Unhappy Birthday, BAPCPA

BAPCPA's been in effect for 10 years now. I still remember the day before it went into effect, seeing round the block lines at the Wilmington courthouse as consumers rushed to file. 

There's lots to say about BAPCPA, for both consumers and businesses, but it boils down to this: it's not a fine wine and hasn't improved with age. The vinegar only gets more sour. 

Glass-Steagall: It's the Politics, Stupid!

It was like eight nights of Chanukkah in one for me watching the Democratic debate last night. There was a Glass-Steagall lovefest going on. But here's the thing:  no one seems to get why Glass-Steagall was important or the connection between Glass-Steagal and the financial crisis. The importance of Glass-Steagall was not as a financial firewall between speculative investment activities and safe deposits. It was as a political Berlin Wall keeping the different sectors of the financial industry from uniting in their lobbying efforts and disturbing the peace of the nation.

Until and unless we realize that the importance of Glass-Steagall was political, we're going to continue wasting our time debating insufficient half-measures of financial regulation like the Volcker Rule, which has the financial, but not the political benefits of Glass-Steagall. More critically, we're going to pass regulations like the Volcker Rule and then wonder slack-jawed why they don't work, as the financial industry undermines them through the regulatory implementation and legislative amendments. Financial regulation is just not that complex technically, even if if has a lot of technical rules (it's the capital, stupid!). The problem we face is not technical, but political.

It Is Very Expensive To Be Poor

Cash checking fees, prepaid card fees, money transfer fees, cashier's check fees -- all together, the unbanked pay up to 10% of their income simply to use their own money. And when lower-income people face an emergency, they must turn to expensive payday loans, title loans, and tax refund loans. As Mehrsa Baradaran (University of Georgia) writes in her new book, How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy, "indeed, it is very expensive to be poor."

How did this happen? And how might we begin to solve the problem? In her book, Baradaran details how banks and government are and always have been inextricably tied, with the government helping banks and the banks supposedly helping the public in return. But this "social contract" has eroded. The banking sector has turned away from less profitable markets, leaving people with small sums of money to deposit without a trustworthy place to stash their cash, and people in need of small sums of money to borrow nowhere to turn but fringe lenders. Moreover, these people understandably often are uncomfortable dealing with large banks. And the result is that an astonishing large chunk of the American population is unbanked or underbanked.

If the unbanked and underbanked had a trustworthy place to deposit their cash, some of the fees they pay simply to use their money would go away. This alone might allow families to stay financially afloat. Likewise, if they had the option to borrow small sums of money at reasonable rates, temporary financial emergencies may not set so many families up for a lifetime of financial failure. Which leads Baradaran to a proposal that I’m fond of (indeed, I’ve blogged about Baradaran’s thoughts on it before): postal banking.

Bankruptcy in Russia, 1740-1800, and the First Non-Merchant Discharge!

I discovered something surprising in my summer research on the history of bankruptcy in Russia: It seems that the first modern, court-ordered bankruptcy discharge available to non-merchant debtors appeared not in the US or England, but Russia, in 1800. I suspect the relief offered was largely theoretical, but I found it shocking and intriguing that a discharge appeared in Imperial Russian law that early on. The law will finally come full circle in October 2015, when the new Russian law on personal insolvency becomes effective. It's been a long time coming!

As in England, bankruptcy law in Russia started from a much more hostile and punitive position toward debtors. In the Charter on Bankrupts of 15 December 1740 (law no. 8300, available online here), debtors who fell into distress through no fault of their own were to be released from debtor's prison and not fined (s. 19), while debtors whose fault contributed to their downfall (e.g., by continuing to trade while insolvent) were to be fined and executed by hanging (ss. 31-32). Luckily for debtors, this law was apparently ignored in practice and was replaced in 1753 with a new law (without a death penalty) by Peter the Great's daughter, Elizabeth. 

A more radical departure from past practice appeared in the landmark Charter on Bankrupts of 19 December 1800 (law no. 19,692, available online here). This law for the first time drew a distinction between merchant and non-merchant debtors, making bankruptcy relief available to the latter in a distinct Part Two.

More on AIG: Between Hysteria and Complacency

I agree with Adam about all that post-Starr hyperventilation. No, it does not mean that bailouts are over, that the Fed has been slapped down, or any of that lurid stuff. (Though tabloidness does feel strangely gratifying in financial journalism.) Nevertheless, we should be careful not to dismiss the AIG decision as a realist vignette. Its implications for crisis management will become clearer over time, and may well turn out to be important.

At first blush, Starr feels like a stock crisis move by the Court of Claims, evoking the Gold Clause cases in 1935, where the U.S. Supreme Court held that the Congress violated the 14th amendment when it stripped gold clauses from U.S. Government debt, but denied Court of Claims jurisdiction because the creditors suffered no damages. Had they gotten the gold, they would have had to hand it right over to the Feds. And if you measured the creditors' suffering in purchasing power terms, getting their nominal dollars back still put them way ahead of where they had been in 1918 thanks to all the deflation.

Putting this history together with Starr, I wonder about two implications. First, it would have to be awfully hard for a firm getting federal rescue funds in a systemic crisis to prove damages. See also the car bailout stuff. By definition, the firm's best case is the gray zone between illiquidity and insolvency (I called it "illiquency" back then). If you accept that a court is unlikely to enjoin a caper like AIG in the middle of a crisis, this gives the government a fair amount of scope to act, even if it turns out to be off on authority after the fact.

Second, the Greek mess makes me think that the real concern in crisis is not with ex ante constraints on bailouts working as planned, but rather with accidental institutional malfunction. At some point (not yet), all the sand in the wheels will create enough friction that policy makers will not be able to respond to a tail event in a sensible way. No institution would have the authority to do "whatever it takes," and no decision-maker would be willing to take the risk. Maybe this is as it should be, but it does give me pause. 

Lessons For Consumer Protection From The World Of Inclusive Capitalism

Lately I have been teaching courses with names such as "Global and Economic Justice" and "History, Impacts and Regulation of Consumer Credit" instead of "Bankruptcy," "Secured Transactions" and "Chapter 11 Reorganizations." So I have been reading different books and listening to different speakers. A lecture I attended recently by Xav Briggs  here brought to my mind a couple of books that I use in one of my courses, “Borrow” and “Debtor Nation” both written by Louis Hyman. In many ways Hyman's books remind me of "Credit Card Nation" the outstanding and "ahead of its time" book by Robert Manning which I used extensively when I created my consumer credit course in 2002. 

