GM's New Chapter

It's not surprising that GM is advertising heavily during the NBA Finals, despite, or perhaps because of, its recent bankruptcy.  But what did catch me off guard is the new slogan I just heard at the end of a commercial:  "Because the only chapter we're focused on is Chapter 1."  I had to look it up online to make sure I'd heard correctly. Was that really a bankruptcy-chapter pun I just heard on prime time TV?

But now I have a different question. Will anybody outside of the bankruptcy world know what GM is talking about? I know bankruptcy is all over the news these days, but still.  What do readers think?

Marginal Credit Card Borrowers Come Back to Haunt Banks

The New York Times just ran a fascinating, short piece on the relationship between unemployment and credit card defaults.  Historically, there has been a strong correlation between the two, and there still is.  But this time around the measures are no longer traveling neck and neck.  In the current recession, increases in the unemployment rate are starting to predict increasingly large spikes in credit card defaults.  Reporters Eric Dash and Andrew Martin provide a great graph depicting this trend. 

The article offers a few explanations for this changing relationship, the most important being that laid off credit card borrowers have a decreased ability to cushion periods of unemployment with home-equity loans and retirement withdrawals than they did in recent recessions past.  But it misses one crucial additional reason for this shift:  loans to weaker borrowers comprise a larger percentage of credit card portfolios than they ever have before.  Over the past three decades, credit cards have made their way down the income distribution, until just about anyone and their dog (literally) could get one.  Many consumer advocates criticized this development, arguing that heavy credit card debt was negatively affecting families who were already struggling.  Deregulation proponents responded with the argument that financially constrained people were more than capable of managing the new, copious amounts of credit being offered, thank you very much. But we all may have missed one important point.  It was really the banks we should have been saving from themselves all along.

Is AIG Insolvent?

Apparently just about every law professor in the country had the same reaction I did upon reading that the AIG bonuses were paid because the contracts were binding, a reaction that can probably be summed up as: “What??” As a profession, we have been blogging up a storm. Several professors contributed to a New York Times forum on disputing the bonuses via contract law. Larry Tribe chimed in at the Atlantic on whether a 100 percent, retroactive bonus tax would be constitutional. (Surprisingly, the answer is a qualified yes.) At the risk of having only a hammer and thinking the bonus problem looks like a nail, I thought it was time to contribute my two cents on the applicability of fraudulent conveyance law. To be fair, Andrew Cuomo had the same idea, and his opinion has a bit more weight than mine.

The Repo Man Cometh.

An AP article by Jay Reeves highlights yet another disturbing consequence of our credit-based recession -- a rise in repo violence. The article details the killing of Jimmy Tanks, a 67-year-old retired railroad worker, who used a rifle to confront a repo crew at 3 in the morning and ended up dead.  The repo man has been arrested for murder. The rise in repo violence probably has a lot to do with the rise in repossessions. Car repos increased by 12 percent in 2008 and are expected to increase another 5 percent in 2009.

But the Uniform Commercial Code has a lot to do with this as well. Under Article 9, a repo is legal as long as the creditor's representatives don't "breach the peace," a test which has led to a body of caselaw that, paradoxically, almost guarantees violence. Basically, if the repo crew can get the automobile away from the debtor without violence occurring (no matter who starts it), the creditor is safe. But if the debtor manages to physically prevent the repo, even by extreme measures such as threats or chaining himself to his car, the creditor's representatives have to leave. This gives repo crews incentive to proceed by stealth, which it turn makes it more likely that debtors will confuse them with car thieves, and it encourages debtors to take extreme measures to defend their cars.

Another disturbing facet of this story is that the debtor had already filed for bankruptcy. The article doesn't mention whether the creditor had managed to get the automatic stay lifted, but if not, then the repo guys had no business whatsoever being there in the first place.

I want to thank my students James Hughes and Beckie Brice for the tip.

Some Good News for Homeowners

JPMorgan Chase and Citigroup have announced a weeks-long moratorium on foreclosures while they await the release of the Obama administration's forthcoming plan to deal with the issue. J.P. Morgan said its moratorium will apply to loans it owns and services, while Citi is including its own loans as well as those on which it has reached agreements with the relevant investors. For both banks, this is an expansion on similar past efforts. It remains to be seen exactly how many troubled home loans this will cover.

The Sky is Falling on Newspapers. Sorry, Dad.

“Nobody outside the newspaper industry really understands just how bad things are.”  For over a decade I’ve heard this statement and others like it everywhere – at the dinner table and on family vacations, over the telephone and in the grocery store on trips home.  I’ve heard them from my father, a newspaper journalist of 40 years, and from his friends, most of whom also began their reporting careers in the late 1960s and early 1970s. 

As of today, nobody in or outside the business can deny the sad reality.  The Tribune Company, which owns two of the nation’s great newspapers – the L.A. Times and the Chicago Tribune – as well as six others, has filed for bankruptcy.  Sam Zell, the chain’s controversial CEO, insists that the bankruptcy is simply a way of restructuring the company's debt and not a catastrophe, but it’s hard to see how this could be true.  Even if he’s right in about the outcome of this one bankruptcy – which I doubt – he’s wrong in the more important sense.  Newspapers are dying.

I should know. Less than a week ago, my father’s current paper, the Rocky Mountain News, was put up for sale.  In the current climate, with credit scarce and other papers on the brink (including the New York Times, which is – incredibly – offering its legendary office building as collateral for an operating-expenses loan), this almost certainly means that the paper will fold.  Probably the best that the employees can hope for is that the process of folding takes long enough for them to find other jobs.  The Tribune bankruptcy adds another layer of financial anxiety.  Nineteen years of my father’s pension – from seven years at the L.A. Times and twelve at the Baltimore Sun – are now tied up in Chapter 11.

