Oops. How the FDIC Guaranteed the Deposits of SVB Financial Group

When President Biden announced the rescue of Silicon Valley Bank depositors, he emphasized that "investors in the banks will not be protected.  They knowingly took a risk and when the risk didn’t pay off, investors lose their money.  That’s how capitalism works." Unfortunately, that's not how US law works. 

There seems to be a gap in the Federal Deposit Insurance Act that is going to protect some investors in Silicon Valley Bank’s holding company, SVB Financial Group. The holdco’s equity in the bank will be wiped out in the FDIC receivership, but the FDIC doesn’t have any automatic claim on the holdco. This is basic structural priority/limited liability:  creditors of a subsidiary have no claim on the assets of a parent.

What's worse is that the holdco, which filed for bankruptcy today, has substantial assets including around $2 billion on deposit with SVB. Almost all of that $2 billion deposit at SVB would have been uninsured, but by guarantying all the deposits, FDIC accidentally ensured that the holdco’s bondholders would be able to recover that from that full $2 billion deposit.

There any provision in the Federal Deposit Insurance Act that subordinates the claims of insiders—like corporate affiliates or executives—that exceed the insured deposit limit to other creditors. So once FDIC guaranteed all deposits, it necessarily guaranteed the deposits of the holdco and other insiders. 

Who Knew Silicon Valley Was in Manhattan?

Silicon Valley Bank's holding company, SVB Financial Group, filed for Chapter 11 bankruptcy this morning...in the Southern District of New York. Who knew that Park Avenue South was in the heart of Silicon Valley?

Seriously, the venue here looks problematic. SVB Financial Group's petition lists its principal place of business as 387 Park Avenue South, Manhattan. There's a SVB location there with about 20,000 square foot of space. That's sure doesn't seem like a corporate headquarters for the 16th largest bank holding company in the US. Instead, it seems to be more of a bank branch. But the petition does bear the signatures, under penalty of perjury, of SVB Financial Group's CRO and, not so clearly under penalty of perjury, of SVB Financial Group's attorney at Sullivan & Cromwell. 

Curiously, SVB Financial Group has been telling federal bank regulators a different story about where it's located. On its Bank Holding Company Report, Systemic Risk Report, Consolidated Financial Statement, and Parent Company Only Financial Statement for Large Bank Holding Companies—documents filed with the Federal Reserve Board—SVB Financial Group said its address is 3003 Tasman Drive, Santa Clara, California. Hmmm.

What's Going on with First Republic Bank?

Following the failure of Silicon Valley Bank, a lot of other regionals have experienced depositor runs and serious pressure on their stock prices. But there's actually a lot of variation among regionals, and the solutions to SVB's problems don't necessarily fit the other regionals' problems, as the case of First Republic Bank shows.

Was SVB's problem a lack of membership?

If the bank is a Fed member, doesn't it take its USTs to the discount window instead of selling them for big losses? Does this suggest that all large banks (however defined) should be Fed members, regardless of their charter status?

Why Weren't Silicon Valley Bank Depositors Using CDARS?

Silicon Valley Bank seems to have had large amounts of uninsured deposits from businesses and high net worth individuals. And those uninsured deposits are likely to be impaired in the receivership, meaning that they will not get paid 100 cents on the dollar whenever they do get paid.

But here's the thing:  there are turnkey products that enable depositors to insure much, much larger amounts than the FDIC-insurance cap of $250k/depositor/account type. For years and years there's been deposit brokerage services that spread out deposits at multiple banks, all in amounts under the FDIC insured cap. The best known service is called CDARS-Certificat of Deposit Account Registry Service. It's offered by IntraFi (formerly Promontory). I don't know if SVB participated in CDARS, but it's a pretty straightforward solution to the deposit insurance cap.

What Could Go Wrong When a DIP Maintains a Large, Uninsured Deposit Account at Silicon Valley Bank?

