452 posts categorized "Financial Institutions"

Further Thoughts on Coinbase: Two Mysteries

posted by Adam Levitin

I've been puzzling over two mysteries in the Coinbase saga:  first, why does Coinbase care so much if Lend is deemed a security, and second, why did the SEC want the list of Coinbase customers who had signed up in advance for Lend. I don't know that I've got all of this sussed out, but I figure I'll put my thinking out into the Internets and see if others have thoughts.

Continue reading "Further Thoughts on Coinbase: Two Mysteries" »

Collins v. Yellen: the Most Important (and Overlooked) Implication

posted by Adam Levitin

The Supreme Court's decision in Collins v. Yellen has garnered a fair amount of attention because it resulted in a change in the leadership at the Federal Housing Finance Agency and largely dashed the hopes of Fannie and Freddie preferred shareholders in terms of seeing a recovery of diverted dividends. But the commentary has missed the really critical implication of the decision:  the Biden administration can undertake a wholesale reform of Fannie and Freddie by itself without Congress.

Continue reading "Collins v. Yellen: the Most Important (and Overlooked) Implication" »

Fake Lender Rule Repeal

posted by Adam Levitin

The House is schedule to take up a vote on repealing the OCC's "Fake Lender Rule," that would deem a loan to be made by a bank for usury purposes as long as the bank is a lender of record on the loan. Under the rule, issued in the waning days of the Trump administration, the bank is deemed to be the lender if its name is on the loan documentation, irrespective any other facts. Thus, under the rule, it does not matter if the bank was precommitted to selling the loan to a nonbank, which undertook the design, marketing, and underwriting of the loan. The bank's involvement can be a complete sham, and yet under the OCC's rule, it loan would be exempt from state usury laws because of the bank's notional involvement. The Fake Lender Rule green lights rent-a-bank schemes, which have proliferated as the transactional structure of choice for predatory consumer and small business lenders. 

Fortunately, the Fake Lender Rule can still be overturned under the Congressional Review Act, which allows certain recently made rules to be overturned through a filibuster-free joint resolution of Congress. Such a joint resolution passed the Senate 52-47 last month. Now the House is poised for its own vote. While the Senate vote was largely on partisan lines, some Republicans did join with Democrats to vote for the repeal. The dynamics in the House are somewhat different, as certain Democratic members have been opposed to the bill, but the fact that a vote is scheduled suggests that there should be the votes for repeal. 

The repeal of the Fake Lender has been endorsed by a group of 168 scholars from across the country, including yours truly and many Slipsters. You can read our letter urging the repeal here

Are Mortgage Servicers Ready for the Loan Mod Rush?

posted by Chris Odinet

On May 4, the CFPB issued a report sharing information the agency had gathered about mortgage forbearances and delinquencies. One notable takeaway is that Black and Brown homeowners, as well as low-income homeowners, are very prevalent among those in forbearance. A large portion of those in forbearance also have loan to value ratios north of 60%. All of this suggests that many who face chronic financial struggles and are most at risk of losing their homes, are also those currently benefiting from the forbearance programs.

This makes me immediately think: what happens when the forbearance periods are over? (which most believe will happen between September and November of this year) Specifically: what will their loan modifications look like?

Continue reading "Are Mortgage Servicers Ready for the Loan Mod Rush?" »

A Campaign to Opt-Out

posted by Chris Odinet

Following-up on my prior post, let’s talk more about what’s at stake in this little legislative kerfuffle in the Hawkeye state, as well as how consumer advocates should seize on this moment in a different way.  

First, repealing this 521 provision in Iowa law is really all about whether states should have, to a large degree, the ability to control the interest rates charged on products and services that are offered to consumers by nonbank firms. 

Many readers of this blog may already know this history backwards and forwards – but for those who don’t, here’s the backstory. In Marquette Nat’l Bank of Minneapolis v. First of Omaha Serv. Corp., the U.S. Supreme Court interpreted the National Bank Act as giving nationally-chartered banks the ability to charge the highest interest rate allowed in the state where the bank is located to borrowers located not only in that state, but also to borrowers located in any other state.  This means, for instance, that a national bank located in Iowa can not only charge the highest interest rate allowable in Iowa to anyone located in Iowa, but it can also charge that same rate to a borrower located in Oklahoma, Louisiana, or any other state.  Even if Louisiana, Oklahoma, or another state’s laws prohibit interest at such a rate, the loan is nevertheless free from being usurious. This concept is known as “interest rate exportation.”  

After the 1978 decision in Marquette, there was a concern about the ability of state-chartered banks to compete with national banks. So, state legislatures started enacting “parity laws” that allowed their state banks to charge the maximum rates of interest allowable by any national bank “doing business” in that particular state. These parity laws were often even broader, granting to state chartered banks all of the incidental powers granted to national banks. In sum, the goal of these parity laws was to put state banks on equal footing with national banks, particularly when it came to usury.  Good so far?

Ok here comes the part dealing with this shady Iowa house bill…

In a final effort to give state-chartered banks a competitive edge, in 1980 Congress passed the Depository Institutions Deregulation and Monetary Control Act (DIDMCA).  A portion of DIDMCA, specifically section 521 (see where this is going...) granted interest rate exportation to any state-chartered bank that was federally insured (in other words, to all FDIC-insured state-chartered banks). 12 U.S.C. 1831d. This allowed a state-chartered bank to charge out-of-state borrowers the same interest rate allowable for in-state borrowers.  Thus, a state-chartered bank located in Iowa could charge an Oklahoma borrower the Iowa-allowable interest rate, even if that rate was higher than what would otherwise be legal under Oklahoma law. 

But here’s the catch. In Section 525 of DIDMCA, Congress gave states the ability to opt-out of section 521 by enacting legislation stating the state did not want section 521 to apply. Only two jurisdictions opted out: Puerto Rico and…you guessed it…Iowa. In 1980, right after DIDMCA was passed, Iowa opted out per 1980 Iowa Acts, ch. 1156, sec. 32. To add one more bit of background, Iowa also did not enact any parity laws. In fact, a former general counsel to the Iowa Division of Banking stated in a 2002 interview that enacting such a law that delegated control over Iowa state banks to the feds would be seen as “a slap in the face” to the Iowa legislature. 

So, there you have it. This little provision in an otherwise unrelated tax bill is to OPT INTO section 521 and thereby reverse the decision Iowa’s legislature made in 1980.

Now you may say to yourself, why is this so bad? The bad part requires you know something about the rent-a-bank partnership model between certain state-chartered banks and a number of online “fintech” lenders. Since the 2008 financial crisis, a growing number of nonbank fintech firms that make loans over the internet have partnered with a handful of state-chartered banks (mostly chartered in Utah, Kentucky, and New Jersey) in order to make and market unsecured installment consumer loans. By and large the way the business model works is that although the loan application is submitted through the nonbank’s website or smartphone app, it is the partner bank that actually advances the funds. The marketing and underwriting process are both performed by the nonbank. Then, very shortly after, the bank sells the loan along with others (or some interest in those loans) to the nonbank fintech company or an affiliate. The fintech or another firm then sells the interest to a pre-arranged wholesale buyer or sponsors a securitization of a large pool of loans for sale as securities in the capital markets. 

The bank’s role is merely passing, and it typically retains no material economic interest in the loans. However, so the argument goes, because the loan is originated by an insured state-chartered bank, it can export the interest rate of its home state to borrowers located in ANY state (with state usury laws preempted by DIDMCA section 521). And sometimes these loans can be quite expensive (rates of 160% APR or more e.g., CashNet USA, Speedy Cash, Rapid Cash, Check n' Go, Check Into Cash). You can get more info on these partnerships and check out some nifty maps provided by the folks at the National Consumer Law Center here. 

So, here’s how I think consumer advocates can turn the tables. There are a number of states that have aggressively gone after these rent-a-bank schemes (adding a lawsuit by AG of DC to the mix here) and a group of state AGs are currently suing the OCC on account of its true lender rule. In other words, a number of states do not want this kind of high cost, fintech-bank lending happening in their jurisdiction. 

Here’s my suggestion to those states: why not just pass your own opt out of DIDMCA Section 521? 

As mentioned above, many of these online lenders in high-cost rent-a-bank schemes favor partnering with FDIC-insured, state-chartered banks rather than national banks. Opting out of DIDMCA would deprive these schemes of their regulatory arbitrage. Without the ability to import the interest rate law of another state into a given jurisdiction, it would force these online firms to apply for a lending license and otherwise abide by the jurisdiction’s usury limit. DIDMCA allowed states to opt out of Section 521, and the statute didn’t give a deadline to do it. So, here’s a call to states like Colorado and others who are going after these usury and regulatory evasive business models…take away the linchpin of the business model. Opt-out of section 521!

And as for those of us back here in the Hawkeye state, here’s to hoping that the Iowa legislature doesn’t (pardon the Peloton pun) get so easily taken for a ride.

Of Usury, Preemption, and Fancy Stationary Bikes

posted by Chris Odinet

Greetings, Slipsters! I’m thrilled to be here guest blogging, and I thank the editors for having me. So with that, let me get started…

Usury, preemption, and pandemic fitness are all colliding here in Iowa. 

