We have been hearing about the oncoming endgame to the Greek saga for almost two years now. Several developments have occurred in the past few months that may make the prediction come true sooner rather than later. 

The first is a seeming shift in the attitudes of European leaders. They are not blinking in the face of Greek government resistance to the punitive conditionality of the loan agreement. In fact, they are asking for such extreme measures in the face of a complete collapse of the Greek economy that one is forced to wonder whether their aim is rather to “volunteer” Greece for a default and, perhaps most of all, a euro exit. In any case, the tone of the debate has changed considerably, with many more European voices openly discussing the scenario of a default and euro exit, some confidently asserting that Greece’s collapse will not be Lehman. A FT article last Monday nonchalantly reported that the troika was using the threat of a hard default as a bargaining chip against the Greek government. This is an amazing statement. It can mean several things: 1) the troika thinks the famous firewall is now in place to avert the infamous contagion effects 2) the troika is playing a hard game of chicken to see who blinks, even though it doesn’t want Greece to default 3) the EU and the ECB are posturing to appease northern Europeans by showing they will really not take any equivocation from Athens on austerity, while Greek politicians are also putting up a show for the sake of their own electorate. Whichever of these things is going on, it signals a remarkable willingness to take the risk of no deal on both sides.

The second development is the dramatic, but unsurprising deterioration in economic and social conditions in Greece. Contrary to the media echo chamber rumors, Greece has managed to comply with the “internal devaluation” imperative quite well. The fiscal adjustment has been in the magnitude of 6% GDP in the course of a year and in the middle of a continued recession. Wages and pensions have been reduced, even though they are still higher than Bulgaria-as the troika indignantly points out. Consumer prices have remained stable, as nothing has been done to bust retail cartels and monopolies. Real wages have thus decreased significantly. The goal of increasing state revenue has also been achieved through an unprecedented tax campaign against the salaried, who constitute the only captive population of the Greek IRS. The same people who were already paying their taxes prior to the crisis are bearing the brunt, with potentially explosive consequences for social cohesion. Hundreds of thousands of small businesses have closed and unemployment is at a dizzying 48% among the youth. Eurostat numbers for 2010 show that one almost one in three people were at risk of poverty in Greece, up from one in five before the crisis. Homelessness, a practically unknown phenomenon in Greece until recently, has exploded, with numbers calculated around 20,000 for central Athens. A friend of mine recently told me that she has now become accustomed to the sight of people robbing the elderly of their grocery bags outside stores in central Athens. The unfolding pauperization of the middle class means that more and more people feel less threatened by the specter of a hard default because they are already in the position of not much to lose. Whether they form a critical mass already or whether we need to wait a few more months remains to be seen.

A third element that has changed is the position of the wealthy in Greece. Back in 2010 the specter of default and exit was a very real threat to Greeks with assets inside Greece who did not want to see them possibly turned into drachmas and devalued. Almost two years have passed since that time and most Greeks with any assets have turned them into bank accounts and apartments in London, Paris, Brussels, Frankfurt. According to media reports, prices in high end London apartments have gone up in the last year because of the wealthy Greek buying spree. That means that the same people who were putting pressure on the Greek government two years ago to accept the troika loan in order to avoid a default that could lead to exit, possibly stand to gain from a potential return to the drachma. Add to that the fact that politicians feel that consent to the new measures may make or break their survival in the coming reshuffling of the Greek political scene and you have a universe in which refusing to sign onto the new loan agreement (or refusing to abide by the terms of one already signed) becomes a plausible political move, even for the leader of the conservative party.

As I am writing these lines (and I had to write them several times over the last couple of days) the Greek government announced that it had reached agreement with the troika. Then some of its members started backtracking-two ministers resigned- and the German finance minister in turn refused to sign onto the new loan agreement under these conditions. Nonetheless, a vote is scheduled to happen in the Greek parliament on Sunday. Greek politicians will employ hundreds of special forces armed with tear gas when the agreement goes through the Parliament to protect themselves from the people they represent, as they did in July 2011. Since all these new elements weighing in favor of default are now in place, the demonstrations may provide a trigger accelerating political developments in Greece, even though the endgame may still drag on for some months. In either case, it is now in sight.

At its annual Capitol Hill Day in Washington this week, the National Association of Consumer Bankruptcy Attorneys sounded an alarm about the growing student loan problem, calling it a “debt bomb.” NACBA released a survey of its members indicating that more potential clients these days have unmanageable educational loans and are facing aggressive collection efforts. See http://www.nacba.org/Legislative/StudentLoanDebt.aspx. It has become common for people to have two mortgage-size debts, one for a home and another for an education. The educational loan problem is looking something like the one a few years back with subprime mortgages.

Absent “undue hardship,” very hard to establish, student debt can be a life sentence because these loans are not dischargeable in bankruptcy. NACBA supports making private students loans dischargeable again (as they were before the 2005 law). Beyond that, it favors going back to the pre-1990 approach of allowing discharge of any student debt after five years. If the education isn’t paying off enough to make the loan repayable after that much time, something has to give so that people can get on with their lives--and some day buy a home, start a family, and save for their kids’ education and their own retirement.

As a participant in the Capitol Hill Day, I found congressional staff reacted very sympathetically. They are mostly young people carrying big student loans or with friends who have them. They know how hard it is to manage this debt even when you have a decent job. They easily recognize what a big problem this is for their generation and even more so for the next one. This issue isn’t going away.

On behalf of Credit Slips, I wanted to welcome Professor Philo Tsoukala from the Georgetown University Law Center. Professor Tsoukala will be joining as a guest blogger, and she will be commenting especially on the Greek debt situation and how the debt situation is affecting everyday life in Greece. Professor Tsoukala specializes in family law and is the co-author of a forthcoming new edition of a well-respected textbook in the field. At Georgetown, she teaches classes in family law and EU law as well as a seminar on the regulation of the family and the market. We're very happy that she has agreed to lend her expertise to our online community.