You gotta feel for BlockFi customers. First, they find themselves creditors in BlockFi's bankruptcy. And now they've found out that BlockFi had a large, uninsured deposit...at Silicon Valley Bank. Yup, it seems that BlockFi had $227 million in a money market deposit account at SVB. (The UST refers to it as a "money market mutual fund," but that cannot be right, or it wouldn't be at SVB or have any insurance. [See "Another update" below regarding possibility that it was a money market mutual fund sweep account, in which case the money would in fact be protected.]) That would mean there's a $226.75 million uninsured deposit. Given what we know about SVB, part of that $226.75 million in uninsured funds is likely lost if it's still at SVB.  

The US Trustee filed a motion today to force BlockFi to put the funds in insured accounts, but it sure looks as if the cow's out of the barn already. If the money's lost, then the question is who's going to pay for this screw up, and it's especially juicy because it's all tied up with venue competition. 

Wither Student Debt Cancellation? Conservative Justices Showed Determination but a Lack of Conviction

[by Dalié Jiménez and Jonathan Glater]

Yesterday, the Supreme Court heard two cases challenging the constitutionality of the Biden administration’s plan for student debt cancellation. Suing to block the plan are a group of states that argue they will lose revenue if student debt is canceled and two borrowers who claim they should have access to more cancellation than they would receive but are asking the Court to prevent the cancellation plan altogether. 

The cases present two fundamental questions. First, the justices must determine whether the plaintiffs have “standing” to sue: have they established that they will suffer a concrete and particularized injury that is caused by the cancellation plan and which can be redressed by preventing cancellation. Second–and only if the answer to the first question is yes–the justices must assess whether the administration has the statutory authority to cancel student debt.  Listening to the arguments, one message was clear: the conservative justices want to reach the merits of the case but understand the difficulties the Court's standing jurisprudence (primarily a feature of conservative justices) poses.

At stake is a signature initiative by the administration, which means that for conservatives on the Court, the cases offer a chance to deal a partisan setback to the president.  And in the long battle waged by conservative justices to weaken executive agencies, these cases also provide a chance to undermine federal agencies more generally.  These justices clearly recognize the opportunity to achieve multiple goals here.

The oral arguments focused roughly equally on the two questions, but even the conservative justices seemed to have difficulty agreeing with the plaintiffs on the question of standing. This is not that surprising, because neither case features a plaintiff who has clearly suffered an injury that would be cognizable under the Court’s well-established doctrine governing who can sue whom for what and when.  

In fact, some of the possible theories of standing asserted by the plaintiffs in lower court proceedings received hardly any airtime at all during the arguments.  The justices focused on the potential, indirect injury to the state of Missouri if debt cancellation reduces revenue earned by a state-created corporation, MOHELA, which services federal student loans as an Education Department contractor. That reduction in revenue could mean that MOHELA pays less money to the state at some future date–a harm that is pretty speculative and uncertain, rather than concrete and particularized.

The conservative justices know that if they allow these plaintiffs to proceed, they may open the door to future plaintiffs whose claims to harm are as thin and attenuated. A future Republican administration, for example, would face litigation risk from parties who currently would not be able to mount a viable legal challenge. That seems a pretty likely scenario and would force the justices either to allow the suit to proceed, which they will not want to do, or to erode their institutional credibility further by coming up with a way of distinguishing that future case from those of today.

Without resolving the matter of standing, the Court cannot move forward to where they clearly want to go: a holding that would permanently stop the plan to cancel student debt and weaken the executive agencies fundamental to the modern administrative state. And while the oral argument did not clearly reveal the doctrinal basis for the justices aversion to the Biden cancellation plan, their questions did make clear just how hostile members of that conservative wing are to the idea of cancellation.  

All of which is bad news for the 40 million-plus borrowers whose financial futures will be affected by what the Court decides, a reality that Attorney General Prelogar and Justice Sotomayor both took time to highlight but that seemed of little import to the conservative justices. They were more concerned about the “unfairness” of the administration’s focused cancellation program for those who already paid off their loans or didn’t take out loans in the first place.  

