Communication From Academic Faculty Who Teach Courses Related to Consumer Law and Banking Law

Seventy-three professors issued a joint letter supporting the creation of a Consumer Financial Protection Agency at the federal level. We are strong supporters of the importance of this legislation in that consumer transactions lack the transparency that is necessary for honest and fair financial products, including, a wide variety of debt instruments (i.e., mortgages, credit cards), payment devices such as debit cards, and banking fees in general. The letter supports the passage of H.R. 3126, introduced by Rep. Barney Frank (D), creating the oversight agency. Some of the impediments to governmental oversight have included the dispersion of regulatory authority over a number of federal agencies none of whom has consumer issues as the primary mission, emerging financial products and technology that raise new regulatory issues, and industry opposition. We will certainly follow the progress of this legislation (and related legislation such as the Consumer Overdraft Fair Practices Act) and the industry response (see, Big Banks Alter Debit Overcharge Rules).

The press release:

FOR RELEASE ON SEPT. 29, 2009 AT 10:00 AM:
Consumer and Banking Scholars Show Support for the Consumer Financial Protection Act
Hempstead and Jamaica, NY – On September 30, 2009, the House Financial Services Committee, chaired by Representative Barney Frank, will hold hearings on H. 3126, titled “the Consumer Financial Protection Act” which would create an independent Consumer Financial Protection Agency. Today more than seventy law scholars who teach in fields related to consumer law and banking law have signed a detailed Statement of Support demonstrating their strong views about the importance of this legislation.

The faculty endorsing the Statement of Support include leading scholars who teach in fields related to consumer law and banking law who teach at many of the nation’s leading American law schools—in states including Alabama, Arizona, California, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Maryland, Massachusetts, Minnesota, Missouri, Nebraska, New Jersey, New York, Nevada, North Carolina, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Texas, Utah, Washington, Wisconsin, and Wyoming as well as Washington, D.C. The signatories have no economic stake in the passage of this legislation.

The Statement concludes that on balance, the existing regulatory structure places “a higher value on protecting the interest of financial product vendors who promote complex debt instruments using aggressive sales practices, than on protecting the interests of consumers in transparent, safe, and fair financial products.” The body of the Statement is 8 pages long, single-spaced. It refers specifically to dozens of scholarly articles and studies demonstrating that at critical moments of consumer confusion and vulnerability,” the existing regulators “have been unwilling to expend resources to develop appropriate rules and guidelines and to police mortgage and credit instruments.” The Statement urges passage of H. 3126 because “consolidated authority and a dedicated consumer-oriented mission would be likely to improve public confidence in the safety and efficiency of the vast consumer financial products marketplace.” It further provides an analysis of desirable aspects of the legislation and points to extensive scholarship supporting the need for a new approach to handling consumer financial regulation.

For further information please contact the signatories of the Statement at their home institutions or:

Norman I. Silber
Professor of Law
Hofstra Law School
516-463-5866
norman.i.silber@hofstra.edu
law.hofstra.edu

Jeff Sovern
Professor of Law
St. John's University School of Law
718-990-6429
sovernj@stjohns.edu
law.stjohns.edu

- JSM

- JJK

Who's the Bull, and Who's the Matador Here?

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This one wasn't hard to predict: credit card issuing banks are already making lemons out of lemondate with the new regulations aimed at curbing abuses. Business Week reports (no link available) that issuers are expecting new fee income (especially from cardholders who pay off their balances in full every month or don't use their cards very often) to more than make up for the losses caused by the new regs. Prohibit them from raising rates without 45 days' notice, and they all switch to variable rates (jumping throung one huge loophole in the regs). Prohibit marketing to college students "near" campus, and they set up tables two blocks away, say near a fraternity or sorority house. For those of us teaching commercial law and regulation, consumer protection, and administrative law, this is one more chapter in the saga of regulators' introducing rules that both fail to curb the real abuses, as well as increasing the abusive potential of the work-arounds put in place by the industry. When are we going to learn?