About two weeks ago, I was alerted to a single strike-through amendment buried in a tax bill currently being considered by the Iowa legislature. This simple little change that eliminates three numbers (“521”) would likely go unnoticed by most lawmakers (or, more realistically—all lawmakers). However, this little change could have a profound impact on Iowa’s ability to prevent high cost, predatory lending from spilling into its borders through website portals and smart phone apps. And, if you stay with me for this bit of guest blogging, you’ll never believe what’s supposedly (so I’m told) behind it all! 

The bill is HSB 272. Most of the bill contains routine tax code clean-ups and modifications. Indeed, the bill itself is sponsored by the Iowa Department of Revenue. But, take a look at the relevant part of Section 5:

1980 Iowa Acts, chapter 1156, section 32, is amended to read as follows: SEC. 32.  The general assembly of the state of Iowa hereby declares and states . . . that it does not want any of the provisions of any of the amendments contained in Public Law No. 96-221 (94 stat. 132), sections 521, 522 and 523 to apply with respect to loans made in this state . . .

If you clicked on the link above and read the entirely of Section 5, you’d probably have to go through the text quite a few times before you’d see what’s being stricken out. The singular change is just the reference to section 521 of Public Law No. 96-221 (94 stat. 132). Otherwise, everything else in this existing statute stays the same. 

So what’s this about? 

The only clue as to what this stricken language actually deals with is the reference to “loans made in this state.” In truth, this single little strikethrough will allow FDIC-insured state-chartered banks located in other states to make loans under the usury laws of their home states to the residents of Iowa. This kind of lending usually comes in the way of partnerships between a handful of state-chartered banks and so-called “fintech” nonbank lenders making triple digit loans, hardly any different from payday financing. This partnership lending practice has also been the subject of recent lawsuits, including a summer 2020 settlement by the Colorado AG. If you’re interested in a deep dive on the rent-a-bank model and the unique legal and policy problems it creates, check out forthcoming articles here (by Adam Levitin) and here (by me!).

The icing on the cake, however, is that the rationale (again, as I’ve been told) advanced by proponents of the bill is that without this amendment, Iowans will not be able to finance the purchase of Pelotons. That’s right. Pelotons!

Here’s the connection: Peloton currently partners with Affirm, a fintech online lender, in order to help consumers finance the purchase of these roughly $3,000 stationary bikes (bike + membership). Interestingly, both firms generally promote 0% down, 0% APR, 0% hidden fees in their financing package. Of course, if you scroll down to the bottom of the promotional website and read the tiny 10.5 point, gray font print, you’ll notice: 

Your rate will be 0–30% APR based on credit, and is subject to an eligibility check. Options depend on your purchase amount, and a down payment may be required. Affirm savings accounts are held with Cross River Bank, Member FDIC. Savings account is limited to six ACH withdrawals per month. Affirm Plus financing is provided by Celtic Bank, Member FDIC. Affirm, Inc., NMLS ID 1883087. Affirm Loan Services, LLC, NMLS ID 1479506. California residents: Affirm Loan Services, LLC is licensed by the Department of Financial Protection and Innovation. Loans are made or arranged pursuant to California Financing Law license 60DBO-111681 (emphasis added).

As you can see, Affirm also plays the rent-a-bank game by partnering with FDIC-insured Utah state bank, Celtic Bank. While 30% APR may not seem like the most expensive loan term in the world, it opens the door to much higher cost lending by firms like Elevate Credit, Opportunity Financial, and more--all of whom use the rent-a-bank model. 

This is about much more than Pelotons…stay tuned for more (including how I think consumer advocates can turn the tables on this strategy!).

UPDATE: It appears that HSB 272 isn't going anywhere: no legislative movement since a canceled House subcommittee hearing on April 6. Meanwhile, a duplicate tax bill has been filed in the Senate, but it does not contain the DIDMCA opt-out (SSB 1268).

Abolish the OCC?

posted by Adam Levitin

I've been saying for quite a while that the OCC is a "problem agency" that is seriously in need of reform. An article in Politico today underscores the problem. The OCC—under a civil servant acting Comptroller—has begun an active lobbying campaign to protect its so-called "True Lender" Rule. Not only is this highly irregular, but it also suggests that the OCC just doesn't "get it." As I explain below, this isn't a one off flub by the agency, but it is part of the agency's DNA, and isn't likely to be changed simply by putting in a good Comptroller. Fixing the OCC may require something more than a personnel change at the top. 

Continue reading "Abolish the OCC? " »

Greensill "Secured" Lending

posted by Stephen Lubben

Slips readers will be interested in Matt Levine's column today, which takes a deep dive into the recently failed Greensill's lending against “prospective receivables,” which is kind of like lending against my prospective estate in Scotland. Both look a lot like unsecured lending.

Not Cool, Bank of America

posted by Adam Levitin

I used my phone to remotely deposit a check today at Bank of America. Before I was able to proceed with the transaction, however, Bank of America required me to agree to new terms and conditions for mobile deposits. The terms and conditions were presented to me on my smartphone (roughly a 4''x 2'' screen). I could have pressed "accept" before I scrolled through any of the terms, but I actually went and scrolled through.  It took several scrolls before I got to the end—these were not a short list of terms and conditions, and there was no indication of what had changed. I have no idea there was only a minor amendment or something substantial. More disturbingly, I was given no option of printing or emailing myself the new terms and conditions to which I agreed; I have no idea where (if anywhere) I can access those terms that I have supposedly "agreed" to.  

Continue reading "Not Cool, Bank of America" »

The OCC Is a Problem Agency

posted by Adam Levitin

It's time to say it loud and clear: the OCC is a problem agency.

Here's a list of only some of the issues from the past year: the fair access rule, toleration of rent-a-banks, the valid-when-made rule, the true lender rule (that the FDIC notably didn't copy), the fintech charter, Figure's bank charter application, failure to deal with BoA's fair housing issues; failure to take JPM's unauthorized overdrafts seriously, even a ridiculous interpretation of preemption standards that came out today. (Does this laundry list of problems remind anyone of the FHLBB or OTS?)  

Continue reading "The OCC Is a Problem Agency" »

Regulatory Comments to the OCC on the Fair Access to Financial Services Rule

posted by Adam Levitin

I submitted comments to the OCC about its proposed rulemaking regarding Fair Access to Financial Services. I previously blogged on the topic here and here. There are a LOT of problems in this poorly thought-through rulemaking, starting with whether there is even statutory authority, continuing to its myriad inconsistencies with safety-and-soundness (and thank goodness for President Trump, who provides many helpful examples), going on to First Amendment problems, and then wrapping up with an antitrust analysis that would flunk any antitrust course—it doesn't even define a relevant product market! Sigh. 

Figure's National Banking Charter Application: Illegal and Bad Policy

posted by Adam Levitin

It's not every day that I write a letter in opposition to the issuance of a bank charter. But that's what I just did. Here is my comment letter to the Office of the Comptroller of the Currency in opposition to the charter application for Figure, which is seeking to operate an uninsured national bank. Not only is that not legally permitted, but issuing such a charter would be jaw-droppingly terrible policy from both a safety-and-soundness and consumer protection standpoint. I often disagree with the OCC only policy issues, but chartering an uninsured national bank goes far beyond any reasonable policy position. 

There are lots of reasons to be concerned about Figure's application on its own, but what really worries me is that Figure will be the camel's nose under the tent. If it's possible to get a national banking charter without being an insured depository or subject to the Bank Holding Company Act or the Community Reinvestment Act, ever tech company and its mother is going to be lining up to become a national bank. 

Commercial and Contract Law: Questions, Ideas, Jargon

posted by Melissa Jacoby

In the Spring I am teaching a research and writing seminar called Advanced Commercial Law and Contracts. Credit Slips readers have been important resources for project ideas in the past, and I'd appreciate hearing what you have seen out in the world on which you wish there was more research, and/or what you think might make a great exploration for an enterprising student. This course is not centered on bankruptcy, but things that happen in bankruptcy unearth puzzles from commercial and contract law more generally, so examples from bankruptcy cases are indeed welcome. You can share ideas through the comments below, by email to me, or direct message on Twitter.

Also, I am considering having the students build another wiki of jargon as I did a few years ago in another course. Please pass along your favorite (or least favorite) terms du jour in commercial finance and beyond.

Thank you as always for your input, especially during such chaotic times.

The OCC Stands Up for Fossil Fuels, Gun Makers, Opioid Manufacturers, and Payday Lenders

posted by Adam Levitin

Those wascally wabbits at OCC are back at it again in the waning light of the Trumpshchina. The OCC has proposed a rule on "Fair Access to Financial Services." 

The gist of the rule is that banks cannot deny service to business based on the bank's opinion of "the person's legal business endeavors, or any lawful activity in which the person is engaging or has engaged."  Instead, the bank may deny service only based on "quantified and documented failure to meet quantitative, impartial, risk-based standards established in advance by the covered bank".  

This means that if a bank has moral qualms about financing the fossil fuel industry, opioid manufacturers, firearm manufacturers, payday lenders, reproductive health services, pornographers, gay conversion therapy, fur farming, makers of drug paraphernalia, the private prison industry, or businesses involved in the deportation of immigrants, to give a range of examples of businesses that pose serious reputational risk to banks (and very direct financial risk in some instances), well, too bad. Unless the bank can show that the borrower doesn't meet quantitative, impartial, risk-based underwriting standards, it must lend because these are all legal industries. Is it like that any bank will ever have "quantitative, impartial, risk-based underwriting standards" regarding a particular disfavored industry? The standard for denial of service is near impossible to meet, as it seems to require some sort of empirically grounded underwriting by industry that banks are unlikely to have. 