Part of the wisdom I find in each of these books is the caveat that you cannot understand consumer protection without understanding the nature of American capitalism or the drive for an above-market return. This was never clearer or more of a "blow to the side of the head" than during the frenzy in the early 2000's, and perhaps nothing demonstrates it more crassly than the rating agencies covering their eyes as they rated subprime securitizations allegedly in order to "keep the business." 

Insurance Capital Games and PMI Reinsurance Kickbacks

The New York Times carried an important story about the risky investment moves of life insurance companies. There's a lot of good stuff in the story, but it missed an important angle, namely the consumer harm that has already resulted from bank affiliation with captive reinsurers in the private mortgage insurance space, namely inflated and unecessary private mortgage insurance premiums because of illegal kickback arrangements. 

A More Ancient Household Goods Rule

Courtesy of Jack Ayer, professor emeritus of law and polymathy, comes the following from the Wikipedia entry on Modigliani -- Amedeo, not Franco:

Modigliani was the fourth child, whose birth coincided with the disastrous financial collapse of his father's business interests. Amedeo's birth saved the family from ruin; according to an ancient law, creditors could not seize the bed of a pregnant woman or a mother with a newborn child. The bailiffs entered the family's home just as Eugenia went into labour; the family protected their most valuable assets by piling them on top of her.

It's on Wikipedia, so who is to dispute it?

Detroit: "Now Is Not the Time for Defiant Swagger..."

Plan confirmation time. Doesn't everyone relish a big trial? Headlines in national newspapers breathlessly proclaim that the fate of Detroit's future is in the hands of one single judge!

Well, no.

Let's get literal about the judicial role at this juncture. There's no way over the finish line without a determination by the bankruptcy court that the City has met its burden of showing its plan satisfies all legal requirements by a preponderance of the evidence.

This standard includes the City showing that the plan is not likely to fail. Back in January 2014, as the parties negotiated the plan's initial version, Judge Rhodes called for restraint in creditor demands, modesty in City promises:

Now is not the time for defiant swagger or for dismissive pound-the-table, take-it-or-leave-it proposals that are nothing but a one-way ticket to Chapter 18 ... . If the plan ... promises  more to creditors than the city can reasonably be expected to pay, it will fail, and history will judge each and everyone of us accordingly.

    --Jan 22, 2014, afternoon session

Detroit's plan includes revitalization investments, and does so not merely to show how it will service its debt. That scope takes the court into a farther-reaching review.  And the judge appointed his own feasibility expert, and is planning to conduct the direct examination of the expert himself. Such factors further fuel the image of a judge as gatekeeper of Detroit's future.

Yet, no bankruptcy judge should be saddled with the full weight of longstanding socio-economic and geographic challenges. Historian Thomas Sugrue teaches us that the roots of Detroit's crisis run quite deep. Deeper than the recent past of corruption in the Kilpatrick administration, or dependence on casino revenues, interest rate swaps on certificates of participation, or questions about thirteenth checks. Even before the height of worries about auto industry competition abroad, or the enactment of Michigan constitution language on pensions. By Sugrue's account, Detroit's economic decline started in the 1940s and 1950s with hemorrhaging (his word) of good jobs and capital. For the spiral downward from there, the book is here, the speech, 19 minutes into the video, there.  Repair depends on collaborative work: many tools, many hands. How to engage all communities in the effort to conquer longstanding racial tensions and segregation, achieve regional cooperation, expand jobs that offer more security and opportunity than downtown coffee shops and sports stadiums? ("Downtown does not trickle down," said Sugrue at a Wayne State conference earlier this year; explanation here). Again, many tools, many hands.

Although these challenges illustrate how the judge's plan confirmation role operates within a much broader framework of actors, judges also can shape a municipality's restructuring and future throughout the bankruptcy process, in more informal ways. In Detroit's case, Judge Rhodes planted the seeds of oversight and influence in the earliest days of the bankruptcy. He drew on tools and techniques used decades earlier in other kinds of complex litigation, including prison reform and school desegregation cases. See here, here, here, and here.

Among the most consequential moves was delegating to Chief District Judge Rosen the authority to mediate nearly every substantive issue in the case. Detroit heads into the confirmation hearing with many settlements in its pocket - with financial creditors as well as workers and retirees. Most discussed is the pension/art settlement (a.k.a. Grand Bargain) that looks the least like a conventional mediated settlement. Chief Judge Rosen has suggested the deal could be a model for other distressed cities. On harnessing the power of the non-profit sector, maybe so. On a sitting life-tenured judge being the designer, broker, and closer of this type of deal, not so much. However socially desirable the content of the Grand Bargain may be (and that debate will rage on), the costs and risks of this procedural model are simply too great. 

So, as the last phase of the historic Detroit bankruptcy commences, the question of judicial responsibility and influence must be put in context. The role of federal judges in shaping Detroit's future has been overstated in some ways, understated in others. Trials matter. But if they capture too much of our attention, we will miss other important things.

Puzzle picture courtesy of Shutterstock

 

Lessons From Postal Banking's Past

Mehrsa Baradaran (University of Georgia) has a short piece in Slate tracing the history of the U.S. Postal Banking system. In sum, post offices once were banks, the system was in place for over 50 years, and post offices can be banks again. Indeed, at its height, the postal banking system was used by millions of Americans. Then banks moved into the majority of cities and towns and offered customers a more attractive option than using postal savings depositories. But when these banks began leaving low-income neighborhoods in the 1970s, the postal banking system already had died a quiet death, leaving the market open to payday lenders and check cashing operations. As Adam pointed out in his op-ed in American Banker from earlier this year, and as Mehrsa's piece highlights, postal banking may be the key to the current lack of financial inclusion. The piece is a quick and interesting read.

Post office building image courtesy of Shutterstock.

