Resolution Authority: The New Court

Under the Dodd bill, petitions to invoke the resolution authority are to be presented to a new Liquidation Authority Panel. Under section 202 of the bill, the Panel is to be comprised of three Delaware bankruptcy judges, selected by the Chief Judge. Presently there are seven bankruptcy judges in Delaware, including the Chief.

This seems like too small of a pool to select the judges from, and Wilmington seems like an unlikely place to hold the kind of secret hearings contemplated in this legislation. Moreover, most of the key governmental, legal, and financial actors in these matters are based in New York.

Solution:  Create a nationwide court, based in New York, utilizing the best bankruptcy judges from around the country. Having a bigger pool also provides a source for alternate members if a particular member is unavailable when the Panel is called. The Panel can share infrastructure with the SDNY bankruptcy court. Since the Panel’s role is essentially administrative, you might even consider having a non-judge on the Panel (e.g., a legal or finance academic). Finally, perhaps there should be annual education requirements for panel members so they stay up to date with the latest developments.

Resolution Authority: What's Wrong With the Dodd Bill

The Dodd bill gets things right on first principles:  there needs to be some type of resolution authority, and it needs to provide the ability to impose haircuts on creditors.  The bill accomplishes that much.  But it goes way off the rails on a critical issue that has received virtually no discussion:  how the resolution authorization process is supposed to work.  

There's been a good deal of ink spilled recently over how to regulate systemic risk, but little consideration of the institutional design of resolution authority.  Who gets to decide to pull the plug on a troubled firm?   And who gets to decide to provide support for other firms or sectors of the economy?  

I would suggest that however we do this, the paramount value should be maximizing political accountability.  Resolution is a distributional matter, which makes it inherently political.  Indeed, systemic risk is really a political issue, not an economic issue--there's no accepted economic metric for systemic risk.  Instead, it is about social anxieties over loss distribution.  Determining the most politically accountable part of government is something that administrative law scholars endlessly debate, but there are some parts that are less accountable politically than others:  the courts and independent agencies (as opposed to cabinet agencies).  Thus, if we are concerned about political accountability, the Fed is the wrong place to vest decision-making authority.  Same for the courts. 

But this is exactly what the Dodd bill does.  First it, like the Frank bill in the House, create a systemic risk oversight council.  Sounds nice, sort of like the Justice League of financial regulation, but in practice it is likely to merely dilute accountability among regulators.  Second, a troubled firm can only be placed into resolution if (1) the Treasury Secretary, generally acting on the recommendation of a supermajority of the Fed Board and the FDIC, successfully petitions (2) a special panel of bankruptcy judges for the resolution.  Again, this mechanism invokes the participation of a number of regulators (including two of the least politically accountable), and then a rather odd subgroup of judges (3 Delaware bankruptcy judges), another politically unaccountable constituency. 

The goal of the Dodd bill seems to be to make resolution a scientific matter.  But it isn't, and we might do better by going for one that abandons the semblances of legalism and goes with accountability.  (Again, for those who want the fuller version of the argument, you can read it here.)

Resolution Authority: What's Wrong With the Republicans' Argument

The Senate Republicans are arguing that resolution authority, including a $50B resolution fund, would institutionalize bailouts.  Implicit in this argument is the belief that without such resolution authority or fund there would not be bailouts.  This is a demonstrably false position. 

There is no way to credibly commit to not having bailouts.  Our current system is to have bankruptcy/FDIC as a default resolution system and bailouts as need be.  Creating resolution authority is hardly going to mean that there will be bailouts where there were none.  We already have bailouts.  Exhibit 1:  the TARP, which was passed with the votes of 33 Senate Republicans (including Mitch McConnell, who has taken the lead in making this silly argument against resolution authority). 

To be sure, Congress could pass a “no bailouts” law. But see how much good that did the EU:  its no bailouts law hasn't prevented the EU from bailing out Greece (contingently).  If Congress gets scared enough it will bail.  Better, then to have a clear and responsive mechanism for doing the bailout.  No matter how well we do risk regulation, bailouts will be inevitable from time-to-time.  Given that reality, we might as well do them well, and an institutional structure is critical for this.  (If you want to read the long version of this argument, you can read my paper, In Defense of Bailouts here.)

Let me be clear, though, while the Republican argument against resolution authority is silly, there is a lot to criticize about the proposed resolution authority, in both the House and especially the Senate bills.  I'll take this up in a subsequent post. 

Resolution Authority: Is It Constitutional

The Dodd financial services reform bill, S. 3217 would give "original and exclusive jurisdiction" over liquidation petitions for failed systemically important financial firms to a panel of three Delaware bankruptcy judges appointed by a the Chief Bankruptcy Judge for the District of Delaware.  This panel is supposed to adjudicate whether a "a covered financial company is in default or in danger of default."  If so, then the FDIC takes over. 

This arrangement strikes me as having (at least) two potential Constitutional problems.  First, it vests original jurisdiction in the bankruptcy court (or really a special subset of the bankruptcy court), a non-Article III tribunal, which is adjudicating eligibility for a federal liquidation.  Recall that in Northern Pipeline v. Marathon Pipe Line,  Justice Brennan's plurality decision prohibited non-Article III tribunals from adjudicating non-federal rights.  While the technical adjudication by the special panel is of a threshold question for an FDIC takeover, it is ultimately determining what will be the system that handles private state law contractual rights.  Original jurisdiction over that question might bring this into the ambit of Marathon's prohibition. 

Second, there is only limited appellate review (by the Circuit Court or the Supreme Court).  Review is limited to whether the determination of the Secretary that a covered financial company is in default or in danger of default is supported by substantial evidence.  At least one reading of the proposed language is that there is not even a right of appeal to challenge the jurisdiction of the court (such as whether a firm is a covered financial company).  I think this creates a Constitutional problem itself; a non-Article III tribunal cannot have the final word on questions of federal jurisdiction (although we'll see how that plays out in the arbitration context in the Rent-a-Center case). 

There might also be a synergy between these problems that makes two separately acceptable flaws combine into a Constitutional problem. 

Resolution Authority: Safe Harbors

This is the first of a series of posts commenting on the resolution authority as it currently appears in the Dodd bill.

The present draft of the bill includes “safe harbors” that excuse derivatives from the normal operation of the resolution authority – with a vague suggestion that the safe harbors might be suspended for five days while the receiver tries to transfer assets to a buyer, although no indication if termination provisions can be enforced once the derivatives are in the hands of the buyer. And the draft does not address the safe harbors already in the Bankruptcy Code, even though the resolution authority contemplates that all but the largest institutions will proceed under the Code.

Every legal academic that has considered the “safe harbors” that excuse derivatives from the normal operation of the Bankruptcy Code has determined that these provisions increase systemic risk. In a recent paper I show how the intersection of derivatives and insolvency could be better addressed with narrowly targeted amendments to the Code, rather than safe harbors.

Safe harbors are typically justified in terms of systemic risk. The systemic risk argument for the safe harbors is based on the belief that the inability to close out a derivative position because of the automatic stay would cause a daisy chain of failure amongst financial institutions. The problem with this argument is that it fails to consider the risks created by the rush to close out positions and demand collateral from distressed firms. Not only does this contribute to the failure of an already weakened financial firm, by fostering a run on the firm, but it also has consequent effects on the markets generally, as parties rush to sell trades with the debtor and buy corresponding positions with new counterparties.