The critical point made in the Democratic Congressmen's letter to FHFA is this:  Director DeMarco's widely reported claim that principal write-downs on Fannie and Freddie mortgages will cost taxpayers $100 billion is simply false.  There are two reasons the statement is a complete misrepresentation.  First, the $100 billion is simply the aggregate amount of underwater mortgage principal on all Fannie and Freddie loans, not just those at risk of foreclosure or where borrowers are seeking modifications.  Second, Fannie and Freddie will lose more than $100 billion on underwater loans in foreclosure sales, according to their own projections, if the loans aren't given principal write-downs.

The relevant comparison is between the foreclosure losses on underwater and defaulted mortgages, on the one hand, and the net payouts from modified mortgages with principal reduction on the other hand; in other words, the dollar difference between doing the write-downs and not doing them.  FHFA's own analysis shows that changing from the current policy--to postpone but not eliminate excess mortgage principal--to a policy of writing down that excess principal, would yield a positive net present value of $28 billion.  This is because fewer homes would end up in foreclosure sales, where losses exceed 50% of principal, and more homeowners could pay their (reduced) debt.

The heat is cranking up on the seat of Edward DeMarco, acting head of the Federal Housing Finance Agency and a holdover from the last administration who has been standing in the way of a meaningful response to the mortgage crisis. FHFA is conservator of FannieMae and FreddieMac, owners or guarantors of a large percentage of US home mortgages, and thus in a position to direct the mortgage giants to take steps that would save taxpayers money, provide relief to struggling underwater homeowners, and revive the US economy. Congressmen Elijah Cummings and John Tierney yesterday released a smoking letter to DeMarco explaining that his agency's own analysis shows that a principal reduction program could save taxpayers $28 billion. http://democrats.oversight.house.gov/images/stories/Cummings_Tierney_DeMarco.pdf Even more revealing, they say a FannieMae whistleblower has disclosed that FHFA was poised to implement a pilot program along these lines just before the November 2010 election but then pulled back for political reasons. Things seem to be getting more interesting. Could we finally see some movement on this critical issue?

In re Bank of America, N.A, 11-24503 MER, 2011 WL 2493056 (Bankr. D. Colo. June 21, 2011):

Since there is no allegation Bank of America is a railroad ...  the Court accepts Bank of America's representation that it is a “bank” for purposes of § 109(b)(2).

What are we to make of the servicing settlement announced today with much hoopla?  The short answer is not much.  The settlement is the large consumer fraud settlement ever, but it accomplishes remarkably little in terms of either alleviating the foreclosure crisis of holding to account those responsible for the housing bubble and subsequent foreclosure abuses.  As my Texas relatives say, it's “All sizzle, no steak.” 

Instead, I think the settlement needs be seen as the conclusion to round one of an on-going struggle for accountability and reparations for the enormous damage the housing bubble did to the United States.  Whether we will ultimately see meaningful accountability and reparations in the end is very much in question.  Round two, featuring the Residential Mortgage-Backed Securities Fraud taskforce, could well be stillborn; the taskforce combines more motivated and more capable agencies, but it isn't clear of the motivated can leverage the more capable or will be bogged down by them. But as for this settlement, if this is all that we get, it’s a big nothing. 

The settlement covers mortgage servicing abuses, as well as a $1 billion settlement of claims that Countrywide (BoA) was cheating the FHA.  It also includes settlements of litigation by the Arizona and Nevada AGs for BoA’s violations of an earlier settlement.  It also covers some origination claims on which the statutes of limitations have run or will shortly expire.  The settlement apparently (and here the precise language is crucial) excludes securitization-related claims, fair lending claims, false claims acts violations, MERS issues, and criminal claims.  It also doesn’t prevent homeowners or investors from bringing their own suits.  So it’s really covering robosigning and overbilling in foreclosures. 

Given the relatively narrow scope of this settlement, it’s not surprising that the dollars involved are quite small compared to the overall harms created by the housing bubble and aftermath.  The formal price tag for the settlement is $25 billion, although it is projected to accomplish up to $40 billion in relief. Only $5 billion of that is hard cash contributed by the banks.  Let me repeat that.  The five banks involved in the settlement, which have a combined market capitalization of over $500 billion, are putting in only $5 billion.  That’s less than 1% of their net worth.  And they are admitting no wrongdoing.  To call that accountability is laughable. 

That $5 billion in hard cash is going to the state and federal government, only some of which will be given to borrowers.  What about the other $20 billion?  That’s to come in the form of $3 billion in refinancings and $17 billion in principal reductions, deeds in lieu, short sales, anti-blight measures, etc.  The banks receive variable credit for these actions, depending on whether these measures are taken for loans owned by the banks or owned by others and serviced by the banks.  Basically, it’s full credit if the bank owns the loan, and half credit if the bank merely services the loan.  Because of this formulation, the $17 billion in principal reductions, DILs, short sales is anticipated to result in $32 billion in actual relief.  In other words, it is expected that the banks will modify the loans owned by others rather than the loans they themselves own.  And when a second lien loan owned by the bank is involved, it only has to be written down pari passu (at the same percentage) as the first lien loan.  So from absolute to relative priority, which is a major handout to the big banks, which have large underwater second lien positions. 

Or put differently, $32 billion of the settlement is being financed on the dime of MBS investors such as pension funds, 401(k) plans, insurance companies, and the like—parties that did not themselves engage in any of the wrong-doing covered by the settlement.  This shouldn’t be a surprise—the state Attorneys General previously cut a similar deal with Bank of America, which promised to make up for its wrongdoing by modifying loans own by other parties. 