It will not bolster the legitimacy of the Court if the conservative majority votes to block this limited cancellation initiative because only forgiveness for all borrowers of all time would be fair, while asserting that cancellation is beyond the authority of the administration anyway.  

 

The Texas Two-Step's New Key

In the wake of the Third Circuit's LTL Management decision many commentators wrote off the Texas Two-Step as dead. Turns out it's not, it's just playing out in a different key with a new filing in SDTX.

Job Opportunity -- Executive Director of National Consumer Bankruptcy Rights Center

With Tara Twomey's selection as the new head of the Executive Office of U.S. Trustee, the National Consumer Bankruptcy Rights Center (NCBRC) is seeking a new director. The NCBRC helps shape consumer bankruptcy law, as it did for many years under Twomey's leadership. This is an opportunity for someone else to do the same. See the NCBRC's web site for the job posting and more details.

Debt-based driving restrictions: new resources

Professor Kate Elengold and UNC Law 2L Michael Leyendecker have just posted very useful reports for no charge on the Social Science Research Network.  In Professor Elengold's words, these reports "classify, catalog, and cite every state law restricting driving privilege based on debt owed to the state or pursuant to a state-controlled system." This includes criminal or civil fines and fees,child support, taxes, tolls, and more. The Twitter announcement of these resources indicates that they welcome additions and corrections, and that a related scholarly article from Professor Elengold will be available soon. 

Here is the driver's license suspension report. 

Here is the car registration suspension report.  

The New Usury

I have a new paper up on SSRN. It's called The New Usury: The Ability-to-Repay Revolution in Consumer Finance. It's a paper that's been percolating a while--some folks might remember seeing me present it (virtually) at the 2020 Consumer Law Scholars Conference, right as the pandemic was breaking out. Here's the abstract:

Consumer credit regulation is in the midst of a doctrinal revolution. Usury laws, for centuries the mainstay of consumer credit regulation, have been repealed, preempted, or otherwise undermined. At the same time, changes in the structure of the consumer credit marketplace have weakened the traditional alignment of lender and borrower interests. As a result, lenders cannot be relied upon not to make excessively risky loans out of their own self-interest.

Two new doctrinal approaches have emerged piecemeal to fill the regulatory gap created by the erosion of usury laws and lenders’ self-interested restraint: a revived unconscionability doctrine and ability-to-repay requirements. Some courts have held loan contracts unconscionable based on excessive price terms, even if the loan does not violate the applicable usury law. Separately, for many types of credit products, lenders are now required to evaluate the borrower’s repayment capacity and to lend only within such capacity. The nature of these ability-to-repay requirements varies considerably, however, by product and jurisdiction. This Article collectively terms these doctrinal developments the “New Usury.”

The New Usury represents a shift from traditional usury law’s bright-line rules to fuzzier standards like unconscionability and ability-to-repay. While there are benefits to this approach, it has developed in a fragmented and haphazard manner. Drawing on the lessons from the New Usury, this Article calls for a more comprehensive and coherent approach to consumer credit price regulation through a federal ability-to-repay requirement for all consumer credit products coupled with product-specific regulatory safe harbors, a combination that offers the greatest functional consumer protection and business certainty.

#PublicDebtIsPublic and #DebtCeilingIsStupid

What could possibly trigger me enough to break a two-year blogging hiatus? A sudden burning desire to consider the difference among budget accountability, debt accountability, and the inane, moronic, irrational, exploding human appendix ****show that is the debt ceiling.

Postpetition Asset Sales in Chapter 13s--Modification, Not Estate Property

Debtors selling houses during a chapter 13 continues to cause conceptual problems for the courts. A recent decision, In re Marsh, from Judge Fenimore in Kansas City is an example. (Hat tip to Bill Rochelle for flagging this decision in his DailyWire column from the American Bankruptcy Institute ($). If you are a bankruptcy lawyer and don't get this column in your inbox each morning, you are missing out.) Judge Fennimore's opinion is a good point of departure to discuss why I don't think these conceptual problems are as difficult as lawyers make it out to be.