Solution:  Safe harbor provisions should be removed from the bill and from the Bankruptcy Code. These statutes can be slightly modified to account for the reality of derivatives in modern finance (e.g., allow “mark to market” collateral adjustments to continue until the derivative is assumed or rejected).

The President on Financial Reform

I had the honor of being invited to the President's speech on financial reform this morning at Cooper Union. The speech was somewhat general, but that is probably to be expected when talking for a short time about a complex issue and a massive chunk of legislation.

(N.B.  I'm writing this up before looking at any of the press coverage so I can present my impressions "untainted" by the conventional wisdom.)

Two important points that I was glad to hear. First, he noted that resolution authority could be paid for ex ante or ex post, and people could legitimately disagree over which was better, but you needed to find a way to make sure the financial industry paid for its own resolution. I think this is right, and reflects the realistic options. I know some suggest we can simply put the big financial firms into bankruptcy without doing anything more, but if Paulson and Bush couldn't stomach that (after one attempt), I don't know who could. The broader consequences of that intellectually pure approach will never be politically palatable.

Second, he refused to demonize derivatives, which would have been the easy political move. He explained that there are legitimate uses for derivatives, but the real issue was bringing transparency to the market, so it would be clear to all if somebody like AIG went off the deep end in terms of counterparty risk and exposure.

The one thing I would have liked to have seen was some support for the safe harbor reforms now percolating through Congress, such as Senator Bill Nelson's proposal. This amendment is not perfect, and I've explained what I think works as a compromise position, but amendments of this sort are a big step in the right direction, and get the issue on the table.

Some Thoughts on Central Clearing

As the financial reform legislation moves forward, central clearing of derivatives has become a key topic of interest, along with the related, but distinct issue of exchange trading of derivatives. Central clearing refers to having a party that acts as the "hub" in derivatives transactions, so that a bilateral contract actually becomes two bilateral contracts, with the clearing agency in the center. This should generally increase transparency, including with regard to conterparty risk.

Most of the focus has been on the counterparties, and which sorts of counterparties should be required to transaction through a central clearing house. But I do worry that not enough focus is being placed on rules to govern the central clearing agency. As I have argued in some recent papers, the central clearing agency must have robust margin requirements for its members, as well as an ability to draw liquidity from at least the larger members in times of crisis. Otherwise the central clearing agency itself will become a "too big to fail" entity in need of a bailout.

I also continue to believe that repeal of the special treatment of derivatives in bankruptcy (and in the resolution authority, as proposed in the Dodd bill) is needed to give the central clearing party the appropriate incentives to monitor its exposure to counterparties.

On the issue of clearing itself, I think we need to take some of the uproar with a grain of salt. The big players -- banks, large hedge funds and the like -- are already moving toward clearing and posting collateral with third-parties. I suspect that sooner or later they are also going to figure out that they are much better off dealing with a single entity in the corporate chain, or at least entities that are all in a single jurisdiction, to avoid the problems seen in Lehman. Thus, putting all derivative trading into a single sub will make sense anyway.

Why then are some of these same parties so vocal in their opposition? Well, some of it surely has to do with the sale of derivatives to parties who might not be ready to take these steps, and a fear that these parties will simply reduce their derivatives purchases rather than take the steps to comply with the new rules. They might also replace more complex swaps with simpler contracts like futures. Neither is clearly bad or inefficient from a societal perspective, but you can understand why the banks might not like it.

That said, I'm going to challenge the conventional reformist wisdom by wondering aloud if its really necessary to centrally clear everything. Some flexibility might be good. Of course, there needs to be a cost to taking that option, since it could impose a cost on the rest of us -- most obviously, the collateral posting requirements could be substantially higher for trades that are not cleared. Perhaps a multiple of margin required for a cleared trade?

UPDATE:  Risk magazine has more.

Collateral and Derivatives

One of the arguments I've been seeing a lot of lately is that industry X needs an exemption from the financial reform legislation, because the new requirements that most swaps be collateralized -- that is, backed up with collateral to support the "out of the money" party's ability to perform -- would drain capital out of said industry.

But never mentioned is the simple fact that many of these industries did not transact under derivative agreements until after the 2005 amendments to the Bankruptcy Code massively expanded the safe harbors that exempt derivatives from key provisions of the Code. After 2005, many ordinary commodity supply agreements suddenly became swaps. Warehouse loans to mortgage originators suddenly became repo agreements. The economic terms of the deals were essentially the same as before, but now the agreements were exempt from the automatic stay and the normal rule that you can't terminate a contract simply because the other side is in bankruptcy.

So I suspect that many of these industries that claim that they would be hurt by having so much money tied up in posted collateral could easily avoid this fate by simply returning to normal, non-derivative contracts. But then they'd have to give up their special bankruptcy exemption . . . of course, they shouldn't have that in the first place.

Wanted: People with Good Credit for Low-Paying Jobs

Despite the increased proportion of Americans who are behind on their mortgages or have lost their houses to foreclosure, the practice of doing credit checks on prospective employees continues to climb sharply in popularity. The Society of Human Resources Management’s recent survey found that 60 percent of employers run credit checks on at least some job applicants; back in that “healthy” economy of 2006, the comparable figure was 42 percent. The growth in credit checks by employers is some evidence to counter arguments that the stigma of financial distress, bankruptcy, or foreclosure is falling as more and more Americans struggle to meet their debt obligations. Employers seem to be taking the opposite tact, with the weak labor market permitting them to be increasingly selective about whom to hire. Credit checks are a fast and cheap way to screen out candidates. And one in 8 employers checks the credit of every applicant for every job--meaning that people like janitors and retail workers can suffer employment discrimination on the basis of their credit.

The Rhetoric of "Ending" Too Big To Fail

From both right and left the theme of the recent days has been the need to end too big to fail. The left seems to think this can be done by breaking up financial institutions, the right thinks it will be done by simply throwing financial institutions into chapter 11, Lehman style. They're both wrong.

Breaking up financial institutions does very little to solve the real problem of too big to fail, which is really too interconnected to fail. The horizontal relationships between financial firms make them unlike other firms, and it really does not matter how big these firms are. So unless we are going to regress to some sort of Jeffersonian paradise without financial firms, breaking them up is at best an indirect solution to the problem. Remember that Long Term Capital Management was not actually that big, compared to the likes of Lehman or AIG. 

On the other hand,the idea that we should simply allow financial firms to liquidate sounds good if you consider the firm in isolation, but really bad once you remember the firm is part of a larger economic system. Moreover, the argument seems to ignore recent history -- if the past administration was not able to commit to such a strategy, is it realistic to expect any politician to simply stand by while the economy unwinds?

In short, a more realistic option is to give politicians a system that provides for a soft landing - that is, the system can't be too harsh, because even though a harsh system may make sense from a philosophical perspective, it will never be used. But we also need a system that avoids what happens in AIG -- shareholders remaining in place, while taxpayers took on the risk of not getting repaid. Shareholders and creditors have to lose their position -- and management face the consequences -- just as they would in any other corporate bankruptcy. 