But let’s get to the bigger problem.  Whether this is a $25 billion or $40 billion settlement is really beside the point.  It’s a drop in the bucket relative to the scale of the problem.  There is approximately $700 billion in negative equity nationwide weighing down the housing market and the economy.  Add to that legions of homeowners dealing with unemployment or underemployment and we’ve got a problem that absolutely dwarfs the settlement numbers.  It’s Pollyannism to think that this settlement will have any impact on the national housing market.  At best it makes some incremental improvements and helps a small number of homeowners.  But at worst, it lets the banks off the hook for the largest financial crime in history. 

I can’t say I’m surprised, however.  There was no investigation was done prior to this settlement.  That had been the sticking point for a number of attorneys general who eventually signed on to the settlement, but only once it was narrowed.  But that doesn’t take away the problem that there was no investigation.  If you go bear hunting without any ammo, you aren’t going to bag a bear.

To illustrate how little the settlement does for the housing market, let’s take the settlement’s most optimistic projections and assume that it really results in $40 billion of mortgage relief of various sorts.  How much does that translate into per distressed homeowner?  Let’s assume that the universe of distressed homeowners is limited to those underwater—roughly 11 million.  So we’re talking $3,636 per homeowner.  That doesn’t help a whit in terms of preventing foreclosure. 

Now to be sure, the relief will be more concentrated on a subset of these homeowners.  The settlement is estimated to help about 2 million homeowners, hopefully to the tune of about $22,000 each.  That's certainly a lot better than $3,636, but consider that the average negative equity is about $50,000.  At a very generous best, then the settlement only gets rid of less than half of the negative equity for 18% of underwater homeowners.  So we're talking about a solution that has less than a 10% impact.  Best case scenario is less than 1 in 10 are helped.  In any case, those luck few, will be chosen not by where the relief will help the most or by who is most deserving, but by what will be most advantageous to the banks.  So some lucky group of homeowners will have “won the lottery” and in some cases might avoid foreclosure.  For most distressed homeowners, it’s “no soup for you!” And because fixing the housing sector is about volume, this means that there's no soup for all of us--the housing sector will remain severely depressed. 

What about the argument that the settlement will help the housing market by enabling foreclosures to start up again and for banks to clear through the shadow inventory?  Well, what’s causing the shadow inventory?  Is it the possibility of state and federal prosecutions for robosigning?  Is it lack of uniform servicing standards?  Nope, and nope.  The shadow inventory problem is at core the result of two problems.  First, the foreclosure system only has limited bandwidth—there are only so many foreclosures that can be processed at a time.  Second, the banks have their own staffing issues.  And third, the bigger problem is that the banks don’t have their paperwork in order to foreclose. This servicing settlement doesn’t affect any of these problems (maybe it will encourage better staffing on behalf of the banks, but if that hasn’t happened by year 5 of the crisis, I can’t imagine it will any time soon).  National servicing standards as part of a settlement in no way replace existing state and local requirements, and to the extent they supplement them, it may make things harder for the banks. The fact that a bank is in compliance with the servicing standards in the settlement doesn't mean that the bank can in fact foreclose, and litigation of foreclosure actions is private litigation, not governed by this deal. (And this leaves aside the question of bank compliance with this settlement.) 

The settlement also creates really awful incentives.  It has zero deterrent effect against future wrong-doing.  This settlement set a price-tag for mortgage servicing abuses.  If the abuses are more profitable than the cost of settlement, what rational bank wouldn’t engage in them?  The early CFPB-settlement analysis that was leaked months ago envisioned $25 billion as being simply the disgorgement component, not the remedial component.  Here we have a settlement with $ 5 billion in actual disgorgement and very little that’s remedial, let alone punitive (which is necessary to have deterrence). 

Also announced in conjunction with the big settlement were the fines the OCC is imposing as part of its consent orders.  They total $394 million, but they are payable either in cash or in kind via relief given to homeowners as part of the OCC Potemkin foreclosure review process.  Please Hammer, Don't Hurt 'Em! (Hmm, maybe the banks' theme song should be "U Can't Touch This".) 

Is this really the best our government can do?  I hope not.  This settlement might or might not be the end of the attempt to rectify the financial crisis, but as things stand, we have a settlement in which the banks commit to follow the law and pay out some pocket change.  The settlement doesn’t fix the housing market.  It doesn’t create accountability for the financial crisis.  It doesn’t even create incentives against future wrong-doing.  But it provides the Obama Administration (and those attorney generals who just jumped in for the settlement at the last minute) with a fig leaf of political cover.  It galls me is that the Obama Administration is going to trumpet this settlement as evidence that it is serious about prosecuting the crimes behind the financial crisis and helping homeowners.  It was heartening to hear Obama talk about protecting the middle class in his State of the Union address.  It was the right message, but the President is simply not a credible messenger.  If Obama wants to run as the champion of Main Street against Romney, the Captain of Wall Street, he’s going to need to do something a lot more credible than this settlement.

 The score:  Banks 1, Public 0. 

Even though I was up at 4am Pacific this morning, the AG and federal government mortgage settlement was nearly old news by then. But in case you haven't heard, here is your official Credit Slips announcement--there was a $26 billion settlement.While the details are still being released, I am already concerned about how the settlement will affect bankruptcy cases. Remember that bankruptcy was one of the first places we saw the misbehavior of mortgage servicers--way back in 2005 when Tara Twomey and I did our study.

As of December 1, new Bankruptcy Rules of Procedure 3001 and 3002 impose new requirements on servicers of loans owed by bankruptcy debtors. Are the terms of the settlement consistent with those new rules? If so, do they add any new procedural benefits to protect bankrupt homeowners against robo-signing and legal violations?

