About the Student Loan Forgiveness Price Tag...

Senator Warren's student loan forgiveness proposal has a lot of scolds moaning about the immorality of debt forgiveness, the unfairness to those who paid their debts, and complaining about the price tag. It's pretty obvious that none of those folks know anything about how the federal student loan system works. If they did, they'd know the we crossed the debt forgiveness Rubicon long, long ago. There is already enormous debt forgiveness baked into the federal student loan program.

The only real difference between Senator Warren's proposal and the existing forgiveness feature in the student loan program is whether the forgiveness comes in a fell swoop or is dribbled out over time. Given the federal government's infinite time horizon, the difference is really just an accounting matter. It's not a matter of principle in any way, shape, or form.  

Student Loan Borrowing Is Different

Education finance and student loan forgiveness have been getting a lot of attention the last couple of days because of our former co-blogger's loan forgiveness proposal.  I'm not going to address the merits of that proposal here.  Instead, I want to make a simple point that many of the critics of Senator Warren's proposal don't seem to understand:  student loan borrowing is materially different from other types of borrowing, such that the borrower has no idea what s/he is getting into.

When I borrow to buy a car or a home, it is a one-and-done deal with a single loan product.  With the car or home, I also know what I’m getting and I know what it costs.  These aren’t perfect markets, but the work on a broad level.  Education finance does not.  That’s why criticisms of student debt relief plans that claim that borrowers know what they’re getting into or the sacredness of the contract just irk me.  Student borrowers have no clue what they’re getting into and if a party doesn’t really understand a deal, it’s hard to see why it should be treated as sacrosanct. (Not to mention, as any good bankruptcy lawyer knows, basically all deals are made subject to the possibility of a bankruptcy discharge.). There is a fundamental market failure in student lending and that is that borrowers simply don't materially understand the nature of the obligations they are assuming...and probably can't.  

The Second Circuit Got It Right in Madden v. Midland Funding

Professor Peter Conti-Brown of the Wharton School has written a short article for Brookings decrying the Second Circuit’s 2015 Madden v. Midland Funding decision. Professor Conti-Brown doesn’t like the Madden decision for two reasons. First, he thinks its wrong on the law. Specifically, he thinks it is contrary to the National Bank Act because it "significantly interferes" with a power of national banks—the power to discount (that is sell) loans. Second, he's worried about Madden from a policy standpoint both because he fears that it is unduly cutting of access to credit for low-income households and because he thinks it is reinforcing the large bank’s dominance in the financial system and impairing the rise of non-bank “fintechs”. I disagree with Professor Conti-Brown on the law and think that attacking Madden is entirely the wrong way to address the serious policy question of what sort of limitations there ought to be on the provision of consumer credit. As for fintechs, well, I just don't see any particular reason to favor them over banks, and certainly not at the expense of consumers.  

Plan Optionality: Extreme Edition (A Pick-Your-Own-Adventure Restructuring with Shopko)

I've seen some Chapter 11 plans that include some optionality, such as allowing the debtor, based on subsequent market conditions or litigation outcomes to undertake a transaction or change the way a class is paid.  Such optionality has always troubled me because I don't think a disclosure statement can provide "adequate information" in the face of debtor optionality--a hypothetical investor might understand that the debtor has options A or B, but the uncertainty about which option will be selected makes it hard to make an "informed judgment about the plan":  the investor might like option A, but dislike option B--without knowing the likelihood of A or B, how can the investor make such an informed decision?  To be sure, it is possible to get two disclosure statements approved, one for option A and one for option B, but then creditors would be able to vote separately on each plan, rather than voting on a plan that gives the debtor optionality.  

A disclosure statement I looked at today, however, takes such optionality to an extreme I've never previously seen.  Specifically, Shopko's proposed disclosure statement is for a plan that "contemplates a restructuring of the Debtors through either (a) a sponsor-led Equitization Restructuring or (b) an orderly liquidation under the Asset Sale Restructuring."  As explained:  

The Plan includes a "toggle" feature which will determine whether the Debtors complete the Equitization Restructuring or the Asset Sale Restructuring. The Plan thus provides the Debtors with the necessary latitude to negotiate the precise terms of their ultimate emergence from chapter 11.  