For this reason, I'm not totally opposed to the Dodd bill.  I do think a chapter 11 model makes more sense than an FDIC model, but the $50 billion fund actually makes some sense. Yes it shows that we're not going to stiff arm the financial firms, which might create moral hazard, but I really don't think the stiff arm threat is credible anyway.  And at least the fund makes the industry pay for the cost of cleaning up its own mess -- although the $150 billion the House proposes is a much better number if we really want to make sure taxpayer funds are not used.

My ideal? A chapter 11 system, where the regulators can file an involuntary petition, no safe harbors for at least a period of time, so the firm can be sold or recapitalized, and use the $150 billion fund to provide short term DIP financing.  And have real regulation, of all aspects of financial firms, not just the insured bits, ex ante to avoid problems.

Consumer Protection & Bank Soundness

To date I've left the issue of the "Consumer Financial Products Safety Commission," or whatever name it ultimately ends up with, to my co-bloggers, who are much more versed in matters consumer. But then today I read that Senator Shelby had this to say at the American Bankers Association:

Safety and soundness trumps everything," Shelby said to loud applause. "It trumps the consumer finance whatever."

Although the bankers apparently ate this up, they should really run from this argument as if it were the swine flu.The argument only makes sense if the nation's banks are so horribly undercapitalized that they depend on the extra margin they get from confusing their customers and getting them to make poor choices regarding their finances. Under the Senator's argument, banks need to conduct "unfair, deceptive, or abusive" advertising and write their documents in "unplain" English in order to maintain their soundness.

Wow.

This has to be his argument, otherwise the argument makes no sense. In every other respect, the new consumer protection agency should help bankers and their ilk by improving their reputation among consumers and protecting them from class-action lawsuits whenever they foul up. Wouldn't the latter increase their soundness in direct proportion to their decreased insurance premiums? How does consumer protection threaten bank soundness? Did toaster companies go out of business when the Consumer Product Safety Commission stopped letting them sell exploding toasters? I guess the ones who couldn't make it selling legitimate toasters did -- but the Senator can't really be saying that America's banking industry is like a shoddy toaster company, can he?

If the Senator (or, more realistically, a member of his staff) would like to explain what he really meant, I'm available -- feel free to contact me offline.

The Financial Stability Oversight Counsel

I want to pick up on yesterday's post by Bob and friend and expand upon it a bit. Under section 111 of Chairman Dodd's proposed bill, the new Financial Stability Oversight Counsel will be made up of

• the Treasury Secretary, who would serve as chair
• the Federal Reserve Chairman
• the Comptroller of the Currency
• the Director of the new Bureau of Consumer Financial Protection
• the Chairman of the SEC
• the Chairman of the FDIC
• the Chairman of the CFTC
• the Director of the Federal Housing Finance Agency
• and an independent member, who must have an insurance background, and would serve a 6 year term

This is a banking heavy group. Especially given that all the key votes by the Counsel require a two-thirds majority.

Felix Salmon noted in a recent post that "[o]ne of the problems with giving lots of supervisory authority to the Fed is that the Fed is run by economists who care primarily about setting monetary policy, as opposed to being run by bankers who care primarily about bank regulation and systemic risk."

Although this is on track, to my mind it does not go far enough. And from my lawyer's perspective, the distinction between economists and bankers is kind of like the difference between policemen and constables. Treasury, the Fed, and the rest of the crew are stacked with economists, bankers, and lawyers focused on banking law.

But one of the obvious lessons of the past two years is that there really is no such think as a unique universe of "banking" or banking law in a world where GMAC and E-Trade are offering home loans, people in the Netherlands have passbook accounts in Reykjavik, and seemingly simple online banks have $26 billion derivatives portfolios (table 1, here).

Financial Consumer Protection--The Last Thing We Need Is Federal Banking Regulator Oversight

Yesterday, I was talking with former Credit Slips guest blogger Pat McCoy about perhaps reprising that role for us. McCoy is a law professor at the University of Connecticut and, along with her co-author Kathleen Engel, was writing about Wall Street's role in financing predatory home loans before anyone else wanted to talk about it. Unfortunately, some upcoming professional travel is going to prevent Pat from joining us until later in the spring.

We started talking about the Dodd financial regulation bill announced yesterday. While we were talking, Pat was explaining to me that the proposed Bureau of Consumer Financial Protection would not be as independent as advertised. It was a point that I had not fully appreciated--it is a 1,300 page bill, after all. Even as she prepared to travel, Pat kindly agreed to write up a few a paragraphs on her thoughts about the issue so I could post them here:

Half a (Rotten) Loaf is Worse Than None at All: The Fate of the CFPA

As political wrangling over financial services reform continues, the creation of an independent CFPA remains a major bone of contention.  A number of compromise proposals have been bruited:  creating an independent bureau in Treasury, vesting the power in the Fed, vesting the power in the FDIC, or vesting the power in the FTC.  Some proponents for stronger consumer protection in financial view a compromise as acceptable on the theory that half a loaf is a better than none at all. 

It's not.  Better not to have a consumer protection agency at all than to have one placed in a prudential regulator.

Overdraft Fee Regulation and the End of Free Checking?

Ron Lieber has a thoughtful column about the future of free checking.  Consumers have become quite used to free checking over the last 15 years or so.  The impetus for the column is whether the Fed's new overdraft regulations, scheduled to go into effect in July (new accounts) and August (existing) accounts this year will change the financial equation such that free checking is no longer viable.

I'm skeptical.  The potential impact of the Fed's overdraft regulation impact is greatly over-hyped. 

Visa Does Not Issue Cards or Extend Credit.

The Union Station Metro station in DC is plastered with Visa ads.  Currency of Progress, Visa is a Payment Technology Company, etc.  But among the ones that was featured was this beauty:

One rarely sees such a defensive ad.  When was the last time you saw a company advertising what it does not do?  That bespeaks a major branding problem.  It might as well have said "I am not a crook" or "We do not harm small furry animals."  The ad is true, but not what one would expect.  (Technically, I don't think the ad is quite true.  Visa doesn't extend consumer credit, but likely extends some sort of daylight overdraft credit to its members due to payments imbalances.) 

Clearly Visa wants to disassociate itself politically with its member banks.  I emphasize politically because the Union Station Metro stop is one of the ones used by Capitol Hill staffers.  I haven't seen this particular barrage elsewhere in the DC Metro, which makes me wonder if it is a targeted campaign aimed at Hill staffers (in DC one also hears card industry radio ads about interchange that aren't aired elsewhere--this is the Beltway bubble). 

What is Visa so concerned about, though?  Financial regulatory reform has largely ignored entities like Visa.  I've got to think that this is about interchange legislation, and this looks like the ad of a company that is running scared. 

A Wager of Law!

Apparently I've been challenged to a duel wager.  I say apparently, because this challenge was never delivered to me.  Instead, it was posted to a website almost a month ago, which is a little odd for a serious bet.  