Something has to change.  No matter how hard or well reporters work, there simply isn’t enough money to support them anymore.  Truth-seeking (for better or worse) has never been a for-profit activity.  Newspapers have just been lucky in that they found a way to subsidize this high-cost endeavor – classified ads.  That subsidy is fast disappearing with the Internet in general and craigslist in particular.  If we as a country want to continue having a written representative in the “fourth branch” of government, we’re going to have to come up with another one.  The fifty cents or so we pay for a printed paper isn’t enough to pay for things like foreign bureaus or investigative reporting.  (Expenses like these are why blogging is no substitute.)  And of course, these days many people read the paper on the web and don’t even pay that fifty cents anymore.  (My dad jokingly lays the blame on me and my online reading habits in his column about the Rocky going up for sale.)

Those of us who write for this blog talk a lot about families who work hard, play by the rules, and still find themselves in trouble.  But until recently I’ve had the luxury of not thinking about my own family in this light.  I don’t want to exaggerate.  My dad will land on his feet; he always has.  But it’s excruciating that he’s facing a layoff less than six months before his sixtieth birthday.  This is someone who’s worked his way up from the lowest echelons journalism, covering high-school basketball games when he himself was still in high school, to the very top of his profession.  (Not that I’m biased.)  My dad believes that he will be one of the last people to turn out the lights in the newsroom.  I just hope the newsroom has more than five years of light left.
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Greenspan Admits "Mistake"

If you missed Former Fed Chairman Alan Greenspan's incredible admission today, here it is. In a stunning statement, he said that much of his previous faith in free markets had been wrong:  "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” He further called this mistake "a flaw in the model ... that defines how the world works." Let's hope that policymakers still in office agree.

A Countrywide Settlement

Bank of America has agreed to settle a deceptive mortgage practices lawsuit on behalf of its relatively new subsidiary, Countrywide Financial, the notoriously aggressive mortgage lender.  The attorneys general of Illinois and California negotiated the settlement on behalf of their states and at least nine others. The settlement will cost BOA approximately $3.5 billion in California and $190 million in Illinois. The settlement funds will go towards reducing payments for Countrywide borrowers with subprime and/or adjustable-rate mortgages, waiving prepayment and late fees, paying damages to customers who have already lost their homes, and subsidizing the relocation of those who are now in foreclosure.

A BOA spokesperson said that the bank plans to introduce the program in December. Hopefully more details about who will qualify will be available soon.

Foreclosure Tragedy

An excruciatingly sad story about the human costs of the home-mortgage crisis:  http://www.cnn.com/2008/US/10/03/eviction.suicide.attempt/index.html. A 90-year-old woman, Addie Polk, shot herself inside her foreclosed, Akron, Ohio home. It appears that she will live, although she is still in the hospital. Representative Dennis Kucinich, a member of her state's congressional delegation, told her story on the House floor during today's bailout debate, saying, "This bill does nothing for the Addie Polks of the world." He voted against the bailout, which finally passed in the House this afternoon.

"My Country Has Had Crisis..."

If you're like me and seek solace in satire when things go bad, this parody from a blog on The Nation's web site hits the note with perfect pitch. I won't spell out the whole thing here, but it begins,

"Dear American:

I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you."

The later statement that "this transactin is 100% safe" seems oddly prescient.

The Right and the Left of It

As debate on the bailout continued today, a funny thing happened on the New York Times' op-ed page. William Kristol, the Times' current token-ultraconservative columnist, and Paul Krugman, who might just be the most-read liberal economist in the country, agreed. They agreed that the bailout proposed by Paulson is a terrible one. Even more, they agreed for many of the same reasons, the main issue being Bob Lawless' point that the plan provides for just about no oversight of its implementation.

My views being what they are, I found Krugman's to be a must-read analysis of the current crisis. He breaks down what went wrong in a simple but not overly simplistic fashion and pinpoints exactly where intervention is needed.

Quick update: A few minutes ago,  Krugman registered more positive opinion of Senator Dodd's alternative proposal.

Congress is Costing You Thousands of Dollars...?

The other day I heard an alarming advertisement on the radio. It began by warning that a new federal law could cost "you" thousands of dollars. It then proceeded to say that, if you want to avoid paying this money, you'd better hurry, hurry, hurry and purchase a home by September 30, when the statute goes into effect. The ad had the tone of a going-out-of-business sale: "Think you have all year to buy a home? Not anymore! Act now while you can still afford to make your dream of home ownership a reality! Offer (or law, in this case) expires on September 30, 2008." (Not an exact quote.) By this point, I was waiting with bated breath to find out how Congress was going to drain potential homeowners of so much money.  Didn't it just pass a law designed to help homeowners weather the mortgage meltdown?

Well, it turns out that the thousands of dollars new home buyers will be paying are their own down payments. After some careful listening and some less careful inference based on the September 30 date, I came to the conclusion that the ad was referring to the ban on seller-financed down payments in the Housing and Economic Recovery Act of 2008. The bill was signed into law on June 30 and will go into effect on the October 1 (hence the rush to sell before then). The law's main focus is providing help for current struggling homeowners, but it gets just a little bit proactive about prevention by banning sellers from lending money for down payments. This provision is intended to protect homeowners in the long run. It forces buyers to do a sticker-shock test on whether they can really afford their new homes. And it eliminates some incentives for seller-lenders to overprice houses. When a seller is financing the down payment, there's a temptation to overstate the price because, in the company's role as a lender, it will have the final say over whether the buyer can really afford to spend that much. The only pricing obstacle left to overcome is the buyer, and it's reasonable to think that buyers will be slightly less sensitive to price when they're not paying as much of it right away.