The Department of Justice participated in the settlement and the U.S. Trustee's Office apparently was at the negotiating table. Their press release,  however, is just boilerplate of the general DOJ release. The only mention of bankruptcy is that the settlement will impose "new requirements to undertake pre-filing reviews of certain documents filed in bankruptcy court." I'm not sure what to make of that. Presumably, filing claims under penalty of perjury already required a review of claims, and Rule 9011 required a significant review of motions for relief from stay to permit a foreclosure to continue. What does the settlement add? I hope the US Trustee will let us know soon, as I am sure debtors' attorneys will get calls today on the issue.

An additional observation is that it is important to remember who is not a party to the settlement--the chapter 13 trustees. Those folks are not bound by the settlement, meaning that they can still challenge servicing practices that comply with the settlement, but in the professional judgment of the trustee violate bankruptcy law. Of course, the trustees are supervised by the U.S. Trustee so perhaps there will be political pressure to make the settlement the final word on the obligations of servicers in bankruptcy, but this could be an issue.

Comments and thoughts on the implications of the settlement for bankruptcy cases are very welcome!

We have not talked a lot about payment protection plans, those great deals where the bank agrees to pay your credit card balance in the event of disability or death in exchange for premiums. They are great for the banks. In an article in the American Banker, Victoria Finkle and Jeff Horwitz reports that the banks only return to the consumer 21 cents of every dollar paid in premiums and earn profit margins of 50% or more on the plans. Finkle and Horwitz report that the FDIC and CFPB are looking into the plans, with a regulatory probe of Discover Financial Services already underway. The article is worth a read, especially for the surprisingly candid assessments of industry insiders.

These plans are another example of "gotcha capitalism"--a business model dependent on sustained miscalculations or mistakes by the other party to the transaction. For everyone but the consumer at death's door, the premiums are way too high to justify the expense.

UPDATE (2/8): More on the CFPB probe of Discovery from Donal Griffin and Carter Dougherty over at Bloomberg.

In the introductory chapter of the book, Broke: How Debt Bankrupts the Middle Class,  I present some data about consumer debt levels in the United States. As Bob Lawless and others have shown, levels of consumer debt are strongly correlated with bankruptcy filings. While conditions such as unemployment, rising health care costs, and skyrocketing college tuition--and recessions--all create pressures on consumers that lead to borrow, debt is the sine qua non of bankruptcy--the relief offered by the system is the reduction or elimination of debt--not the promise of a good paying job or a strong social safety net. Because bankruptcy is driven by debt, those filings help reveal whether the levels of consumer debt will create serious problems for the economy and American families.

In Broke, I present a figure, courtesy of the San Francisco Fed, that shows the dramatic growth in household debt in real dollars over the last few decades. Reproduced below, the figure shows that the sharp acceleration began in the mid 1980s. This is an important point to understanding why recovery is proving difficult from the recession. As I explain in the book, "The consumer debt overhang, however, began long before the financial crisis and the recession. Exhortations about subprime mortgages reflect only a relatively minor piece of a much broader recalibration in the balance sheets of middle-class families. . . . The boom in borrowing spans social classes, racial and ethnic groups, sexes and generations." Broke, pp 4-5. The gray bands on Figure show recessions; this recovery is more difficult, at least in part, because we have an unprecedented gap between income and debt. Is this gap disappearing as a consequence of consumer reluctance to borrower and tightened credit conditions?

Since the recession, borrowing has slowed. This seems to have lead some commentators to suggest that consumer debt is back to a "normal" or "safe" level. A piece in the Wall Street Journal suggested that because the debt-service ratio, debt payments as a share of after-tax income, is at its lowest level since 1994, that "the things that worry Wall Street might not be so worrisome for Main Street." The perspective that I offer in Broke is much less cheery. Overall consumer debt only declined about 8% from its peak in 2008, and the newest data suggest that consumer debt has stopped declining (see here for a comprehensive look), and may even be starting to climb. (see here re credit card balances). Consumer debt remains very high by historical standards, meaning that bankruptcy may be ebbing in the very short-term but bankruptcy, and the debt-driven financial distress that it evidences, are certainly are not problems of the past.

You can read the a page proof version of the chapter here at the Stanford University Press website.

Since 1999, Professor David Coates has been the Worrell Chair of Anglo-American Studies at Wake Forest University.  Prior to joining the faculty at Wake Forest he directed the International Centre for Labour Studies, and was Professor of Government at the University of Manchester in the United Kingdom.  He also writes a blog at www.davidcoates.com, and it’s absolutely a fantastic read in all cases.

I found Professor Coates’ blog last year on my birthday as I was searching the Web for like voices and when I came across his, I felt like I had been given a birthday present.  And I wrote to him at the time and told him exactly that.

David’s latest article, for example, is titled: Republican Truth and the Real Truth: GSEs and the Housing Bubble.

David and I have been communicating over the last year and I invited him to join me on a podcast because he offers points of view that are as fascinating as they are erudite and well-considered.  They are also not the same thing you’ve heard before, as they cover the foreclosure crisis both here in the U.S and in the UK.  He also talks about the global financial crisis and the political ramifications that are manifesting themselves in this country and frankly, what he says is important at every turn.

David has also written two books, both of which you can find on his blog.  One is, “Answering Back,” which offers “liberal responses to conservative arguments,” and the other, “Making the Progressive Case.”  Both are worth reading.

I’ve learned a lot from Professor Coates and I’m confident you will too.  So, turn up your speakers… click below… sit back and relax… and listen to an uninterrupted hour with Professor David Coates as he talks about the foreclosure crisis here and in the UK, why democracy and progressive politics are more important today than perhaps ever before…  and whole lot more… on A Mandelman Matters Podcast.