So what is this about?  Slips readers will be familiar with (or exhausted by) my back-and-forth with David Evans and Joshua Wright on the Consumer Financial Protection Agency (CFPA).  Briefly, Evans and Wright wrote a paper, funded by the American Bankers Association, that argued that the CFPA would be a disaster.  I wrote a critique that took issue with some statistics they cooked up about the impact of the CFPA (the rest of the paper was familiar anti-regulatory boilerplate).  I said that the methodology by which they produced their numbers were bs, they defended some of their numbers, and I disagreed, but noted that they weren't able to respond to the most damning part of my critique--that some of their numbers were simply plucked out of the air.   

Wright responded with a challenge of a wager.  Wright's George Mason colleague Todd Zywicki provided color commentary at Volokh Conspiracy.

The challenge to a wager is very nice and gentlemanly, but it is a distraction from the real issue:  the severely flawed methodology Wright and his co-author David Evans use to manufacture evidence for their arguments against a CFPA. 

Proposals for Haircuts at the FDIC

FDIC-sponsored haircuts have become a hot item in the blogosphere. My wife used to work for the FDIC, and I smile every time I hear the term as I think about the building on F Street with a big barber pole in front of it. Here, the term is not being used in its hirsuted sense but as part of the colorful vernacular that surrounds insolvency work. A "haircut" describes a situation where a creditor is paid less than that to which they are entitled.

The FDIC proposal comes from Representatives Brad Miller and Dennis Moore and would limit the recovery of secured creditors to 80% of the value of their collateral in FDIC takeovers of failed banks. (I can't seem to locate the original text of the proposal on the Internet, but it has been widely reported.) Academic types will remember a similar proposal from Professor Elizabeth Warren back in the 1990s that would have limited recovery to 80% of the collateral's value. While Warren's proposal would have applied to many types of secured lending (at that covered by Article 9 of the Uniform Commercial Code, the current proposal is limited to failed financial institutions taken over by the FDIC.

The usual criticism has arisen in the usual places, namely that the latest proposal will discourage capital formation in banks. In turn, it is said that banks will lend less. Growth will be deterred. And we'll see even more gruesome scenarios involving the cross-breeding of dogs and cats. All of that might be true--well the dogs-and-cats part is less likely--but these criticisms miss the point. The question is not whether we like capital formation and economic growth but whether the costs are worth the benefits. The costs here come from the moral hazard that is created by asset partitioning.

Evans and Wright on the CFPA: Round 2

A couple of weeks ago I wrote a short critique of one piece of a long study written by David Evans and Joshua Wright about the Consumer Financial Protection Agency and funded by the American Bankers Association.  The related blog post is here.  Evans and Wright have responded.  

There's a lot that I thought was objectionable or questionable in Evans and Wrights study, but most of it was well within the bounds of reasonable argument.  I have no problem intellectually with arguments that any particular regulation could impose costs that outweigh its benefits.  Instead, I was was moved to write because Evans and Wright were making precise numerical claims about the cost impact of the CFPA, and that these claims were based on either (1) a highly questionable comparison to dissimilar regulation or (2) pure conjecture.  

In their reply, Evans and Wright spend a good deal of time arguing about things that are really beside the point to my critique.  For example, Evans and Wright emphasize that I have not proved the affirmative case for the CFPA's positive impact (a passing point I made to show that the economic impact of regulation is susceptible to multiple predictions) and that I have "disputed virtually none of [their] findings that the CFPA Act would impose high costs on lenders and ultimately result in denying borrowers choice."  Let's be clear.  My critique was about three spurious numbers.  I didn't set out to prove a positive case in the critique and don't need to do so to make my central point.  And to imply a concession from silence about other issues is ridiculous in this context.  This sort of logical move is, however, consistent with the problems with Evans and Wright's statistical claims.  

But let's get to the heart of the matter.  My issue with Evans and Wright is about the numbers, not about their priors regarding regulation.  There are three numerical claims in Evans and Wright's piece with which I took issue. First, Evans and Wright claim that a CFPA would result in a 160 basis point increase in the cost of credit and a derivative 2.1% decrease in credit demand.  These assertions were based on a comparison with a study of non-analogous regulations that have been found to have an 80 basis point impact.  Evans and Wright argue that even though the regulations are different, they are less invasive, so therefore at least twice the impact would be the lower bound. Why twice?  Just because.  Evans and Wright still have no justifiable basis for doubling, as opposed to tripling the number, etc.  It is not as if 160 basis points is within some statistical confidence interval or the like.  While a 160 basis point number appears to have the imprimatur of social science, it is just conjecture, or, to be charitable, a very rough guesstimate.  

In a cost-benefit analysis, however, precision matters.  A CFPA might be worthwhile at 120 basis points, but not at 160 basis points, for example.  The problem with Evans and Wright's methodology is that they can no better defend a 160 basis point number than a 120 basis point number or a 700 basis point number.  Evans and Wright emphasize that there were merely setting a lower bound, but that hardly makes their number more defensible.  Evans and Wright simply do not and cannot know the impact, including what the lower bound would be.  Of course, precision is beside the point if the goal is to produce a scare statistic, rather than a rigorous cost-benefit analysis.  

The third spurious statistic in Evans and Wright is a claim that a CFPA would result in 4.3% slower job creation.  They achieved this number by taking a statistic about the role of small startups in job creation and then "supposing" that a CFPA would inhibit five percent of this.  I noted there were problems with their job creation statistic (namely that it failed to account for the spectacular failure rate of small startups after their first year, when they result in net job loss, not creation).  But that was a side point.  The critical problem was that they "supposed" a impact number without any basis whatsoever for their supposition. 

Evans and Wright take issue with my statement that "The key point here, however, is the impact of the legislation is speculative and certainly not susceptible to precise statistical predictions.”   They state, "That is a nihilistic approach."  Actually, it is an intellectually honest approach.  A debate that is poisoned by spurious statistical claims, rather than their debunking, are what will engender nihilism.  It'd be great to have an empirically informed policy debate.  But that's not license to make up numbers.  Policy debates have to function within our epistemological limitations.  There's a constructive debate to be had about the CFPA.  But constructive doesn't mean making things up.  

Too-Big-To-Fail Resolution: Why One Size Can't Fit All

The debate over what to do about too-big-to-fail is heating up (see here (FRB) and here (BoE) and here (Simon Johnson for a summation and commentary).  A lot of the moves in the debate are well-rehearsed:  the moral hazard issues involved with too-big-to-fail have been amply noted elsewhere, and the problems with having firms create “living wills” that specify wind-down procedures is fairly self-evident—it is simply too hard for firms to predict the state of the world at the time a wind-down would be necessary, so firms might be committing themselves to suboptimal action.

I think it is important, however, to draw attention to a serious defect in proposals for a special resolution system for large systemically important firms.  There is simply no way to regularize a resolution system for too-big-to-fail institutions because they cannot be resolved without the commitment of government funds, and provision of government funds is a political decision that cannot be decided ex ante.  The nature of too-big-to-fail resolution is inherently political and locked into a preexisting system. 

Bogus Statistics: The Banking Industry's Go-To Lobbying Tool

Fake statistics have been a central feature of the banking industry's lobbying strategy on every major consumer credit issue since the 2005 bankruptcy amendments. 

