468 posts categorized "Financial Institutions"

SCOTUS National Bank Act Preemption Ruling

posted by Adam Levitin

The Supreme Court issued an important ruling about the National Bank Act's preemption standard today that precludes broad, categorical preemption of state consumer financial laws, but instead requires a fact-specific analysis.This decision opens the way to more expansive state consumer financial regulation that affects banks.

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What Is a Wire Transfer?

posted by Adam Levitin

Heads up payment nerds: we have what promises to be the most interesting payments litigation involving a Citibank wire transfer since...the last payments litigation involving a Citibank wire transfer.

In the latest case, the NYAG has sued Citibank for violating the Electronic Fund Transfer Act in connection with wire transfer transactions for consumer customers. The EFTA offers consumers substantial protection against unauthorized electronic fund transfers, both in terms of process and substantive liability limitations. The  NYAG alleges Citibank has not been providing these required protections to consumers who have had their accounts drained by unauthorized wire transfer orders.  

Now you might be saying, "I feel bad for the consumers, but come on, everyone knows that the EFTA doesn't apply to wire transfers." And you might even point to the EFTA definition of an "electronic fund transfer" as excluding "any transfer of funds, other than those processed by automated clearinghouse, made by a financial institution on behalf of a consumer by means of a service that transfers funds held at either Federal Reserve banks or other depository institutions and which is not designed primarily to transfer funds on behalf of a consumer." And you'd be right—both the NYAG and Citibank agree that the EFTA does not apply to wire transfers.  The issue in the case is "what is the wire transfer?"

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Something Doesn't Add Up in NY Times Article

posted by Adam Levitin

The NYTimes has an article about how many consumers and small businesses have been getting their deposit accounts shut down and lines of credit cut off without explanation.

Something here doesn't add up. Banks have an obligation under the Equal Credit Opportunity Act and Regulation B thereunder to provide customers with "adverse action" notices if they terminate a line of credit. Those notices either have to provide an explanation of why or a notice of how the customer can get an explanation (for small businesses, that notice can be in the application itself). ECOA/Reg B apply not just to consumer credit, but business credit as well. Now, ECOA/Reg B does not cover deposit accounts, but if a bank cuts off both a deposit account and a line of credit, it would have to provide an adverse action notice about the line of credit.

So something here doesn't add up. Either banks have been failing to comply with ECOA or customers have checked their mail or haven't been forthright with the journalists. Large scale non-compliance with this sort of ECOA provision seems unlikely, as this is an easy-to-automate rule, where the cost-savings from noncompliance would be minimal. So, I suspect that something funny is going on on the consumer end, although, to be fair, an ECOA adverse action notice doesn't have to be particularly illuminating about why the bank took the adverse action.

SEC Coinbase Suit

posted by Adam Levitin

The SEC has finally brought its long-anticipated lawsuit against Coinbase. The suit alleges that Coinbase has operated as an unregistered securities broker, an unregistered securities exchange, and an unregistered securities clearing agency, and that it has made unregistered sales of securities, namely of its staking-as-a-service products. The litigation hinges entirely on one key question: are any of several tokens listed or products offered by Coinbase “securities.” If the tokens and products are not securities, then Coinbase has no problem. And if they are securities, Coinbase almost assuredly loses.

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It's Not Just an SVB Problem: the Systemic Nature of the Bank Regulation Failure

posted by Adam Levitin

A mid-sized regional bank specializing in lending to tech start-ups, crypto companies, or law firms hardly seems of systemic importance, even if its failure would have caused disruption in some industries regionally and might have triggered a cascade of corporate bankruptcies because of large uninsured deposit balances. That sort of collateral damage from a bank failure is unfortunate and painful for those involved, but that's the nature of market discipline.

If that's where things ended with Silicon Valley Bank, I suspect regulators would have said too bad, so sad, as they were initially prepared to do. Yet the problem with Silicon Valley Bank's failure was that it had the potential spark for a banking-industry-wide panic, in which depositors pull their funds from smaller banks and move them either to big banks or to money market funds. That sort of panic could have been devastating to small and medium banks, as they would have faced a liquidity crunch that many could not meet...for the very same reason that SVB got into trouble, namely that they are sitting on large unrealized losses on their bond portfolios because they failed to manage interest rate risk appropriately. And if we had a correlated failure of lots of small and medium-sized banks, it would have resulted in serious economic disruption in small business and agricultural lending and a lot more spillover insolvencies of firms that had large uninsured deposits at those banks. That's the systemic risk scenario with SVB, and I suspect that as the weekend after the SVB failure advanced, that's what scared federal bank regulators into guarantying all deposits at SVB and SBNY.