In other words, what is being disclosed is "we might liquidate or we might reorganize, our pick."  The plan has, of course, two separate distributional schemes, depending on which restructuring path is chosen.   I really don't get how such a single disclosure statement for a single plan with optionality can be approved given the huge difference between these two paths.  A creditor can't know what outcome it is voting on and might like one, but not the other.  Maybe others have seen this move before, but I suspect this will be a first for the Bankruptcy Court for the District of Nebraska.  

Consumer Bankruptcy Reform ... and American Xenophobia?

I hope I'm not stepping on Bob's toes in announcing the public release of the long-awaited report of the ABI Commission on Consumer Bankruptcy. The Commission, with Credit Slips' own inimitable Bob Lawless as its reporter, was formed in December 2016 to explore revisions to the US consumer bankruptcy system that would improve the operation of its existing structure; that is, evolution, not revolution. With this explicitly limited charge, one would not necessarily expect to find much high-level discussion of how the US approach squares with or fits within the many recent global developments in consumer insolvency relief, and one would expect to see a concentration on local solutions for local stumbling blocks.

That being said ... and in no way to detract from the monumental amount and truly impressive nature of the work the Commission has done here ... one might have expected to see a bit of discussion, if not even a touch of inspiration, from comparative sources. In 1970, the Bankruptcy Commission rejected any consideration of foreign developments in consumer bankruptcy, in part because there were few such developments, and in part because so little was known about the operation of non-US bankruptcy law at the time (for those younger than I, note that neither home computers nor the public Internet existed in 1970 ...). Nearly 50 years later, we now have at our fingertips a mountain of comparative data and analysis on the development, operation, and revision of consumer insolvency systems around the world, much of it reported in English specifically to make it widely available to law reformers like the ABI Commission. Again, one would not have expected this comparative material to occupy center stage in a reform of largely US problems in the uniquely US consumer bankruptcy system. But in a bit part here and there, some comparative observations might have supported the Commission's already compelling recommendations.

DebtCon3: A Curtain Raiser and a Love Story

DebtCon3, the Third Interdisciplinary Sovereign Debt Research and Management Conference, is starting in just a few hours at Georgetown Law. This year's DebtCon takes place in parallel with IMF and World Bank Spring Meetings. When we first launched the DebtCon project in the snowstorms of 2016, the idea was to have a giant party -- a sovereign debt Coachella -- channeling nerdy energy across different academic disciplines and institutional ecosystems, gathering everyone willing to obsess over public debt to help solve a handful of concrete problems. Mitu wanted to serve frozen pizza, but kind souls chipped in for dinner, and we had fish. The Argentina (!#@%*!) panel was snowed out. Nobody got the Sovereign Debt Research and Management joke ...but the temporary tattoos worked on key demographics, and we came back. In 2017,   Ugo Panizza and his colleagues at the Graduate Institute put on a fabulous DebtCon2 in Geneva, which set an impossibly (Swissly!) high bar for organization, and here we go again. At last count, the star-studded DebtCon3 program has some 120 speakers, plus over 200 registered guests from around the world -- a humongous number for what is often considered a narrow topic. So what is it about sovereign debt? ... and what is it about DebtCon?

P2P Payments Fraud

AARP has a nice piece (featuring yours truly) about the consumer fraud risks with peer-to-peer (p2p) payment systems like Zelle and Venmo.  

Both Zelle and Venmo expressly state in their terms of use that they are not for commercial use, yet there is certainly a healthy segment of their use that is commercial.  Some of it is sort of "relational" commercial--paying a music teacher or a barber--someone whom the payor knows, so there's a social mechanism for dealing with disputes and which protects against fraud.  But there is also some use for making commercial payments outside of a relational context--paying for goods purchased on the Internet--and that is very vulnerable to fraud.  

I wish p2p payments systems would do a bit more to highlight to consumers their prohibition on commercial use, including flagging the fraud risk, but I suspect that they have no interest in doing so--while the systems disclaim commercial use, they nonetheless benefit from it, and have little reason to discourage it.  