Coverage Visitor at Tulane, Spring 2010

Posted on behalf of Mark Wessman, Tulane Law School:

Because of the sudden and tragic death of our colleague, Brooke Overby, Tulane Law School is seeking a coverage visitor for the spring 2010 semester. Our most pressing need is for someone who can teach Contracts II, which, at Tulane, is an Article 2 Sales course taught to first-year students. The second course is negotiable, but would ideally be either Real Estate Transactions or Payment Systems (in that order of preference). Self-nominations are welcome, but, as it is late, so are suggestions of others who might be available.

Please reply directly to Prof. Wessman at his contact information listed below.

Mark B. Wessman
Thomas J. Andre Professor of Law
Tulane Law School
6329 Freret Street
New Orleans, LA 70118
Phone: (504) 865-5989
FAX: (504) 862-8815
mwessman@tulane.edu

Call for Papers--Debtor-Creditor Law Broadly Understood

Call for Papers—AALS Section on Creditors’ and Debtors’ Rights

The Future of Debtor-Creditor Scholarship

Both domestically and internationally, for both well-known businesses and anonymous consumers, world events lately have thrust issues of debt, creditor rights, and debtor protection into the spotlight. The field of debtor-creditor scholarship has perhaps never been as fertile as it is today. Its future will ultimately become the responsibility of those having entered the academy during this most robust period. This year’s program is designed to highlight the contributions of those who have just begun to toil in this field, to reveal for the section the newest ideas from recent newcomers, to give these developing scholars an opportunity to present their thoughts and receive feedback in a friendly and receptive forum, and to give more experienced section members a chance to mold and inspire these developing producers—and the future of our section—with constructive questions and comments.

The Section on Creditors’ and Debtors’ Rights thus issues a call for papers on the topic of debtor-creditor scholarship, most broadly understood, for presentation at the AALS Annual Meeting in New Orleans in January 2010. Proposals are welcome from a wide array of perspectives with a connection to creditors’ rights and debtor protection. Proposals may be in any stage of production, from early-stage idea to mid-stage working draft to polished paper, though work that will not be published by January 2010 will be strongly preferred. The section does not plan to publish the papers in a symposium, so presenters are free to seek publication elsewhere. Strong preference will be given to proposals from those who will not yet have been awarded tenure by January 2010 and to those whose work is not already well known within the section. We would anticipate three presentations of 15-20 minutes, each followed by 10-15 minutes of questions and comments from the audience. The Section’s brief business meeting will conclude the program.

Deadline for submission is Monday, August 31, 2009. Please email proposals to section chair, Jason Kilborn, at jkilborn-at-jmls-dot-edu. Selections will be made by late September by the Executive Committee of the Section (chair Jason Kilborn, chair-elect Katie Porter, secretary/treasurer Rafael Pardo, executive committee members Michelle Arnopol Cecil and Alan White, and immediate past chair Jean Braucher). Pursuant to AALS policy, presenters will have to cover their own travel expenses and registration fee for the annual meeting (typically with support from their home institutions), as the Section is prohibited from reimbursing for such expenses.

Children as Payment Devices??!!

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The depths to which overwhelming debt will push some people are vividly illustrated by a story covered by CNN this weekend.The headline zeroed in on the public-interest and human-rights angle, decrying a Saudi judge's ruling refusing to annul an arranged marriage of an 8-year-old girl to a 47-year-old man. The part most interesting to me was a passing comment on the reason why this girl's father had arranged the marriage of his young daughter: to settle his debts with the 47-year-old man, "a close friend" of his. Whatever one might think about arranged marriages, child marriages, or marriage in general, using this institution as a means of settling debts doesn't strike me as consonant with the ideas behind the institution in any religious tradition. Using children as payment devices can't be consistent with what either G*d or the Prophet had in mind . . .

Banks Extending the Crisis pt. II

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Someone needs to send these bankers to the principal's office and not let them out for recess any more--or perhaps expel them altogether. First the AIG bonus scandal, now we hear (yet again) that banks are deepening and extending the current crisis, despite Herculian federal efforts to pump them up with liquidity to solve the problem. Banks and their overly finicky underwriters are now making it difficult for even the most creditworthy borrowers to get loans. If the theory behind the stimulus moves is prop up the housing market by pumping liquidity into the mortgage finance market through the banks, it isn't working.