56,000 People – and One Guest Blogger – Can’t be Wrong

When the Federal Reserve asked for comments on its proposal to prohibit credit-card issuers from engaging in “certain unfair or deceptive acts,” it had no idea what it was getting into. The draft rules generated approximately 56,000 comments, most of them from angry consumers. This is an overwhelming response to what is known in legal jargon as a “Notice and Comment Period,” a regulatory tradition that is usually about as exciting as it sounds. While many of these were form letters that people had clipped or copied from advocacy materials, a large percentage were from individuals sharing their own stories. That is a lot of effort on the part of a lot of people.

The New York Times has published a helpful editorial about the proposed rules and the overwhelming response to them. From a Credit Slips perspective though, the most interesting part is that it cites guest blogger Ronald Mann. And the editorial board didn’t just call him up for a quick quote. The editors actually read and digested his article Bankruptcy Reform and the Sweatbox of Credit Card Debt.  They even provide a link.  In this article Professor Mann argues that the real reason credit-card companies benefit from BAPCPA is that they get more time to collect penalty interest and assorted late fees as distressed borrowers wait longer to file for bankruptcy. What’s so interesting about this framework is that it takes something that people used to characterize as a side effect – the piling on of interest and fees when borrowers default – and places it front and center, arguing that it is now the distressed borrowers, rather than the paying customers, who are at the heart of the credit-card issuers’ business model – and their lobbying efforts.

The paper is quickly becoming a classic in the field. It’s one of those rare articles that takes the same events all of us were looking at and frames them in a completely new way. So it’s especially exciting to see it prominently featured in the mainstream press. The academic debate is shifting from one where we think of defaulting borrowers as something lenders need to protect themselves from to one where we see defaults as something issuers actively solicit and worked to enshrine in law. If this point can penetrate into popular discussion, we’ll be making some real progress.

No Cushion

This past weekend The Washington Post began an excellent series on the financial issues facing low-income workers.  The first installment is based on a poll of 1,350 randomly-selected people who made $27,000 or less in 2007.  According to the Post, this covers approximately 40 percent of the American work force. 

The results will not come as a surprise to many Credit Slips readers, but they are worth examining because they document the fragility of so many families’ finances outside of a bankruptcy setting.  Some of the respondents probably have filed for bankruptcy – the poll does not appear to have asked – but, unlike many of the studies we discuss on this blog, it is not a survey of people in bankruptcy.  Yet many of the surveyed families are coping in the same ways that bankruptcy filers do.  They are doing things like putting off medical treatment, working additional hours or jobs, and moving to cheaper housing.  A full 26 percent said that they had increased their credit card debt in the past year in order to make ends meet.

What is particularly interesting is that the financial profile of the people surveyed looks something like a “before” picture of the “after” families we see in bankruptcy. 

Obama on Credit Cards and Bankruptcy

This is quick post about Obama's speech on the economy in Raleigh, N.C. He spent two and a half "paragraphs" of it discussing credit cards and bankruptcy. (The link is to the whole speech. I've also excerpted the relevant passage in the "continue reading" part of this post.)  I'm intrigued by his five-star risk rating idea for credit cards because I have a particular interest in meaningful disclosures, ones that can actually help real people make decisions about financial products. But I am a little disappointed by the limited way he discussed bankruptcy reform. Yes, letting people prove medical bankruptcy would be a good start.  But as many of us look more closely at the post-BAPCPA data, I'm becoming more convinced that it's the procedural barriers and the expenses they entail keeping people out of bankruptcy, not the means test itself. If that's correct, a small improvement to the substance of the law might not make much of a difference, especially if it were accompanied by additional procedure (i.e., the process by which people would "demonstrate" that they filed because of medical bills).

Reading Redux

Last year around this time, I wrote a Credit Slips post about a law-professor friend whose realtor expressed shock and dismay when she and her husband insisted on reading every document she gave them to sign regarding the house they were purchasing.  In the post, I somewhat sanctimoniously referred to myself as someone who always reads her contracts.  This year, it was my turn, and I have to admit that I did not pass my own test.

I faithfully read every home-purchasing form contract my realtor and lender sent me from the day I made the offer until the day before closing.  I even actually managed to do something productive for all my trouble; I switched inspectors because the first one insisted on a rights-waiving contract.  But partway through the closing itself, faced with two inches of papers to sign, my resolve wavered.  I was tired and hungry, and my mind kept circling around to all the moving-related errands I needed to do in Austin before the end of business hours and my flight out of town the next day.  (A word to the wise:  Never go to a closing on an empty stomach.)  So I took a few shortcuts.

The Repo Man Cometh

Repossession isn’t just for struggling car owners or low-income rent-to-own borrowers anymore.  The combination of the recent overextension of credit and the current corresponding crash has resulted in a newly strengthened market for the repo man:  boats.  And we’re not talking about the poor fisherman who can no longer make the payments because of weakening economy.  No, these boats are genuine luxury items – boats with names like “Jersey Dreaming’” or “Toy Box.” According to an article by David Streitfeld of the New York Times, boat repossession is on the rise.  Streitfeld follows a repo man in Michigan who says that his usual summer "slump," when boat owners make an effort to catch up on payments so they can enjoy the season, is not occurring this year.  A related CNBC video clip documents a boat repo man whose business has increased by 300 percent since 2006.   

MasterCard’s Machiavellian Twist

Having just spent the last six months or so giving job talks on a paper about why credit cards issuers should allow consumers to precommit to certain levels of spending and borrowing, I am simultaneously excited and disappointed to see MasterCard's latest offering, the "inControl" card, as reported by Aili McConnon in BusinessWeek. I'm excited because it shows beyond a doubt that allowing consumers to set predetermined limits on their spending and borrowing is technologically feasible and perhaps not even that expensive. (McConnon did not discuss the fee structure for the new product.)