"Don't give me so much that you've given me nothing" - Remembering M. Caldwell Butler's Contribution to Bankruptcy Law

Former Virginia Congressman M. Caldwell Butler died last week. He is widely known for his role in the Nixon impeachment proceedings, his efforts to limit extensions of the Voting Rights Act, and his support for ensuring legal representation for low-income individuals. But Congressman Butler is also a major figure in the history of bankruptcy law. He was a principal co-sponsor of the Bankruptcy Reform Act of 1978 that serves as the foundation of the modern bankruptcy system. Professor and lawyer Kenneth N. Klee worked closely with Congressman Butler on the House Judiciary Committee in the 1970s. I asked Professor Klee to share a few words of remembrance with us, which I repeat in their entirety here:

I first met M. Caldwell Butler in 1975 when he became the Ranking Minority Member of the Subcommittee on Civil and Constitutional Rights of the House Judiciary Committee. Caldwell was most interested in the Voting Rights Act legislation and finding a way for the South to get out from under the Act. In his view, Washington was improperly interfering with the sovereignty of the southern states based on predicate acts that had long since ceased to serve as a basis for federal control. He asked me to draft a series of amendments that would permit the South to extricate itself from the Voting Rights Act. The requirements to regain sovereignty were quite demanding, to the point that the amendments became known as the "impossible bailout."  Nevertheless, the amendments did not come close to passing. It was evident that there were no circumstances under which the majority in Congress wanted to let the southern states out from the Voting Rights Act.

Caldwell assumed his responsibilities over bankruptcy legislation with diligence and good cheer. His fabulous sense of humor carried us through many long markup sessions during which the members of the Subcommittee read the bankruptcy legislation line by line. He had a sharp legal mind and deep curiosity. He also was very practical and to the point. He was fond of telling me "don't give me so much that you've given me nothing."

It was a privilege and honor to work with him. The bankruptcy community should join in paying him tribute.

                        -- Ken Klee

Congressman Butler made another round of contributions to bankruptcy reform in the 1990s. The fact that they are not all reflected in today's Bankruptcy Code makes this story more pressing, not less. Well over a decade after he had returned to the practice of law in Virginia, Congressman Butler was appointed to the National Bankruptcy Review Commission, for which I was a staff attorney. Expressing satisfaction with the 1978 Code, the House Judiciary Committee directed this Bankruptcy Commission to focus, for two years, on "reviewing, improving, and updating the Code in ways which do not disturb the fundamental tenets of current law."  Not one to leave the heavy lifting to others, even in a pro bono post, Congressman Butler stepped up to the challenge of forging a compromise, among those with diverging politics and views, to improve the consumer bankruptcy system.

Larry Summers' Attempt to Rewrite Cramdown History

Larry Summers has a very interesting book review of Atif Mian and Amir Sufi's book House of Debt in the Financial Times. What's particularly interesting about the book review is not so much what Summers has to say about Mian and Sufi, as his attempt to rewrite history. Summers is trying to cast himself as having been on the right (but losing) side of the cramdown debate. His prooftext is a February 2008 op-ed he wrote in the Financial Times in his role as a private citizen. 

The FT op-ed was, admittedly, supportive of cramdown. But that's not the whole story. If anything, the FT op-ed was the outlier, because whatever Larry Summers was writing in the FT, it wasn't what he was doing in DC once he was in the Obama Administration.

Let's make no bones about it.  Larry Summers was not a proponent of cramdown.  At best, he was not an active opponent, but cramdown was not something Summers pushed for.  Maybe we can say that "Larry Summers was for cramdown before he was against it." 

Book Review: Jennifer Taub's Other People's Houses (Highly Recommended)

I just read Jennifer Taub's outstanding book Other People's Houses, which is a history of mortgage deregulation and the financial crisis. The book makes a nice compliment to Kathleen Engel and Patricia McCoy's fantasticThe Subprime Virus. Both books tell the story of deregulation of the mortgage (and banking) market and the results, but in very different styles. What particularly amazed me about Taub's book was that she structured it around the story of the Nobelmans and American Savings Bank.

The Nobelmans?  American Savings Bank? Who on earth are they? They're the named parties in the 1993 Supreme Court case of Nobelman v. American Savings Bank, which is the decision that prohibited cramdown in Chapter 13 bankruptcy. Taub uses the Nobelmans and American Savings Banks' stories to structure a history of financial deregulation in the 1980s and how it produced (or really deepened) the S&L crisis and laid the groundwork for the housing bubble in the 2000s.

Working and Living in the Shadow of Economic Fragility

Credit Slips readers, please note the publication of a new book edited by Marion Crain and Michael Sherraden. The New America Foundation is hosting an event on the book tomorrow, Wednesday, May 28, 2014 at 12:15 EST. Not in Washington, D.C.? The event will be webcast live. 

The book project developed out of a stimulating multi-disciplinary conference at Washington University in St. Louis. Participants had great interest in considering how bankruptcy scholarship fits within the larger universe of research on financial insecurity and inequality. My chapter with Mirya Holman synthesizes the literature on medical problems among bankruptcy filers and presents new results from the 2007 Consumer Bankruptcy Project on coping mechanisms for medical bills, looking more closely at the one in four respondents who reported accepting a payment plan from a medical provider. Not surprisingly, these filers are far more likely than most others to bring identifiable medical debt, and therefore their medical providers, into their bankruptcy cases. We examine how payment plan users employ strategies - including but not limited to fringe and informal borrowing - to manage financial distress before resorting to bankruptcy, and (quite briefly) speculate on the future of medical-related financial distress in an Affordable Care Act world.

1924 and Today

History can sometimes provide a fresh perspective on current events. My years of observations at UNCITRAL led me to wonder about how working methods in this international organization compare to those of similar (some would say sister) organizations -- UNIDROIT and the Hague Conference on Private International Law. This research revealed references to work at the turn of the 20th century (1879, 1904, 1925) on an international convention on the treatment of cross-border bankruptcy cases. I was intrigued, but primary documents eluded me.

On a recent trip to London I was lucky to enough to score big in two different libraries: at the British National Archives in Kew Gardens I found 7 file folders from the British Board of Trade, circa 1924, describing preparations for participation at the Hague Conference's Fifth Session for deliberations on a draft insolvency convention; at the British Library I finally scored the long-sought records of the proceedings of these 1925 meetings at The Hague.  Nerd heaven!

American Hustle

If you want to understand credit and its abuses, you have to delve into the human heart, in all its weakness and strength, and literature and film are powerful ways to do so.  In this observation, I join the growing backlash (see, for example, here and here) against the philistine notion that the humanities are a waste of time.  Literature and history can teach us at least as much as the social sciences and often are better written and more insightful about the nuances of our psyches.