Put another way, the OCC's proposed rule says reputation risk doesn't matter. That's insane. It's a quite reasonable business decision for a bank to say that it doesn't want to be known as the bank that financed school shootings or consumer lending products that it would never offer itself. A bank might reasonably fear that it would lose a chunk of its deposit base if it became known as the go-to bank for a controversial industry. If you don't think reputation risk matters, look at the law firms that have been dropping President Trump's election appeals like a hot potato. They are terrified that they are going to lose other clients who don't want to be associated with those efforts. All the more so with a bank, where depositors are literally financing the loans.  

Continue reading "The OCC Stands Up for Fossil Fuels, Gun Makers, Opioid Manufacturers, and Payday Lenders" »

OCC Suggests "Fair Access" Rulemaking to Require Banks to Finance the Oil and Gas Industry

posted by Adam Levitin

Just when you think it can't get more ridiculous... The Office of Comptroller of the Currency, which hasn't taken racially discriminatory lending seriously, is concerned about banks' discriminatory refusal to serve the oil and gas industry. In fact, the OCC is so concerned that it is suggesting legal theories so farfetched that would be laughed out of a courtroom if it actually tried to act on them. 

The underlying issue here is that banks seem have gotten cold feet about financing fossil fuels. Why? Any number of reasons, including that their investors don't like it (ESG), that global warming threatens their own balance sheets, that oil and gas prices right now are so low that investment in the sector might not be a good business move, and that there's huge risk to fossil fuel projects' value based on the 2020 election outcome. But Senator Dan Sullivan of Alaska wants to drill in the Arctic and has expressed concern about banks' unwillingness to fund global warming to the OCC.

In response, the Acting Comptroller of the Currency, Brian Brooks, wrote a letter to Senator Sullivan that can only be described as verging on legal malpractice in the service of political expediency while pushing a vision of economic regulation that looks like communist China. 

Acting Comptroller Brooks argues that 12 U.S.C. § 1(a):

requires the OCC to ensure that banks provide "fair access" to financial services. Decisions by major banks to deny the oil and gas sector, among other targeted industries, access to financial services may violate that statute. Accordingly, the OCC will examine the possibility of issuing regulations defining fair access to provide clarity to banks and customers alike.

Let's take a look at 12 U.S.C. § 1. The relevant section states:  

There is established in the Department of the Treasury a bureau to be known as the “Office of the Comptroller of the Currency” which is charged with assuring the safety and soundness of, and compliance with laws and regulations, fair access to financial services, and fair treatment of customers by, the institutions and other persons subject to its jurisdiction.

12 USC 1 is a general expressive statement of the general purposes of the OCC. It's not even a "be excellent to each other" sort of exhortation. It is not by any stretch a provision creating any substantive rights or obligations. If OCC tried to use this as the basis for a "fair access" rulemaking, as Brooks suggests, the rulemaking would get thrown out by a court on an APA challenge in a hot minute. 12 USC 1 authorizes the OCC to do precisely nothing. 

Whatever 12 USC 1 is, it is not a roving commission for the OCC to undertake rulemakings about "fair access" and "fair treatment", etc. It is not a free-standing authorization to undertake any sort of rulemaking. It is very plainly not a delegation by Congress. Furthermore, the suggestion that "Decisions by major banks to deny the oil and gas sector ... access to financial services may violate that statute" is risible. 12 USC 1 is at most an obligation on the OCC, not on banks. It's embarrassing to see the OCC put forth such a legal argument.  

Note that what Brooks is proposing is the flip-side of the allegations made against Operation Chokepoint, namely that regulators were discouraging banks from lending to certain disfavored industries. Now Brooks is talking about forcing banks to lend to certain favored industries. That sounds like ... communist China. It makes my head spin. 

(btw, where are the conservatives who bitch about affordable housing goals and the CRA? Aren't they up in arms that a financial regulator is talking about forcing banks to lend to someone?)  

But let's say that I'm wrong and Brooks is right. Consider the implications. Imagine what a Comptroller with a different political tinge might have with provisions such as "fair treatment of customers" and "fair access to financial services". Who needs UDAAP when you've got "fair treatment"? Who needs CRA, when you've got "fair access"? If Brooks wants to weaponize 12 USC 1, he might want to first recognize that "fair" is a word that progressives can do a lot more with than he can.  

No More Bailouts

posted by Adam Levitin

I have a new white paper out from the Roosevelt Institute's Great Democracy Initiative. The paper, which is co-authored with Lindsay Owens and Ganesh Sitaraman, proposes a standing emergency economic stabilization authority to provide an off-the-shelf immediately available response to common problems that recur in national economic crises.

The motivation for the white paper is that in the past dozen years we've been through two rounds of massive ad hoc bailouts. We shouldn't be doing this on the fly. Instead, we need to have a suite of programs ready to go. Think of this as an "in case of emergency, break glass" approach.

Continue reading "No More Bailouts" »

How to Start Closing the Racial Wealth Gap

posted by Adam Levitin

I have an article out in The American Prospect about How to Start Closing the Racial Wealth Gap. Unlike a lot of writing bemoaning the racial wealth gap, this piece has a concrete reform that could be undertaken on day 1 of a Biden administration without any need for legislation or even notice-and-comment rulemaking. The article  points the disparate impact of an obscure, but enormous indirect fee on mortgage borrowers that the Federal Housing Finance Agency has required Fannie Mae and Freddie Mac to charge since 2007. The fee is structured in a way that disadvantages borrowers with fewer resources and lower credit scores, which has a disparate impact on borrowers of color. (I'm not saying it's an ECOA violation--that's a different analytical matter.) The fee was adopted in response to a competitive environment in 2007 that doesn't exist today; there's really no good reason for the fee to exist any more. 

The Great American Housing Bubble

posted by Adam Levitin

My new book, The Great American Housing Bubble:  What Went Wrong and How We Can Protect Ourselves in the Future was just released by Harvard University Press. The book is co-authored with my long-time collaborator, Wharton real estate economist Susan Wachter. It's the culmination of over a decade's worth of work on housing finance that began in the scramble of fall 2008 to come up with ways of assisting hard-pressed homeowners.

Continue reading "The Great American Housing Bubble" »

The Brown M&M Theory of Telltale Minor Regulatory Violations or What's Wrong with "Earn a savings rate 5X the national average"?

posted by Adam Levitin

A CapitalOne savings account ad has got me thinking about whether Van Halen has anything to teach regulators. Van Halen is famous for its use of a contract that requires provision of M&Ms for the band, but expressly prohibits provision of any brown M&Ms. It's not that they taste different, of course, but that if a concert promoter fails to adhere to the brown M&M term in the contract, it's a red flag that there might be other more serious problems, so the band will undertake a safety check of the stage and equipment. 

IMG_5469So what does this have to do with CapOne?  I'm one of the few folks in the world who bothers to teach the Truth in Savings Act, so I'm probably more inclined to pay attention to deposit account advertising than most folks. I was about to throw out an early May issue of The Economist (yes, my tastes run distinctly to middle brow), when a CapitalOne ad caught my eye.

The ad, which I've posted to the right says, "Why settle for average?  Earn a savings rate 5X the national average."  In smaller, less bold font it then says "Open a new savings account in about 5 minutes and earn 5X the national average." Under that, in smaller, but bold, "This is Banking Reimagined®." Faint, fine print on the bottom says "ONLY NEW ACCOUNTS FOR CONSUMERS. RATE COMPARISON BASED ON FDIC NATIONAL RATE FOR SAVINGS BALANCE < $100,000. OFFERED BY CAPITAL ONE, N.A. MEMBER FDIC © 2019 CAPITAL ONE" Above this is a photo featuring some random dude (or celebrity I don't recognize) with a croissant and coffee and faux casual outfit (jeans and a t-shirt, but a jacket with a pocket square) inviting the reader to join him. Breakfast and banking perhaps? But in the background, over his shoulder is a sign that says "Savings Rate 5X National Average" (its hard to read in the original, and doesn't come across in my photo, unfortunately).

So what's the problem here?

Continue reading "The Brown M&M Theory of Telltale Minor Regulatory Violations or What's Wrong with "Earn a savings rate 5X the national average"?" »

PPP Loan Fees for Banks

posted by Alan White

$10 billion of CARES Act funds are going to the banks, especially megabanks, in fees for making “small” business PPP loans. The fees established by Congress, to be paid by the Small Business Administration, i.e. Treasury, range from 1% for loans above $2 million to 5% for loans below $350,000.

The maximum loan amount is $10 million, so those loans generate a nifty $100,000 fee each. At least 40 large public companies received loans from $1 to $10 million.