I'm disappointed because of the product itself. Instead of using the technology to help consumers gain the credit control many so desperately seek, MasterCard is using it to allow employers to set limits on employee corporate-account spending. MasterCard is giving employers a diverse set of tools that are incredibly useful. Managers can set limits not only on the amount of spending, but on where and when employees spend, and it even offers the option of sending real-time text messages back to the company whenever employees use the card. These options are almost exact analogues of the ones I proposed:  allowing consumers to set their own hard credit limits, to "black out" certain stores they find particularly tempting, and to enable them to receive a receipt stating how much room they have left in their credit limit each time they make a purchase. The card is even called "inControl," when I'd suggested "You're in Charge" as a possible product name.

More Subprime Side Effects?

When credit card borrowers have trouble paying their debts, issuers respond in a number of ways, but one of them is particularly surprising:  they often extend more credit.  According to the Boston Globe article Credit Card Companies Woo Struggling Mortgage-holders, issuers are extending this strategy to subprime homeowners as well.  Globe staffer Robert Gavin reports on a study by Mintel International Group, which claims that as the subprime mortgage market continues to implode, credit card issuers are stepping in to offer more credit to struggling homeowners. 

Or at least that’s what the headline says. 

"The Best Loan Possible" from Whose Point of View?

"I want to be sure you are getting the best loan possible," is a line from a Countrywide Financial Service Corporation sales pitch.  Since a sales person would be the one saying it, borrowers could be forgiven for thinking that this meant the "best loan" for them. But as Gretchen Morgenson shows in an expose in Sunday's New York Times, it apparently means the "best loan possible" for Countrywide.  Relying primarily on anonymous interviews with former employees and documents they provided, Morgenson demonstrates how every aspect of Countrywide's business steers borrowers towards loans that are more profitable for the company and therefore more expensive for the borrower. 

Blaming the Correct Governmental Body

Bob should be pleased to see that today's New York Times editorial on taxing debt forgiven in foreclosure puts the blame squarely on Congress' shoulders. On Monday, Bob posted about a New York Times news article on the same topic.  He argued that the problem was real, but the responsibility lies with Congress, not the I.R.S., on the sensible grounds that Congress has the power to write the rules, whereas the I.R.S. just enforces them. The New York Times editorial page apparently agrees, because today's piece says that it's not the I.R.S.' fault and ends with a call to Congress to provide relief.

I, for one, am going to take this as confirmation that the Times' editorial board is composed of Credit Slips readers.

Leave It to "The Onion"

After John's thoughtful post on the sub-prime meltdown yesterday, I thought I would respond in a less thoughtful vein:  via everyone's favorite satirical newspaper, The Onion.  Today, it posted its reaction to the sub-prime mortgage crisis with a "Statshot" ("A look at the numbers that shape our world") entitled "How Are We Paying Off Our Subprime Mortgages?" It is worth a look for some gallows humor on a difficult topic. My favorite response -- provided by 17% of the paper's fictional respondents -- is, "Getting a job at loan office, bringing down company from inside."

Bad Hippo

The New York Times has a double dose of consumer credit pieces today. If you haven't seen them yet, the first is an editorial about the intersection of bankruptcy law and the rise in home foreclosures.  Interestingly, the editorial's primary concern is not with the changes from 2005, but about a 30-year-old provision prohibiting the modification of repayment terms on primary residence mortgages in Chapter 13. The editorial argues that this provision may have been sensible when most mortgages were straight-forward, low-risk loans, but that with the rise of riskier, more complicated mortgage products, courts need more discretion to protect homeowners.

Second is Erik Eckholm’s article, "Enticing Ad, Little Cash and Then a Lot of Regret" about the new wave of mail-order-financed computer companies, such as BlueHippo, Circuit Micro, and Financing Alternatives, where customers make small installment payments through bank-account deductions in exchange for computers that (ideally) arrive by mail. I had heard BlueHippo’s radio ads and wondered about the service. I have my own variation on the motto, "if it seems too good to be true, it probably is," which is that, "if it's a new, heavily advertised financing option aimed at low-income people that seems reasonable at first, it's probably not." So I'd assumed there was something fishy about the service, but I hadn't had a chance to look into it. Fortunately, the New York Times did the investigation for me.  It turns out that Better Business Bureaus across the country have been flooded with complaints about these services. Financing Alternatives is currently the Norfolk, Virginia office's number one subject of complaints. The Orange County office has had a similar relationship with Circuit Micro. And attorneys general in Maryland, Illinois, and West Virginia have taken action against BlueHippo.

In theory, a service that enables low-income consumers to buy computers using small payments over time is a good idea. These days, computer competence is a basic prerequisite of upward-mobility. Most higher educational institutions assume (or require) that their students have computers. Obtaining the skills to compete with their middle-class, My Space-entrenched peers is crucial for the younger generation of low-income people. For low-income parents who want their children to do well, finding them a computer is a pressing concern. There are two major problems with these computer sellers, however. 

The New York Times on Bear Stearns and the Foreclosure Crisis

It was easy to miss among the multitude of legal news articles about the Supreme Court rulings, but the New York Times issued an excellent editorial today on "Housing and Hedge Funds."  The piece picks up where Credit Slips blogger Elizabeth Warren left off on Sunday and is well worth a read. One of the editorial's most interesting points is that the involvement of hedge funds in the mortgage crisis means that struggling homeowners are no longer the only people suffering as a result of bad mortgages.  Wall Street is now losing money too. And the negative effects could spread throughout the whole economy. This makes it more likely that Congress will step in and take action, but it also makes the ethics of Congressional intervention more complicated.  Congress would no longer be helping only ordinary families working to keep their homes; it would also be bailing out Wall Street firms who squarely shouldered the risk.

