• Phony Numbers

    Posted by

    Elizabeth Warren

    In today’s New York Times, Vikas Bajaj and David Leonhardt offered a creative explanation for how home sales could be slowing and inventories building while home prices continued to nudge upwards:  incentives.  They report that in a weakening market sellers are giving rebates on prices, either in goods, services or outright cash.  In other words, the records may show that the house sold for $350,000, but the effective price was $343,000. 

    The reasons for this ruse are partly psychological (individual sellers who think: "I don’t want to lower the price!") and partly economic (builders who think:  "I don’t want the people who already signed contracts for homes in this subdivision to know that the new guys can get in for lower prices.") 

    Back in the day (say, 1972) when the median first-time home buyer coughed up an 18% downpayment, a few bucks of incentives probably wouldn’t have mattered.  But with the median first time homebuyer today making a ZERO down payment, a little rebate means the mortgage starts out in the red.  Bajaj and Leonhardt note at the end of the article that the mortgage companies try to police the rebates, but c’mon, does anyone think that really happens?  Besides, by keeping the prices high, the comparables stay high as well, giving everyone an inflated appraisal on which to base that 100% financing. 

    Here’s one more little piece of evidence why everyone on this list should be selling their mortgage-backed securities (if anyone on this list ever had any mortgage-backed securities):  The valuation numbers are phony.  Maybe just a little phony in this case, but at 100% financing, a even a little bit phony is going to come out of the investor’s hide. 

    As housing values continue to deflate, those of us who teach mortgage foreclosure law will have many attentive students. 

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  • Small Business or Consumer?

    Posted by

    Bob Lawless

    Leslie Eaton of the N.Y. Times today reports on the state of small business in New Orleans, one year after Hurricane Katrina. It is a great article, exploring the relationship of small business both to the social fabric and economic health of a community. In the article are stories about the financial decisions small-business owners have made in recovering from Katrina’s devastation. A restaurateur expresses hope that he has not made a "foolish decision" by using all of his savings to reopen his restaurant. To cover losses stemming from months when her store was closed and slow sales since reopening, a shopkeeper has "mortgaged her house to the hilt" and borrowed from in-laws.

    Whether these are reasonable risks or foolish decisions, these stories illustrate that "consumer" credit policy presents subtle and highly textured issues. First, I highlight "consumer" because one wonders how to classify the financial decisions of these business owners. Are these consumer debts or business debts? If the restaurateur now begins to rack up credit card debts for his daily living expenses because his savings are sunk into the business, how do we count that? Is the shopkeeper’s home mortgage a business debt? For a significant segment of the public, their financial affairs are in a gray area between consumer and business. About one out of every seven bankruptcies, for example, is someone that is or recently was self-employed. Most every small-business owner’s personal and business affairs are intertwined and interdependent.

    One might wonder why these small-business do not incorporate or form a limited liability company, to separate business and personal affairs. The answer is that they may have done do so, but why does it matter if they have put their personal credit at risk to finance the business? Even if they have not, that can be a rational decision. With the press of all the other demands of a small business, the time and expense it takes to incorporate may not seem worth it if you have put your personal credit on the line anyway. Regardless of the fiction of legal separateness, small-business owners cannot financially walk away from a failed business.

    When we think about "consumer" credit policy, we are thinking about different groups, and small-business owners comprise one of these groups. Often, however, consumer credit policy thinks about consumers monolithically. The monolithic image that often results is the irresponsible, overspending, unsophisticated consumer, and we end up with rules that are unsuitable for large portions of the public. An example is the new bankruptcy requirement that all individual filers undergo consumer credit counseling. If the New Orleans business owners mentioned in the N.Y. Times article later end up in bankruptcy court, query what credit counseling would tell them. Don’t take business risks? The credit counseling requirement is just one example. Last year, I taught a seminar where looked at a host rules that looked great for consumers or looked great for big businesses but did not work well for small business owners.

    Credit and bankruptcy laws directed at consumers will sweep in small-business owners. At that point, another law may come into play–the law of unintended consequences.

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  • A Real Live Involuntary Bankruptcy

    Posted by

    Melissa Jacoby

    Involuntary bankruptcy petitions are a fascinating and a fundamental part of our bankruptcy system.  They are quite rare overall, although somewhat less so in the biggest chapter 11 cases, according to LoPucki and Whitford’s early research.   But the disappearance of a Chapel Hill lawyer has prompted the filing of an involuntary petition – – a media report here.   Pursuing a bankruptcy case against a missing person will be a challenge worth watching.