(Plus… I don’t know about you, but somehow the foreclosure crisis sounds better in a British accent… go figure.)

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Mandelman Out.

For the umpteenth time, President Obama has announced that his solution to the foreclosure crisis is to encourage "responsible" homeowners to refinance at lower interest rates.  Adopting the Tea Party rhetoric and blaming home buyers who got houses in 2006 for their inability to foresee what few economists foresaw, Obama has steadfastly refused to push for principal reductions and payment suspensions for homeowners behind in payments, lest their luckier neighbors who bought at lower prices become resentful.  As a result, he continues to offer help to homeowners who need it least.

Behind the rhetoric is an important policy choice: who will bear the billions of mortgage losses that have yet to be flushed out of the system.  Principal reduction modifications for defaulted borrowers would distribute the losses among taxpayers (via Fannie and Freddie), private investors and banks (who hold non-GSE loans), and give underwater homeowners some relief.  More importantly, principal modifications mitigate the aggregate losses to the system while accelerating the necessary deleveraging. Refinancing current borrowers does nothing to prevent the huge deadweight losses from continuing foreclosures, at 50% loss severities, on homes whose owners are delinquent.  Choosing to do no more for the 7 million or so delinquent mortgage debtors means maximizing losses to those homeowners, but also to taxpayers and investors.  It would certainly help to continue driving down home prices, which does benefit new first-time buyers, but at a huge aggregate cost. 

In fact, as conservator of the nationalized Fannie Mae and Freddie Mac, the federal government could make the needed modifications of delinquent mortgages happen with a stroke of the pen, more or less. Instead, the Administration proposes the dubious strategy of loading up the FHA portfolio with 4% mortgages at 125% loan-to-value ratios, thus continuing the process of transferring future mortgage losses from banks to taxpayers, and amplifying those losses, while letting the foreclosure crisis continue, just as Mitt Romney proposes.  Nothing about the refinancing strategy moves forward the process of realigning mortgage debt to home values.  Instead, the strategy relies on the doubtful proposition that home values will soon return to rising at their pre-2007 clip.

Pacta sunt servanda and the housing market and broader economy be damned. 

A case out of the Third Circuit demonstrates the frustration that many of us have with the current state of consumer arbitration law. The consumer had purchased a Dell computer that he alleged had design flaws leading to repeated failure of his motherboard. After Dell refused to fix the computer a third time, he brought a class action against Dell for the alleged design defects.

Dell invoked an arbitration clause which read that any dispute "SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM (NAF)." This clause was found in "clickware," that is an agreement to which the consumer agreed by checking a box on Dell's web site when he purchased the computer. The capital letters were in the original agreement, presumably to make this language stand out due to its importance. As many readers of this blog will quickly pick up, there is a problem with this language -- because of abuses the National Arbitration Forum agreed to a consent judgment where it would no longer administer consumer arbitrations.

The majority of the appellate court, however, sets up an outcome where Dell wins where the coin comes up heads and where the consumer loses when the coin comes up tails. The court notes that the word "exclusively" in the arbitration clause could be read to modify "binding arbitration" rather than the forum where the arbitration occurs. Well, I suppose that language could be read that way, but we normally do not go out of our way to construe an ambiguity in favor of the drafter, especially in a consumer form contract.

The majority also makes much of section 5 of the Federal Arbitration Act, but it makes the same mistake that many of my students make coming out of a first-year law school curriculum that is heavy in case analysis. The majority spends a lot of time talking about what courts say about section 5, literally relegating the actual language of section 5 to a footnote (the underlining is mine):

If in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator, or arbitrators or umpire, or in filling a vacancy, then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require, who shall act under the said agreement with the same force and effect as if he or they had been specifically named therein; and unless otherwise provided in the agreement the arbitration shall be by a single arbitrator.

Section 5 could be read to allow the court to name an arbitrator on these sorts of facts which, in fairness to the court majority, some courts have done. But, there are at least two questions raised by such an interpretation. On the facts of this case, is there a "lapse in the naming of an arbitrator?" Second, is the National Arbitration Forum even an "arbitrator" within the meaning of the statute. The NAF is an arbitral forum, and the language of the statute as a whole suggests that, where it says "arbitrator," it means the actual human being who will conduct the arbitration. Here, the problem was not a lapse in naming an "arbitrator" but the unavailability of the organization designated to administer the arbitration as chosen by the parties to the contract.

Fair-minded people might see contractual and statutory arguments going both ways, and the majority admits as much. Thus, the majority rests heavily on what we might call a "tie breaker," and it is here where my frustration lies. In reaching its decision, the majority makes six references to the "federal policy favoring arbitration." This seemingly high-minded policy is not exactly a neutral principle. A policy "favoring arbitration" necessarily favors big corporate interests over consumers. It is a policy that is hostile to consumer claims and to class actions. Maybe the court wants to be hostile to such claims, but it is dishonest to dress it up as a neutral appeal to preferring arbitration. One also might wonder where this "policy" comes from such that the court would not be wiser sticking to the "policy" articulated by Congress in the words of the statute.

The application of this so-called policy becomes a "heads I win, tails you lose" rule. When companies get the arbitration clause correct, they can ask the courts to enforce the clause as written. When companies overreach and offer arbitration clauses with enforceabillity issues, they can ask the courts to fix their mistake, construing the clause or law to require arbitration nonetheless. In their extreme application, these principles can undermine public confidence in the courts to treat all parties equally.

Bloomberg out with an interesting story about how private equity firms are buying single family homes at foreclosure to rent out. It surprises me that there is real interest in what remains a relatively small scale, highly heterogeneous asset. Previous attempts to achieve economies of scale in this area have been disastrous -- see Bank of America.