Blame the Borrower

These days, smart opponents of regulating controversial lending practices talk in terms of consumer choice. They portray people like me who often think regulation is a good idea as the ones hurting consumers by limiting their options. So it's a rare occasion to come across someone who is willing to blame the borrower as thoroughly and openly as Kris Frieswick does in her piece "Here Comes the Repo Man" in this week’s Boston Globe Magazine (free registration required).

The article's subtitle: "It's easy to scold sub-prime lenders for the glut of home foreclosures. It's also wrong. Blame the buyers." Her take on current proposals to regulate subprime mortgage lenders and brokers in Massachusetts: "I applaud the licensing and counseling concepts, but legislators must accept that home buyers deserve the bulk of the blame for the foreclosure crisis." And her solution for halting the rise in home foreclosures: "We don't. Time does."

Payday Lending: The New “Laboratory of the States”

Last week, the Oregon Senate voted to cap interest rates on all consumer loans under $50,000 at 30 percent above the federal reserve discount rate, which is currently at 6.25 percent.  The bill is widely expected to pass in the Oregon House of Representatives, and Governor Ted Kulongoski has said he will sign it.  Although it technically applies to all consumer loans, the legislation will mainly affect payday and car title lenders, who claim that it will put the vast majority of them out of business in the state.  Or, as Bill Graves writes in the The Oregonian, the bill “transforms Oregon from one of the most payday friendly states in the nation to one of the most strictly regulated -- with the exception of 10 states that effectively ban payday lending.”

Consumer groups, some religious leaders, food bank operators, and the Oregon AARP have all pressed for the regulation of payday lenders.  While these are groups with which I usually agree on this type of legislation, I do worry about whether and where would-be payday borrowers will obtain cash in emergencies if fewer payday loans are available.   Fortunately, with new laws like Oregon’s, it is finally possible to really study this issue again.  Until recently, it has been impossible to use what Justice Brandeis famously called “the laboratory of the states” to compare how consumers fare in states with different levels of usury restrictions, because, for the most widely-used types of borrowing, all states effectively had the same usury rate – none. 

A “Small” Exception in Credit Card Arbitration Clauses

The other day I took out a store credit card at a department store.  I wasn’t happy about it, but it was one of those stores that does not take Visa or MasterCard, and I had planned on paying for my purchase with a debit card.  I read the contract, even though the sales person rang up my purchase before handing it to me.  (I admit that I take an academic interest in even my own credit transactions.)  I was not surprised to find that the contract featured a binding arbitration clause, but I was impressed to see that this clause included an exception for consumer actions in small claims court.  Specifically, the issuer agreed not to invoke its right to arbitration if the customer sued it in small claims court. 

Mutual Finger-Pointing

As Lisa Lerer wrote in The Politico last week, mortgage lenders and mortgage brokers are fingering each other as the culprit in the recent rise of home foreclosures.  In her article Lawmakers Seek to Protect Borrowers, Lerer reports on Mortgage Bank Association Chairman John Robbins’ speech at the National Press Club, where Robbins blamed brokers for steering consumers into risky subprime loans. 

The National Association of Mortgage Brokers did not take these charges lying down.  The association’s president, Harry Dinham, responded in an email that, “It is truly unfortunate that the president of the Mortgage Bankers Association has attempted to shift blame away from Wall Street, federally chartered banks, state-chartered lenders and underwriters for the subprime situation we find ourselves in today.”  The brokers are even going so far as to lobby for more regulation . . . of the mortgage lending industry, naturally.  They are seeking national standards for continuing education and criminal background checks for banks and other lenders.  Such requirements might improve the quality of brokers as well, but who’s counting?

What’s positive about this inter-industry lobbying squabble is that it means both groups are worried.  If lenders and brokers did not think that consumer-protection bills such as those introduced by Senators Charles Schumer and Jack Reed had some chance of passing, they might have shown more restraint in attacking each other. 

Finally, here’s a war where consumers benefit no matter who wins.

The American Law & Economics Association Annual Meeting

This weekend was the annual meeting of the American Law & Economics Association (ALEA).  It was a two-day conference at Harvard Law School, with five concurrent panels of three presenters for each time slot.  Although the topics ranged from plea bargains to family law to referees in the NBA, there was almost always a bankruptcy or contracts panel taking place.  (I knew I was on the right track because the sessions I wanted to see were all in the same room.  I got to know Pound 102 quite well.)

I saw too many presentations to recount all of them, so I’ll summarize briefly three papers I think will be of particular interest to Credit Slips readers. 

Commercial Law Beats Out Crim for Excitement (Who Knew?)

My colleague, Carissa Byrne Hessick, was a guest blogger on PrawfsBlog last week.  Although she wrote several interesting posts in her field of criminal law, she was disappointed that she received by far the most comments on her “non-academic” post about buying a house. 

Far from being non-academic, the post and comments comprise a nice mini-debate on the virtues and pitfalls of reading contracts before you sign them.  Carissa’s post is about her realtor’s shock when she and her husband (also a law professor) actually read the various agreements she gave them to sign.  The reader responses give several accounts of the reasons why people don’t read consumer contracts.  The common issue of not understanding them anyway is undoubtedly less relevant for people who read legal blogs than for your average consumer, but even this legally sophisticated crowd had faced obstacles when attempting to read consumer contracts before signing.  It’s socially awkward.  Because so few people read these contracts, time for reading is rarely built into the process, and you usually have to read while the realtor or sales person sits impatiently and watches you.  One person compared those of us who read our contracts to people who cannot order restaurant meals without making a million changes and substitutions.  (I *wish* I could make a million changes and substitutions when I read a contract of adhesion.)

Are Mortgages the New Credit Cards?

