftermath of the policy. Here, we observe that this carveout allowed a significant amount of troubling auto lending activity to continue and expand, with potentially systemic consequences. Loan servicer misbehavior, particularly in the form of robosigning, is the focus of our third case study. Although Dodd-Frank did not explicitly address robosigning, the new agency it created, the CFPB, was able to draw on its broad authority to address this newly arising problem. And, because the CFPB had authority over student loan servicers, the agency could pivot relatively quickly from the mortgage context to the student loan context. Our fourth and final case study is the rise and fall of Operation Choke Point, an understandably controversial interagency program, convened by the U.S. Department of Justice, which, with the GFC fresh in mind, attempted to curtail fraudulent activities by cutting off access to online payment mechanisms. Here, we see an anti-fraud effort that was particularly vulnerable to a change in presidential administration and political climate because its designers had invested little effort in building public awareness and support for the program.

The Article concludes with an overall assessment and suggestions for other focal points for which our approach would be useful. The examples span a range of other domestic and global policy contexts.

 

 

 

Liked Evicted? -- Read Maid

Stephanie Land recently tweeted this depressing statistic: "a single parent would have to work 140 hours a week at minimum wage to pay for basic necessities." And Land would know. Her new memoir -- Maid: Hard Work, Low Pay, and a Mother's Will to Survive -- chronicles her time as a single mother working as a house cleaner and just scraping by on the combination of her paycheck and various forms of government assistance. In telling her story of ending up a single mother living in a homeless shelter with effectively no family or friends to turn to for help, of figuring out how to make a little money working insanely hard, and of dealing with the stigma of asking for government "handouts," Land weaves a narrative about life on the financial precipice that sticks with you. And embedded in her story are glimpses into the lives of her clients, through which Land creates portraits of the trials of (usually) better off families who nonetheless struggle in different ways.

In short, read her memoir. It's fantastic. And if you're not totally convinced that you must read it right now, there's more after the jump.

Republic and PDVSA Bonds: No Trades With Friends and Family

Mark Weidemaier and Mitu Gulati

A few days ago, we wondered why the U.S. government had constrained U.S. holders of PDVSA debt instruments to sell only to non-U.S. parties. The constraint would likely kill liquidity for these bonds and impose losses on bondholders. But why? And why impose the constraint on PDVSA bonds but not the Republic’s bonds?

On Friday, the Treasury apparently amended the sanctions order to impose the same constraint on the Republic’s bonds. Now these too can only be sold to non-U.S. persons.

But again, why?  Venezuela hasn’t issued new bonds for a while, so why kill the secondary market for existing bonds? 

Here are four possible explanations; we’d be grateful to hear others from readers:

1.    Cut Off Oxygen: Venezuela has made a habit of issuing bonds and then parking them in domestic financial institutions, for later sale when the government is low on cash. Counterparties have been willing to accept these bonds in the hope that a future government will pay, even if the current one won’t. Perhaps the U.S. government believes Venezuela still has a stockpile of these parked bonds and is trying to eliminate this last source of oxygen for the Maduro government.

2.    What’s Coming is Brutal: Perhaps the U.S. government expects a brutal restructuring and wants to give U.S. holders an opportunity to escape by selling to non-U.S. parties. But query: If this is the story, why would anyone want to buy? (Ans: They wouldn’t, thereby reducing liquidity even further).

3.    Don’t Want Irate Bondholders Calling and Yelling at US Treasury Officials: This explanation is a version of the first one (Oxygen denial) and says that the U.S. wants to dramatically reduce the value of Venezuelan bonds in the short run, but not to zero, so that U.S. holders who really need to exit will still have a small escape window.

4.    Cut Venezuela Out of the Index: Nearly two years ago, Harvard economist Ricardo Hausmann urged JP Morgan to remove Venezuelan bonds from its index (see here, for Hausmann’s now-famous “Hunger Bonds” article). Venezuela needed to solve a humanitarian crisis, not pay coupons to foreign bondholders. Hausmann understood that many investors would view Venezuelan bonds less favorably if the bonds were removed from JP Morgan’s index. Indirectly, the U.S. government might be trying to bring about this result. To stay in the index, a bond must be traded to some minimal degree. If the sanctions prevent this, Venezuelan bonds may be removed from index. But why would this matter to the U.S. government? Hausmann was worried about coupon payments being made to foreign creditors in lieu of assistance to the people of Venezuela. But Venezuela is not paying any coupons these days (except on the one collateralized PDVSA bond).

