In a long story in today's edition, the New York Times is reporting a bubble in often deceptive and abusive subprime auto lending on unaffordable terms, including very high rates of interest. Although not quite the threat to the overall economy that the subprime mortgage bubble created eight or nine years ago, this apparent new bubble in lending for used vehicles has some similar features (targeting vulnerable consumers, lax underwriting, securitization, investors seeking high returns) and is causing significant pain for low income and unsophisticated borrowers. A few regulators are mentioned in the story, but oversight so far seems to have been lax.
Author: Jean Braucher
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Supreme Court denies certiorari in Sinkfield (chapter 7 lien strip-off case)
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The U.S. Supreme Court has denied a petition for writ of certiorari in Bank of America v. Sinkfield, an 11th Circuit case raising the issue whether a junior lien wholly unsupported by collateral value can be stripped off in chapter 7.
The high court's denial of certiorari yesterday (March 31) is a victory not only for the debtor who prevailed in the case below but also for the National Association of Consumer Bankruptcy Attorneys, represented by the National Consumer Bankruptcy Rights Center, which argued in an amicus brief against Supreme Court review on the ground that the case had not been fully litigated below and thus was a poor one for the Supreme Court to take up.
The creditor in Sinkfield stipulated to the result that strip off was permitted in the case, based on an Eleventh Circuit opinion so holding in another case, In re McNeal, 735 F.3d 1263 (11th Cir. 2012), one in which en banc rehearing has been sought.
The Supreme Court's decision not to review Sinkfield avoids for now the possibility of disturbing the solid precedent for lien strip off in chapter 13. McNeal is the first circuit court case to allow lien strip off in chapter 7; two other circuits have extended Dewsnup v. Timm, 502 U.S. 410 (1992), to come to the opposite conclusion. See here for background. Lien strip off in chapter 13 has been one of the few ways for debtors in bankruptcy to hold on to homes on which they are underwater while making them more affordable by removing junior liens unsupported by collateral value. Extending that sort of relief to chapter 7 cases would be helpful, but Supreme Court review also poses a serious downside risk of making bankruptcy less promising for consumer debtors.
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Gainful Employment Rule Redux
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It’s time for us to pick up this story again. Late last week, the U.S. Department of Education finally released an 841-page notice of a new proposed final Gainful Employment Rule (GER) aimed at predatory, debt-laden higher education, particularly at for-profit colleges. The for-profits enroll about 13 percent of the total higher education population but account for about 31 percent of all student loans and nearly half of all loan defaults.
The new rule seems to have a better chance of withstanding an inevitable legal challenge than DOE’s 2012 version, and it gets tougher on career colleges in a few ways outlined below, although it's still pretty forgiving to the colleges.
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American Hustle
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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-19th 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.
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Jonathan Lipson on “Relational Reorganization”
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Prof. Jonathan Lipson of Temple University School of Law has an interesting post today on the idea of “Relational Reorganization.” Find it over at the ContractsProf blog. He advocates more attention by scholars and lawyers working on debtor-creditor issues to the relational perspective of Stewart Macaulay, a leading contracts scholar in the law-in-action tradition. Macaulay has studied, among other contracts phenomena, the ways that business do and don’t use contracts, including that they typically readjust relationships in light of business realities rather than formal contracts entitlements.
Lipson points out that when business debtors struggle to meet their many obligations, workouts are the norm, and formal contracts give way, no matter the care with which they were entered. Even bankruptcy reorganization is typically mostly consensual. What is different in the debtor-creditor world is that multiple relationships often have to be adjusted or abandoned in a reorganization process. Lipson suggests that more attention to relational thinking could help us better understand various bankruptcy practices, particularly those used in close-knit groups of repeat players, including bankruptcy lawyers, claims traders, and professional distress investors.
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President Obama takes on the student debt bomb; meanwhile, the Gainful Employment Rule saga enters a 5th year
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Prospects do not look good for President Obama’s vastly ambitious initiative (not yet really a plan) to take on growing college debt.
Consider that the U.S. Department of Education (DOE) is going into its fifth year, and counting, of efforts to regulate just one higher education sector, for-profit schools, to stop those with the worst record of imposing unmanageable debt from continuing to live on a federal dole. After a big setback in a legal challenge by the industry last year to a new Gainful Employment Rule, DOE has recently resumed its efforts, with a second round of negotiated rulemaking set to begin in September.
The for-profit industry itself has argued for an expansion of regulatory scope to all colleges, presumably not because that would lead to quicker controls on for-profit schools' own operations. The Obama administration may have lost necessary focus. It should be taking on worst things first rather than subjecting even the most efficient, debt-free sectors of higher education to expensive new regulation.