Today, Harvard’s Joint Center for Housing Studies released two reports on understanding the home mortgage market.  One study, entitled “Mortgage Market Channels and Fair Lending:  An Analysis of HMDA Data,” explores the dramatic changes in the mortgage market over the course of the past two decades, including the rise of subprime lenders offering risk-based pricing.  The other report, “Understanding Mortgage Market Behavior:  Creating Good Mortgage Options for All Americans,” analyzes the cognitive and behavioral biases that limit consumers’ ability to compare different types of mortgage products in accordance with their own long-term preferences.  For example, the study explains how some consumers will have difficulty evaluating products such as adjustable-rate mortgages because many people face cognitive distortions when comparing short-term and long-term risks.  It also documents how, as the number and type of mortgage products have multiplied, choosing a mortgage has become breathtakingly complex. 

Both reports have several compelling findings, including some important analysis on racial and ethnic disparities in mortgage types.  But what fascinates me is how familiar this all sounds.  There is another industry frequently discussed on Credit Slips that has recently expanded into subprime territory, that is accused of playing on cognitive biases to induce customers to take out loans that are ultimately unaffordable, and that features contracts so complex law professors must work to understand them.  The good news is that we can use these similarities to cross-pollinate our ideas for improving both systems, adapting for the mortgage context ideas that were developed for credit card borrowing and applying mortgage reform proposals to credit cards.  The bad news is that there are now two ways for people to find themselves in unforeseen unmanageable debt.

For Great Credit Card Deals . . . Read my Academic Paper

Yesterday I wrote that I posted a paper on SSRN. Today I went to check on this paper and noticed a curious phenomenon:  my SSRN page is hawking credit cards.  If you look down the side of the web page that displays my abstract, there are five Google text ads, all related to credit.  One offers a low-rate credit card.  A couple offer debt relief or credit counseling.  One even offers debt-settlement services, an unsavory offshoot of credit counseling wherein the company advises its clients to stop paying their creditors and instead save up for a future settlement payment.

In order to see whether this was a coincidence, I looked up the abstracts of some of my colleagues in the Climenko Fellow program.  One who writes about criminal sentencing had ads for defense attorneys, criminal-law degree programs, and – I kid you not – gunshot ring tones for the cell phone.  Another had written a paper about insurance law, and his abstract featured an ad for life insurance.  Other fellows who write on topics less amenable to consumer advertising had more generic advertisements, such as products offering to protect one’s legal data.  As one of my colleagues, who writes about international human rights tribunals, put it, “Apparently, the advertising market in the area of war crimes, genocide, etc. is rather limited.”  The ads change each time you refresh the abstract page, so sometimes I got the generic legal data advertisement next to my abstract and others I got a new array of credit-related products.

Not to Pat One’s Own Back (It’s Hard; Try It)

I just posted to SSRN a paper that Credit Slips readers might find interesting. It's called, "Beyond Usury:  A Study of Credit Card Use and Preference Among Low-Income Consumers." It is the first of two papers based on an empirical study I did about how low-income women use and think about credit cards.  This paper examines paternalism questions in the usury debate.  Most people who write about the topic seem to accept – and the available data seem to support – the premise that re-imposing usury caps on credit card loans would lead to fewer credit cards for low-income people.  I wanted to learn what low-income consumers thought about that trade-off. It seems that no one had ever asked these consumers themselves what they thought of the current system of easy credit with high interest rates versus a system wherein interest rates were lower but with a corresponding greater degree of difficulty in obtaining a credit card in the first place.  The participants in my study were deeply ambivalent on this question.  They were frustrated and angry at their credit-card companies, but they still thought credit cards were a necessary financial tool.  It turned out that the issue they were most concerned about was not high interest rates in of themselves but rather the temptation to spend and borrow at those rates, even when they knew they would regret it.  The discussion then shifted to how to redesign credit cards so that consumers could better control their temptation response to them.  In the paper, I build off their ideas to develop a proposal for "self-directed credit cards," which would allow consumers to pre-commit to set levels of credit-card usage and avoid the temptation to spend or borrow more in the heat of the purchasing moment.

The King and Queen of Debt

John Leland published a fascinating article in today’s New York Times.  Debtors Search for Discipline via Blogs describes a new trend, blogging for willpower.  People publish the intimate details of their of personal debt in order to use the exposure and reader feedback to help them control their debt accumulation.  The bloggers believe that by forcing themselves to publish everything they spend, they will become more conscious of their spending and have a stronger incentive to do less of it.  As Tricia of www.bloggingawaydebt.com said, “I think about this blog every time I’m in the store and something that I don’t need catches my eye.”

For those of us who are interested in debt, a few interesting points emerge.  First, for these bloggers, stigma is alive and well.  They are using the Internet as a clever way to circumvent it and still obtain the help they need.  Many of these bloggers are revealing private information they conceal from their families and friends. One couple refused permission to use their names in the article because, “We don’t want our parents to find out and kill us.”  This same couple is even sharing information they find difficult to discuss with each other in person.  The self-titled “King and Queen of Debt” say that, although they have good communication skills in other areas, it is only by writing the blog that they have been able to communicate about their finances.

“Health Care Gluttons” in Bankruptcy

Yesterday New York Times blogger Judith Warner (registration required) asked a startling question:  What if the “health care glutton” is the new welfare queen?  This idea came at the end of a column addressing the recent efforts to scale back the Family and Medical Leave Act (FMLA), which provides workers with twelve weeks of unpaid leave to care for a personal illness, a new child, or a sick relative.  The statute’s critics want to tighten eligibility, allowing only workers with the most “serious” medical conditions to use the program.  Warner spends most of her column making the usual arguments that the FMLA cannot afford to be any more feeble than it already is.  The leave is unpaid, giving workers little incentive to take it unnecessarily, and the United States already has one of the weakest family leave systems in the world.  Our lack of paid maternity leave is on par with that of Liberia and Swaziland.

