Credit Slips

Thank you to Anna Gelpern

As the first snow of the season swirls around here in Washington, I'd like, on behalf of the Slips, to thank Anna Gelpern for her guest-blogging tour of duty. Anna introduced us to some of the international aspects of the financial crisis, and we should be forever greatful for her linguistic innovation: "illinquency". Perhaps a financial institution will adopt as its motto the Gelpernian variation on the old Frankie Lymon doo-wop song: "I'm not a juvenile illinquent."

Thanks Anna!

Financial Summitry

The G-20 Summit to Save the World and Reinvent Finance produced a surprisingly meaty declaration and action plan.  At least one specific mention of bankruptcy: 

* National and regional authorities should review resolution regimes and bankruptcy laws in light of recent experience to ensure that they permit an orderly wind-down of large complex cross-border financial institutions. *

In general, the most interesting parts deal with regulatory reform.   

Contracts in Crisis: Variations in Z and S

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

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

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

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

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

Do We Want More Consumer Lending?

Yesterday, Treasury Secretary Paulson announced a major shift in strategy for the federal government's financial rescue plan. Treasury now would make $50 billion available for lending to companies making credit card, automobile, and student loans. The idea is to jump start consumer lending sector, although I am not sure to what end. There is no doubt that the consumer lending sector has frozen up along with the other credit markets. What concerns me is that the Treasury's latest plan seems an attempt to return us to the same policies that got us to where we are today.

International Financial Architecture: Dumb Chills and Opportunities

I am grateful to Adam, Bob and Credit Slips for scheduling this guest stint on the eve of what is billed as the Grand Global Rethink of All Things Finance. This Saturday, November 15, the leaders of the Group of Twenty rich and developing economies will meet in Washington to talk about crisis and reform. Regrettably, the organizers’ absurd pretensions to the legacy of Bretton Woods have diverted public attention away from the substance of what is surely an important international effort at coordinating economic, financial and regulatory policy.

Why should legal academics and debtor-creditor folk care?

Operation Repo

TruTV has a reality series called Operation Repo. Basically they follow around a crew of brawny, heavily tattooed auto reposessors (men and women) in the San Fernando valley. Drama and hijinks ensue.

I'm sure they only show the more dramatic repos on TV (and I found the show strangely compelling, especially to see how a lot of the time the repo crew gets tips about auto whereabouts from disaffected family members), but what I was most struck by was how often the repos "breach the peace." People are routinely getting pepper-sprayed or shoved or put into headlocks as they try to stop the repo actions. Occasionally someone pulls a gun on the repo men, and they back off.

My secured credit class spends a tiny bit of time on repos, but the show is a vivid reminder that practice and law (repomen can't breach the peace) are very far removed. I think it's safe to say that the law of repomen is law of the jungle.

Welcome to Anna Gelpern

Credit Slips would like to welcome Anna Gelpern as our newest guest blogger. Anna is an Associate Professor of Law at Rutgers School of Law Newark; she has a joint appointment with the Rutgers Division of Global Affairs and is a visiting fellow at the Peterson Institute for International Economics.

Anna writes about international finance and regulation, particularly sovereign debt and financial crises in developing countries. Anna's a particularly keen observer of the Treasury and Fed's efforts to deal
with the current financial crisis, having worked in the Treasury Department in the late 1990s and early 2000s.

Welcome Anna!

Circuit City Bankruptcy Petition

Thanks to a Credit Slips contributor, the chapter 11 petition for Circuit City can be found here. The document includes the list of the fifty largest creditors. The case was filed in Richmond, Virginia, which is not known as a hub of corporate bankruptcy activity. I'll leave the comments open for readers who might have some insight on why this venue was chosen.

Bankruptcy Filings Spike in October

As yet another indicator of the tough economic times for American families, bankruptcy filings spiked in the month of October. According to the latest data from Automated Access to Court Electronic Records (AACER), there were 108,595 total bankruptcy petitions filed in the month of October for an average of 4,936 for each of the 22 business days during the month. October 2008 is the first time since the 2005 changes to the U.S. bankruptcy that there have been more than 100,000 bankruptcy filings in one month. (Anyone looking for more sensational but less helpful headlines can focus on the absolute number of filings in October 2008 and ignore the fact that the month had one more business day than many other months.)

Why the increase? Obviously, one factor is the tough economic climate for everyone. An important factor that is often ignored is that, in the short-term, decreases in the availability of credit actually drive up the bankruptcy filing rate. I document this phenomenon and explain it in more detail in my paper, The Paradox of Consumer Credit. Of course, in the long-run, bankruptcy filing rates rise hand-in-hand with increases in credit availability. Over the short-term, however, bankruptcy filing rates as individuals find it more difficult to borrow to stave off the day of financial reckoning. With the seizing up of the credit markets, the October bankruptcy numbers (and the smaller increases in July, August, and September as I discuss below) show this scenario has played out again.

Fellowships for Consumer Debt Book

Just a brief announcement for our academic audience (law or non-law) that I am directing the University of Iowa's Obermann Summer Seminar in 2009. Up to 6 fellowships of $2250 (plus an award of $1250 to cover travel, housing, per diem) are available for participating scholars to participate in the seminar, which will be held June 7-14 in Iowa City, Iowa. Selected scholars will have access to the 2007 Consumer Bankruptcy Project data in advance of the seminar to prepare an empirical paper on consumer debt or bankruptcy. These papers will be collected into a volume for publication with an academic press. Interdisciplinary applications are particularly encouraged but law professors are obviously welcome. The full call for proposals and application guideines are available here. The deadline for application is Tuesday December 9, 2008.

Hands on Their Faces

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

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

Worst Practices: Residual Interest

Professor LoPucki's APR issue might not be two-cycle billing as many of the commentators think. Just as likely, it is residual interest (a/k/a trailing interest), the often ignored, but just as potent cousin of double-cycle billing.