But notice the nature of the problem: it wasn't just SVB that mismanaged its interest rate risk. It was lots and lots of other banks. Mismanaging rate risk is a Banking 101 screw-up, but it's also a Bank Regulation 101 screw-up. Rate risk is hardly a novel problem, and it's an easy one to address through derivatives like interest rate swaps, but those eat into profitability. Why bank regulators let rate risk get out of control almost across the board is something Congress needs to understand—I suspect that the story is much like consumer protection violations, which historically were tolerated because they were profitable. This much is clear, however:  if regulators had done their job generally, SVB's bank would not have posed systemic risk because there wouldn't have been the possibility of a panic. It would have been a one-off bank failure and nothing more. Regulators should have been on SVB's problems much sooner, but the real regulatory failure was an across-the-board failure to ensure that banks managed their rate risk because that's what set up the panic scenario.

Put another way, this isn't just a problem that can be hung on the neck of the Federal Reserve Bank of San Francisco. The problem here implicates every federal bank regulator.

FDIC's Poor Track Record in Holdco Bankruptcies

posted by Adam Levitin

Last week I did a post about how the FDIC as receiver for Silicon Valley Bank probably doesn't have a claim against SVB Financial Group, the holdco of the bank. I got some pushback on that (including from a former student!), but I'm sticking to my guns here. It's a result that seems wrong and surprising, but if you look at the three most recent big bank holdco bankruptcies (this takes some digging in old bankruptcy court dockets), the FDIC has ended up with little or no claim.

Continue reading "FDIC's Poor Track Record in Holdco Bankruptcies" »

SDNY: EFTA Applies to Crypto

posted by Adam Levitin

I'm teaching cryptocurrency today in my Payment Systems class, and I'd been puzzling about why no one has applied the Electronic Fund Transfers Act and Reg E thereunder to crypto: after all, if you have a crypto account with an exchange, it would seem to be an "account" at a "financial institution" that is primarily for personal, family, or household purposes and is used for electronic transfers of "funds." In fact, I had just emailed Bob Lawless for a sanity check on this, when I came across a very recent SDNY decision that held that the EFTA applies to crypto. That's a huge consumer protection win. Reg E has important consumer protections regarding unauthorized transactions, error resolution, and provision of receipts and periodic statements. It also creates huge compliance headaches for crypto exchanges, which are not set up for dealing with any of those problems. All of the Zelle scam error resolution issues are now going to become crypto scam error resolution issues. And the ruling also indicates that consumer protection at cryptocurrency exchanges is now squarely within the existing regulatory authority of the Consumer Financial Protection Bureau. This could get interesting. 

The Regressive Cross-Subsidy of Uncapping Deposit Insurance

posted by Adam Levitin

There's talk about removing the FDIC deposit insurance caps in response to the "Panic of 2023"®.  There's a refreshing realism about such a move. But let's also be clear about the distributional impact of such a move:  it's a huge cross-subsidy from average Joes to wealthy individuals and businesses.>

If FDIC insurance coverage caps are removed, banks will pay more in insurance premiums. They will pass those premiums through to customers because the market for banking services is less competitive than the market for capital. In particular, the higher costs for increased insurance premiums are likely to flow to the least price-sensitive and most “sticky” customers:  less wealthy individuals.  So average Joes are going to be facing things like higher account fees or lower APYs, without gaining any benefit. Instead, the benefit of removing the cap would flow entirely to wealthy individuals and businesses. This is one massive, regressive cross-subsidy. It's not determinative of whether raising the cap is the right policy move in the end, but this is something that should be considered.

The Financial Regulatory Credibility Problem

posted by Adam Levitin

Financial regulation has a credibility problem. Actually, it's got two credibility problems.

It's not credible any more to think that financial regulators will shut down troubled institutions until they are forced to do so. And it's no longer credible that financial regulators will allow depositors to incur losses. Both are really problematic.

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Why Weren't Silicon Valley Bank Depositors Using CDARS?

posted by Adam Levitin

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

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

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The New Usury

posted by Adam Levitin

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

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

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

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

Binance's Custodial Arrangements: Whose Keys? Whose Coins?

posted by Adam Levitin

For months, cryptocurrency FTX (and its majority owner, Sam Bankman-Fried) have been the lender of last resort in crypto markets and pretty much the only distressed acquirer around. Now we learn that FTX has itself failed and is getting scooped up in a distressed acquisition by Binance. Does this remind anyone of Bank of America's purchase of Merrill Lynch and Countrywide in 2008? We'll see if the transaction closes, but at the very least it poses the question of whether Binance stands on any stronger ground than FTX? Binance's revenue has been way down this year, but who really knows its financial condition? It's not a public company, so there's limited visibility into its financial condition.

Here's what I do know about Binance, however, and it gives me real pause: Binance.us's Terms of Use disclose absolutely nothing about its custodial arrangement for crypto holdings. From the documents on Binance.us's website, it is impossible to determine the legal relationship between Binance.us and its customers and hence the type of counterparty risk they have from dealing with the exchange. That's scary.