Given the highly streamlined application process, these fees likely far exceed the costs of originating these loans. The 1% interest rate, while low, still exceeds bank cost of funds. Do the banks need a bailout? First quarter earnings reports for the largest banks show steep drops in earnings, but earnings are still positive. The earnings drop is entirely due to provisioning for expected loan losses; obviously predicting loan performance over the next year is a very tricky business. Nevertheless, the PPP fee structure is designed to subsidize financial institutions not especially in need of a bailout, especially compared to restaurants, main street stores, and other small businesses. In fact, given that SBA is waiving the guarantee fee, why don’t the banks just waive the fees and interest on these loans? And given the robust public subsidies to megabanks, why should SBA pay these fees in the first place? If banks have inadequate capital to weather the coming storm, surely there is a better way to support them than having SBA pay these arbitrary PPP loan fees.

Corona Cash and Refund Anticipation Checks

posted by Adam Levitin

Vijay Raghavan, who will be joining the Brooklyn Law School faculty this summer shared a troubling observation about the payment of the recovery rebates ("Corona Cash" or "Mnuchin Mnoney") through direct deposit to taxpayers. It seems that the payments for around 15% of individual tax filings might be going to bank accounts that are closed or not controlled by the taxpayers. That 15% is surely a much larger percentage of households eligible for Corona Cash. I wouldn't be surprised if close to a quarter of eligible households are affected.

Raghavan writes:

Recovery rebates (stimulus payments) under the CARES Act are supposed
to go out this week. A number of people have noted that the payments
will be delayed for unbanked consumers and the funds are at risk of
being swept by lenders or debt collectors. What has received less
attention is the fact that many banked or underbanked taxpayers may
not receive their rebates because they financed tax preparation with a
refund anticipation check (“RAC”). [AJL: a RAC is distinct from a refund anticipation loan, when the preparer advances the taxpayer part of the anticipated tax refund.]

RACs allow taxpayers to defer the cost of tax preparation and finance
preparation out of their refund. The refund is deposited in a
temporary bank account that the tax preparer arranges to have opened.
The taxpayer may never be made aware that the temporary account
exists. The refund is then distributed to the taxpayer minus
preparation fees and ancillary fees via check, direct deposit, or
using some other payment instrument.

The conventional wisdom is RACs are primarily used by unbanked
consumers. But many banked or underbanked taxpayers may also use RACs.
Smaller tax prep chains and individual tax prep stores rely on RAC
financing for at least two reasons. First, the intermediaries these
tax preparers use to process the returns charge numerous
per-transaction fees, which are easier to pay for out of a taxpayer’s
refund since the cash-strapped taxpayer can’t afford to pay for the
intermediaries’ services up-front. Second, financing may serve to
conceal inordinately high tax preparation fees. As a result, it is not
uncommon to find tax preparation stores in low-income neighborhoods
that refuse to accept up-front payment and only process RAC-financed
returns. In the 2018 tax year, approximately 21 million returns were
financed with RACs. [AJL: for context, there were around 150 million individual returns filed in 2018.]

RACs present a few problems for stimulus distribution. If returns were
already filed and processed, the temporary banks accounts may be
closed, which will delay distribution of the rebate. If the temporary
account is still open, the rebate may sit in the account without being
distributed. There should be less problems if returns have not been
filed or are still pending. But if refunds are initially distributed
to the tax preparer as opposed to the taxpayer (which happens in some
cases), there is some risk tax preparer may take the CARES Act money.

The good news is large chains like H&R Block and tax software
companies should have bank account information for the returns they
processed. They could turn this data over to the Treasury but the
CARES Act may limit the Treasury's ability to disburse payments. The
CARES Act seems to only allow electronic disbursement to accounts the
taxpayer has previously authorized. Taxpayers who regularly financed
tax prep with RACs likely have not authorized disbursement to their
own bank account or may not maintain an open bank account in regular
use. Treasury probably has to lean on preparers and software companies
to ensure that payments to RAC-financed returns are disbursed to the
taxpayer bank accounts.

The problems in doing a quick disbursal of Corona Cash highlight some deficiencies in the US payment and banking system. The House counterproposal to the CARES Act had in it a provision for the creation of FedAccounts--giving every consumer a bank account held at the Fed. It's kind of late in the game to try and set up such a system to deal with the corona virus crisis, but the crisis is exposing areas that need to be shored up going forward. 

The Bailout Cronyism and Corruption Have Already Begun

posted by Adam Levitin

We need to bail out the economy, and it's not going to be cheap. The government is going to have to carry the economy for 18-24 months. There's no way of avoiding that. But we don't need to be stupid or corrupt about the way we do it. And stupidity and corruption is unfortunately so hardwired into the Trump administration's DNA that it is being reflected in virtually every proposal out of the administration. 

Start with Treasury's ill-advised proposal to send checks out to every man, woman, and child in the United States. Beside being operationally difficult and misdirecting much of the aid, it is first and foremost a political move. These are serious times. They call for serious responses, not political maneuvers.  

And now, we learn that Treasury Secretary Steven Mnuchin is proposing turning to Goldman Sachs executives to provide assistance in administering the bailout. It's hard to think of anything more politically tone-deaf other than perhaps delegating the bailout to Wells Fargo.

More importantly, Goldman is objectively not the right institution to help. Goldman does virtually no small business lending, and their consumer lending is a small portfolio of loans to affluent individuals. It’s not even at the top of the bracket in commercial lending generally. Goldman is primarily an investment bank that does M&A and securities underwriting; they're not known as commercial bankers. The challenges in the bailout response are restructuring and commercial banking issues, including a lot of operational problems. That's just not where Goldman's strengths lie. So why Goldman? Just more cronyism.

This should be a bright flag to ever member of Congress that Steven Mnuchin cannot be trusted to lead the bailout efforts. If he does, we're looking at something a lot worse than HAMP 2.0. A key part of any bailout is going to be its governance. There's inevitably going to be a fair amount of discretion involved in the bailout efforts. We need the bailout to be led by serious people. Sadly, there are not many serious people in any position of authority in the Trump administration. That suggests that Congress needs to come up with a governance structure for any bailout funds that is new and independent of the Trump administration.

I don't mean by this that it needs to be a bunch of people who share my political views. There are plenty of competent and serious people from both parties who aren't in the Trump administration. Hopefully this is a time that Senator McConnell recognizes that he can't turn the keys over the Trumpists; the effectiveness of a bailout is going to depend on whether Congress gets the governance structure right. We need to take a serious problem serious and not see it as an opportunity for self-enrichment and political gain. 

 

COVID-19 Response: The Need for Speed

posted by Adam Levitin

While Congress struggles to figure out the best way to respond to the coronavirus pandemic, it is very apparent that immediate relief measures are necessary, if only to buy time for a more comprehensive approach. Layoffs are already happening and with they continue, it will result in more economic disruption from diminished consumption.

1. Sending out checks isn't fast enough (and can't happen in two weeks)

There is, fortunately, some recognition of that speed is imperative, but there's a right way and a wrong way to do it. The wrong way is what the Trump administration is proposing, namely sending everyone a check. Besides being poorly tailored—$1,000 isn't enough for those who really need help and is wasted on many other folks—the problem is it just cannot happen fast enough. No one is being honest about the operational problems. Treasury Secretary Steven Mnuchin is going around saying that he wants to get checks for $1,000 to every American within two weeks. That's just not possible, and Mnuchin should stop overpromising. 

Here's why it won't work fast enough: for Treasury to send everyone a check, it would need to know where to send the checks. It doesn't. Treasury knows where to send checks to individuals who are receiving Social Security and Disability Insurance (actually, it would be electronic transfers in almost all such cases). But what about everyone else? Treasury doesn't know (a) who is still alive, and (b) where they live. The first problem might mean sending out some checks that shouldn't happen, but the second problem is more serious, as it means that checks won't get where they need to go. Treasury is able to send me a tax refund because I give an address with my tax return. At best Treasury has year-old information, which will be wrong for many people. Those people who most need the money are the people who are most likely to have moved in the last year—economically insecure renters (see Matthew Desmond's Evicted on this). Sending everyone a check really isn't a very good solution. 

2. Foreclosure/eviction moratoria are equivalent to an immediate cash injection to the economy.

Fortunately, there's a better solution:  an immediate national moratorium on foreclosures, evictions, repossessions, utility disconnects, garnishments, default judgments, and negative credit reporting for all consumers and small businesses. The point of a national collection action moratorium is not to be nice to debtors. A national collection moratorium is a stimulus measure:  it has the effect of immediately injecting cash into the economy in that it allows people and businesses to shift funds from debt service obligations to other consumption. It's basically a giant forced loan from creditors to debtors. And it happens immediately, without any administrative apparatus. There's nothing else that will have such a big effect so immediately. Congress should move on moratorium legislation asap as a stand-alone bill to buy itself some more time for a longer-term fix.  

Now let's be clear—what I am talking about is not debt forgiveness. It is forced forbearance. The debts will still be owed and may accrue interest and late fees (there may be ways to limit those, but that's another matter). That's important because it substantially reduces the argument that the delay constitutes a Taking—government is always free to change how remedies operate, such as changing foreclosure timelines, etc. without the changes being a Taking.

This is exactly what a moratorium would be doing. A number of states and localities have already undertaken such moratoria, and FHFA and HUD have done so for federally or GSE insured or guarantied loans. But we've got a national crisis, so this should be done uniformly on the federal level using the Interstate Commerce power for the entire consumer and small business debt market. Given that all collection actions involve the mails or wires and that debt markets are national, this seems squarely within the scope of federal power. 