In 2005, there was the phantom $400 bankruptcy tax used to push through the BAPCPA.  Then there was the Mortgage Bankers Association's 200 basis point interest rate increase claim about cramdown.  For credit cards, there was no fake statistic, but a pseudo-academic study funded by the American Bankers Association.  (In retrospect, lack of a scare number was a major strategic mistake for the industry.) 

Now we have the latest installment in the parade of phony numbers:  an American Bankers Association-funded study about the likely impact of the Consumer Financial Protection Agency (CFPA) on consumer credit cost and availability and economic growth.  The study is by David Evans of LECG and Joshua Wright of George Mason Law School (Wright may be familiar to some Credit Slips readers from his blog comments in the past). 

There's a lot of tendentious claims in Evans and Wright's study, but the heart of it are some very precise claims as to the impact of the CFPA on the cost of consumer credit (160 basis points), the demand for consumer credit (2.1% decrease), and the net job creation (4.3% slower).

How, you might ask, did anyone possibly arrive at such precise predictions based on legislation that does not create any substantive regulation of the credit industry, but would merely transfer largely existing powers to a new agency? 

The short answer:  just make up the numbers.  I kid you not.  Evans and Wright selectively chose a study on the impact of a different regulation (interstate banking restrictions) on credit cost.  They briefly argue it is analogous to the CFPA Act, which they claim will have double the impact.  (Why double?  Why not?)   Then they take that number and multiply it by an elasticity metric for the demand impact.  And for the coup-de-grace, they take a misleading number on net job creation and conjecture with no basis that it would be reduced by 5%.  These numbers are presented as "plausible, yet conservative" assumptions. 

There's a lot of room for good faith disagreement about methodology, but Evans and Wright's numbers don't come close to passing the straight-faced test.  (Even the Mortgage Bankers Association had some facially plausible basis for their cramdown claim.)  I am still shocked that two serious scholars would attach their names to this study. My short critique of their study is here. 

Tenant Protections in Foreclosure

A foreclosure has a ripple effect, as a number of commentators have observed. Foreclosed properties often sit vacant, leading to nuisance concerns, lower property values for neighboring houses, and higher crime rates. But some properties are not vacant on the day of foreclosure, and these occupied properties generate their own externalities. 

After foreclosure, the new owner (usually the lender is the purchaser at the foreclosure sale) will typically send someone to see if the property is vacant. If not, the lender files an eviction or lawful detainer action. In many instances, especially in those formerly-booming real estate markets like Florida and Nevada, the occupants are tenants, not the homeowners. Depending on state law, renters often have no right to notice of the foreclosure and no right to remain in the property. The Chicago sheriff, Thomas Dart, stopped doing evictions after foreclosure last fall because of concerns about unjust harm to tenants. 

Title VII of the Helping Families Save Their Homes Act provides uniform federal protection to tenants after foreclosure--at least until the law expires on Dec. 30, 2012 (apparently the date by which someone thought the foreclosure "crisis" will have abated). The law requires the new owner of a foreclosed property to allow tenants to stay in the foreclosed property for the remainder of the lease. If there is no lease, or if the lease is terminable at will under state law, tenants must be given at least 90 days' notice before they may be evicted. This is a floor that does not preempt more generous state law. 

I'm interested in how financial institutions and tenants are going to deal with these requirements. Lenders have attorneys who routinely handle evictions after foreclosure. Being a landlord is a different task. Are tenants supposed to call the former owners' mortgage servicer when their pipes burst? If not, how is the tenant supposed to learn exactly who is the new owner of the property? Are note holders actively hiring property management companies to comply with this rule? Perhaps more interestingly, the bill doesn't seem to permit an eviction during the 90 days even if the tenants declare they aren't going to pay a dime of rent!

The Office of the Comptroller of the Currency has hardly offered answers to national banks. After waiting three months after the law's effective date, it put out a one-page release advising banks to "adopt policies and procedures to ensure compliance." Gee, that's helpful. I'm betting the readers of Credit Slips will have some more concrete thoughts about this.

Truth in Lending or Truth in Ownership of Residential Mortgage Notes

During my last two Bankruptcy Boot Camps, one of the topics we have discussed has been the recent amendments to the Truth in Lending Act, brought about by Section 404 of Public Law 111-22. Specifically, our interest has been focused on the new statutory requirement that a consumer-borrower must be sent a written notice within 30 days of any sale or assignment of a mortgage loan secured by his or her principal residence. Violations of this Section provide for statutory damages of up to $4,000 and reasonable legal fees. The amendments also clearly provide that the new notice rules are enforceable by a private right of action. 15 USC 1641.

Is Bankruptcy Mortgage Modification Back?

As I write this, the Senate Judiciary Committee's Subcommittee on Administrative Oversight and Courts is holding a hearing entitled, "The Worsening Foreclosure Crisis: Is It Time to Reconsider Bankruptcy Reform." The witnesses include Credit Slips's own Adam Levitin.

After the Senate failed to support changing the Bankruptcy Code to allow judges to do mortgage modifications, it appeared to be a dead issue. The hearing is great news and hopefully an indication there may be some interest in moving the legislation forward. There have been increasing reports (e.g., here) recently that lenders are not doing voluntary mortgage modifications in the numbers that need to happen. Yeah, I know -- who could have possibly foreseen the possibility that a solely voluntary system would not work? There need to be carrots that encourage lenders to do the modifications. The change in the bankruptcy law is the missing piece -- the stick that makes the program work.

In Favor of the Consumer Financial Protection Agency (CFPA)

Adam's earlier post started the ball rolling on the CFPA discussion, and I wanted to weigh in (favorably) having now waded through the 153 pages of proposed legislation.  I take the case to be made for sheer regulatory consolidation as surely correct: the crazy quilt of overlapping agencies would make even Sir Humphrey cringe.  But the case in favor rests on much more than that, and of shrewd appeal to both typical bailywicks of the left and right.

Thorne's Post to the NYT's blog, "Room for Debate"

A couple days ago, I was asked to write up a comment/response to the following statement for the NYT’s blog, “Room for Debate: A Running Commentary on the News”:

“As Congress and federal regulators move to limit how much banks can charge credit card holders who’ve fallen behind on payments, banks are starting to think about making up the lost income by going after those with good credit – like reviving annual fees and eliminating or reducing grace periods for paying off card debt. We asked some experts, should responsible card users (those who typically pay off their monthly charges) bear the cost of credit card services as revenues decline from those with credit problems? Would that shift penalize habits of thrift?”

For what it’s worth, my response is written below. After listening to the stories of indebted Americans for the past decade, I have had it up to here with the portrayals of them as irresponsible deadbeats--so very few fit this stereotype. Therefore, consider yourself forewarned--my pro-consumer perspective is obvious.

Creating Legislative Intent Years After Passage of Revised Article 9

The legislative drafting errors in BAPCPA have certainly launched a fascinating  set of statutory construction challenges for the courts.  For example: What level of ambiguity is necessary before the court resorts to legislative intent? If the statute itself is clear how ridiculous must the result be before the court may “ignore” the clear but clearly incorrect meaning? 