Warner derives the idea of the “health care glutton” from President Bush’s recent foray into the health-insurance debate, where he accused many American workers of having “overly expensive, gold-plated” health plans, and from the rhetoric of the National Coalition to Protect Family Leave (yes, that’s the group pushing to water down the law), which says that Americans are abusing the FMLA by taking leave for cosmetic surgery and “pink eye, ingrown toenails and colds.”  She conceives the “health care glutton” as the “villain du jour,” who “consumes doctor’s visits like so many donuts, sloughing off the burdens of his waste onto the hard-working and the health-care abstemious.”  She concludes by warning that if such rhetoric takes hold, the quality health insurance some American workers do have could go the way of welfare benefits.

If the image of the “health care glutton” takes hold, it could have a damaging effect on the consumer bankruptcy debate as well.  One of the central arguments for a generous consumer bankruptcy system is that vast majority of families who file for bankruptcy do so because of job loss, divorce, and/or medical problems.  But if the fact of having high medical bills becomes stigmatized in and of itself, where does that leave us?  Current bankruptcy critics argue that families who file are spendthrifts who acquire too many luxury goods.  I have nightmarish visions of future bankruptcy critics contending that these families are spendthrifts who acquire too much luxury health care.

The Department of Labor is accepting comments about the FMLA here until February 16.

Debt Relief for Prosecutors and Public Defenders

Earlier this week Senator Dick Durbin introduced legislation that would create a student-loan repayment program for new prosecutors and public defenders.  The program would cover up to $10,000 per year of loans, with a lifetime cap of $60,000.  To be eligible, attorneys would commit to at least three years of service.  It is heartening to see progress on student loans being made during the week that Credit Slips guest blogger David Moss has so effectively articulated the inadequacies of the current system.

More than 80 percent of law students finance their education with loans, and they graduate with extraordinary amounts of student debt – an average of $51,056 for state school graduates and $78,763 for those who graduate from private schools.  Many of these students still carry additional debt from their undergraduate educations.  Starting salaries for attorneys in the criminal justice system are in the mid-$40,000s, with a median of $46,000 for State prosecutors and $43,000 for public defenders.  (Federal prosecutors are already covered under a separate program.)  Persuading students to take jobs with starting salaries below their level of total debt is a tough sell.  A program like this would eliminate some of the hardest choices students face.

The Fed and Foreclosure

Imagine if instead of the warnings on cigarette packages, tobacco companies were required to insert a small pamphlet containing facts and figures about smoking.  It would be written in plain English, but the information could still be primarily technical.  It would encourage purchasers to ask themselves questions like, “Is smoking the right choice for you?”

That is what the Federal Reserve has done in its recent update to its Consumer Handbook on Adjustable-Rate Mortgages.  The new handbook includes many welcome warnings about the risks of ARMs.  It cautions consumers that their mortgage payments may increase dramatically, that most brokers are not required to find them the best deal, that interest-rate caps do not provide complete protection from rate increases, that pre-payment penalties can prevent them from refinancing or selling their homes, and that minimum payment plans can result in consumers owing more money than they originally borrowed.

But simply providing the right information is not enough.  The handbook needs to warn consumers that taking out adjustable-rate mortgages they cannot afford could lead to them losing their homes. (Not once does the handbook mention the f-word, foreclosure.)  And it needs to drive that message home in such a way that consumers will grasp the message on a psychological level.  It needs to do the equivalent of the thetruth.com ad I saw on TV this weekend where a “singing cowboy” "sings" “you don’t always die from tobacco” through a hole in his throat.

Fake News Gets It Right

Today the satirical newspaper The Onion unwittingly parodied one of the central debates in consumer bankruptcy – whether American consumers are choosing to spend too much money on luxuries or being forced to spend too much money on necessities.  The "news article" is entitled "End-Life Crisis Marked By Extravagant Spending Spree" and describes the "indulgent" spending of a 75-year-old grandfather on items such as blood transfusions and visits to the cardiologist.  The article "quotes" friends and family members who criticize "all those fancy new breathing tubes he now wears" and ask, "What's he going to do next, gallivant off to some $10,000-a-day, all-inclusive hospice?"

Happy Birthday, Justice Brandeis

Today marks the 150th birthday of Supreme Court Justice Louis Brandeis.  He was not only one of the great American legal thinkers, but also one of the most influential proponents of using information about the reality of people’s lives to drive legal analysis.  Brandeis was at the forefront of the movement to bring empirical research into the law, and in many ways all of us here at Credit Slips are working in the tradition he helped create.  Adam Cohen published a very nice piece in the New York Times today about Brandeis’ life and his “insistence on injecting facts and real-world analysis into the law.”  It is well worth reading.

Credit Card Debt Goes Top 40

Now we know credit card debt has truly arrived.  There’s a new way to win money on the radio.  In addition to the usual cash prizes and concert tickets, Boston’s local Top 40 station, Kiss 108, has started paying listeners’ credit card bills.  Contestants send in a copy of their credit card bill and an explanation of why they can’t pay it themselves.  The radio station then announces the lucky debtors in much the same way that it would announce the winners of Justin Timberlake tickets.

Legislating Confusion

Consumer bankruptcy attorneys just can’t win.  Among the most controversial changes the Bankruptcy Abuse Prevention and Consumer Protection Act made to the Bankruptcy Code are the provisions regulating the relationship between consumer debtor attorneys and their clients.  Collectively, sections 526, 527, and 528 of 11 U.S.C. impose a number requirements on consumer debtor attorneys, restricting the advice they can give, compelling them to make disclosures not required of other attorneys, and requiring them to advertise themselves as “debt relief agencies.”  The statute refers to consumer bankruptcy attorneys as “debt relief agencies” throughout. See, e.g., 11 U.S.C. § 101 (12A).  Debtor attorneys are not exactly overjoyed about the changes and have been challenging these provisions since they went into effect, arguing, among other things, that “they restrict attorney advertising in a manner inconsistent with the First Amendment.”