Explanations one and three seem most plausible to us. Perhaps the U.S. government is hoping for regime change in the near future. If so, the pain bondholders feel will be temporary and offset by gains once a reasonable government is in place. But if Maduro retains power, then the pain for U.S. holders of these instruments will be significant.

Euro Area Sovereign Bonds: CACs or no-CACs?

Mitu Gulati and Mark Weidemaier

Beginning January 1, 2013, Euro Area authorities required member countries to include “collective action clauses,” or “CACs,” in sovereign bonds with a maturity over one year. CACs are a voting mechanism by which a bondholder supermajority (e.g., 66.67% or 75%) can restructure bond terms in a vote that binds dissenters. Before 2013, the vast majority of sovereign bonds issued by Euro area countries not only lacked CACs; they essentially said nothing about restructuring. For much more on CACs, European and otherwise, see here, here and here.

Because of this policy change in 2013, almost every Euro Area sovereign has two sets of bonds outstanding: CAC bonds and no-CAC bonds. Is either type of bond safer for investors to hold in the event of a restructuring?

The Woes of PDVSA Debt Holders

Mark Weidemaier & Mitu Gulati

Many things about the current situation in Venezuela bewilder us. Among them are parts of the new sanctions.  The one that especially puzzles us is the part that says that transfers of PDVSA debt claims by US persons are only permitted to non-U.S. persons.

What could possibly be the logic here?  To attempt to see that, our first question was: What is the likely effect of such a constraint. Answer: To kill the liquidity of the bonds and promissory notes and any other debt instruments, since US investors are likely 50% or more of this market.  And that in turn means that the price of these PDVSA instruments is going to drop precipitously.

But why hurt the market for PDVSA debt instruments so viciously?  Maybe the UST knows that there are large chunks of these instruments held by Maduro cronies who have been issuing these instruments to themselves (without paying fully for them) so that they have a nest egg in the event of a change in government.  But does that help get rid of Maduro and his cronies faster?  Not clear.  But maybe there is a story here. We'd love to know more.

Alternatively, and this is a bleaker story for the PDVSA holders, maybe the Trump administration knows that a future restructuring of Venezuelan debt under the new government is going to have to be particularly brutal.  And maybe they want to make sure that US holders have largely sold off their holdings to non US entities?  Maybe.  But if this is the case, then why are similar sale restrictions not being imposed on the bonds of the Republic?

Or maybe this bit of the new sanctions is just an error.  Maybe.

On the Attachability of Blocked Venezuelan Assets

Mark Weidemaier and Mitu Gulati

We gather that there is still activity in the U.S. government to think through the implications of the recent expansion of sanctions against Venezuela. Here’s the original version of the most relevant Executive Order. In brief, it provides: “All property and interests in property that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person of the following persons are blocked and may not be transferred, paid, exported, withdrawn, or otherwise dealt in…” The new sanctions add PDVSA to the blocked list.

One question is whether this stops the Crystallex attachment proceeding in its tracks. After all, shares in PDV-H are an interest in property owned by PDVSA, and an execution sale is nothing if not a transfer of assets. To spin this out even further, what about the shares in CITGO-H, which were pledged as security for the PDVSA 2020 bonds? If the sanctions extend to property owned by entities controlled by PDVSA, then the sanctions would also seem to block holders of the PDVSA 2020s from foreclosing (without first getting a special license). These complexities will require clarification; perhaps Treasury will provide it soon.

More broadly, let’s assume that the effect of the sanctions is to divert a significant pool of assets into some blocked accounts in the U.S. As we said in our prior post, we are skeptical that there is a big pool of assets, but we might be wrong. Let’s further assume that the U.S. administration eventually declares that Juan Guaidó and associates, as the officially-recognized leaders of Venezuela, have access to the funds. Are the funds now attachable by Venezuela’s creditors (like Crystallex)? At least as a formal matter, the answer would seem to be “yes.” The assets would no longer be blocked, and would also seem to belong to the government. Creditors with claims against the government would be entitled to assert claims (subject to the law of foreign sovereign immunity). Yet this can’t be the intended result—or so we hope. It would effectively divert government assets to a handful of creditors, enabling them to achieve disproportionate recoveries (compared to other creditors) at the expense of the Venezuelan people. We hope the administration will make clear this is not the intent.