The Article 9 revision process of  a decade ago  was the polar opposite of the BAPCPA experience in terms of drafting.  The combined American Law Institute (“ALI”) - National Conference of Commissioners on Uniform State Laws (now known as the Uniform Law Commission[“ULC”]) labored for years to make sure of their drafting and vetted their proposed language extensively. Still, no one is perfect and things change so in 2007 the Permanent Editorial Board of the Uniform Commercial Code authorized a committee to consider the need for possible statutory modifications or comment amendments to the Official Text of Article 9 of the Uniform Commercial Code.    When the ULC and the ALI considered the report of that group the ALI and the ULC  jointly  authorized a drafting committee, the Joint Review Committee for Article 9 of the UCC and the Drafting Committee has met several times. 

Mortgage Modification Vote in Senate

Credit Slips has featured a lot of articles about a legislative proposal to give bankruptcy judges the power to modify home mortgages in chapter 13 (here, here, here, here, and here for a just a few examples). Heck, we were blogging about back this idea back in 2007. In March, the House passed H.R. 1106, the Helping Families Save Their Homes Act of 2009, which would enact this proposal into law. Since then, it has faced an uncertain future in the Senate. Yesterday, CongressDaily reported that Senate Majority Leader Harry Reid will bring the mortgage modification proposal for a floor vote in the Senate. Although this might seem like good news for supporters of the legislation, close observers of the political scene seem to be predicting defeat. Two Democratic Senators (Ben Nelson of Nebraska and Jon Tester of Montana) and Republican Senator Bob Corker of Tennessee are quoted in the CongressDaily article as being against the legislation, with Corker going so far as to say "Cram-down is dead."

If you support the legislation, however, now would be a good time to tell that to your senators -- or, in the case of Minnesota, senator. It's not over until the fat lady lets the horses out of the barn.

Finally, Some White House Interest in Credit Card Abuses

The Obama Administration today turned its attention toward abusive credit card practices. After years of presidencies that were at best indifferent or at worst supportive of the credit card industry abuses, to finally have the White House give some attention to these issues is an incredibly welcome development. Specifically, the Obama Administration has indicated it will support H.R. 627, the Credit Cardholders' Bill of Rights Act of 2009. Representatives Carolyn Maloney and Barney Frank have played a leadership role in this legislation, as they have for years with consumer credit issues, and they were able to get the bill through the House Financial Services Committee. The full House is almost certain to pass the bill, but it faces an uncertain future in the Senate.

The Credit Cardholders' Bill of Rights would end retroactive interest rate hikes and hikes without notice, put an end to double cycle billing, and limit fees and penalties. It is legislation that needs to be adopted. Not surprisingly, the bill is facing tough opposition from the financial services industry which is trotting out the usual arguments about credit restrictions and price hikes. These canards, although I know some will disagree with me about that characterization, are used every time consumer lenders face legislation that might make them play fairly. I'll let that debate play out in the comments, as it undoubtedly will.

There is one particular industry argument, however, that strikes me as particularly disingenuous. The New York Times reports that the industry is arguing the federal legislation is unnecessary because it largely duplicates recently adopted Federal Reserve rules. It is true that the legislation does have some overlap with the rules, but that is still no reason for the legislation not to go forward. First, the legislation is not identical with the Fed rules, meaning the legislation would fix some problems the Fed rules will not. Second, to point out the overlap is to beg the question of which action is the redundancy. Why aren't the Fed rules now redundant and beside the point? Third, the Fed rules won't take effect until July 1, 2010, and the legislation would take effect three months after adoption (generally speaking). Fourth and perhaps most importantly, I suspect the real reason the financial industry wants to keep the lawmaking at the Federal Reserve level is that the industry has more influence there. Once these new rules become enshrined in legislation, it will be much more difficult for the financial industry to undo them, which is as it should be.

Open Access Factories

This semester, I have been teaching a seminar simply called "Bailouts." This week, we have been talking about the automobile industry. One of my students, Aaron Moshiashwili, put forth an interesting idea in his written work for the week. In the seminar, I have stressed that the idea is not to save a particular company but the productive assets that company represents--a point that generalizes to many other contexts in corporate law. In other words, we shouldn't care about the logo that is on the door, but we should care about what goes on inside the building. Regardless of whether they make it or not, the automobile companies are going to create a lot of excess capacity in physical plant and human capital.

Bankruptcy Mortgage Modification Getting More Attention

You know the steam is starting to pick up for the horses to close the barn door before the barn burns done while we're counting our chickens when .... let me try that again.

Bankruptcy mortgage modification is moving beyond the specialty blogs such as this. David Abromowitz over at The Huffington Post has a post up advocating passage of a bankruptcy mortgage modification bill. I'm hoping the fact that the bill is getting broader attention means the train is about to sail.

Bankruptcy Modification and the Emperor's New Clothes

A new argument being advanced against bankruptcy modification is that it will result in trillions of dollars of losses and the collapse of the financial system.  This is the "the sky will fall" argument.  

Leaving aside the grossly inflated numbers, let's be really clear that these are not losses that would be caused by bankruptcy modification.  These losses exist with or without bankruptcy modification.  All bankruptcy modification does is force these losses to be recognized now, rather than at some point down the road.  Bankruptcy modification doesn't change the underlying insolvency of many financial institutions.  One way or another, there are a lot of financial institutions that have to be recapitalized. 

Financial institutions want to delay loss recognition as long as possible.  Maybe they're hoping that the market will magically rebound.  Maybe they think that 2006 prices are the "real" prices and "2009" prices are a very short-lived aberration.  But here's the crucial point:  homeowners bear the cost of delayed loss recognition by financial institutions.  Delayed loss recognition means homeowners floundering in unrealistic repayment plans and then losing their homes in foreclosure.  Delayed loss recognition means frozen credit markets because no one trusts financial institutions' balance sheets.  Delayed loss recognition means magnifying, shifting, and socializing losses.  We only make matters worse when we try to pretend that these losses don't exist.  

We all know the story of the Emperor's New Clothes, and how everybody plays along with the emperor's conceit until a little boy points out that the emperor is stark naked.  To suggest that widespread financial institution insolvency would be caused by bankruptcy modification is akin to blaming the little boy for the emperor's nudity. 

A Class on Bailouts

In early 2008, I had to figure out what courses I would teach in the next academic year, and it was decided that I would offer a seminar of some sort in the 2009 spring semester. "Just call it a seminar on consumer credit as a placeholder in the course listing," I said. It seemed likely that such a seminar would be timely. Who knew? By the fall, of course, we were in a full-blown financial crisis, and the seminar became the Bailouts class.

Students looking for me to lecture from the front of the room with answers will be disappointed. I have more questions than answers. Although the seminar became more of a class as enrollment grew, I still intend to conduct the class principally as I would in a seminar with emphasis on reading and discussion.

Cramdown Controversy #2--Will I "Succeed?"

Our active readers at Credit Slips already started debating the second controversy about the pending cramdown legislation: is the failure rate of chapter 13 too high to make mortgage modification in bankruptcy a very useful tool? To briefly reprise that discussion and add my own gloss, there are longstanding lamentations that chapter 13 is a poor system because a minority of debtors completes the repayment plan and receives a discharge. The academic studies suggest the number is about 33%; I believe the National Association of Chapter Thirteen Trustees thinks it is about 40% (one wonders why the US Trustee Program doesn't carefully track this and publish it?)