So imagine my surprise when I came across the following warning on a Federal Trade Commission consumer-education web page: “BUYER BEWARE! ADS PROMISING ‘DEBT RELIEF’ ACTUALLY MAY BE OFFERING BANKRUPTCY.” 

As Colorado Goes, So Goes the Nation?

The Denver Post just published a fourth article in its well-researched series on foreclosures in Colorado.  The articles focus on the extreme conditions in Colorado – the state with the highest foreclosure rate in the nation – but many of its themes apply across the across the county. The series tells of recently-built neighborhoods in which one-fourth of the homes have been foreclosed.  It discusses the increasing proportion of interest-only and adjustable-rate mortgages, which account for an astonishing 43.6 percent of mortgages in Colorado. The national rate of 26.7 percent may seem small in comparison, but it too has skyrocketed in recent years. (In 2001, fewer than 2 percent of home loans were interest-only mortgages. Adjustable-rate mortgages accounted for about 14 percent of the market as recently as 2003.)

The Post also did some original empirical research of its own, and the results suggest that the state’s rates of foreclosures and its rates of high-risk mortgages are not unrelated. The newspaper studied all the foreclosure notices filed this August in three Colorado counties which have been particularly hard hit by the foreclosure boom.  Of the nearly 1,000 notices it examined, it found that, when excluding mortgages based on certain federally insured loans that require a small down payment, over seventy percent of the underlying loans were no-money-down. This means that the families became homeowners with no equity in their homes.

This series also tells a Colorado version of a story that has been documented nationally by the Consumer Bankruptcy Project.  The families in the Post articles take on mortgages with payments that are barely affordable when times are good. When something goes wrong, these families are forced into foreclosure.  Here that “something” ranges from divorce to surgery following a car accident to pay cuts to neighborhood covenants that required the new owner to landscape the property.  The Post’s research comports with the Consumer Bankruptcy Projects national findings in one other key respect.  Although a negative life event may be the immediate catalyst that sends a family into crisis, it is the family’s underlying financial structure – too much debt, too few assets (in this case, home equity) – that leaves it so vulnerable in the first place. As the reporters wrote in the most recent article in the series:  “In interviews with dozens of homeowners in foreclosure, The Post found that life events such as job loss, medical problems and divorce often precipitate a default. But lack of equity, which gives homeowners options when they face financial problems, was a factor in nearly all cases.”

You’ll Wish the IRS Were Collecting Your Taxes.

The New York Times and the AP report that the IRS is moving forward with its plan to turn over the collection of relatively small amounts of back taxes to private collections agencies. Starting this September, CBE Group Inc., Linebarger Goggan Blair & Sampson LLP, and Pioneer Credit Recovery Inc. will be in charge of collecting back taxes of under $25,000 from 12,500 taxpayers.  The agency plans to contract with eight more private debt collection companies to collect back taxes from approximately 350,000 taxpayers by 2008. 

There’s an idea.  Take an industry that’s come under scrutiny for abusive practices in two recent exposes [and here] and turn over a core governmental function to it.  The private companies will be paid by the amount they collect, so they will have strong incentives to use aggressive collection tactics. The Associated Press quoted National Treasury Employees Union President Colleen Kelley as saying that she has “‘no confidence at all’ in the agency's ability to make sure the private firms are not overstepping their bounds.”

Budgetary constraints appear to have forced the IRS’ hand. The agency has funds already allocated for a private program, but believes that it could not get budget authorization from Congress to hire additional IRS collection agents. But there are several problems with this proposal, not the least of which is that the IRS acknowledges that it will cost the federal government substantially more to contract with private companies than to hire more IRS agents to do the job.  In addition, giving volumes of confidential personal information about taxpayers to private companies raises significant privacy concerns.  But from a debtor-creditor perspective, my worry is this:  in an industry where debt collectors are often accused of overreaching, what kind of power will companies have when they can say they are collecting debts on behalf of the United States government?

Small Claims Courts: The New Debt Collectors

One point from the Boston Globe story that’s particularly interesting is the role of small claims courts.  These courts are supposed to be about small-time justice, about providing a informal forum for ordinary people who can’t usually afford lawyers, about ensuring some degree of law and order for plaintiffs whose claims are of less value than the lawyers’ fees it would otherwise cost to prosecute them.  In my personal experience, I’ve seen a freelance computer programmer sue for payment for completed work and tenants sue sub-letters for non-payment of rent.  But according to the Globe, “an estimated two-thirds of small claims lawsuits are now filed by debt collectors.”  Undoubtedly, part of the attraction for debt collectors is the low filing fees.  It costs just $40 to sue someone for up to $2,000 in Massachusetts small claims court.  These companies couldn’t afford to bring so many suits for $500 or $1,000 if they had to go to district court.  But that was supposed to be the beauty of small claims system in the first place; ordinary citizens couldn’t sue each other for $500 or $1,000 either if they had to use a more expensive forum.

This raises some questions about what we want our small claims system to look like. We tend to think of small claims cases as being ordinary citizens suing other ordinary citizens about mundane, ordinary matters, like minor property damage or fender-bender auto accidents.  And in the best case scenario, they can be a forum for ordinary citizens to take on more powerful interests, as when freelance workers sue for unpaid wages.

But the Globe story shows what happens when the system is turned inside out.  Now powerful repeat players have found a cheap way to sue on debts.  These big-time players--not ordinary citizens--are using two-thirds of this judicial resource in Massachusetts.  No longer are these courts a level playing field for the ordinary citizen to seek justice.  Perhaps it is time to limit institutional players’ access to this forum before our small claims system simply becomes an arm of the collection agencies.