About half of U.S. undergraduates go to community colleges. As of 2011-12, according to the College Board, the average annual published tuition at public two-year schools was $2,963 (sticker price), and after taking into account grant aid and tax benefits, the average student paid nothing for tuition and fees (actually on average they got $810 more in aid than tuition and fees, meaning some money for living expenses). In the most recent figures available on debt (probably getting worse because of public funding cuts leading to higher tuition), 62% of two-year public school graduates incurred no debt, and only 5% finished school with more than $20,000 in debt. Most of the students at community colleges pay as they go by working their way through school. These schools need continued public funding to preserve their largely debt-free culture, which also makes not finishing school a low risk to students’ financial futures. President Obama’s new rating system for all of higher education would not address the problems in this all-important two-year public sector, which offers subsidized education that only costs as much per student as high school.
For-profit schools, which have grown to enroll about 10% of college students, are at the other end of the debt spectrum—their students incur the most debt and have the highest default and delinquency rates (while the schools pay the least for actual education as opposed to marketing and other administrative costs). For an exposition of the for-profit schools' business model, including heavy dependence on federal funds, see my paper from last year; it also provides a comparison to the debt picture at public and non-profit institutions as well as an account of the regulatory process through spring of 2012).
It is good news that DOE hasn’t given up on regulating for-profits better despite a loss, discussed more below, in federal district court in June of 2012. That decision actually provides a roadmap for redoing the Gainful Employment Rule (GER) to pass legal muster, while making it tougher than the very weak regulation that was struck down.
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Who is Mel Watt?
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On May 1, President Obama nominated Rep. Mel Watt (D-N.C.) to be the director of the Federal Housing Finance Agency, the conservator for the mortgage giants Fannie Mae and Freddie Mac.
These two entities together currently back a large majority of new mortgages and hold or guarantee about half of all U.S. mortgages. Like other entities immersed in the mortgage market, Fannie and Freddie suffered great losses in the mortgage meltdown and were taken over by the federal government at the end of the Bush administration in September 2008.
Watt could be a key figure in the late stages of the mortgage crisis and in redefining the role of Fannie Mae and Freddie Mac going forward. So who is this eleven-term congressman and what does he care about most?
Probably the most important points to stress are these: He rose from humble beginnings through the meritocracy and is a Yale-educated lawyer who likes to immerse himself in the facts. He is broadly respected at home in Charlotte, N.C., and represents a safe district where he has biracial support. He carefully listens to the financial services industry, a major player in his community, and one that has supported his campaigns. Most important of all, he has made working for the economic well-being of African Americans his life’s work, whether as a lawyer in private practice representing minority businesses or as a lawmaker seeking to shore up consumer protection, particularly to strengthen the legal basis for challenging predatory lending, often used against racial minorities and other vulnerable populations.
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Adam Levitin awarded the Young Scholar’s Medal of the American Law Institute
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Congrats to Credit Slip’s Adam Levitin for winning a prestigious honor! Of course, this award is well deserved.
The American Law Institute announced today that Adam Levitin of Georgetown Law Center has been awarded its Young Scholar’s Medal. ALI says that this honor is “designed to recognize early-career law professors whose work is relevant to the real world and has the potential to influence improvements in the law.”
William Treanor, Dean of Georgetown Law Center, said: "Professor Levitin's work not only has the potential to improve American law, it already has influenced improvements in law in multiple areas across the financial sector."
Justice Goodwin Liu of the California Supreme Court, who chaired the Young Scholars Medal Selection Committee, said, "Professor Levitin's work on the recent financial crisis has helped to guide lawmakers in the areas of housing finance and bank regulation."
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National Consumer Protection Week and Disclosure 3.0
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It’s National Consumer Protection Week (NCPW)! Federal, state, local, and nonprofit consumer protection agencies and organizations are making extra efforts to promote consumer awareness.
First I have to get out of my system thoughts of Tom Lehrer’s song, National Brotherhood Week:
Step up and shake the hand/Of someone you can’t stand . . .
It’s only for a week so have no fear/Be grateful that it doesn’t last all year.
But to get back on message, of particular interest to Credit Slips readers is this part of the mission of consumer protection described on the NCPW website:
"Financial Fraud Scams: American consumers owe a whopping $11.31 trillion dollars in debt and are behind on paying about $1.01 trillion of that amount. Mortgages, student loans, and credit cards account for a large portion of that debt. Consumers are often haunted with huge monthly payments, and fraudsters take advantage of that with debt relief scams, tax scams, and other financial fraud scams. Scams target individuals who are in financial distress, but they fail to fulfill their promises, and typically leave consumers worse off than when they started."
Let me say that Lauren Willis has done a great job on this site recently taking us, patiently and painstakingly, through the many problems with the idea that disclosure can be refined into a digital juggernaut to protect consumers. See here and here and here.
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CFPB’s Anti-Abuse Authority: A Promising Development in Substantive Consumer Protection
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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.