Arguably the most fertile period of American cultural production was the mid-19^th century, when  Edgar Allan Poe, one of America’s first professional authors, examined closely the techniques of scamming, quickly joined by other literary greats such as Herman Melville and Mark Twain.  See here for my paper on this subject. Poe was also the first to link scammers’ motivations to the spirit of Wall Street.  Defining a scammer as working on a small scale, Poe also connected the dots to grand predators: “Should he ever be tempted into magnificent speculation, he then, at once, loses his distinctive features, and becomes what we term ‘financier.’”  See here for source.

David O. Russell provides a fresh take on this point in a must-see new movie—just in time for the holidays.  American Hustle’s dark wit speaks to the loss of any remaining American innocence in the lingering wake of the Great Bubble and Pop.

Set in the seedy late 1970s, the film lushly renders the world of runaway inflation, terrible clothes, shaggy hair (and comb-overs), disco fever, rising divorce rates, and rundown real estate for which the decade is remembered.   But it tells a timeless tale of raw ambition for riches and status turning every human interaction into a con.

Detroit's Chapter 9 and the Vanishing Umpires

When the Chief Judge of the Sixth Circuit selected Judge Rhodes to preside over the City of Detroit's chapter 9 case, she attached a letter from the Chief Judge of the Eastern District of Michigan. Among other things, it lauded Judge Rhodes' case management skills, and asserted the need for those skills in a case of this nature. To many, the phrase “case management” may evoke procedural judicial tasks of little normative content. But the sandwich of the two words should invite deeper questions about the role of courts, judges, judicial adjuncts, and trials, and the impact of the presence or absence of disputes playing out in public view.

Usury and the Loan Shark Myth

Consumer financial education, disclosure, and defaults all dispensed with in my prior posts, shall we move on to “substantive” regulation, dare I even say “usury”? Before we do that, I need to clear up another myth that, like the belief in the efficacy of consumer financial education, is deeply ingrained: the loan shark myth.

Forthcoming in the Washington & Lee Law Review is a historical expose of the relationship – or lack thereof – between credit price regulation in the small loan market and loan sharking. The author, political scientist Robert Mayer, finds that what the popular culture has called loan sharking consists of two different types: violent and nonviolent. Both have been characterized by: (1) high prices, in excess of usury restrictions where such restrictions have applied, and (2) short-term, nonamortizing loans made to people who have a decent likelihood of being able to pay the interest amount due at maturity but a low likelihood of being able to pay off the principal balance, resulting in a steady stream of interest income to the lender as the loans roll over and over. It is this second feature that in the 19th Century first earned even nonviolent loan sharks their “shark” moniker – a single loan, even if it is expensive, looks harmless enough, but stealthily traps the borrower in a cycle of debt.

Usury Laws Are Dead. Long Live the New Usury Law. The CFPB's Ability to Repay Mortgage Rule

[Updated 1.14.13] The CFPB has come out with its long awaited qualified mortgage (QM) rulemaking under Title XIV of the Dodd-Frank Act.  The QM rulemaking is by far the most important CFPB action to date and will play a crucial role in determining the shape of the US housing finance market going forward. The QM rulemaking also represents a return in a new guise of the traditional form of consumer credit regulation—usury—and a move away from the 20th century’s very mixed experiment with disclosure.

An Empirical Overview of Modern Sovereign Debt Litigation

In December, I attended a terrific conference examining historical parallels to the European debt crisis. I was there to talk about the early-20th century antecedents of modern collective action clauses, the magic contractual potion - or is it snake oil? - that will banish holdout litigants from the kingdom forever more. There were some really great papers, including this one (Sovereign Defaults in Court: The Rise of Creditor Litigation 1976-2010, by Julian Schumacher, Christoph Trebesch, and Henrik Enderlein), which may interest many Credit Slips readers.

One of my interests involves how changes in sovereign immunity law influence bond contracts, and I have written about that relationship here. Schumacher et al. address a related but quite distinct subject: the determinants of sovereign debt litigation. Why are some restructurings followed by a flood of lawsuits when others produce few or none? Are poorer countries more likely to be targeted? Does the size of the haircut matter? They have assembled a comprehensive dataset, which includes essentially all lawsuits filed in London and New York since the advent of the modern era of sovereign immunity (which they date to the 1976 enactment of the Foreign Sovereign Immunities Act in the US). My synopsis of their findings after the jump.

CFPB's Anti-Abuse Authority: A Promising Development in Substantive Consumer Protection

The Consumer Financial Protection Bureau is doing something promising with its anti-abuse authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  It is going after credit industry exploitation of consumers, particularly when business models involve using confusing terms that disclosure cannot adequately address.  See my paper on this topic. So I was not surprised to see George Will attacking this development.   We can't have smart, effective consumer protection, no matter how popular it might be.

In a column published in many newspapers this week,Will wrote: “The CFPB's mission is to prevent practices it is empowered to ‘declare’ are ‘unfair, deceptive, or abusive.’ Law is supposed to give people due notice of what is proscribed or prescribed, and developed law does so concerning ‘unfair’ and ‘deceptive’ practices. Not so, ‘abusive.’”

The flaws in Will's critique are legion. First, the CFPB has given lots of notice of what it is doing, in a detailed examination handbook.

Allied Bank revisited?

Last Friday was the filing deadline set by (a rather irked) Judge Griesa for Argentina and interested third parties in that country's long-running battle with NML and other restructuring holdouts. NML's reply brief is due today, but it has already made clear that it wants to be paid in full (roughly $1.4 billion) and that it expects the district court's injunction to bind a lot of third parties, including the trustee for the exchange bondholders. The genius of NML's strategy is that it has found a way to enforce its claims without having to find and seize Argentine assets. (Not that it's afraid to seize an asset or two.) If the strategy works and can be used in other cases, it will have major policy implications.

Readers familiar with the sovereign debt markets may remember the Allied Bank litigation - a trilogy of opinions that launched the modern era of holdout litigation. The parallels between the Allied Bank case and this one are striking, right down to the identity of the district judge.

Race and the Housing Bubble

While we wait to see if the second Obama administration will do anything new to help homeowners hit by the lingering mortgage crisis (finally replace Bush-holdover Ed DeMarco at FHFA to make way for debt relief?), there’s time to review a recent development that didn’t get the full attention it deserved.