The Local Law Advantage in the Euro Area: How Much of a Constraint are the Existing CACs?

Collective Action Clauses for the Euro Area were mandated, starting in January 2013.  Yes, bizarrely, even though the introduction of Euro CACs was literally the single biggest innovation in sovereign bond contract terms in the history of this market, no one seems to have a clear idea of how these CACs (contractual restructuring mechanisms) are actually going to operate.  Specifically, if a Euro area country needs to restructure some day soon (e.g., Italy?), and it has a subset of bonds with these CACs (by next year, Italy will have something close to a super majority of its bonds with these Euro CACs), is it required to use the CACs to do the restructuring or can it use other mechanisms? That is, regardless of the presence of these CACs, can the sovereign still take advantage of the fact that almost all of its multi trillion dollar debt stock is governed by Italian local law to engineer the restructuring (the "local law advantage" in the words of sovereign debt guru Lee Buchheit - see here)?

Most people I know in the European sovereign debt world take the view that the CACs will have to be used if they are in the bonds (it is a different question altogether as to what can be done with the subset of bonds without CACs and also under local law).  And, indeed, that may be why there is currently a move to reform and improve the first-generation of Euro CACs (they appear, on their face, quite vulnerable to hold outs).  But do the Euro CACs have to be used to engineer the restructuring, if the bond that needs to be restructured has them?

As an aside, some of you may remember this question recently came up in the context of measuring redenomination risk in Euro area bonds, where because of the assumption that the bonds with CACs were protected against unilateral redenomination of the currency on the bonds by the sovereign, some were trying to use the CAC bond versus No CAC bond yield differential as a measure of redenomination risk.  (See here and here, for articles from the FT along; there are many  more) [This is not at all a crazy position, since the CAC bonds require a supermajority approval of creditors (roughly) for a change to the currency of the bond; and this is indeed the view that the market appears to have taken -- see the link/graph above from the FT - but has Mark Weidemaier demonstrated that the market was wrong in a big way?  If so, that's a big deal]

To cut to the chase, our fellow slipster, Mark Weidemaier, has a superb new paper, "Restructuring Italian (or Other Euro Area) Debt: Do Euro CACs Constrain or Expand the Options?", that suggests the foregoing thinking is misguided. Best I know, Mark's paper is the first one to address this central question about Euro CACs under local law head on (although I'm optimistic that some of our students will have good papers exploring this very question in greater depth soon).  My prediction is that there are many who will disagree strongly with Mark; particularly those who see the Euro CACs as representing some sort of holy European treaty promise.  But Mark makes a powerful argument that that view is more smoke than fire.  Euro CACs, according to him, are nothing but an option for the sovereign.  That's it, he tells us; they are nothing more. The sovereign can choose not to use this option and take an alternative (easier) route to doing its restructuring.

Nonpartisan Supreme Court Expansion

My latest argument for a substantial nonpartisan expansion (i.e., not a partisan "packing") of the Supreme Court, which would require the Court to sit in randomly assigned panels, is up on Bloomberg Law.   Among other benefits, it would enable the court to hear more cases, so the bankruptcy world might finally rid itself of some of the lingering circuit splits (e.g., equitable mootness or actual vs. hypothetical test for assumption). 

Student Loan Fixes

While presidential candidates propose sweeping new policy initiatives, a few simple legislative fixes could go a long way to alleviate the student loan crisis. Three numbers set by Congress have a huge impact on the burden borne by millions of borrowers: the Stafford loan interest rate, the income-driven repayment plan income share, and the number of years to balance forgiveness. These three numbers (currently 5%/6.6%, 10%/15% and 20/25 years, respectively) essentially allocate the burden of funding postsecondary education between students and taxpayers. The interest rate, for example, has produced a net profit for the Treasury for many years, meaning that former students pay more than the cost of loan administration and loss recoveries, essentially paying a surtax. Some income-driven repayment plans require borrowers to pay 10% of disposable income, while others call for 15%, and of course several numbers go into defining disposable income. Finally, income-driven repayment plans call for debt balance cancellation at the end of 20 or 25 years. Reducing the interest rate, the income percentage and the repayment period are all means to shift the funding of an educated workforce from graduates (and noncompleters) to the broader taxpaying public. Student loan costs can be reduced incrementally; the choices are not limited to the status quo or free college for all.