In the case at hand, the debtors scheduled the value of their home at $140,000. Between the $125,000 mortgage and a $15,000 homestead exemption, there was no value for unsecured creditors. The debtor confirmed a plan that provided for payment of the mortgage through the trustee, known as a "conduit plan." Although the debtor was below-median income and qualified for a three-year plan, the debtor opted to do a five-year plan, presumably to make it easier to cure the mortgage arrearage. The plan specified that unsecured creditors were to receive no distribution.

Forty-three months into the case the debtors filed a motion to sell the home for $210,000, which the court approved and which generated about $78,000 in cash after payment of the mortgage and fees. The debtor filed a "motion to retain" the cash. The chapter 13 trustee resisted, noting the cash would pay unsecured creditors in full.

Biden DOJ's Excellent Pick to Head USTP

The Department of Justice has announced Tara Twomey as the next head of the U.S. Trustee Program (USTP). This is an outstanding selection. I will leave her impressive biographical details to the DOJ press release, which you really should read. We here at Credit Slips would have added that she is a former guest blogger for us (which is probably why we are not allowed to write DOJ press releases).

Having known Director-designate Twomey for quite a few years, I wanted to add a few things that are not in the release. She is universally respected by her colleagues. Twomey is innovative in her approaches to legal questions, both as an advocate and a scholar. She is giving of her time to help better the law and the profession. More than once, she has served as pro bono counsel to help with an amicus brief, including for me. In her current position, she has filed many amicus briefs herself in the courts of appeals and Supreme Court, with one of her most recent efforts being cited favorably in a Tenth Circuit opinion released just this morning.

Many congratulations to Director-designate Twomey. Also, many congratulations to Attorney General Merrick and the Biden Administration on their excellent decision. Along with the work of the USTP during the leadership of the interim director, Ramona Elliott, the profession's confidence in the USTP is being restored. My inbox this morning has been full of nothing but positive comments on the selection.

Impact of the Illinois Predatory Loan Prevention Act

In 2021 Illinois passed its Predatory Loan Prevention Act (PLPA), which imposes a 36% military APR (MAPR) cap on all loans made by non-bank or credit union or insurance company lenders. Not surprisingly, the law has not been popular with higher cost lenders who either have to change their offerings, cease doing business in Illinois, or figure out some way to team up with a bank that won't run afoul of the law's anti-evasion provision. 

Recently, opponents of the PLPA have been making some noise, pointing to a study by a trio of economists—J. Brandon Bollen, Gregory Elliehausen, and Thomas Miller—about the impact of the PLPA. (The latter two are familiar scholars whose work consistently takes a dour view of consumer finance regulations: readers might recall my debunking of another recent study by Professor Miller, co-authored with Todd Zywicki, that was fundamentally flawed because of the miscalculation of loan caps in various states.)

Using credit bureau data, the Bollen et al. paper finds that the PLPA resulted in a 30% decrease in the number of unsecured installment loans to Illinois subprime borrowers and a 37% increase in the average installment loan size to Illinois subprime borrowers, which they attribute to the difficulty in making smaller loans profitable at 36% MAPR. Additionally, based on a lender-administered survey of 699 online borrowers (not necessarily of installment loans), the Bolen paper also reports a decline in borrower financial well-being following passage of the PLPA. 

Unfortunately, the Bollen paper suffers from serious data and methodological problems such that it does not tell us anything meaningful about the wisdom of the PLPA. Here's why. 