I am referring to a lawsuit, Adkins v. Morgan Stanley, filed in the Southern District of New York in October by the ACLU. We don’t usually associate the ACLU with consumer protection in mortgage finance, and not surprisingly, it has brought a fresh perspective on the abuses that led to the housing bubble, highlighting race disparity in subprime originations.

Together with the National Consumer Law Center, the ACLU has brought a class action against Morgan Stanley charging that it financed a major subprime mortgage originator, dictated the nasty terms offered, and bought up a big portion of the resulting junk to feed its securitization maw.  The originator was New Century Mortgage Corp., which filed in bankruptcy in 2007.

The plaintiffs are African-American homeowners in Detroit who were sold New Century mortgages and who have ended up facing foreclosure. Also joining as a plaintiff is Michigan Legal Services, which has been swamped with mortgage cases in foreclosure ground zero, Detroit.

The legal theories used include the Fair Housing Act and the Equal Credit Opportunity Act, which are promising because these federal laws cover purchasing loans and also make disparate racial impact sufficient to make out a discrimination case. The 71-page complaint presents data that Detroit-area African-American customers of New Century were 70 percent more likely to end up in subprime loans than white borrowers with similar financial characteristics. The suit seeks a jury trial and disgorgement of ill-gotten gains, among other relief including appointment of a monitor (a good idea given the constancy of race discrimination in US housing finance practices).

Pesky holdouts, old-timey edition. (Or, more on why Argentina matters.)

"[T]he principal beneficiaries of the litigation were an unscrupulous body of commercial pirates, who had purchased ... bonds at a mere nominal price..."

When would you guess the litigation referenced in this quote took place? The sentiment sounds like something an Argentine finance official might have expressed in the last week or so. But the quote (p. 449) refers to buyers of distressed Bolivian bonds in the 1870s. Like modern holdouts, these old-timey "commercial pirates" recovered an amount disproportionate to their investment, and it didn't win them any friends.

In this post, I want to discuss the historic treatment  of holdouts in sovereign debt restructurings. In a (just posted) paper, Mitu Gulati and I review terms used in both sovereign bonds and sovereign debt restructuring proposals over the course of the 20th century. We're primarily interested in collective action clauses-which, as many readers know, are clauses that allow a majority of bondholders to approve a restructuring in a way that will bind dissenters. Indirectly, however, these historic practices also shed light on the pari passu clause at the center of the NML vs. Argentina litigation.

Crystal Ball Department: Bankruptcy Filings to Rise in a Few Years

Good times in the economy mean goods times a few years later for bankruptcy professionals who deal with consumer cases.  We saw this from the mid-1990s through the 2000s. The last big party in the bankruptcy world was in 2010 (1.5 million non-business cases filed!), a few years after the end of the last debt binge came to a crashing halt starting in 2007.  The reverse is also true.  Bad times in the economy make for fewer bankruptcy filings a few years later, which is what we have been seeing lately.

Those of us who blog on Credit Slips get frequent calls from reporters asking about bankruptcy filing statistics, specifically:  what do they mean?  Filings, which are mostly consumer filings, have gone down steadily for two years now, so it gets hard to come up with anything new to say, as Bob Lawless recently wrote here.

When filings go down, reporters new to the bankruptcy beat often think that means the economy must be getting better. Wrong. What drives bankruptcy filings is debt.  Decreases in debt are followed a few years later by decreases in bankruptcy, and increases in debt are followed by increases in bankruptcy.  The Great Recession that started in 2007 resulted in a great decline in household debt due to a combination of reduced access to credit and consumers voluntarily cutting back on debt-driven spending because of a lack of consumer confidence.

It’s so old hat to talk about the continuing decline in bankruptcy filings, produced by a long process of household deleveraging (meaning taking on less debt and instead paying off old debt), that I’m going out on a limb with a prediction. We may finally be seeing signs of a reversal in progress—consumer confidence going up, which should drive up debt volume, and presto chango, we’ll see more bankruptcy in a few years. Bankruptcy attorneys, take heart: recovery will mean a return to your good times, too, but a few years hence. 

In Defense of Bankruptcy Courts (or, Is Bankruptcy Really That Exceptional?)

Although not always acknowledged expressly, exceptionalism is pervasive in bankruptcy scholarship. Some work makes no attempt to contexualize bankruptcy within the federal courts, apparently assuming its unique qualities (for example, the disinterest in most bankruptcy venue scholarship about venue laws applicable to other multi-party federal litigation). But other projects are more deliberate in their exceptionalist pursuits.

Why No Prosecutions

The NYTimes had a very good editorial today bemoaning, with resignation, that there will not be any serious prosecutions of senior bank executives or institutions for the financial crisis.  The biggest fish to be caught was Lee Farkas. Who? That's the point. There have been prosecutions of some truly small fry fringe players and some settlements that are insignificant from institutional points of view (even $500 million, the SEC's record settlement with Goldman over Abacus was a yawn for Goldman), but that's it.  

The NYT editorial incorrectly states that the relevant statute of limitations have expired.  The usual statutes of limitations have or will shortly expire, but not those under FIRREA (for frauds that affect federally insured banks), which are 10-years long. So there is still theoretically the possibility of prosecutions (and remember that Mozilo's deal, for example, was with the SEC, not with the states...). But don't count on it happening.

My prediction is that when the history of the Obama Administration is written, there will be some positive things to say about it, but also two particular blots on its escutcheon.  First, the failure to act decisively to help homeowners avoid foreclosure, and second, the failure to hold anyone accountable for the financial crisis. These two failures are intimately tied, of course. Both are explained by the "Obama administration’s emphasis on protecting the banks from any perceived threat to their post-bailout recovery." 

The logic here is that financial stability and economic recovery are more important than rule of law. There's an argument to be made that law has to give way to basic economic needs.  I, however, would reject the choice as false. Instead, the best way to restore confidence in markets is to show that there is rule of law.  The best route to economic recovery was through rule of law, not away from it. (Yes, I realize there are those who would argue that the GM/Chrysler bankruptcies and cramdown aren't rule of law, but rule of law can include flexible systems like bankruptcy, rather than just rigid rules.)

The Administration, however, determined that it wasn't going to rock the boat via prosecutions, even though there is no person in the banking system who is so indispensible to economic stability as to merit immunity from prosecution, and as the experience of 2008-2009 shows, recapitalizing institutions isn't rocket science. In any case, the Administration's policy has produced the worst of all worlds, where we have neither justice nor economic recovery. This is our new stagflation. Call it injusticession.  