While some Democrats propose to "refinance" student loans, Congress can reduce interest rates on existing loans at any time, saving borrowers and federal contractors lots of transaction costs. Loan defaults could be virtually eliminated by making income-driven repayment the default, automatically enrolling borrowers, and authorizing IRS income reporting. In lieu of creating new national service programs, the existing public service loan forgiveness program could be fixed to allow enrollment on graduation and automatic employer certification and payment progress reporting. The current 10-year PSLF repayment period could also be shortened. Finally, the Pell grant amount could be set to cover the full cost of attendance for low-income students at public 2-year or 4-year colleges in each state.

A New Proposal for Restructuring Venezuelan Debt

The Venezuelan debt crisis has dragged on for so very long now that there are literally dozens of proposals out in the public domain (aka ssrn.com) on how Venezuela should do its restructuring.  Given how quickly the situation on the ground is changing, the plausibility of these various proposals also has been moving with great speed. 

A new and interesting one just showed up today from Daniel Osorio of Andean Capital (available here).  Daniel is someone who knows the Venezuelan situation inside out and has a lot of experience distressed debt workouts.  I don't think we agree on the optimal way to peel this onion, but Daniel is super smart and I always take his views seriously.  His proposal, as I understand it, is to do an debt exchange where investors are given what he calls Patient Capital Bonds. Basically, investors are being asked to be patient and cooperate with the Venezuelan government by giving them a lot more time to repay them (much more than say the proposals for a Venezuelan reprofiling (which would just buy the time for the IMF to do an estimate of the economic situation) have been asking for). The benefit to investors, that Daniel is positing will attract them to his proposals, is that there is a big potential upside if Venezuela is able to get economically healthy.

A couple of questions though.  First, is Daniel being unduly optimistic in assuming that the holdout problem can be easily solved?  (after all the amount of litigation on the defaulted debt is increasing on a daily basis and specialist holdout firms are the opposite of "patient" capital). Second, can Venezuela get back to health in a reasonable amount of time without imposing significant cuts on the principal obligations on its debt stock? (maybe, if the stretch out of payments is long enough, but that then brings its own problems in terms of getting investors to be that patient).

I do agree with Daniel though that stretching out payments will ultimately have to be part of the equation and that whatever mechanism that is used will need to ensure that the majority of creditors come in voluntarily (that is, the non holdouts). I also agree with him that the post-Saddam restructuring of Iraqi debt has lessons to teach us.

Here is the abstract of Daniel's nice and short paper (six pages):

Regime change in Venezuela is imminent. The transition may take longer than what most Venezuelans would like, but when it occurs it will be faster than most expected. The challenges of the reconstruction of Venezuela and its economy will be more similar to those faced by a country after a vicious war or a violent natural disaster than the aftermath of an economic and/or political crisis. First and foremost, this reconstruction must start by addressing Venezuela’s urgent humanitarian needs. This initial phase of the normalization of Venezuela must be done in a collaborative fashion between the private and public sector as well as Venezuelans and the international community. However, this spirit of collaboration must not end there, but continue in order to meet the economic challenges that Venezuela will face.

He also talked about this on the telly, on Bloomberg News. 

Senate Banking Committee Testimony on Housing Finance

I'll be testifying on Tuesday at a Senate Banking Committee hearing on housing finance that is focused on Chairman Crapo's reform outline.  My written testimony may be found here.  Suffice it to say, I'm skeptical.  I argue that a multi-guarantor system is a path to disaster and that the right approach is a single-guarantor system with back-end credit-risk transfers.  Oh wait, we already have that system in all but name.  The system has been totally reformed since 2008.  So why are we looking to do anything major with housing finance reform?  Hmmm.