Now a collection moratorium is not a permanent fix and will cause some dislocations itself. Consumers/small businesses will eventually need to come current on their obligations, and they may need assistance to do so, but that's something that we can work on later when we're not in free fall. But right now what we need more than anything is time, and a collection moratorium can buy us some time more broadly and more immediately than any other possible step. 

Federal Reserve Emergency Lending as a Coronavirus Response

posted by Adam Levitin

Senator Elizabeth Warren has put out a plan for mitigating the economic fallout from the coronavirus. Of particular note is that she is proposing having the Federal Reserve use its emergency lending power to support businesses affected by the coronavirus in order to ensure that they are able to provide paid health care leave to affected employees and avoid mass layoffs.  

This post addresses whether the Fed has the legal authority for such lending, what precedent exists, how it differs materially from the 2008 bailouts, and why it's a good idea. (Full disclosure: I consulted with the Warren campaign on this plan.)  

Continue reading "Federal Reserve Emergency Lending as a Coronavirus Response" »

Trump Administration Declares Open Season on Consumers for Subprime Lenders

posted by Adam Levitin
The Trump administration has just proposed a rule that declares open season on consumers for subprime lenders. The Office of Comptroller of the Currency and the Federal Deposit Insurance Corporation (on whose board the CFPB Director serves) have released parallel proposed rulemakings that will effectively allowing subprime consumer lending that is not subject to any interest rate regulation, including by unlicensed lenders.

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The Rigged Game of Private Equity

posted by Adam Levitin
The Stop Wall Street Looting Act introduced by Senator Warren has the private equity industry's hackles up. They're going to get a chance to say their piece at a House Financial Services Committee hearing on Tuesday. The bill is a well-developed, major piece of legislation that takes a comprehensive belt-suspenders-and-elastic waist band to limit private equity abuses: it's got provisions on private equity firm liability for their portfolio company obligations, limitations on immediate looting capital distributions, protections for workers and consumers in bankruptcy, protections for investors in private equity funds, and of course a reform of private equity's favorable tax treatment. The bill shows that Senator Warren truly has the number of the private equity industry.
 
In this post I want to address the provision in the bill that seems to truly scare parts of the private equity industry: a targeted curtailment of limited liability for the general partners of private equity funds and their control persons. This provision terrifies some private equity firms because it requires private equity to put its money where its mouth is. The provision is essentially a challenge to private equity firms to show that they can make money off of the management expertise they claim, rather than by playing rigged game with loaded dice. 
 
Private equity claims to make money by buying bloated public companies, putting them on diets to make them lean and mean, and then selling the spiffed up company back to the public. The whole conceit is that private equity can recognize bloated firms and then has the management expertise to make them trim and competitive. If true, that's great. But as things currently stand, it's near impossible for a private equity general partner—that is the private equity firms themselves like Bain and KKR—to lose money, even if they have zero management expertise. That's because they're playing a rigged game. The game is rigged because there is a structural risk-reward imbalance in private equity investment. That's what the limited liability curtailment in the Stop Wall Street Looting Act corrects. Here's how the private equity game is rigged:  

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Private Equity’s Chicken Little Dance

posted by Adam Levitin
The private equity industry is lashing out at Senator Warren’s Stop Wall Street Looting Act with some pretty outlandish claims that rise to Chicken Little level. According to an analysis by the US Chamber of Commerce's Center for Capital Market Competitiveness, the bill will result in the $3.4 trillion of investment provided through private equity over the past five years entirely disappearing from the economy, along with as much as 15% of the jobs in the US economy disappearing.    
 
I cannot sufficiently underscore how laughably amateurish this claim is. I’ve seen some risible financial services industry anti-regulatory claims before, but this one really takes the cake for extreme hand-waving. I expected better from the Masters-of-the-Universe.
 
Here’s why the private equity industry’s claims are utter bunkum.

Continue reading "Private Equity’s Chicken Little Dance" »

Coercive "Consent" to Paperless Statements

posted by Adam Levitin

If you've logged on to any sort of on-line financial account in the past few years, there's a very good chance that you've been asked to consent to receive your periodic statements electronically, rather than on paper. Financial institutions often pitch this to consumers as a matter of being eco-friendly (less paper, less transportation) or of convenience (for what Millennial wants to deal with paper other than hipsters with their Moleskines). While there is something to this, what's really motivating financial institutions first and foremost is of course the cost-savings of electronic statements. Electronic statements avoid the cost of paper, printing, and postage. If we figure a cost of $1 per statement and 12 statements per year, that's a lot of expense for an account that might only have a balance of $3,500—roughly 34 basis points annually.

I'm personally not comfortable with electronic statements for two reasons. First, I worry about the integrity of electronic records. I have no way of verifying the strength of a bank's data security, and I assume that no institution is hack proof. Indeed, messing around with our financial ownership record system would arguably be more disruptive to the United States than interference with our elections. FDIC insurance isn't very useful if there aren't records on which to base an insurance claim. Of course, the usefulness of a bank statement from two weeks ago for determining the balance in my account today is limited too, but if I can prove a balance at time X, perhaps the burden of proof is on the bank (or FDIC) to prove that it has changed subsequently. 

Now, I recognize that not everyone is this paranoid about data integrity. Even if you aren't, however, paper can play an important role in forcing one to pay attention to one's financial accounts, and I think that's valuable.  I am much more likely to ignore an email than I am a paper letter in part because I know that the chance the paper letter is junk is lower because it costs more to send than the spam.  As a result, I look at my snail mail, but often let my e-mail pile up unread. And even when I read, I don't always click on the link, which is what would be in an electronic bank statement.  Getting the paper bank statement effectively forces me to look at my accounts periodically, whereas an emailed link to a statement wouldn't. And monitoring one's accounts is just generally a good thing--it helps with fraud detection and helps one know one's financial status.  

So here's where this is going:  I've got no issue if a consumer wants to freely opt-in to electronic statements.  But the way my financial institutions communicate with me when I go on-line involves really coercive choice architecture. One bank presents me with a pre-checked list of accounts to be taken paperless, such that to not go paperless I have to uncheck several boxes.  I am essentially opted-in to paperless. Another bank has a prominent "I agree" button without an equivalent "I decline" button-the only way to decline paperless is to find the small link labeled "close" to close the pop-up window. "Consent" in this circumstances strikes me as iffy. This strikes me as an area in which regulators (I'm looking at you CFPB) really ought to exercise some supervisory muscle and tell banks to cut it out. If folks want to go paperless, that's fine, but don't try and coerce them. Doing so is contrary to the spirit of the E-SIGN Act at the very least and might enter into UDAAP territory.

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How to Deal with a $3 Trillion Bully

posted by Adam Levitin

I don't like bullies.  And I just ran into a $3 trillion one.  JPMorgan Chase Bank, armed with six partners at two AmLaw 100 firms (Wilmer Hale and McGuire Woods) took the truly unusual step of filing an objection to an amicus curiae brief I filed in a 9th Circuit case called McShannock v. JPMorgan Chase Bank N.A. in support of neither partyChase objects because the brief is late (which it is) and supposedly irrelevant to the disposition of the case. So why is Chase spending thousands of dollars on attorneys fees to object to an irrelevant brief, particularly when it claims no prejudice from the late filing?

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Amicus Brief on Valid-When-Made

posted by Adam Levitin

I have filed an amicus brief regarding "valid-when-made" in Rent-Rite Super Kegs West, Ltd. v. World Business Lenders, LLC. The brief shows pretty conclusively that there was no such doctrine discernible in the law when either the National Bank Act of 1864 or the Depository Institutions Deregulation and Monetary Control Act of 1980 were enacted, and that subsequent cases consistent with the doctrine are based on a misreading of older law. 

The Sky Is Falling: Securitization, Chicken Little Edition

posted by Adam Levitin

It's been quite a week for "valid-when-made (up)".  Not only did FDIC and OCC race to court to defend the doctrine in the context of a 120.86% small business loan, but there's a Bloomberg story out about a set of class action usury law suits (here and here) against the credit card securitization trusts used by Capital One and Chase. The story suggests that these suits threaten the $563 billion asset-securitization market and also the $11 trillion mortgage securitization market. That claim is so readily disprovable, it's laughable. 

Here's the background. New York has a 16% usury cap under Gen. Oblig. Law 5-501. The National Bank Act § 85 provides that that cap does not apply to national banks that are based in other states (such as Delaware), but the National Bank Act only covers banks. The securitization trusts are not banks, but are common law or Delaware statutory trusts. The class action suits argue that under the 2d Circuit's Madden v. Midland Funding, LLC precedent, it is clear that New York usury law applies to the trusts; they cannot shelter in National Bank Act preemption because they are not national banks. 

Obviously, the banks see it the other way, and have invoked valid-when-made as part of their defense. They're wrong, but what irks me is that financial services industry lawyers and trade associations are claiming that if these class action suits succeed the sky will fall for securitization and that the Bloomberg article didn't really question this claim: Bloomberg's headline is that the entire $563 billion ABS securitization market is at risk, and bank attorneys suggest in the article that the $11 trillion mortgage securitization market is at risk too. 