Everything You Always Wanted to Know About CDOs (But Were Afraid to Ask)

Bill Bratton and I have a new paper out, called A Transactional Genealogy of Scandal:  from Michael Milken to Enron to Goldman Sachs.  The paper is about the development of the collateralized debt obligation (CDO) and its incessant connection to financial scandal, from its origins in Michael Milken transactions through Enron (who knew that Chewco was basically a CDO?) and then of course Goldman Sachs' Abacus 2007-AC1 transaction.  

The paper is chock full of scandalous transactional detail (my personal favorite is how the Federal Home Loan Bank Board interpreted its 1% junk bond investment limit to mean 11%), but it also has a larger theoretical move: the CDO is a particular type of special purpose entity (SPE) that is often used for regulatory and accounting arbitrage purposes. SPEs are a new form of corporate alter ego. Whereas the traditional alter ego such as the subsidiary or affiliate has equity control, the SPE is nominally independent, but is in fact controlled by pre-set contractual instructions. As a result, SPEs like CDOs that are used in regulatory and accounting arbitrage transactions are particularly prone to scandal even over minor compliance violations whenever there is red ink in a deal because of the mismatch between corporate formalities (protesting separateness) and economic realities (the alter ego).  Accounting treatment has caught up with the SPE, but corporate law has not. Yet because accounting gets incorporated into securities law, in particular, transaction engineers need to be particularly cognizant that liability may track the economic realities, not just the legal formalities of transactions. 

Sovereign Debt

From the the second volumn of J.F. Molloy, Court Life Below Stairs (rev ed. 1885), regarding events after the death of George III's spouse, Queen Charlotte:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A 5% recovery is pretty bad, even by modern Greek standards, but maybe that's where things are headed. Of course, maybe the proper point of comparison is actually personal bankruptcy. But note the numbers -- £1,000 in 1818 (the year the Queen died) would be worth about £70,000 today; about £85,000 if we count from 1827, the date of the Duke of York's death. So the Duke's debts were ... large. Much larger that most personal bankruptcies today for sure.

Bankruptcy's Living History

The American College of Bankruptcy (ACB) in cooperation with the Biddle Law Library at the University of Pennsylvania has made available a great and often overlooked resource for scholars who prefer to study "law on the ground" instead of just the "law in the books." The National Bankruptcy Archives collects historical material regarding the development of bankruptcy, and three separate oral history projects make up a particularly interesting part of that material. These oral history projects come from Judge Randall J. Newsome, the National Conference of Bankruptcy Judges, and the Biddle Law Library's own oral histories related to bankruptcy.

On the web site, one can access transcripts of the interviews, audio recordings, and often videotapes (although more on the videotapes in a moment). Of course, the web site is open to anyone with an Internet connection who might have a professional interest or just a curiosity about bankruptcy and its history. And, who would not harbor such interests?

Whence Corporate Bankruptcy

A correspondent and I were discussing the changes wrought by the 1978 enactment of the current U.S. Bankruptcy Code. My correspondent noted that corporate bankruptcy became more salient after 1978 and linked this phenomenon to the 1978 law. My perception is the same: corporate bankruptcy became more salient after the 1978 enactment of the Bankruptcy Code, and my guess would be that many experts would have the same reaction. We all remember big cases like Johns-Manville, Drexel Burnham, most all of the airline cases (Pan-Am, Eastern, Braniff), and many others. These cases all tend to occur after 1978 suggesting that the 1978 law did lead to a boom in corporate bankruptcy filings. Then I wondered whether my perception was backed by empirical fact.

Do You Remember How Overdraft Protection, Overdraft Fees, and Free Checking Used To Work?

Calling everyone in the over-40 set to help me remember something. When dealing with those old-fashioned things called “checks,” how did your own overdraft protection used to work?  My recollection is that, back in the day, as long as a person had a certain level of creditworthiness, the bank used to cover your check in a discretionary manner. Then, as I recall, middle class people were encouraged to set up various protections to keep checks from bouncing, such as automatic transfers from savings or a line of credit to cover overdraft accounts.  Why don’t more people use these? Is it because they do not qualify? I keep hearing about $35 and even $39 overdraft fees, on both debit and check transactions, like in the New York Times blog today, and wondering who is paying them. Apparently lots of people, since the $38 billion in overdraft fees earned by lenders in 2009, is double what lenders made off these fees in 2000. Is this the ultimate example of banking for the “haves” versus the “have-nots?”

Recommended Reading

As I await the arrival of this semester's exams, and all the fun that those will entail, I'm getting caught up on my reading. The best of the bunch thus far is Emily Kaden's history of the Pitkin Affair, which appears at 84 Am. Bankr. L.J. 483 (2010), and online here. Having read a lot of bankruptcy history, I was generally familiar with the plot, but Emily presents the definitive history of the entire episode, which is so often referenced, but not explained, in latter histories of English and American bankruptcy.

A Conversation with Trailblazing Women

Yesterday, I attended the International Women's Insolvency and Restructuring Confederal (IWIRC) Annual Spring Program. The featured event was entitlted, "A Conversation with Trailblazing Women in the Insolvency Field." Moderated by the Hon. Marjorie Rendell of the 3rd Cir. Court of Appeals, the panel's participants incuded Norma Corio of JPMorgan Chase, Marcia Goldstein of Weil Gotshal & Manges, Hon. Barbara Houser, Chief Bankruptcy Judge, N.D. Texas, Hon. Mary Walrath, Bankruptcy Judge, District of Delaware, and Bettina Whyte of Alvarez and Marsal. The program opened with a parable. A man cuts himself shaving in the shower. He wonders out loud what is wrong with the razor. A woman cuts herself shaving in the shower. She wonders out loud what she did wrong. 

The Upside of High Fees

Some of the comments to Stephen Lubben's post on "overhead" raised the longstanding complaint about high fee awards in New York and Delaware Chapter 11 cases. We all know the academic and political condemnations of Chapter 11 as merely a feast for lawyers.

It's important to remember, though, that the possibility of higher attorney's fees was considered a feature, not a bug, when the Code was enacted in 1978. Or, more precisely, the liberalization of fee awards was intended to attract lawyers (the elite bar) who had largely shunned bankruptcy practice after the New Deal-era bankruptcy reforms. There's no doubt that the overall quality of representation in business bankruptcy cases has increased markedly since 1978, along with the cost of that representation. That's why I don't understand those critics whose objections really seem to be about the presence of large, sophisticated (and expensive) national law firms in Chapter 11 cases.  