Tell me again why nationalizing these banks would be a bad idea . . . Does anyone reasonably believe that the feds would do a worse job of managing lending???

When Small Clerical Errors Explode Into Big Problems

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Two recent big stories may mean greater interest for the types of classes that we here on the Commercial Law blog teach. First came the spectacular UCC-3 filing error involving bank creditors of the law firm Heller Ehrman ("Oh, did I say 'termination,' I meant 'continuation!'") and the very serious consequences that this "clerical" error caused when the debtor went into bankruptcy. Now we have more press on an older and more serious problem. The New York Times this weekend reported on the lax assignment protocol followed (or rather, not followed) in the transfer of hundreds and thousands of mortgage notes into securitization pools. When the rare but brave judge (often in bankruptcy court) asks the foreclosing bank for proof of its ownership of a transferred/negotiated note, this proof is often unavailable--very good news for defaulting homeowner-debtors (as consumer advocates around the country are now informing their colleagues at CLE meetings), very bad news for banks. Perhaps lawyers-to-be will become more interested in following the nitty-gritty details of these transactions in the future to avoid spectacular losses. This interest will lead them right into our waiting hands!

Nitty-gritty details--that's what we commercial law profs are all about!

The Wacky World of Investment Holding/Transfer

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I've been struggling with the "new" rules for perfecting security interests in investment property for several years now, and the latest edition of my secured trans text deepened my confusion. Luckily, I found a couple of great articles that confirmed, I believe, that I had properly understood the inordinately complex world of establishing "control" over certificated, uncertificated, and most importatly, indirectly held securities (securities entitlements in securities accounts). Readers of this blog in particular might appreciate David Donald's advocacy piece here (and his descriptive piece here, in German), as well as the excellent introductory notes to the 1994 revisions of Article 8 of the U.C.C., all of which are invaluable navigational aids. If you are having trouble with endorsements, re-registration, and control agreements, check out these fine resources.

French Tortoise Beats U.S. Hare?

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Do we not learn or do we not care? Over 2600 years after Aesop told his famous fable of the tortoise and the hare, we in the U.S. continue to insist that explosive speed punctuated by spectacular slowdowns is the best model for our economy, rather than a slow-and-steady approach to constant growth. Apparently, France has internalized the notion that "slow and steady wins the race." The W$J today has an intriguing story about how France has been spared the worst of the current global economic meltdown thanks, perhaps counterintuitively, to its restrictions on mortgage lending, a dominant public employment sector, and lack of reliance on a few sectors to drive impressive year-on-year economic growth. These characteristics of the French economic model have been criticized mercilessly by economists in recent years, but now who's eating crow? Or rather, who SHOULD be eating crow, as I'm sure few economists are abandoning their disproven theoretical models (which is ironically one reason why many are apparently finding it hard to find jobs)--after all, empirical data about what has ACTUALLY happened to the world economy seems to be less important to most economists than what their models predict SHOULD have happened (if you haven't heard the joke about the economist and the can opener, check it out). The final paragraphs of the article, of course, conclude with dire warnings from an economist that France will "return to a pattern of slower growth" after the world economy recovers. These guys just don't get it. Perhaps WE're the ones who should consider embracing "slower growth" to avoid having to recover from the next inevitable economic breakdown caused by our maniacal focus on above average growth.

Islamic Business and Commercial History Reading Rec

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I've found myself drawn again and again to discussions of Islamic finance in recent months. I'm reading a great paper now that lays the foundation for what I hope will be my better appreciation of its contribution and continuing role in the modern world. Timur Kuran was kind enough to share with us through SSRN his fascinating paper, The Scale of Entrepreneurship in Middle Eastern History: Inhibitive Roles of Islamic Institutions. This is not the short-sighted, xenophobic rant that one has come to expect of western commentary on Islamic institutions in the post-9/11 world (indeed, I apologize for revealing that the title gave me that impression). Instead, Prof. Kuran lays out a level-headed exploration of how and why Islamic law facilitated early entrepreneurialism, based as it was on personal, short-lived business arrangements, but it impeded modern entrepreneurialism after the transition to more impersonal, longer-term business arrangements. I'm not finished with the paper yet, but its central argument seems to be one I've seen before: the central role played by the corporate form in collecting and locking in long-term capital, catapulting European (and U.S.) commerce, was not available in Islamic law until much later, thus critically inhibiting growth.