The Texas Two-Step's Liquidation Problem

This post is a joint post by Hon. Judith K. Fitzgerald (ret.)[*] and Adam Levitin

The Texas Two-Step has been the latest fad in mass tort bankruptcies, used, among others, by Johnson & Johnson, Georgia-Pacific, and, in a variation, 3M. The essential elements of the Texas Two-Step are the segregation of the debtor's mass tort liabilities in a non-operating subsidiary, which then enters into a funding agreement with the parent company to cover the mass tort liabilities up to some level. The subsidiary then files for bankruptcy and seeks to have the court stay the mass tort litigation against the non-debtor parent. If this maneuver is successful, the non-debtor parent goes about its normal business,[1] as do all of its creditors ... other than the mass tort victims. Meanwhile, the non-operating debtor subsidiary—whose sole creditors are mass tort victims—just sits in bankruptcy indefinitely.

The basic strategy behind a Texas Two-Step is “delay to discount”: the extended delay of the bankruptcy process pressures tort victims and their counsel to accept discounted settlement offers. The non-debtor parent feels no urgency for the bankruptcy to end because litigation is stayed against it. Moreover, the parent is able to continue its normal operations without being subject to bankruptcy court oversight or even to the regular expenses of defending the mass tort litigation. And because the debtor is a non-operating entity, it is under no pressure to emerge from bankruptcy. The debtor and its parent are both happy to let the bankruptcy drag on as long as necessary. In other words, the Texas Two-Step is an underwater breath-holding contest where the debtor has a snorkel. 

The ultimate end-game in a Texas Two-Step bankruptcy, however, is obtaining releases for the non-debtor parent (and other affiliates), bolstered by a channeling injunction that precludes tort victims from bringing suit against the parent and affiliates after the bankruptcy. There’s a fly in the ointment, however. A channeling injunction under section 524(g) requires that the debtor receive a discharge, and the debtor entity in the traditional Texas Two-Step case is not eligible for a discharge because it is a non-operating corporate entity that will be liquidating.

Sorting Bugs and Features of Mass Tort Bankruptcy

I have posted a short draft article about mass tort bankruptcy. If you would like to send me comments on the draft, that would be lovely, but please keep two caveats in mind. First, I must submit the revisions by February 9. Second, the article must not exceed 10,000 words. For every addition, some other thing must be subtracted. The required brevity means the article does not and cannot canvas the large volume of scholarship about the topic, let alone the mini-explosion in recent years. 

For the Credit Slips audience I would like to particularly highlight Part I of the article, which contextualizes debates about current mass tort bankruptcy by reviewing two sets of sources from the 1990s and early 2000s. The first is the 1997 final report of the National Bankruptcy Review Commission. The second is scholarship, including two Federal Judicial Center books published in 2000 and 2005, of Professor Elizabeth Gibson, whose expertise lies at the intersection of civil procedure, federal courts, and bankruptcy.  If you are working on or talking a lot about mass bankruptcy but have not reviewed these materials in a while (or ever), then I hope you will be incentivized to check those out for yourselves. 

New Year, New Personal Bankruptcy Law--in Kazakhstan

The list of countries with new personal insolvency laws continues to grow. Bloomberg noted today that the President of Kazakhstan had signed a new law setting out several procedures for relieving the debts of non-entrepreneur individuals (sole proprietors remain relegated to the existing law on rehabilitation and bankruptcy). The text of this 30 December 2022 law is here (in Russian only), and most of its provisions will become effective in 60 days, around March 1, 2023. 

The structure of this law and its four pathways to relief are clearly inspired by the 2015 law of Kazakhstan's northern neighbor. This indicates a continuing trend, as new personal insolvency laws are generally based on a model from the law of a country the adopting country respects, and the model in this case is a fairly good one (the parent law is described here and here). The Kazakh law differs in some respects from this predecessor model, but the basic system is the same: (1) a no-asset procedure ("out-of-court bankruptcy") providing a simple discharge to debtors with debt below about $11,000 (i.e., 1600 "monthly calculation units," which for 2022 was KZ₸3063, just over US$7, so 1600 x $7 = $11,200), (2) a 5-year payment-plan procedure ("restoration of solvency") for debtors with regular income who choose to propose a 5-year plan for court (not creditor) approval, (3) a traditional liquidation-and-discharge procedure ("judicial bankruptcy") unfolding over six months and leaving the debtor with exempt property, including a sole residence, and (4) a settlement option ("amicable agreement") for debtors who manage to convince their creditors to agree to a private compromise (read: never!).