Of course, high fee awards come out of the pockets of unsecured creditors, who don't have much say in hiring the attorneys. The system needs an outsider monitor to take account of that inherent principal-agent problem, and that's where the US Trustee plays a crucial role. But anyone who has practiced in New York knows that the US Trustee's Office has not always been predictable in its fee objections. The overhead argument is an example.

 

Anna Nicole Smith and Mass Torts in Bankruptcy

Stern v. Marshall presents another issue that deserves attention. In addition to the constitutional arguments, the respondent (the creditor) raised a statutory objection to the bankruptcy court's ability to hear and decide the debtor's counterclaim as a core proceeding. The judicial code (28 U.S.C. § 157(b)(2) and (b)(5)) limits the power of bankruptcy courts to adjudicate "personal injury tort and wrongful death claims" as core proceedings--provisions that come into play in mass tort bankruptcy cases.

I'd like to focus on why we have such a genuinely odd qualification of the jurisdiction of the bankruptcy courts.

Robosigning and Evidence

The robosigning issue brought to mind a Talmudic evidentiary rule that declares the testimony of certain types of people inadmissible:  

These are they who are ineligible (as witnesses): a dice-player, a usurer, pigeon-flyers, traffickers in Seventh Year produce, and slaves. This is the general rule; any evidence that a woman is not eligible to bring, these are not eligible to bring.  

Mishnah Rosh ha-Shanah 1:8.  

This is hardly the Federal Rules of Evidence, but I just thought it interesting.  

Modern Redlining in Historical Context

A paper that I wrote while an employee of the Federal Reserve System a couple years back documents the presence of ‘redlining’ in the issue of credit cards. Credit Slips picked it up here (link).

(To ensure there are no misunderstandings, this paper did not and does not represent the views of the Federal Reserve Bank of Boston or the Federal Reserve System; in fact, both entities did their utmost to prevent its release) ... continue…

To be more specific: I find that credit issuers use the racial composition of a neighborhood in determining how much credit to give to individuals that live in it. I use the term ‘redlining’ with historical reference: this idea is that particular areas have been identified as high risk. What I find is that the ‘high risk’ areas are highly correlated with the presence of minorities.

I’ll be clear, I cannot definitely prove that lenders use race—I’m an economist, not a lawyer! Regardless, I’ll present the point that the practice is still redlining even if lenders never use race, but use location-based information that is correlated with race.

Measures of TARP

The curtain drew on TARP to a flood of assessments, from Treasury's up to TARP COP's down, with the commentariat all along the spectrum in between, converging around about the "necessary-evil-begets-moral-hazard" meme.  But this New York Times graphic and the surrounding talk of taxpayer repayment left me wondering.  To be sure, it is always better to make money than to lose money.  And I suppose if a government program were an abject policy failure but made a killing for the Treasury, it would not feel quite as bad as a failure that cost an arm and a leg.  The Clinton Administration's package for Mexico in 1995 is often described as a success in key part because it was repaid in a year, and made a profit for the Treasury -- so much so that Paul O'Neil, George W. Bush's first Treasury Secretary, famously endorsed his Democratic predecessors' controversial bailout.  All this makes sense if the fiscal rescue works like the central bank's lender of last resort function, meant to overcome illiquidity with safe short-term loans at penalty rates.  As Steve Davidoff points out, TARP's overriding goal was rapid stabilization, in which case the big difference between TARP's containment strategy and the preceding Fed facilities is some mix of extreme fear and political exhaustion.  I suspect that this view of  what makes TARP successful lends itself to certain methods-- big loans to banks over little subsidies to households, which would take a long time to wind their way back to the Treasury.  Should "bailouts" make more of an effort to distribute and stimulate, even if it means more risk of near-term loss?  I wonder.  Would any political body ever do it?  I doubt it.  Bye, TARP.

Time Flies

To keep this debt thing in perspective ... Germany is about to pay the last of the debt it took on to finance World War I reparations.  This debt is mostly interest payments to private bondholders.  The reparations came out of the Treaty of Versailles in 1919, but Germany had no money, so it issued bonds in the private capital markets in the 1920s to fund its payments to the Allies.  The bonds defaulted in the 1930s (first crash, then Hitler, then it got really messy), but resumed principal payments under a 1953 agreement.  Interest payments were deferred until reunification, and resumed once the Berlin Wall fell, with the last one due this weekend.  Der Spiegel story here.  How poignant yet deeply screwed up all around. 

The Beginning of a Return to Consumer Protection?

Many years ago, in the mid 1970's, when I began my career as a legal services lawyer practicing consumer law, it seemed that we were on a roll. Congress and state legislatures were passing a bevy of laws to protect consumers (including the Bankruptcy Reform Act of 1978.)  The FTC was passing regulations and taking action against consumer scams. Innovative lawyers, often in legal services programs, were bringing class actions against a wide variety of illegal and unfair practices. These cases were received sympathetically by courts that, from a common sense perspective, could see that those practices took advantage of consumer ignorance or confusion.  Little did we know that we were at the peak of the consumer protection movement and it would be almost all downhill from there.

Pro-Consumer Innovations in Payments

Todd Zywicki wrote in a Wall Street Journal op-ed yesterday that "The most important pro-consumer innovation in payment systems of the past two decades has been the general disappearance of annual fees on most credit cards." 

Todd is right that consumers are happy to see annual fees go away, but the disappearance of annual fees wasn't a freebie for consumers.  It came about as part of a shift in the credit card business model whereby upfront fees were replaced with backend fees that have lesser salience to consumers when the consumers decide which cards to carry and use.  This was a move that was made to increase revenue for card issuers (or put another way, to siphon off more consumer surplus); it was not a charitable act.  The disappearance of annual fees is an important innovation, but I think it is a stretch to call it a pro-consumer innovation, when it is viewed contextually.  

The disappearance of annual fees was a step in the democratization of credit (or put another way, the decline in underwriting standards).  Whether this was a good thing is unclear.  It certainly increased consumer's borrowing ability and choices, and might have led to a substitution from secured installment credit to unsecured revolving credit.  But greater ability to borrow and more borrowing choices are not necessarily good.  They are only good to the extent that a consumer is capable of repaying the increased credit line and making informed choices among credit options.  Both of those are questionable for many consumers.  