So lots of chapter 13s fail. But what conclusion should we draw from that fact? This is a broad question and one that I'm exploring in a new empirical research project. I do not believe that chapter 13s "fail" just because they do not reach discharge. For now, let me narrow that concern to whether cramdown legislation is sound policy.  A  couple of observations:

1. The failure rate for chapter 13 may be, at least to some unknown degree, a result of housing affordability problems. Tara Twomey, John Eggum, and I have a forthcoming paper showing that over 70% of chapter 13 homeowners in our 2006 sample spent more than 1/3 of their incomes on mortgage payments, the HUD benchmark for unaffordable housing. If cramdown lets debtors reduce their mortgage payments, it may permit more debtors to confirm plans and give debtors needed flexibility in adjusting their budgets to the normal ups and downs of life. Put another way, the low chapter 13 completion rate may be an effect of the inability under current law to modify mortgages, which is all the more reason to permit such modification.
2.  Lots of people are going to have upheavals in their lives just because that is life. As one of our Credit Slips commentators said: "Chapter 13 cases fail primarily because '_____  happens' in the 3-5 year term of the plan. Debtors live and die; they change jobs; they lose jobs; they move; they buy and sell homes; they get married; they get divorced; they have kids; they lose kids; they get sick; etc. -- all of which impact their financial circumstances." These circumstances would occur and be problematic regardless of how we structured the mortgage relief--that is, they would hamper non-bk court modifications too.
3. One benefit of modifying mortgages in bankruptcy is the potential to actually monitor what happens. IF the Administrative Office of the US Courts and the US Trustee Program release the needed data, scholars and advocates can track these cases. How many debtors are seeking modifications? What kinds of terms are courts granting? How are these debtors faring? Such data has been scarce of non-existent for the voluntary modification programs. What data do exist, such as those that Alan White examines, seem to me to indicate that a very high fraction of modifications are doomed to failure.

Cramdown Controversy #1--Who Do I Pay?

The pending legislation to permit courts to modify home mortgages is stirring up some controversies--even among its advocates. The key issues are operational and very important, I think, to the success of this legislation. Here's the first brewing controversy: How will consumers make the payments on these modified mortgages (directly to the mortgage servicers or through the chapter 13 trustee?) 

The pending legislation contains language that would require the payments on mortgages modified in bankruptcy to be made "directly to the holder of the claim." In more than 2/3 of jurisdictions, chapter 13 trustees serve as conduits for at least many mortgage claims, meaning that the debtor pays the trustee the mortgage payment, along with their payment on their unsecured claims, and the trustee transmits the payment to the mortgage company. The legislation, apparently at the urging of some consumer advocates, would bar this practice. I think this is a bad approach for several reasons: Why change existing practices that are working well and add confusion? Some courts have local rules that require debtors to pay all claims through the trustee; the legislation would override such rules, which are growing in popularity becuase of problems with letting debtors make mortgage payments. Many debtors like the convenience of making only one payment--to the trustee--and letting the trustee disburse. It helps keep them on track financially and may improve completion of chapter 13 plans. Further, given the numerous and well-documented problems with mortgage servicers' ability to correctly apply payments in chapter 13 cases, why put the burden of sorting all those problems out on the debtor or debtor's counsel? If the trustee is the conduit for the payment, then the trustee can take steps to ensure the payments are applied properly and the debtor is being charged correctly. I suspect this stems from some concern that consumers shouldn't have to bear the added costs of paying a trustee. Many trustees, however, take only 5% commission instead of the usual 10% for the disbursement on mortgages, and if Congress is concerned about this, they could amend section 586 to provide for a lower trustee fee for mortgages. Also, consumers who pay the trustee are getting services; the trustee is the one who must wait on hold with the mortgage servicer, try to reconcile the accounting, deal with RESPA and escrow issues, etc. I think it is fair to pay trustees for that work. I think debtors should have the option of making payments on a modified mortgage either directly to the mortgage company or through the trustee, as is currently the practice.

Cramdown Commentary

Bob scooped me on an initial post about the deal between Citigroup and Senate Democrats on pending legislation to permit bankruptcy judges to modify mortgages in bankruptcy. But I have details. And commentary. And questions.

First, the letters from Citibank to the House and Senate outlining the changes that they request be made to the legislation are available in the middle of this WSJ article. They requested three changes to S.66 or H.R. 200 (both denominated the Helping Families Save Their Homes in Bankruptcy Act of 2009). First, that the legislation be limited to loans in existence when the legislation is enacted. This gives the bill a sunset, of sorts, but it could be a long one, given some people have 30 or 40 years left on their loans. Second, only when a violation would give rise to a right of recission under the Truth in Lending Act can the claim be disallowed. Given the relative difficulty and cost of litigating such claims, this is not, in my opinion, a large concession. Consumers retain their rights under the Truth in Lending Act to bring a claim under its provisions and recovery (puny) statutory damages. Third, a reduction in a loan's principal balance is only available if the homeowner certifies they contacted the lender to modify the loan before bankruptcy. Note that the "reduction in principal" is only ONE of the options available to bankruptcy courts. Apparently, the court could freeze or adjust interest rates or extend the term of a loan even if a borrower had not contacted the lender. The only problem I see here is if lenders begin litigating whether the borrower has indeed contacted the lender. Borrowers who did so by phone won't have great records of having done so. I would advise borrowers who call to also send a written letter and keep a copy asking for a modification.

Apparently, the news of the Citi's support for the legislation traveled fast and yesterday at chapter 13 confirmation hearings around the country, debtors asked to have their hearings continued to see if the legislation passed. I also wonder what are the options for homeowners who filed chapter 13 a few years or months ago and were not able to modify their home mortgages. Can they ask the court to modify their plan if the legislation passes?

Chapter 13 Cramdown Bill

The Wall Street Journal is reporting that Citigroup is negotiating over the terms of a bill to give bankruptcy judges the power to adjust home mortgages in chapter 13. The article further reports that the National Association of Home Builders has dropped its opposition to the bill, although Citigroup says it still has not made a decision on what its final position will be. Credit industry opposition is the primary obstacle to passage of this legislation. If this opposition evaporates, the bill almost certainly will become law given its support among congressional leaders and the incoming Obama Administration. For background on how the law would work, see here.

UPDATE: Just as soon as I posted this, the news broke that a deal had been reached. This is a welcome development. Of course, the devil is in the details. If anyone has a link to the text of the legislation that would result from the deal, please post in the comments.

Bankruptcy in the Senate, December 4

I'm in Providence, Rhode Island, for a field hearing of the Senate Judiciary Committee. The hearing is "Credit Cards and Bankruptcy: Opportunities for Reform." The other witness are former Credit Slips guest blogger and attorney for the National Consumer Law Center John Rao, Bankruptcy Judge Thomas Small of the Eastern District for North Carolina, and Professor John Chung of the Roger WIlliams University School of Law. The cab driver from the airport was among the most friendliest I've encountered and was pointing out the many fine features of Providence as we drove in. It's always nice to have your first contact with a place be with someone who is proud of their town.