Let's be clear. This is utter nonsense on a Chicken Little scale. These class action law suits affect only part of the $123 billion credit card securitization and the very small $30 billion unsecured consumer loan securitization markets. Even then they do not threaten to kill off these markets, but merely limit what loans can be securitized to those that comply with the applicable state's usury laws. They do not affect mortgage securitization at all and are unlikely to have much, if any impact on auto loan securitization or student loan securitization. To suggest, as the Bloomberg article does, that these class action suits affect the securitization markets for cellphone receivables or time shares (where is there a usury claim even possible in those markets?) is embarrassingly ridiculous. The sky isn't falling, Turkey Lurkey. Full stop. 

Continue reading "The Sky Is Falling: Securitization, Chicken Little Edition" »

FDIC and OCC Race to Court to Defend 120.86% Interest Rate Small Business Loan

posted by Adam Levitin

FDIC and OCC filed an amicus brief in the district court in an obscure small business bankruptcy case to which a bank was not even a party in order to defend the validity of a 120.86% loan that was made by a tiny community bank in Wisconsin (with its own history of consumer protection compliance issues) and then transferred to a predatory small business lending outfit. Stay classy federal bank regulators. 

[Update: based on additional information--not in the record unfortunately--this is clearly a rent-a-bank case, with the loan purchaser having been involved in the loan from the get-go.]

FDIC and OCC filed the amicus to defend the valid-when-made doctrine that the bankruptcy court invoked in its opinion. FDIC and OCC claim it is "well-settled" law, but if so, what the heck are they doing filing an amicus in the district court in this case? They doth protest too much.

What really seems to be going on is that FDIC/OCC would like to get a circuit split with the Second Circuit's opinion in Madden v. Midland Funding in order to get the Supreme Court to grant certiorari on the valid-when-made question in order to reverse Madden. The lesson that should be learned here is that while Congress seriously chastised OCC for its aggressive preemption campaign by amending the preemption standards in the 2010 Dodd-Frank Act, that hasn't been enough, and going forward additional legislative changes to the National Bank Act are necessary. Indeed, the FDIC and OCC action underscores why FDIC and OCC cannot be trusted with a consumer protection mission, even for small banks (currently they enforce consumer protection laws for banks with less than $10 billion in assets). The FDIC and OCC are simply too conflicted with their interest in protecting bank solvency and profitability, even if it comes at the expense of consumer protection. Moving rulemaking and large bank enforcement to CFPB was an important improvement, but what we are seeing here is evidence that it simply wasn't enough. 

More on the background to the story from Ballard Spahr. Needless to say, I completely disagree with the historical claim by FDIC/OCC (and echoed by Ballard Spahr) about "valid-when-made". Valid-when-made-up is more like it.  

Anderson and Nyarko's Cool New Papers on Contract Evolution

posted by Mitu Gulati

Two of the contracts papers I’ve been most looking forward to this fall have just been posted on ssrn. They are are Rob Anderson’s “An Evolutionary Perspective on Contracting: Evidence From Poison Pills” (here) and Julian Nyarko’s “Stickiness and Incomplete Contracts” (here).

Both papers aim at deepening our understanding of how contracts evolve and, in particular, why they evolve in ways so very different from the standard model used in law schools where parties are assumed to negotiate for an optimal set of terms for their relationships.

One would predict a very different set of contract terms for parties if one takes the contract production process seriously and thinks of contract provisions as products (ala Barak Richman, here) or product attributes (ala Doug Baird, here).  Specifically, Rob and Julian both use models of contract production where new contracts are constructed by building on pre-existing templates.

In this world, one should expect a high degree of path dependence in the data.  And that is precisely what Rob and Julian demonstrate, looking at two very different areas of commercial contracting – poison pill and choice-of-forum provisions. The implications of their papers, both of which are studying the most sophisticated and well-heeled of all contracting parties, for the one of the core exercises in contract law – how should judges interpret contracts – are considerable.  That said – and this is not meant to take away from the two papers at all -- these papers are more about empirically documenting and understanding the phenomena than normative questions of what judges should be doing.

There is an enormous amount of new material in both papers and I will not do more than scratch the surface in terms of their respective contributions.  Here, however, are a couple of things about each of the papers that stood out to me.

Continue reading "Anderson and Nyarko's Cool New Papers on Contract Evolution" »

Private Equity's Abuse of Limited Liability

posted by Adam Levitin

One of the central features of the Stop Wall Street Looting Act that was introduced by Senator Elizabeth Warren and a number of co-sponsors is a targeted rollback of limited liability.

This provision, more than any other, has gotten some commentators’ hackles up, even those who are willing to admit that there are real problems in the private equity industry and welcome some of the other reforms in the bill. (See also here and here, for example.)

The idea that limited liability is a sine qua non of the modern economy is practically Gospel to most business commentators.  These commentators assume that without limited liability, no one will ever assume risks, such that any curtailment of limited liability is a death sentence for the private equity industry.

They're wrong. Limited liability is a substantial, regressive cross-subsidy to capital at the expense of tort creditors, tax authorities, and small businesses. Limited liability is a relic of the underdeveloped financial markets of the Gilded Age and operates as an implicit form of leverage provided by law. But it’s hardly either economically efficient or necessary for modern business activity. It's a fairly recent development in the western world, there are numerous exceptions to it, and a number of notable firms have prospered without it (JPMorgan & Co., Lloyds of London, American Express, and many leading law law firms).

In any event the Stop Wall Street Looting Act rolls back limited liability solely for private equity general partners in a surgical manner such that doesn’t affect limited liability more broadly. All the Stop Wall Street Looting Act will do is reveal which private equity firms have real managerial expertise, and are thus able to thrive without limited liability, and those that don’t and require the legal subsidy to be profitable. Far from undermining the private equity industry, it is a restoration of a central tenet of honest American capitalism: reward should be commensurate with risk.

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Coyle on Studying the History of a Contract Provision

posted by Mitu Gulati

The way many of us teach interpretation in Contract Law, there is little role for history (admittedly, this is just based on casual observation). The meaning of a clause is a function of the words that make up that clause.  The parties to the transaction are assumed to have drafted it to document the key aspects of their transaction, to balance risks and rewards blah blah.  If a dispute arises, we might have an argument as to whether a strict textualist reading of the words accurately represent what the parties really meant by them or whether we need to also examine the context of the relationship. What we do not ever do, however, is to delve into the history of the clause from before these parties contemplated using it – that is, of what prior drafters of the original versions of this clause might have meant in using it.

The foregoing makes sense in a world in which the contracts for each deal are drafted from scratch. But does anyone draft contracts from scratch?  What if we live in a world where 99.9% of contracts are made up of provisions cut and paste from prior deals; provisions that are assumed to cover all the key contingencies, but not necessarily understood (or even read)? In this latter world, where there are lots of provisions that the parties to the transaction never fully focused on (let alone understood), might there be an argument – in cases where there are interpretive disputes -- for the use of a contract provision’s history? Might that history not sometimes be more relevant than the non-understandings of the parties as to what they did or did not understand they were contracting for? (Among the few pieces that wrestle with this question are these two gems: Lee Buchheit's Contract Paleontology here and Mark Weidemaier's Indiana Jones: Contract Originalist here)

I’m not sure what the answer to the foregoing question is. But it intrigues me.  And it connects to a wonderfully fresh new body of research in Contract Law where a number of scholars have been studying the production process for modern contracts.  The list of papers and scholars here is too long to do justice to and I’ll just end up making mistakes if I try to do a list.  But what unites this group of contract scholars is that for them it isn’t enough to assume that contracts show up fully formed at the time of a deal, purely the product of the brilliant minds of the deal makers who anticipate nearly every possible contingency at the start.  Instead, understanding what provisions show up in a contract, and in what formulation, requires understanding the contract production process. (Barak Richman's delightful "Contracts Meet Henry Ford" (here) is, to my mind, foundational).

It is perhaps too early to tell whether this research will catch on and revolutionize contract law. I hope it does, but I’m biased.

One of my favorite papers in this new body of contract scholarship showed up recently on ssrn. It is John Coyle’s “A History of the Choice-of-Law Clause” (here). I have rarely found a piece of legal scholarship so compelling.  The paper is not only a model of clarity in terms of the writing, but it is brave. It is completely unapologetic in not only taking on an entirely new mode of research (a painstaking documentation of the historical evolution of the most important terms in any and every contract), but in coming up with a cool and innovative research technique for unpacking that history (this project would have been impossible to do without that innovation).

Continue reading "Coyle on Studying the History of a Contract Provision" »

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

posted by Adam Levitin

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.  

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Reflections on the foreclosure crisis 10th anniversary

posted by Alan White

Before it was the global financial crisis, we called it the subprime crisis. The slow, painful recovery, and the ever-widening income and wealth inequality, are the results of policy choices made before and after the crisis. Before 2007, legislators and regulators cheered on risky subprime mortgage lending as the "democratization of credit." High-rate, high-fee mortgages transferred income massively from working- and middle-class buyers and owners of homes to securities investors.