Continue reading "Binance's Custodial Arrangements: Whose Keys? Whose Coins? " »

New Book Alert: Delinquent

posted by Melissa Jacoby

Cover ImageThe University of California Press has published Delinquent: Inside America's Debt Machine by Elena Botella. 

Botella used to be "a Senior Business Manager at Capital One, where she ran the company’s Secured Card credit card and taught credit risk management. Her writing has appeared in The New RepublicSlate, American Banker, and The Nation."

Here's the description from the publisher between the dotted lines below: 

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A consumer credit industry insider-turned-outsider explains how banks lure Americans deep into debt, and how to break the cycle.

Delinquent takes readers on a journey from Capital One’s headquarters to street corners in Detroit, kitchen tables in Sacramento, and other places where debt affects people's everyday lives. Uncovering the true costs of consumer credit to American families in addition to the benefits, investigative journalist Elena Botella—formerly an industry insider who helped set credit policy at Capital One—reveals the underhanded and often predatory ways that banks induce American borrowers into debt they can’t pay back.

Combining Botella’s insights from the banking industry, quantitative data, and research findings as well as personal stories from interviews with indebted families around the country, Delinquent provides a relatable and humane entry into understanding debt. Botella exposes the ways that bank marketing, product design, and customer management strategies exploit our common weaknesses and fantasies in how we think about money, and she also demonstrates why competition between banks has failed to make life better for Americans in debt. Delinquent asks: How can we make credit available to those who need it, responsibly and without causing harm? Looking to the future, Botella presents a thorough and incisive plan for reckoning with and reforming the industry.

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Looking forward to reading this book! Also expecting to see more from the University of California Press of direct interest to Credit Slips readers in the years ahead. 

Let's Make Some Crypto Law!

posted by Stephen Lubben

One of the undiscussed consequences of the spate of recent crypto bankruptcies – domestically including Celsius and Voyager – combined with Congress' inability to legislate is that the bankruptcy courts, namely those in the SDNY, will have a chance to make a lot of law regarding crypto.

For example, is Tether a good? (the citation to the UCC is odd - that's not actually the law anywhere, right?).

 

What Happens If a Cryptocurrency Exchange Files for Bankruptcy?

posted by Adam Levitin

Exchanges play a key role in the cryptocurrency ecosystem, but no one seems to have given any consideration to so far is what happens when a cryptocurrency exchange that provides custodial services for its customers ends up in bankruptcy. We’ve never had such a crypto-exchange bankruptcy in the US—Mt. Gox, for example, filed in Japan—but it’s certainly a possibility.  These exchanges are not banks, so they are eligible for Chapter 11 if they have any US assets or incorporation, and they face substantial risks from hacking and their own proprietary trading in extreme volatile assets.

So what happens to a customer if an exchange files for bankruptcy?  I think it ends very badly for the customers, as explained below the break. I do not think customers understand the legal nature of the custodial relationships, and exchanges have no incentive to make the legal treatment clear to customers. In fact, the exchanges are lulling the consumers with language claiming that the consumer "owns" the coins, when in fact the legal treatment is quite likely to be different in bankruptcy. In bankruptcy, it is likely to be treated as a debtor-creditor relationship, not a custodial (bailment) relationship. That means that customers are taking on real credit risk with the exchanges, which is a particular problem because of the opacity of the exchanges and their lack of regulation.

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FDIC Power Struggle

posted by Adam Levitin

Remember when there were two dueling claimants for the title of CFPB Director? Well, we're now seeing a repeat of that conflict play out with the FDIC.

The FDIC is governed by a five member board, consisting of the FDIC Chair, a Vice-Chair, the CFPB Director, the Comptroller of the Currency, and at-large director. By statute, no more than three of the board members may be from the same political party. The Chair, Jelena McWilliams, is a Trump appointee. The vice-chair position is vacant. The other three directors are all Democratic appointees. That means that three of the four directors on the board are Democrats, but the chair is a Republican. So who is calling the shots at the FDIC?

The issue just came up because the three Democratic appointees voted to direct the FDIC's Executive Secretary to transmit a Request for Information for publication in the Federal Register (which provides the notice required under administrative law of a proposed action). That vote and instruction only appear in a statement released on the CFPB's website. The FDIC's website (presumably controlled by Chair McWilliams) states that no such action was approved by the FDIC.

What's going on here?

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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.

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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.

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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.  

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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?)  

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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.

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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.

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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:  

Continue reading "The Rigged Game of Private Equity" »

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.

Continue reading "Coercive "Consent" to Paperless Statements" »

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?

Continue reading "How to Deal with a $3 Trillion Bully" »

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.

Continue reading "Private Equity's Abuse of Limited Liability" »

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