One of the topics will be S. 3259, the Consumer Credit Fairness Act introduced by Senators Whitehouse and Durbin. This bill defines a "high cost consumer credit transaction" as one in which the interest and fees create an interest more than 15% higher than the rate on 30-year U.S. Treasury obligations (up to a maximum of 36%). Right now, that would be a credit transaction with an interest rate a little over 18% 19%. The bill then would subordinate to all other claims in a consumer bankruptcy any "high cost consumer credit transaction" and would excuse from the means test any bankruptcy caused by a "high cost consumer credit transaction."

The Bailout -- another perspective (part 1)

First, I want to thank Bob Lawless and the rest of the Credit Slips folks for having me back yet again -- I'm getting to be like the guest who would not leave.

Second, while it might make me part of the "establishment," I'm going to say right from that start that I join those who favor the bailout.

I also think we need to avoid a whole lot of knee jerk reactions that are floating around out there -- like the SEC's ban on short selling, which is quickly becoming the Bad Management Protection Act of 2008.  Of course, the notion that the administration can open the door on this issue "just a little" is also equally suspect.

I view the economy and the larger financial system as being at a Titanic like moment:  post iceberg, per submersion.  It is certainly reasonable to disdain those who got us into this situation, but I'm not going to let my feelings for them get in the way of saving as many people as possible.

That said, I understand why there is a good deal of skepticism about the bailout.  In part chapter 11 is to blame -- there has been almost no effort to explain why AIG is different from Enron, United Airlines, or any other really big corporation that has recently failed.  And the financial industry needs to fess up that it blew its chance to self-regulate the credit default swap market -- too many people, even myself to some degree, bought the "trust us, we're experts" line from ISDA and other market players.

No wonder people aren't buying that line in connection with the bailout -- especially when the administration has its own credibility problems in this regard in connection with other big, complex projects in the non-financial area.

More on the chapter 11 issue, and why I think the administration has done a terrible job of selling this but still generally support the bailout, after the jump.  I'll save my thoughts on the CDS market for another post.

Hearings on Squeezing the American Family

Yesterday, the Joint Economic Committee of the U.S. Congress (JEC) held a hearing on the economic state of the American family. We've got falling real incomes, a mortgage crisis and a housing market in turmoil, record gas prices, and other increases in the costs of living. It's not going well.

Among the witness was Credit Slips's own Elizabeth Warren who started off with this:

From 2000 to 2007, measured in real dollars, incomes declined while basic expenses increased sharply. By the time today’s family makes a few basic purchases—housing, health insurance, food, gas, phone—it has about $5800 less than it had back in 2000.

Warren backs up that statement with numerous charts and statistics that demonstrate how incomes have failed to keep up with the rising cost of living. Her full testimony is here.

Consumer Credit Fairness Proposed for the Bankruptcy Code

On Monday, Senators Whitehouse and Durbin introduced S. 3259, the Consumer Credit Fairness Act. The bill would cut back on some of the worst consumer credit abuses by trimming back on collection rights in bankruptcy.

The bill begins by defining a "high cost consumer credit transaction" as any extension of credit, including costs and fees, that exceeds the lesser of (a) 15% plus the 30-year Treasury bond rate (a calculation that currently stands at 22.4%) or (b) 36%. There are two consequences that would flow from a transaction that met this definition. First, the creditor in a "high cost consumer credit transaction" would have their claim subordinated to all other claims in the bankruptcy case. Second, any debtor who filed bankruptcy as a result of a "high cost consumer credit transaction" would be exempt from the means test that determines eligibility for chapter 7 bankruptcy.

Fewer Frisbees on Tennessee Campuses This Fall

Every fall as the Credit Slips bloggers prepare to begin teaching, we are treated to the sight of tables, tents, and marketing literature aimed at marketing credit cards to college students. This year, those familiar signs won't be appearing on the campuses of the University of Tennessee system. On May 21, 2008, Tennessee enacted a law prohibiting credit card issuers from recruiting students on campus or through university facilities or student organizations. (There is an exception for "days when there are athletic events" so presumably home football games retain their usefulness for credit card issuers). The bill also requires the University of Tennessee institutions that receives funds from student credit cards or from the use of the school name or logo on credit cards to disclose the amount of money received and how the money was used.

Calls for restricting credit card marketing to students are nothing new (see here and here and here) but I think this is the first law to be enacted that absolutely bans campus marketing. I'm confident the credit industry will challenge the bill, probably on preemption grounds, arguing that as the state of Tennessee lacks authority to regulate national banks. I think that argument should fail. The state isn't banning credit cards as a matter of general commerce; the legislature is acting in its role as overseer of the state's educational institutions.  If an institution itself (Rochester Institute of Technology, University of New Mexico) can ban or sharply limit the solicitation of students for credit cards, I think a state legislature can enact the same prohibition for the campuses that it controls.

Should We Not Disclose Credit Card Information?

The paper Professor Richard Wiener (Univ. of Nebraska), a psychology professor, discussed presents findings that are completely contrary to economic predictions. Standard economic theory would predict that if consumers are given complete information, they will act rationally and not overspend where the costs of spending outweigh the benefits of consuming. However, the preliminary conclusions he and his co-authors reach in Limits of Enhanced Disclosure suggest that giving consumers additional credit card disclosures does not reduce consumer spending and, in some instances, may make consumers spend even more.

The Future of Mortgage Servicing

In my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).

The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.

In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.

IRS Should Have Gone for a Baker's Dozen with RAL

Each year the IRS releases a Dirty Dozen of tax scams. I wish the 2008 list had labeled another practice a scam--refund anticipation loans or RALs. A RAL is a short-term cash advance against an anticipated tax return. Essentially, the taxpayer is paying to access their own money immediately rather than waiting for the IRS to process their refund. There are about 9 million RALs made each year, with APRs ranging from 50% to 500%. Perhaps their high fees are justified by the fact that they are short-term loans. On the other hand, the tax preparers have a lock on this market, which could reduce competition. It seems hard to believe that the risks of nonpayment are very significant when the amount of the refund is being determined during the tax preparation process and the preparer captures the refund directly, rather than relying on voluntary remittance from the debtor.

The IRS does warn against "dishonest" tax return preparers who "make their money by skimming a portion of their clients’ refunds." Although most leading preparers offer RALs, I think RALs are "making money by skimming clients' refunds."

Illinois Statute Gives Debtors Less Protection After Bankruptcy?

A crazy Illinois law demonstrates how bad drafting is not just for the U.S. Congress. State legislatures can do it too! It is my understanding that some Illinois automobile lenders are citing this law (625 ILCS 5/3‑114) as a reason to give some debtors less protection after they filed bankruptcy. Under this reasoning, these debtors are in  worse legal position because of the bankruptcy filing. That can't be right.

Discussions of the Kind That I Stimulated By My First Post

Discussions of the kind that I stimulated by my suggestions on Monday (about what Congress might do) reveal widely different assumptions about the number and type of debtors that will default. Shouldn't we look for the data? The data might keep conservatives from falling off the cliff to the right and the liberals from falling off on the other side- at last that is my hope. So who are the debtors and how many will default? Those are the questions for investors, legislators and lenders. But the answers are not easy to find, and, with incomplete data, each of us is the captive of his political bias. What about the defaulting debt and about the deserts of the debtors (Fools all? Every one defrauded?)