While the requirements for accessing the no-asset out-of-court bankruptcy procedure seem wildly unrealistic and uniquely austere (no property of any kind!?), the new Kazakh system is fairly well structured. Judging by the northern neighbor's recent experience with its very similar set of procedures, it seems most likely the payment-plan procedure will be selected by very few debtors, and the courts will reject the unviable plans of the few debtors who try to pursue this route. Judicial bankruptcy will become the main pathway to relief, which seems to be within reach for ordinary Kazakh citizens. Eventually, the extremely restrictive access requirements for out-of-court no-asset bankruptcy seem likely to be relaxed--either in practice or in a first round of law reform--and that procedure will become the workhorse for the personal bankruptcy system.

Yet another laboratory to observe the effects of the messy compromises that create personal insolvency procedures--and thank goodness, yet another large population of debtors who finally have access to legal relief from debts that would otherwise hound them and their families forever, with no hope of recovery. The new year brings new hope for such families in Kazakhstan!

The Financial Inclusion Trilemma

I have a new draft article up on SSRN. It's called The Financial Inclusion Trilemma. The abstract is below. 

The challenge of financial inclusion is among the most intractable policy problems in banking. Despite being the world’s wealthiest economy, many Americans are shut out of the financial system. Five percent of households lack a bank account, and an additional thirteen percent rely on expensive or predatory fringe financial services, such as check cashers or payday lenders.

Financial inclusion presents a policy trilemma. It is possible to simultaneously achieve only two of three goals: widespread availability of services to low-income consumers; fair terms of service; and profitability of service. It is possible to provide fair and profitable services, but only to a small, cherry-picked population of low-income consumers. Conversely, it is possible to provide profitable service to a large population, but only on exploitative terms. Or it is possible to provide fair services to a large population, but not at a profit.

The financial inclusion trilemma is not a market failure. Rather it is the result of the market working. The market result, however, does not accord with policy preferences. Rather than addressing that tension, American financial inclusion policy still leads with market-based solutions and soft government nudges and the vain hope that technology will somehow transform the fundamental economics of financial services for small balance deposit accounts and small dollar loans.

This Article argues that it is time to recognize the policy failure in financial inclusion and give more serious consideration to a menu of stronger regulatory interventions: hard service mandates that impose cross-subsidization among consumers; taxpayer subsidies; and public provision of financial services. In particular, this Article argues for following the approach taken in Canada, the EU, and the UK, namely the adoption of a mandate for the provision of free or low-cost basic banking services to all qualified applicants, as the simplest solution to the problem of the unbanked. Addressing small-dollar credit, however, remains an intractable problem, largely beyond the scope of financial regulation.

Karens for Hire

The Washington Post has an article about a new business, "Karens for Hire," that is basically a way to hire a customer service advocate. Having spent way too much time with customer service of late, the article really hit a nerve. It gets at the central problem of consumer law, namely that the dollar amounts at issue in almost every dispute are way too small to litigate. Instead, consumers have to work through customer service and hope that they receive some sort of resolution, but that's a process that imposes substantial transaction costs (wait times, e.g.) and in which the consumer has no guaranty of a positive resolution, even if the consumer is in the right. 

There's some level of reputational discipline on companies with bad customers service, but it's pretty weak and indirect: when was the last time you investigated a company's customer service reputation before making a purchase? 

There are a few attempts to regulate customer service of which I am aware—TILA/EFTA error resolution procedures and RESPA loss mitigation procedures—but there's no general system of public regulation. Figuring out exactly what, if anything, would work as a more general solution to ensuring fair and efficient resolution of customer service calls remains one of consumer law's great challenges.