After the crisis, policymakers had a choice, to allocate the trillions in wealth losses to investors, borrowers or taxpayers. U.S. policy was for taxpayers to lend to banks until the borrowers had finished absorbing all the losses. The roughly $400 billion taxpayers lent out to banks via the TARP bailout was mostly repaid, apart from about $30 billion in incentives paid to the mortgage industry to support about 2 million home loan modifications, and $12 billion spent to rescue the US auto industry. The $190 billion Fannie/Freddie bailout has also returned a profit to the US Treasury.  Banks recovered quickly and are now earning $200 billion in annual profits. Of course, equity investors, particularly those wiped out by Lehman and many other bankruptcies, or by the global downturn generally, lost trillions as well. The long-term impact, however, was to shift corporate debt to government balance sheets, while leaving households overleveraged.

Thomas Herndon has calculated that 2008-2014 subprime mortgage modifications added $20 billion to homeowner debt (eroding wealth by $20 billion). In other words, all the modification and workout programs of the Bush and Obama administrations did not reduce homeowner debt by a penny. In fact, mortgage lenders added $20 billion (net) fees and interest onto the backs of distressed homeowners. During the same period, $600 billion in foreclosure losses were written off by private mortgage-backed securities investors, implying a similar or greater loss in wealth for foreclosed homeowners. These data include only the private-label side of the housing finance market; adding the debt increase and wealth losses for Fannie and Freddie homeowners could conceivably double the totals.

Nearly 9 million homes were foreclosed from 2007 to 2016. While some were investor-owned, even those often resulted in the eviction of tenant families. Four and one-half million homeowners still remain underwater, i.e. owe more mortgage debt than the value of their home.

 While baby boomers' housing wealth was decimated by foreclosures and increasing mortgage debt, millennials piled on student loan debt, closing the door to home buying and asset building. A recovery built on incomplete deleveraging, and new waves of consumer debt buildup, contains the seeds of the next crisis. While various pundits bemoan the resurgent federal fiscal debt, we would do well to address policies that continue to stoke unsustainable household debt.

CLO Yawn

posted by Adam Levitin

There's a big story in the NY Times about how the financial structures being used to finance many corporate loans—so-called Collateralized Loan Obligations or CLOs—look very similar to those used to finance mortgages during the housing bubble.  Yup.  That's true. CLOs are a securitization structure, like MBS.  (If you want to know more gory details, see here.)  But that's really where the similarities end.  While the financing transactions are similar, the asset class being securitized is fundamentally different in terms of the risk it presents, and that's what matters.  The financing channel might be more vulnerable to underpricing than other financing channels because of opacity and complexity, but is the underlying asset class that matters in terms of societal impact.  This is for (at least) four reasons. 

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ISDA Promotes a Race to the Bottom

posted by Stephen Lubben

Frustrated that Congress did not decide to collapse the CFTC and SEC as part of Dodd-Frank, and facing the reality that the SEC is still working on its rules under Title VII of Dodd-Frank, ISDA, the swaps industry trade group, is out with a white paper that urges the adoption of a "safe harbor."

This is not the infamous bankruptcy safe harbors, but rather a rule that would be adopted by both regulators. The basic idea is that compliance with one regulator's rule is "good enough." That is, swaps traders could choose which regulator they want.

What could possibly go wrong?

Excuse Me?

posted by Stephen Lubben

Barry Ritholtz has a generally sensible column about the ten-year anniversary of the financial crisis, but the bankruptcy stuff really makes no sense at all. Start with this proposition:

I believed then (and still believe) that the best course of action would have been prepackaged bankruptcies for all the insolvent institutions instead of bailouts.

How precisely would that work? A prepack involves pre-bankruptcy solicitation of votes from creditors – largely bondholders if we are talking about a SIFI's holding company. Under the securities laws, the solicitation will take at least 20 days. That is about 19 days more than will be required for the run on the SIFI to be fully commenced.

And then we have:

I would have had the federal government provide debtor-in-possession financing, allowed qualified private institutional investors to bid on the assets thereby letting markets set the valuations, with the government picking up the rest.

So this is not a prepack at all. If we are bidding on assets post-bankruptcy, there is no pre-bankruptcy plan for creditors to vote on. Indeed, until we see how the sale goes, there is no plan at all.

In short, we are just doing chapter 11, Lehman style. Maybe with a bit more pre-planning, which could not hurt. But if you assume better facts, you are bound to think you have found a better way

I continue to doubt that bankruptcy has much to offer with regard to a SIFI failure – which is really much more a question of ex ante regulation, and post default politics.

Available at finer booksellers everywhere (and Amazon too!)

posted by Stephen Lubben

CoverMy new book is out – the Law of Failure.

The sub-title is "A Tour Through the Wilds of American Business Insolvency Law," which pretty much tells the whole story. I try to cover all business insolvency law – not just the Bankruptcy Code. State laws, and federal laws like Dodd-Frank's OLA are covered too. All in a concise little volume.

In my research I discovered that many states have specialized receivership and other insolvency laws for specific types of businesses. And some states – I'm looking at you New Hampshire – still have corporate "bankruptcy" statutes on the books from the days when there was no federal bankruptcy law, or (as was the case with the early Bankruptcy Act) the law did not extend to all types of businesses. Can any of these laws really work? It is hard to say, since the Supreme Court has not dealt with a bankruptcy preemption issue in a very long time.

I welcome discussion on this question, or the book in general, from Slips readers, either below or via email.

How to Tie CFPB Enforcement Up in Knots

posted by Patricia A. McCoy

While Acting Director Mick Mulvaney is apparently on a tear to defang the Consumer Financial Protection Bureau, some of his actions have flown under the radar. In this and future guest blog posts, I will shine light on one key initiative that largely has gone unnoticed:  namely, the twelve Requests for Information that Mr. Mulvaney launched on January 26. These notices, dubbed "RFIs," seek public comment on scaling back every core function of the CFPB, from enforcement and supervision to rulemaking and consumer complaints. 

Although the RFIs provide the veneer of public participation, in reality they are slanted toward industry. Many are couched in such vague language that consumers and consumer advocates cannot tell which rollbacks are gaining traction behind closed doors. Just last week, Mr. Mulvaney raised new concerns that the RFI process is infected with bias when he personally pressed bankers attending a meeting of the National Association of Realtors to file responses to the RFIs. 

Continue reading "How to Tie CFPB Enforcement Up in Knots" »

Trump’s Bank Regulators

posted by Alan White

ProPublica’s new web site “Trump Town” tracks political appointees across federal agencies. In light of the president’s promises to “drain the swamp”, it is interesting to peruse some of the Treasury Department appointees responsible for bank regulation. I previously wrote about Secretary Mnuchin and Comptroller Joseph Otting and their connections to subprime mortgage foreclosure profiteers. Lower-level political appointees at Treasury seem to come mostly from one of three backgrounds – lawyers and lobbyists for banks, real estate investors (and sometimes Trump campaign officials), or former staffers for Republican members of Congress. Here are some examples:

Continue reading "Trump’s Bank Regulators" »

The Economic Growth, Regulatory Relief, and Consumer Protection Act

posted by Stephen Lubben

Or EGRRCPA, for short. That is the official name of S. 2155, a bill which seems to be tearing Senate Democrats apart. Republicans are uniformly in favor of the bill, which Bloomberg describes as "another faulty bank-reform bill." Some Democrats see it as needed regulatory relief for small banks, while others, including the one who used to blog here, see S. 2155 as a rollback of keys parts of Dodd-Frank for big banks that remain too big to fail.

It is both. Indeed, if the bill were stripped of its title IV, I think most people could live with it. But title IV is a doozy.  

Most notably, it raises the threshold for additional regulation under Dodd-Frank from $50 billion in assets to $250 billion. Banks with more than $50 billion in assets are not community banks.

The banks in the zone of deregulation include State Street, SunTrust, Fifth Third, Citizens, and other banks of this ilk. In short, with the possible exception of State Street, this is not a deregulatory gift to "Wall Street," but rather to the next rung of banks, all of which experienced extreme troubles in 2008-2009, and all of which participated in TARP.

My prime concern – given my area of study – is that these banks will no longer be required to prepare "living wills." That is, they will not have to work with regulators on resolution plans.

How then do we expect to use Dodd-Frank's orderly liquidation authority if they fail? It would be impossible without advanced planning. Same for the misguided attempts at "chapter 14." I have real doubts about the wisdom of "bankruptcy for banks," but if it is ever to work, it will require lots of advanced planning (and luck).

And we can't use the normal FDIC approach of finding another, bigger bank to take them over, because that would simply create another colossus, like Wells Fargo. Certainly we don't want that.

Maybe a bailout then? Is that the "new" plan?

How S.2155 (the Bank Lobbyist Act) Facilitates Discriminatory Lending

posted by Adam Levitin

If you think it's ridiculous that the CDC can't gather data on gun violence, consider the financial regulatory world's equivalent:  S.2155, formally known as the Economic Growth, Regulatory Relief, and Consumer Protection Act, but better (and properly) known as the Bank Lobbyist Act.  S.2155 is going to facilitate discriminatory lending. Let me say that again.  S.2155 is legislation that will facilitate discriminatory lending. This bill functionally exempts 85% of US banks and credit unions from fair lending laws in the mortgage market.  Support for this bill should be a real mark of shame for its sponsors. 

Continue reading "How S.2155 (the Bank Lobbyist Act) Facilitates Discriminatory Lending" »

Trump’s “Draining the Swamp” Scorecard: One Year In

posted by Mitu Gulati

Donald Trump came into office promising, among other things, to “drain the swamp” and get rid of all that corruption.  One year in, how are things looking in terms of swamp draining? 