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  • Iraq Payday

    Posted by

    Elizabeth Warren

    President Bush announced this morning that he is recalling 2,500 Marines to active duty, and more recalls may be on the way in the next few months.  "Recall" in this context means that men and women who have completed the agreed term of their active service and who are now civilians with jobs, families, mortgages, credit card bills, car loans and, as Zorba said, the "whole catastrophe" will pick up stakes and head back to Iraq. 

    So what do their families do?  What if they made financial commitments based on new jobs that pay better?  What if their families need to move to wait out the deployment?  What if they can’t make it on a marine’s pay? 

    Katie Porter just posted about the recently released report from the Department of Defense that tells what the market solution has been:  some of these families will turn to the payday lenders that surround the military bases.  And some of these families will seal their financial doom when they do so.  The DoD has weighed in, asking Congress to rein in the payday lenders, explaining that the practices of payday lenders hurt our troops. 

    I note the deployment here to make a point:  it’s all connected.  There are no credit issues in a vacuum.  Lenders ring military bases because military families are vulnerable.  As we push our troops harder to fight a war in Iraq, their families become more vulnerable.  And as their vulnerability increases, the payday lenders and other predators close in tighter.

    I cannot think of an issue that affects American families that does not also connect to a credit issue.  And I cannot think of a credit issue that does not affect an American family.  Iraq and payday lending are just one more reminder.

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  • “Wasting” Your Money on Rent?

    Posted by

    Katie Porter

    An earlier post by co-blogger Melissa Jacoby (Turning Stucco Into Sand) commented on homeowners who file bankruptcy. That demographic seems likely to grow in light of rising interest rates and falling home prices. New mortgage products, including interest-only loans and adjustable rate mortgages in which the initial rate is the floor, leave consumers bearing all the risk of these market fluctuations. Higher loan to value ratios are positively correlated with foreclosure, and yet today’s first-time home-buyers put down only 3 percent when they purchase a house.


    What do these trends mean for financial advisers, educators, advocates, and even parents who are concerned with ensuring financial success and security for today’s young people? While more research is certainly needed, an article in USA Today offers one possible answer—rent! (“For Some, Renting Makes More Sense”, 1A, Aug. 10, 2006) The traditional advice to buy a home as soon as possible and stop “throwing away money on rent” may need to yield to the costs and risks of modern mortgages. The USA Today article examines the gap between the median mortgage payment and the median rent in several housing markets. It finds that many consumers would have a couple of thousand extra dollars each month if they rented. The national gap between mortgage payment and rent was calculated at $816 monthly. If families put this money into tax-advantaged retirement programs or into an emergency fund would they be better protected from financial failure? Is a home no longer the best way to achieve financial security? Does the government do too much to promote homeownership at the expense of urging and enabling families to save for retirement, purchase insurance, or save?


    By the way, the Wall Street Journal had an interesting piece on Tuesday on NINA mortgages (no income/no asset verification) loans and some of the “red flags” created by that lending product. (‘Stated Income’ Home Mortgages Raise Red Flags, Wall Street Journal, D2, August 22, 2006).

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  • You’ll Wish the IRS Were Collecting Your Taxes.

    Posted by

    Angie Littwin

    The New York Times and the AP report that the IRS is moving forward with its plan to turn over the collection of relatively small amounts of back taxes to private collections agencies. Starting this September, CBE Group Inc., Linebarger Goggan Blair & Sampson LLP, and Pioneer Credit Recovery Inc. will be in charge of collecting back taxes of under $25,000 from 12,500 taxpayers.  The agency plans to contract with eight more private debt collection companies to collect back taxes from approximately 350,000 taxpayers by 2008. 

    There’s an idea.  Take an industry that’s come under scrutiny for abusive practices in two recent exposes [and here] and turn over a core governmental function to it.  The private companies will be paid by the amount they collect, so they will have strong incentives to use aggressive collection tactics. The Associated Press quoted National Treasury Employees Union President Colleen Kelley as saying that she has “‘no confidence at all’ in the agency’s ability to make sure the private firms are not overstepping their bounds.”

    Budgetary constraints appear to have forced the IRS’ hand. The agency has funds already allocated for a private program, but believes that it could not get budget authorization from Congress to hire additional IRS collection agents. But there are several problems with this proposal, not the least of which is that the IRS acknowledges that it will cost the federal government substantially more to contract with private companies than to hire more IRS agents to do the job.  In addition, giving volumes of confidential personal information about taxpayers to private companies raises significant privacy concerns.  But from a debtor-creditor perspective, my worry is this:  in an industry where debt collectors are often accused of overreaching, what kind of power will companies have when they can say they are collecting debts on behalf of the United States government?

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  • Are Interest Rate Caps Patriotic?