In many respects, bankruptcy is a one-size-fits-all legal process. Yes, there are ample differences in the law (and a world of difference in practice) between the bankruptcy of a large corporation and a typical consumer. But the Bankruptcy Code itself contains plenty of provisions of general applicability. A major example of the one-size-fits-all approach to bankruptcy is the official forms for filing a case. The basic petition and schedules are the same forms for Big Airline Co. and Mr. Joe Blow. The information on the forms is wildly different, with Big Airline Co. listing hundreds or even thousands of creditors, with many more digits in their debts, than Joe Blow. But the form for those debts--Schedule F--is the same form. That may all be changing soon.

The Bankruptcy Rules Committee began a Forms Modernization Project a few years ago, and one of its top agenda items has been creating new forms just for use in consumer bankruptcy cases. Although few people seem to be aware of the effort, a draft version of those new forms is available to the public and to my mind, well worth a look. To see the forms, go here, then click on September 2011, download the file, and look  at pp. 189-315 of the PDF (or tab 7.1 if you use the PDF index.) One thing that is obvious from the page numbers in the prior sentence is that the new forms are really long--way longer than the current forms as completed in the typical consumer case. The added length results in part from the development of extensive instructions for each form. Below is an example of a new form with some commentary on its notable new features.

The period for public comment on these forms has not yet begun, and the Bankruptcy Rules Committee may well make changes before then. In future posts, I will say more about what kinds of changes I hope to see and offer some thoughts on whether this initiative is a positive development for the system.

During the State of the Union address, the President crowed about the success of the GM/Chrysler bailouts, noting that these companies were thriving again. An NPR program this evening was holding up GM/Chrysler as a beacon of hope for Kodak, as if bankruptcy were now the fountain of corporate youth.  

But this just begs the question of why did the GM/Chrysler bankruptcies work? What made these bankruptcies success stories? NPR raised the question, but had some lame answers, namely that it forced management to make decisions it hadn't wanted to do like cutting loser brands (Saturn, Pontiac). It might have helped focus management decision-making, but that alone can't be the answer, I think. I'm curious to hear readers' thoughts. A few thoughts of my own below the break.

I'm not a car afficianado, but I've got to say that this surprises me. I was not under the impression that GM/Chrysler were turning out particularly great cars in 2007-2008, and I don't have the sense that they're boasting radically different product lines now (I'll find out soon, however, at the DC Auto Show...). But maybe the answer is that they were producing reasonably good cars and now they're able to price them more competitively. Thoughts anyone?

(2) How much of a management shake-up did bankruptcy entail? Perhaps bankruptcy revitalized management. Still, I suspect that what management can do with firms of this size is fairly constrained. 

(3) GM/Chrysler did manage to avoid major layoffs of their own employees. But they also closed down a lot of dealerships. In other words, there was major job loss as a result of their bankruptcies. Not as bad as it might have been, but it wasn't a bloodless operation. The job loss from the dealerships, however, was spread out geographically, rather than concentrated in the Rust Belt. So this was akin to amputating a toe to prevent gangrene from spreading. I'd be curious if anyone knows of any figures on the actual job loss.

(4) Did it help to have the government as DIP lender? That is, does public DIP financing actually facilitate reorganizations because the DIP lender's goal is reorganization, rather than maximization of its economic return? 

Again, I really am interested in hearing thoughts on this. 

Anna Gelpern's Gunboat Diplomacy post pretty much sums out the leaked German term sheet on Greece. I would only note one other thing--the highly idiosyncratic use of "absolute priority." The Germans seem to have taken the language of Chapter 11 and repurposed it, with absolute priority meaning foreign unsecured creditors get paid in full before anyone else sees a cent. Of course, maybe the Germans really do know how to get blood out of a stone.  But in the meantime, I think this is best referred to as Teutonic priority.  

Someone who wanted to be very mean to the Germans just leaked this document, where they manage to come off as both desperate and inept. The proposal purports to address Greek failure to meet program targets by installing an EU overlord, whose job it would be among other things to pay off the foreign bondholders before funding public services in Greece.

The strategy goes back to the days when imperial gunboats took over debtors' customs houses to pay foreign bondholders, but has been considered impolite in creditor country circles for a century or so. Now it is back as an EU institutional innovation. As for the business of "absolute priority" for foreign creditors, the statement is nonsensical on its face: Greece will enact a law that would make creditors feel "de facto" senior. At best, this would be "de jure," and without a shred of credibility. The actual phrase used--"De facto elimination of the possibility of a default"--surely qualifies for an Oscar nomination.

All this innovating does follow a pattern: take a program that does not work, double down on it, and ratchet up enforcement to the point where no one would ever dream of it. Genius.

And further to my last post, it looks like Richard Barley and Felix Salmon took sides on the EFSF swap possibility a couple of days ago, except that they seem to operate on the assumption (which I shared last May) that EFSF would have to take the loss up front. Now I think that the swap would be worth it even if it only captured the discount for Greece. Phase Two happens when it does.

Unless Greece and its creditors reach a deal in the next few days, Greece has no money to pay €15 Billion or so due to its bondholders in March.

From the start, this has been a crisis of fake legal and economic constraints masking very real political constraints. In 2010, Greece could have restructured its debt quicker than most sovereigns in modern memory -- or it might have been bailed out, had Europe chosen to go the route of fiscal transfers. Neither of these paths was taken because the European Central Bank was unwilling to countenance the sin of debt restructuring, but member states with money were unwilling to pay for the appearance of collective virtue.