Residual interest has not gotten nearly as much attention as it should (and it is often confused with double-cycle billing). Residual interest is a nasty billing trap that drains away discretionary income (also known as potential savings) from American consumers, and should be at the top of the Congressional hit list for predatory credit card billing practices.

Bank Derivative Activities and Capital

We've heard a lot in recent months about bank derivative activities. What's striking is how rapidly they grew without capital growing to cover potential losses. Here's a time series graph of bank derivative exposures (all types of derivates, including credit, forex, and interest rate; the number reflects maximum possible exposure everything went wrong), bank Tier 1 (core) capital, and the ratio of the two. The data comes from FDIC Statistics on Depositary Institutions. I have excluded federal thrifts from the graph because they report Tier 1 capital, but not derivatives.

Greenspan Admits "Mistake"

If you missed Former Fed Chairman Alan Greenspan's incredible admission today, here it is. In a stunning statement, he said that much of his previous faith in free markets had been wrong:  "I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” He further called this mistake "a flaw in the model ... that defines how the world works." Let's hope that policymakers still in office agree.

What Happened to Truth-in-Lending?

Professor Lynn LoPucki sent this email, which I pass along with his permission. Perhaps someone will want to answer his question.

Last  month I was a little short of cash, so I left $3,000 on my credit card balance. The bill I got today shows a finance charge of $122. Citibank states that the APR is 14.49%, but by my calculation, the rate charged is 48.8%.

Layaway Christmas

K-Mart has a new ad: Pick out your Christmas presents today, pay a little now and a little as you go along, then pick up your paid-for presents in time for holiday giving. If we needed evidence of the constriction of consumer credit, here it is. K-Mart is advertising the layaway plan that department stores used for decades before the free flow of credit turned the layaway plan into a relic.

Was There a Systemic Banking Crisis?

A group of researchers at the Minneapolis Federal Reserve has a new study out that argues that Federal Reserve data indicates that that many of the stories that have animated the political discourse about the bailout are incorrect. The four points the researchers make are:

1. There has been no drop in bank lending to non-financial corporations and individuals.

2. Interbank lending has remained robust.

3. Commercial paper (short term debt financing) for non-financial businesses has remained steady.

4. 80% of the financing of non-financial corporate businesses is done through bond financing, not bank loans, which makes the claim that disruptions to the banking system threaten corporate finance questionable.

I'm not sure what to make of this data. I suspect it doesn't tell us everything, but it certainly makes one pause. It's worthwhile noting that a lot of the evidence for systemic disruptions was anecdotal--that a GM dealership in Chattanooga was tightening up its lending standards, for example (NPR had something like that as an example). That hardly shows that banks aren't willing to lend because of fears of other banks' insolvency--it just shows a sensible caution given that many formerly creditworthy consumer borrowers are now underwater on their houses.

On the other hand, the amount of money that banks were parking at Federal Reserve Banks (without interest at the time) shot up from something like $300 million at the start of September to $31 billion by early October. (See here, under Deposits with F.R. Banks Other than Reserve Balances, Other) That's a sign of serious interbank mistrust.

Thank You Again, Christian Weller

Thanks again to Christian Weller of the Center for American Progress and the University of Massachusetts, Boston for taking the time to guest blog here. Professor Weller is an economist and offered many informative perspectives on the current financial crisis. We very much appreciate the time Christian took out of his busy schedule to join us and, as we told him offline, hope he is able to join us again soon.

Creditors: Fear Not?

Just as public ire at the mortgage industry reaches a pinnacle, courts have offered the mortgage companies refuge from their mistreatment of consumers in some recent rulings. While these decisions may be aberrations, they have powerful lessons for consumer debtors and their attorneys that bear some discussion.

A bankruptcy court ruled last week that the United States Trustee (UST) lacked the authority to bring a complaint against Countrywide for abusive mortgage servicing practices. (Hat tip to Amir Efrati at the Wall Street Journal for bringing the ruling to my attention.)The In re Sanchez court concludes that the UST failed to state a claim for sanctions because the UST is not authorized to pursue sanctions. I disagree.

Note to Policymakers: Be Aggressive, but Smart

With Wall Street in turmoil and the economy on a downward slope, policymakers' ingenuity to help financial markets and the economy is demanded. The response will have to be large, but also smart. Voters will likely not accept an approach that simply throws money at the problem, never mind that the government will eventually run into some hard times itself if policymakers think that more money will fix all that ails us. Undoubtedly, some tax cuts and some spending increases will have to be part of the solution, but given the recent financial rescue package and the need for a short-run money injection to avoid a major recession, policymakers will need to think smartly about other tools at their disposal to help the economy to recover.

Behaviorally Informed Financial Services Regulation

A new policy paper issued by the New America Foundation and authored by Michael Barr, Sendhil Mullainathan, and Eldar Shafir argues that we need to move toward "behaviorally informed financial services regulation." By this the authors mean that financial services regulation should incorporate the insights of behavioral economics and cognitive psychology, regarding things like default rules, framing of information, and hyperbolic discounting.

This paper comes on the heels of Richard Thaler and Cass Sunstein's book Nudge, the culmination of their work in developing what they call "libertarian paternalism"--a soft-form version of paternalism that instead of mandating outcomes, such as requiring retirements savings, sets default rules and menu choices in a way that encourages them, such as making workers opt-out of retirement savings plans, rather than opt-in.

There's much to commend about this work (Barr et al., as well as Thaler & Sunstein), and the incorporation of behavioral economics into law has been an important development in the last decade or so of legal scholarship. I do not doubt that behaviorally informed financial services regulation would be an improvement over our current model. But I am dubious about its ultimate efficacy for three reasons.