The following is based on work with my super co author, Stephen Choi, of NYU Law School.

To answer (at least partially) the question posed at the start, we have analyzed data on Securities and Exchange Commission (SEC) enforcement actions under the Foreign Corrupt Practices Act – the primary U.S. statute that gets at, among other things, bribes to influence foreign officials with payments or rewards. 

We report data that compares SEC enforcement actions against public companies and subsidiaries of public companies under the FCPA from both the final year of the Obama administration and the first year of the Trump administration. We focus on public companies and subsidiaries of public companies because these are the larger economic actors that affect the economy. The Department of Justice also has authority to bring actions, but there were 0 actions brought by the DOJ against public companies and subsidiaries of public companies during the period we examined (although the DOJ has brought several actions against non-U.S. reporting issuers including a number of prominent foreign companies).

Image1

Figure I, we think, speaks for itself. On the graph, actions brought during the Trump months (from January 20, 2017 to January 31, 2018—roughly Trump’s first year) are in red, those during the Obama months (January 1, 2016 to January 19, 2017) are in blue. As compared to SEC enforcement activity under the Obama administration, the SEC under the Trump administration, appears to have taken a pause from FCPA swamp cleaning activities. For those who saw our report on partial year information (up to the end of September 2017) here, some months ago – the story has only become clearer with the passage of more time).  

The data is from the Securities Enforcement Empirical Database (SEED),a collaboration between NYU and Cornerstone Research.  It tracks SEC FCPA actions from January 1, 2016 to January 31, 2018. SEED defines a public company as a company with stock that trades on the NYSE, NYSE MKT LLC, NASDAQ, or NYSE Arca stock exchanges at the start date of the SEC enforcement action (note that this includes both U.S. incorporated and foreign incorporated companies). 

There, of course, are caveats as to what else might be going on.

Continue reading "Trump’s “Draining the Swamp” Scorecard: One Year In" »

Bankruptcy's Lorelei: The Dangerous Allure of Financial Institution Bankruptcy

posted by Adam Levitin

I have a new (short!) paper out, Bankruptcy's Lorelei:  The Dangerous Allure of Financial Institution BankruptcyThe paper, which builds off of some Congressional testimony from 2015, makes the case that proposals for resolving large, systemically important financial institutions in bankruptcy are wrongheaded and ultimately dangerous. At best they will undermine the legitimacy of the bankruptcy process, and at worst they will result in crash-and-burn bankruptcies that exacerbate financial crises, rather than containing them.  The abstract is below.

The idea of a bankruptcy procedure for large, systemically important financial institutions exercises an irresistible draw for some policymakers and academics. Financial institution bankruptcy promises to be a transparent, law- based process in which resolution of failed financial institutions is navigated in the courts. Financial institutions bankruptcy presents itself as the antithesis of an arbitrary and discretionary bailout regime. It promises to eliminate the moral hazard of too-big-to-fail by ensuring that creditors will incur losses, rather than being bailed out. Financial institutions bankruptcy holds out the possibility of market discipline instead of an extensive bureaucratic regulatory system.

This Essay argues that financial institution bankruptcy is a dangerous siren song that lures with false promises. Instead of instilling market discipline and avoiding the favoritism of bailouts, financial institution bankruptcy is likely to simply result in bailouts in bankruptcy garb. It would encourage bank deregulation without the elimination of moral hazard that produces financial crises. A successful bankruptcy is not possible for a large financial institution absent massive financing for operations while in bankruptcy, and that financing can only reliably be obtained on short notice and in distressed credit markets from one source: the United States government. Government financing of a bankruptcy will inevitably come with strings attached, including favorable treatment for certain creditor groups, resulting in bankruptcies that resemble those of Chrysler and General Motors, which are much decried by proponents of financial institution bankruptcy as having been disguised bailouts.

The central flaw with the idea of financial institutions bankruptcy is that it fails to address the political nature of systemic risk. What makes a financial crisis systemically important is whether its social costs are politically acceptable. When they are not, bailouts will occur in some form; crisis containment inevitably trumps rule of law. Resolution of systemic risk is a political question, and its weight will warp the judicial process. Financial institutions bankruptcy will merely produce bailouts in the guise of bankruptcy while undermining judicial legitimacy and the rule of law.

House Financial Services Fintech Hearing

posted by Adam Levitin

This Tuesday I'm going to be testifying about "fintechs" before the House Financial Services Committee's Subcommittee on Financial Institutions and Consumer Credit.  My written testimony on this impossibly broad topic is here.  It contains lots of good stuff on the so-called Madden Fix bill, "true lender" legislation, data portability, federal money transmitter licensing, small business data collection, and the need for a general federal ability-to-repay rule.    

(More on) Sticky Shipping Contracts

posted by Mitu Gulati

A few days ago, I put up a post about a very interesting recent article by Richard Kilpatrick on highly sticky (and inefficiently so) shipping contracts. The focus of Richard's article was on the failure of these standard-form ship contracts to pre-specify the allocation of financial responsibility among the various parties (ship owner, chartering party, etc.) when refugees need to be picked up and the ship's pre-planned journey gets diverted. Refugees needing to be rescued at sea has, as we know, become a huge international issue over the last couple of years.  In that post, I wondered aloud about what the explanation for the stickiness in the ship contracts might be. Theory, after all, would suggest that in a market with highly sophisticated repeat players, inefficient contract clauses would get reformed quickly -- yet they do not. Richard, whom I had never corresponded with before this, was kind enough to send me his thoughts on the question. With his permission, since his thoughts on this are fascinating -- especially the bit at the bottom about how these same parties are simultaneously highly innovative (with ship technology) and highly conservative (with contracts) -- I'm reproducing them below.

From Richard:

I’ve thought about these same questions over the past months and certainly agree that there is a more work to be done in understanding and exposing why there is continued reliance on these antiquated contract forms. In the charterparty context, this is especially surprising given that new iterations of similar forms have been promulgated by the same organization (BIMCO) that drafted the ‘46 form. One answer that invariably comes up is that the shipping industry is deeply conservative and resistant to change. At a recent Singapore Shipping Law Forum, a bunch of us legal and industry people discussed this phenomenon in the context of international conventions on carriage of goods. The Hague Rules governing bills of lading were drafted in the 1920’s (and revised very minimally in the 1960’s via the Visby amendments). These rules desperately need updating because containerization and multimodalism has completely changed the shipping landscape. The subsequent "Hamburg Rules" largely failed. And while the recently drafted "Rotterdam Rules" attempt to rectify some of these problems, they are already viewed by some observers as unlikely to catch-on. Only 4 countries have ratified them so far (including Cameroon in Oct 2017): http://www.uncitral.org/uncitral/en/uncitral_texts/transport_goods/rotterdam_status.html .

At least in part, this appears to be because the industry folks, including their fancy shipping lawyers, don't like change. Note also that the shipping industry is constantly evolving in other ways, particularly in its reliance on technology. Larger and more sophisticated vessels are constantly entering the market, and ports (as well as the vessels themselves) are increasingly being operated by computers rather than traditional labor. So I think it is fair to say there is a very traditional view towards regulation and liability allocation, but a relatively innovative approach towards operations. This creates an increasingly widening gap between the legal framework and the realities of business practice.

Why is Netflix Listing its European Bonds on the Isle of Guernsey?

posted by Mitu Gulati

Netflix has long interested me as a company, not only because of shows like "Master of None" (Aziz Ansari and Alan Yang have delivered brilliantly), its darwinian management philosophy (very cool podcast on Planet Money), but because of its uncertain future. It is competing against rich giants like Amazon and Apple to deliver original content in a field that is getting increasingly crowded.  My guess is that it is having to spend more and more on content, but is unable to increase its prices very much. One solution for Netflix: borrow at a high interest rate from investors who are willing to bet on your future.  And that it has done, in spades. Most recently -- a few days ago -- it borrowed $1.6 billion (yes, billion). I was intrigued and trying to avoid doing my real work, so I went looking for its offering documents and while I didn't immediately find the current docs, I found the offering circular for the bond issue Netflix did a few months prior in Europe (Euro 1.3 billion) in an offering listed on the International Stock Exchange, which is an exchange licensed by the Bailiwick of Guernsey.  Yes, really. So, surely, at least some of you are asking the same questions I am. What? Where? Who?

Guernsey, for those of you who are clueless like I am, is a British Crown "dependency" (not sovereign, but not independent, and not quite like a former colony like the British Virgin Islands or Bermuda (they are "British Overseas Territories")). Basically, a cynic might say: Perfect for a tax haven. But it is the stock exchange that interested me, especially since it seems to have been quickly rising in popularity for US and EU companies over the last couple of years.

If I remember my basic corporate finance class (I don't), we were told that exchanges performed a monitoring and disciplinary role; they were "gatekeepers", as the fancy corporate types liked to say. So, is Netflix going all the way to the Isle of Guernsey to get extra special monitoring from the Channel Islanders? Curious, I went to the website for the Guernsey exchange, to see what it said. And it does say that it has wonderfully rigorous regulatory standards ("some of the highest regulatory standards globally"). But does it really?

Continue reading "Why is Netflix Listing its European Bonds on the Isle of Guernsey?" »

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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