Now that the restructuring is inevitable and the virtue bill unpayable, the fake constraints are back. The ECB holds about €50 of Greek debt, which must go into the restructuring to get enough debt and cashflow relief. But the central bank would not take losses, and remains allergic to triggering credit default swaps (which is more likely to happen if it sits out). Worse, its votes might be needed to (credibly threaten to) amend Greek bonds using retrofit Collective Action Clauses. (See latest from Gulati-Zettelmeyer here.)

There seems to be a simple fix: swap the Greek bonds held by the ECB for bonds of the European Financial Stability Facility at a price that does not cause ECB losses. Then have the EFSF go into the exchange and vote the bonds if it needs to. At a minimum, this captures for Greece the discount at which the ECB bought its bonds. If Europe is unwilling to see the EFSF take a loss from the ECB's purchase price, Greece could conceivably make up the difference with a special bond issue for the EFSF on terms that reflect the specialness of the vehicle and the circumstances.

As precedent, the operation might be healthy for all involved. An EFSF swap would signal the parameters for any future deals involving ECB-held debt: on the one hand, it is not fully preferred, on the other hand, there is a built-in limit to the haircut. There is even a whiff of harnessing the market. (I once heard a story that Latin American debt managers in pre-Brady days had made up "Capture the Discount" t-shirts.)

More broadly there is a decent argument that the EFSF is sui generis--an ad hoc crisis vehicle that can do what no one else can be expected to do. For example, it has never been encumbered by feckless claims of preferred creditor status, unlike the new treaty-based European Stability Mechanism, due out this summer. This is as close as it gets to a credible "just this once".

There is an argument that under some version of best market practice for CACs, EFSF should not be allowed to vote its Greek bonds in an exchange, because Greece is among its shareholders. I think this objection is surmountable, to the extent the EFSF is not controlled by and does not answer to Greece. Here is some analogous reasoning.

All this to say, wait for the next fake constraint to derail what could be a palatable solution to a horrible situation, followed by more suffering for all.

Steve's title was subtle, so in case anyone missed it, here are the materials on Public Citizen's website. The petition calls on the Federal Reserve and the Financial Stability Oversight Commission to use their authority under Dodd-Frank to break up Bank of America. (But still check out Steve's analysis on Dealbook!).

On behalf of all the Credit Slips bloggers, it is my pleasure to announce the permanent return of Professor Melissa Jacoby as one of our "Occasionals." For the past several weeks, she had doing some guest posts, but we are very happy that she has agreed to stick around. Melissa is a professor at the University of North Carolina School of Law and a leading expert on bankruptcy law with a number of prominent studies on medical debt as well as housing issues. As one of the founding members of Credit Slips, Melissa is one of the reasons we're here at all. Welcome back.

Bank of America, OLA, and the problems of oversized financial institutions, up now on Dealbook.

1. Fraud Digest | A STATEMENT ON MORTGAGE FRAUD THAT EVERY ATTORNEY GENERAL COULD ISSUE TODAY
2. Testimony Concerning Mortgage Fraud, Securities Fraud, and the Financial Meltdown: Prosecuting Those Responsible
3. Fraud Digest | Mortgage Fraud – GMAC Mortgage, LLC and The Law Offices of David J. Stern

UNC's Center for Community Capital has posted a new analysis of 19.5 million mortgage loans originated between 2000 and 2008 finding that mandatory down payments of 10% would lock out nearly 40% of all creditworthy borrowers while a 20% down payment would exclude 60%. The study finds a significantly higher exclusion rate for African American and Latino borrowers. The authors (Roberto Quercia of UNC, Lei Ding of Wayne State University, & Carolina Reid from the Center for Responsible Lending) do find valuable default-reduction benefits of other forms of strong underwriting as the Dodd-Frank Act already requires (through the "QM" and "QRM" classifications), but signal caution about the significant access costs of government-mandated down payment levels that government regulators may be currently considering.

I wade into the chapter 11 professional fee debate again, this time in the context of the UST's proposed guidlines for attorneys fees in big cases.

I wade into the chapter 11 professional fee debate again, this time in the context of the UST's proposed guidlines for attorneys fees in big cases.

The article discussed in the N.Y. Times story today is heavily empirical. It is also deliberately light on the prescriptive. Bob Lawless, Dov Cohen and I did make two modest proposals: (1) that a question about race of the debtor should be included on the form for a bankruptcy petition to make it possible to confirm (or disprove) the finding that African Americans file in chapter 13 at a much higher rate than debtors of other races (about double in the data we have), and (2) that all actors in the bankruptcy system—judges, trustees, attorneys and clients—be educated about the apparent racial disparity and the possibility that subtle racial bias may be producing it. The Times certainly helped with the second one!

Beyond that, we leave it to others and to each of us individually to come up with policy responses. In my view, Henry Hildebrand, a longtime chapter 13 trustee in Tennessee, got the big picture exactly right; he is quoted in the Times story as saying we should “use this study as an indication that we should be attempting to fix what has become a complex, expensive, unproductive system.” He will probably reappraise his views if he finds out that I agree with him! Those of us who participate in or study the system know that its complexity is onerous.

The bankruptcy system got dramatically more complex and thus expensive with the 2005 amendments. Race disparity is just one instance of rampant disparity for those in similar financial situations. Complexity, including the possibility that any given debtor is choosing chapter 13 for moral reasons, makes it possible to justify any chapter choice in most cases and tends to mask unfair disparity of various kinds, including by race.

Speaking just for myself, I think we need a single portal to the bankruptcy system for individual debtors. This would make it a lot easier to move toward more similarity of results for the similarly situated and to reduce the cost of administration through simplification. Debtors with higher incomes might be required to pay something out of surplus income to old creditors, and the current standing chapter 13 trustees could be redeployed as the trustees for all individual cases. More of the details of this position are spelled out in my 2006 article, A Fresh Start for Personal Bankruptcy Reform: The Need for Simplification and a Single Portal. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=912561 I have heard that the National Bankruptcy Conference is working on a single chapter approach to consumer bankruptcy, and I wish NBC success in this project, although the difficulty of the politics of attaining any positive change through legislation cannot be overstated.