In Todd's defense, though, I am hard pressed to think of another widespread innovation that would qualify unabashedly as pro-consumer, so maybe the disappearance of annual fees wins by default.  I would have placed the card associations' waiver of all consumer liability for unauthorized transactions (going beyond TILA) as the clear winner, but I don't know how far back this policy goes.  (Please pipe in if you do.)  

The difficulty in naming pro-consumer innovations is a sorry indictment of the payments industry, and one that says something about the nature of innovation and competition in payments.  Maybe others have thoughts about pro-consumer innovations.  Comments are open.  

Bankers, pawnbrokers, actors, jugglers, acrobats, quacks, and brothel keepers...in 16th Century Holland

It's pretty amazing how the status of some professions has changed over time.  I came across this astounding passage in Simon Schama's The Embarassment of Riches:  An Interpretation of Dutch Culture in the Golden Age (now you know what I read for fun): 

"Bankers were excluded from communion by an ordinance of 1581, joining a list of other shady occupations---pawnbrokers, actors, jugglers, acrobats, quacks, and brothel keepers---that were disqualified from receiving God's grace.  Their wives were permitted to join the Lord's Supper, but only on condition that they publicly declared their repugnance for their husband's profession!  Their families shared the taint and were only permitted to join communion after a public profession of distaste for dealing in money.  It was not until 1658 that the States of Holland [the representatives of the estates of nobles and commoners to the court of Holland] persuaded the church to withdraw this humiliating prohibition on "lombards."

That's a remarkable shunning of those in finance by a culture that was absolutely obsessed with material goods of every sort (tulips, satin, brocade, damasks, gold, silver, pearls, etc.).  There's a long history of religious discomfort with finance, but to see this in as commercial of an early modern culture as there was surprised me. 

Are You a Work Horse?

Two items of interest . . . .

First, from West's "headnote of the day" service on a case interpreting what it meant for a horse to a "work horse" within the meaning of an exemption statute. Given the holding, I wonder how many modern-day householders might fit the description! I, for one, vow never to be broken to gear.

To entitle a poor debtor to the benefit of the act which declares "one work horse," etc., shall be retained for the use of every family in this state "free and exempt from levy or sale by virtue of any execution or other legal process," it is not necessary to prove that the horse had been broken to gear, or used in harness; but it is enough if he performed the common drudgery of the homestead, either by hauling wood, drawing the plow, carrying the family to church, etc., under the saddle or in traces. And he need not have performed all these services. If he is intended to be used in any or all of them, or in others of a kindred character, he comes within the exemption. Noland v. Wickham, 9 Ala. 169 (1846).

The second item -- there is a headnote of the day service? Who knew?

By the way, I mainly wanted to post this for the benefit of our resident horse expert, Debb Thorne, who I am sure will chastise me for my cavalier attitude toward the comparisons between humans and horses.

Hat tip to Bob Hiller for pointing the way to this.

New English Bankruptcy History Archive on SSRN

Actually, it's not really an archive per se, but the long list of collected works by John Paul Tribe, KPMG Lecturer in Restructuring at Kingston University (London) School of Law, is impressive enough to merit its own subject heading in a library collection (also, check out the intriguing ancient bankruptcy images at the Muir Hunter Museum of Bankruptcy, of which Prof. Tribe is the curator). Tribe's work was uploaded to SSRN in January and February, so many may not know of its existence yet--this is a resource not to be missed. Most of the work is historical, a great resource for those of us looking for citations (for academic or persuasive rhetorical purposes) on the earliest history and development of bankruptcy and insolvency in England, including its ever-famous death-penalty roots. Not all of the papers are downloadable (the one entitled Discharge in Bankruptcy: A Comparative Examination of Personal Insolvency Relief is particularly enticing to me, but the full-text paper is not available), but other attractive titles are free for the taking, such as A Definitive Bankruptcy and Related Subject Bibliography: From the Earliest Times to 1899 in Chronological Order and Bacon in Debt: The Insolvency Judgments of Francis, Lord Verulam. Check them out--and Prof. Tribe, if you're reading, please upload the missing papers and share the extraordinary wealth!

Contracts in Crisis: Variations in Z and S

Luigi Zingales of Chicago GSB put out a mortgage modification proposal about a month ago that got a bit of attention, but deserves more even if it has no political prayer.  It is one of a genre -- advocating across-the-board contract change in response to a macro shock -- that has at least two other prominent exponents, Randall Kroszner and Joseph Stiglitz.  I am noodling this literature for a U. Conn. symposium paper.

Zingales proposes legislation to allow homeowners to reduce the loan principal in line with the drop in home prices in their zip code from the time of purchase (as measured by Case-Shiller).  Creditors would get an equity kicker TBD.

T.A.R.P. R.I.P.: Illiquency Watch

TARP's third incarnation as a consumer lending catalyst goes straight to my pet crisis peeve.  I am endlessly flummoxed at the authorities' insistence on throwing liquidity at a solvency problem -- with TARP I, AIG, and now, the consumers.

I have ranted elsewhere about the perils of drawing a sharp line between illiquidity and insolvency in a financial and macroeconomic crisis.  While the bankruptcy world has moved beyond the distinction in important ways, it still dominates the crisis policy response.

Hands on Their Faces

Whenever there's a stock market crash, you can be sure that a bunch of newspapers are going to run cover photos of some broker with his hands on his face. There's probably an interesting history to this cultural meme. I always figured that there was just a few stock photos that got recycled crash after crash. And what was the story of the actual individual in the photo? Did he lose his shirt in the market? Or perhaps he was rubbing his eyes in disbelief that he'd just made a killing? Or maybe it was allergies?

Turns out that someone has gathered a collection of photos of brokers with hands on their faces. A little gallows photo humor here.

Some Curious Parallels with the 1930s

There are lots and lots of differences in the financial institutions situation of the Depression and today. And yet there are some remarkable parallels in the problems and government responses. We shouldn't overread parallels as predictive matters. But some of them are pretty astounding:

Regulation Cannot Depend on Irrational Markets

At this point, it is all too clear that financial markets can get things wrong. This is not an isolated phenomenon. No, getting it wrong tends to be the name of the game for financial markets. Understanding that financial markets regularly underestimate or overestimate the risks of investing is crucial to the proper design of financial market regulations.