What is the U.S. Government’s Strategy in Venezuela?

Mark Weidemaier and Mitu Gulati

Even by the eccentric standards of its ongoing debt crisis, weird things are afoot in Venezuela. Opposition leader Juan Guaidó has declared himself president and been recognized by the U.S. and other governments. That’s not especially weird. What’s odd is that the political convulsions in Venezuela are manifesting in part as a battle over control of the CITGO board. Guaidó has said he plans to appoint a new board. Rumors are circulating that this is part of a plan, assisted by the U.S. government, not just to cut off the flow of oil revenues to the Maduro regime but to redirect that flow towards opposition coffers. As the Wall Street Journal previously reported: “U.S. officials say they want to divert oil money--as well as control over other assets like gold reserves--away from Mr. Maduro to the new interim president without stopping crude exports from the country.” That’s also consistent with a recent statement recently put out by the U.S. Treasury. 

Since these reports, the U.S. administration announced new sanctions, which don’t direct funds to opposition coffers but which do appear intended to prevent CITGO from remitting oil-related payments to Venezuela. Instead, the funds must be held in blocked accounts in the U.S. Here’s Bloomberg on the sanctions, and the Wall Street Journal, and Reuters, and the New York Times.        

What’s going on here?

The Commonwealth and the GOs, part 2

In my last post, I noted that the joint committee-Board objection to the 2012 and 2014 Puerto Rico GOs was at least plausible, and thus is likely headed for more extensive litigation. As Mark and Mitu have also noted, it also matters a good deal that the objectors also have arguments for why the claim on the bonds is not replaced by a similar claim for unjust enrichment or the like (although we might wonder if such a claim would enjoy the special constitutional priority the GOs do, if we think that priority really matters in a sovereign/muni bankruptcy process).

This past weekend, the FT's John Dizard quoted a hedge fund type as saying that the objectors' argument about the Building Authority's leases (see my prior post) was "nonsense." Not a lot of deep analysis there, but it does confirm there is a fight ahead. And we can assume that the Commonwealth's words will be used against it – after all, at the time of issuance, Puerto Rico and its agents undoubtedly said lots about how assuredly valid these bonds were.

The obvious conclusion is that the objectors have made this move as an opening shot in a broader play to negotiate a haircut with the GOs. After all, they look like they are almost done dealing with the COFINA debt, the other big chunk outstanding.

Sure. But what I find really interesting is the more subtle point that with this move, the objectors have also opened up some space between the GOs as a class. That is, presumably the non-challenged GOs will not have to take as severe of a haircut if $6 billion has already been knocked off the GO total. If I'm a holder of 2011 GOs (which I'm not, btw), I might then start to think that I don't really mind if the objectors win. And thus intra-GO warfare might break out.

Some asset managers are also going to face challenges if they have 2011 GOs in one fund, and 2014 GOs in another. And then there is Assured Guaranty Municipal Corp., which insured both the 2011 and 2012 (but not the 2014) ... 

Mozambique’s Guarantees on the Tuna Bonds: Can They be Repudiated?

Mark Weidemaier & Mitu Gulati

There have recently been headline articles in the press about three loans made to state-owned security companies in Mozambique (see here, here and here) and guaranteed by the government. The reason for the attention to these loans – made originally between 2013 and 2014 by Credit Suisse and the Russian bank VTB – is that US federal prosecutors are pursuing charges against a number of bankers from Credit Suisse and government officials from the Mozambique finance ministry. (Somehow the VTB folks seem to have escaped so far.) To simplify, these individuals were allegedly involved in siphoning off funds ostensibly intended to support Mozambique’s fishing industry and enhanced security in its territorial waters. Concretely, the loan was supposed to be used for new boats: some to catch fish (hence the moniker “tuna bonds”) and others to bolster the coast guard (“maritime surveillance”).

Instead, much of the money seems to have disappeared. The loans went into default; few tuna were caught. For contemporaneous reporting, see here, here, and here.

We have been thinking about debt repudiation of late. And Tracy Alloway of Bloomberg (and formerly of FT Alphaville) specifically got us thinking about the Mozambique tuna bonds on a recent podcast for Bloomberg’s Odd Lots (Tracy is a spectacular host).  Prompted in part by Tracy, we wondered--now that the corruption on the part of the agents for the banks and agents within the Mozambique finance ministry has been revealed—whether the government can repudiate the loans on the grounds that they were infused with illegality.