The professionals in the bankruptcy system are on the whole a very conscientious, self-critical and public-spirited group, committed to equal justice, and I expect that judges, trustees, and attorneys will rally to take on the challenge of eliminating any unjustified racial disparities, even without a needed legislative overhaul to simplify the system. The consumer debtor attorneys who took the time to answer our survey based on a vignette have already helped greatly; they volunteered their time to improve the bankruptcy system, knowing that we were interested in the mechanisms of chapter choice.

In our article, we did not have any data to examine the role of bankruptcy judges and trustees in producing racial disparity in chapter choice, but that does not mean they are off the hook. Judges and trustees are important players in the system, and they can influence the recommendations of attorneys. They need to be part of the solution, and they will want to be. Furthermore, the U.S. Department of Justice, particularly its Executive Office for the U.S. Trustees, should be involved in addressing this issue. Monitoring by judges, trustees and DOJ would be made easier by having information about race in the paperwork of cases.

The U.S. court system should start collecting race information from debtors on their bankruptcy petitions. This is not an uncontroversial position, for privacy reasons. Race, like the Social Security numbers already collected on petitions, should be kept private. But race information needs to be available to trustees and judges in each case. For the public, the race information should be in aggregate form only, matched with other data points collected by the U.S. Court system. Having race information about the full census of cases would be the best way to confirm or disprove the finding of disproportionate use of chapter 13 by African Americans.

In discussions with bankruptcy lawyers and other professionals about the article, I’ve found that some say they knew about the race disparity already because they have seen it with their own eyes in meetings of creditors required in each case. These professionals told me they see a higher proportion of African American debtors in the chapter 13 meetings than in the chapter 7 meetings. This seems to be most evident in the South and other areas where the black population is large and thus the disparity is more apparent. The racial disparity appears to exist, however, across regions even where the minority population is very small. In a complex system, however, those who have witnessed racial disparity in chapter choice don’t know for sure if there is a good justification, for example the possibility that African Americans have more of a commitment than other debtors to repayment and for that reason choose chapter 13 more often. But because of the importance of attorneys in guiding a complex choice, an obvious factor to study is their influence through their chapter choice recommendations. In our vignette study we found that these recommendations accounted for two-thirds of the racial disparity seen in a study of real world cases (in which African Americans used chapter 13 at about twice the rate of debtors of other races).

Bob, Dov and I of course encourage examination of our methodology, which is why we chose to place the article in a peer-reviewed journal. Academics are probably going to do a better job of finding flaws than most practicing attorneys. We tried very hard to be rigorous in our methods and account for hypotheses for justified race disparity in use of chapter 13. The vignette used figures for income and expenses that are close to national medians of bankruptcy debtors. Also, in the real world study’s data, controlling for homeownership, income and many other factors did not explain the race disparity. We also looked at available data on results in chapter 13, and we found that African American debtors are not getting better results, so that does not explain why they are filing more in that chapter. African Americans actually propose slightly higher percentage payments to unsecured creditors than debtors of other races. African Americans also have higher dismissal rates for their chapter 13 cases.

We are not saying, as some seem to think, that chapter 13 is always financially worse than chapter 7 for any given debtor, white, African American or of another race. Even when no discharge is obtained, a chapter 13 can buy more time to stave off foreclosure long enough to relocate. Chapter 13 also can be preferable for other reasons that lawyers legitimately take into account, for example, to strip junior liens with no collateral value to support them, to pay nondischargeable, priority debts such as child support and taxes in the plan ahead of other unsecured debts, to make up arrearages on secured loans in attempts to save a home or car (although this feature may be overused, because saving the collateral may not be feasible), to reserve conversion to chapter 7 for a discharge there later if finances deteriorate further, and to pay attorneys’ fees over time, among others. But the ways in which chapter 13 can be better for particular debtors do not appear to explain the wide race disparity in its use since all these reasons apply across race and since several apply only to homeowners, a factor for which we controlled.

As Adam noted in his kind post, the New York Times today featured our study, "Race, Attorney Influence, and Bankruptcy Chapter Choice." My co-authors are Credit Slips blogger Jean Braucher, a law professor at the University of Arizona, and Dov Cohen, a professor at the University of Illinois who holds a cross appointment in psychology and law. And, we all express many thanks to the NYT reporter, Tara Siegel Bernard, who spent a lot of time slogging through the statistics and legal intricacies in our study.

In a nutshell, the study reports real-world data from the Consumer Bankruptcy Project showing that, among bankrupcy filers, blacks file chapter 13 at higher rates than all other races. The effect is large -- for example, blacks even had a higher chapter 13 rate (54.6%) than homeowners (47.1%). The second part of the study showed that, in a random sample, bankruptcy attorneys were more likely to recommend chapter 13 for a hypothetical couple named "Reggie & Latisha" who went to the African Methodist Episcopal Church as compared to "Todd & Allison" who went to the United Methodist Church. Also, attorneys were more likely to see "Reggie & Latisha" as having good values and being more competent when they expressed a preference for chapter 13.

The full study is forthcoming in the Journal of Empirical Legal Studies. The working paper version is available on the Social Science Research Network (SSRN). And, a shorter version of the study reporting the real-world data appears as a chapter in the book, Broke: How Debt Bankrupts the Middle Class, which was edited by Credit Slips blogger Katie Porter.

In the coming days, I'll try to put up a few posts talking about the study in more detail. If anyone has any questions about the study, please post them in the comments (preferably after reading the study), and I'll do my best to answer them.