    Posted by

    Katie Porter

    The DOD recently issued a report on predatory lending, concluding that "predatory lending undermines military readiness, harms the morale of troops, and adds to the cost of fielding an all volunteer fighting force." The DOD defined predatory lending broadly, including in its sweep common practices such as refund anticipation loans and car title lending. The report builds on academic research by Christopher Petersen and advocacy work by the National Consumer Law Center and the Center for Responsible Lending.

    The report is shocking for two reasons. First, note that the federal government is advocating a usury law, which is quite a departure from its usual position on consumer credit policy. The DOD recommended a 36 APR cap on all extensions of credit to military servicemembers and their families. The DOD explicitly rejected suggestions that "education, counseling, assistance from [military] aid societies" and other alternatives are "sufficient" to curb predatory lending. Second, the report’s proposals may have political traction. The interest rate cap was included as part of a comprehensive military bill that passed the Senate in June. It is currently pending in a House-Senate conference commitee. If it becomes law, it will provide a natural, nationwide experiment on the effects of interest caps on moderate and low income families, and could be used to build support for a similar law that applies to all consumers.

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  • Column on Bankruptcy Reform in Houston Chronicle

    Posted by

    Bob Lawless

    Loren Steffy, a columnist with the Houston Chronicle had a column in Sunday’s paper about the 2005 bankruptcy amendments. He writes, "After almost a year under the so-called bankruptcy reform that Congress
    enacted at their behest, the law has proved to be what it appeared: a
    love letter to lenders." (Thanks to Professor Tim Zinnecker for bringing this to our attention.)

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  • On Absurdity

    Posted by

    Bob Lawless

    A few days ago, I discussed the sloppy drafting in the 2005 bankruptcy amendments, focusing on one particular piece of drafting that could be construed to eliminate involuntary bankruptcy petitions. Tom Perkins made a good point in the comments. A venerated legal maxim holds that courts are to apply the plain meaning of a statute unless the results would be absurd, but "[c]ourts are now faced with having to define absurdity much more
    frequently in light of many of the curiously drafted or pasted together
    provisions of BAPCPA."

    In January, Judge Bruce Markell published a thoughtful opinion exploring what it means for a result to be absurd such that a court should not follow the literal words of the statute. Judge Markell was dealing with a part of the 2005 amendments related to homestead exemptions. He uses Justice Scalia’s legisprudential writings as a point of departure: "Justice Antonin Scalia is one of the strictest, if not the strictest, textualists active today. . . .  If the methods used by Justice
    Scalia would lead to the reformation of the statute, then the statute probably
    should be reformed, and little time need be spent in discerning the proper or
    ultimate test for all federal statutes." This opinion has been called the WWSD or "What Would Scalia Do" approach. The legal citation is In re Kane, 336 B.R. 477 (Bankr. D. Nev. 2006) and is well worth a read by anyone grappling with applying the 2005 bankruptcy amendments.

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  • Floyd Norris Asks a Good Question

    Posted by

    Bob Lawless

    In today’s N.Y. Times ($), columnist Floyd Norris asks a good question. Were parts of the 2005 bankruptcy amendments meaningless? Specifically, Mr. Norris writes about a section of the new law that appears to put limits on retention bonuses for executives of bankrupt firms. Mr. Norris details the dispute between the reorganizing Dana Corporation and its creditors. Dana wants to pay its CEO a $3 million bonus for staying with the company until it emerges from bankruptcy.

    As the law that eventually emerged in 2005 wended its way through Congress in the early part of this decade, reports appeared about bankrupt corporations signing multimillion dollar contracts with corporate executives to ensure the executives stayed with the company through bankruptcy. If generals make the mistake of always fighting the last war, politicians make the mistake of always solving the last corporate crisis. Hence, the congressional solution was a new law banning payments to induce a corporate insider to remain with the bankrupt business. These payments are allowed only if the insider was essential to the business, the insider had a competing offer to go elsewhere, and the payment was no more than 10 times the amount paid to nonmanagement employees to induce them to stay with the company.

    To answer Mr. Norris’s question, this particular section is meaningless. The weakness lies in the way the section was drafted, a point I made yesterday about the 2005 law generally. The predicate for its application is that the payment has to be made for purposes of inducing the insider to stay with the business. It is a simple matter to structure a compensation package so the payment is made for other purposes. For example, a bonus payable upon confirmation of a chapter 11 plan or to meet certain performance goals is an incentive payments to meet those goals, not retention payments. I have yet to encounter an attorney doing chapter 11 work who thinks this new provision will have any substantial effect on compensation practices in chapter 11.

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