One of the three loans is worth treating separately from the others. This loan was made specifically for tuna boats. It involved an $850m bond for a company called Ematum—allegedly a sham—which has since been converted from a state-guaranteed bond to a sovereign Eurobond. For the other two loans, the repudiation question—since the borrower companies seem to have no assets—is whether the state can withdraw its guarantee on account of the corruption. There is a good argument that the answer is “yes.” Contract law in many key legal jurisdictions makes contracts infected by corruption and bribery voidable.

Some years ago, one of us analyzed this question in an article with Lee Buchheit, where we analyzed the question of “corrupt debts” (here – at pp 1234-39). We quoted this illustrative language from a 1960 New York Court of Appeals case: “Consistent with public morality and settled public policy, we hold that a party will be denied recovery even on a contract valid on its face, if it appears that he has resorted to gravely immoral and illegal conduct in accomplishing its performance.” Jeff King, in his new book on Odious Debts (here – at pp 119-23), has a section on sovereign obligations infected by corruption and makes much the same point under English and a number of other laws. And Jason Yackee tackles the corruption defense for sovereigns in the BIT context here. Bottom line: There is a pretty good defense here.

Puerto Rico’s Audacious Move: Can it Cut its Debt by $6 bn?

Mitu Gulati & Mark Weidemaier

Last week, the Government of Puerto Rico, acting through the Financial Oversight and Management Board (and in conjunction with the creditors’ committee), filed a claims objection seeking to invalidate roughly $6 billion of its General Obligation debt. The reason is that the government allegedly borrowed in violation of the Debt Service Limit and the Balanced Budget Clause of the Puerto Rican constitution. Stephen’s recent post on this subject discusses the merits of this argument in some detail. In this post, we are especially interested in the question of restitution. The Commonwealth doesn’t get much benefit from invalidating loans unless it also avoids the obligation to pay restitution (i.e., return the purchase price). So the objectors make the additional argument that bondholders have no equitable right to restitution under a theory of unjust enrichment.

There is some precedent for the objectors’ arguments in similar contexts, although not a lot of it. Some of the important cases, such as Litchfield v. Ballou (1885), are also very old. However, at least one law review article—a student note in the North Carolina Banking Institute journal (here)—squarely addresses Puerto Rico’s argument, ultimately concluding:

How can Puerto Rico’s penalty for illegally borrowing above its means be that it is allowed to declare the debts void and keep the money for itself? Despite the manifest unfairness of such a result, the applicable law indicates that this is likely the proper legal result.

The Commonwealth and the GOs, part 1

While there has been some press coverage of the recent attempts to annul some $6 billion of Puerto Rican general obligation bonds – essentially all such debt issued starting in 2012 onward – the move has not received much deep coverage. Yesterday I took some time to read the claims objection filed in the Commonwealth's article III case, and in this post I'm going to consider the arguments against the bonds' validity. In a further post, I will consider what is going on here from a strategic perspective.

The objection was jointly filed by the creditors' committee and the Financial Oversight and Management Board for Puerto Rico, but the Board only joined in one of the two main arguments that are put forth. (There is a third argument in the objection – about OID and unmatured interest under section 502 fo the Code – that I'm not going to talk about because its rather pedestrian by comparison).

In sum, the committee argues that GO bonds issued in 2012 and 2014 violated two provisions of Puerto Rico's constitution, and thus the bonds should be deemed void. The Board joins in the objection with regard to the first constitutional provision, but not the second. If successful, this objection would eliminate $6 billion of the $13 billion in GO bonds currently outstanding.

More details after the break.

Jay Alix, McKinsey Redux

A quick note on this ongoing issue, in which Jay Alix (the individual) claims that McKinsey has gained bankruptcy work and market share by flouting the requirements of the Code. Reports are out this morning that some judges have sent this matter to mediation. I don't get that.

The basic issue is that McKinsey, under the most charitable interpretation, was extremely aggressive in deciding what needed to be disclosed to the bankruptcy court. This is basically a legal or policy question as to how to interpret section 327 et al.  How is that a proper subject for mediation? Can the parties really agree on the scope of disclosure? 

I know mediation is all the rage these days in large chapter 11 cases, but there are some issues that simply need to be addressed by the court.