We in the West obviously have much to learn about Islam and its role in facilitating and restricting business and commerce (the amount of money flowing through Islamic law-compliant banks and funds is impressive and growing). Prof. Kuran's paper helps novices like me to take a comfortable first step in the direction of better objective, non-judgmental understanding. Check it out!

Gambling and Investment Banking--Redundant?

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A story on the front page of today's W$J reinforced a feeling I've had for a while now. Does the nature of the people who are drawn to working as traders at investment banks explain the rise of such ultra-risky (insane?) gambles as naked (speculative) CDS, subprime CMBS, and other derivatives and the spectacular losses that they created? I think so. Yesterday, Deutsche Bank announced its first yearly loss in a half-century. The loss was attributed to the roller-coaster investment returns of one trader, Boaz Weinstein, whose losses for 2008 wiped out the gains for the two previous years and produced a $1.8 billion annual loss for DB as a whole!

The take-home line for me was the description of Weinstein: "a chess master, poker and blackjack devotee and top trader at Deutsche Bank AG." I read a paper last night about credit default swaps, and it characterized perhaps the most common usage of that "product" as little more than gambling on the fate of third-party-owned credit products. This gambling meme has come up time after time, and I think it explains so much. Perhaps this is obvious, but it seems to me to warrant explicit observation: those who are attracted to the high-intensity job of Wall Street trader are likely to be the kind of people who like to gamble . . . and gamble big. What better way to catch the ultimate gambling rush than to trade with billions of dollars of other people's money. I don't mean this as a criticism of traders. I do mean this as a reminder that when regulators let these markets loose (as they did in the 2000 Commodity Futures Modernization Act), we should not be surprised when the stake rise sky high, and eventually the sky actually does fall.

Scrooge and Other Recommended Reading

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Two recent pieces of scholarship should not escape the attention of our readers. First, Alireza Gharagozlou has a fun little piece coming out in the Nova Law Review entitled When did Scrooge Become a Role Model? Why Criticism of America's National Debt is Misplaced. It's a nice, basic introduction to the macro-economics of saving versus spending, written in a very lucid, accessible, and entertaining way (yes, this is an entertaining paper about macro-economics). Gharagozlou offers a rare critique of saving (at least over-saving) and explains how spending drives the broader economy. In my view, the paper gives relatively short shrift to the benefits of saving (at least on the individual level, as insurance cannot effectively address the dangers of unemployment and health care crisis to which more and more Americans are exposed today), and it mildly overstates the backstopping effect of bankruptcy (though the explanation of the purpose of bankruptcy within a capitalist system is spot on). But because the paper focuses on sovereign debt and spending, these criticisms do not go to the heart of the paper, which is a quick and well-worthwhile read.

My second shout-out goes to a paper by Gail Hillebrand of Consumers Union (the publisher of Consumer Reports). Published in volume 83 of the Chicago-Kent Law Review, Hillbrand's insightful article is entitled Before the Grand Rethinking: Five Things To Do Today With Payments Law and Ten Principles To Guide New Payments Products and New Payments Law. The strongest part of this very strong paper is its detailed discussion of the application of the Electronic Fund Transfers Act and Reg E to the panoply of plastic cards out there today. This is a topic with which I've struggled as a teacher of Payment Systems, and Hillebrand's paper does a great job of explaining why EFTA and Reg E are or are not clearly applicable in light of the growing areas of uncertainty as new products emerge (see especially the discussion at pp. 789-96 on prepaid debit cards, payroll cards, flex spending account cards, and "bank in your pocket" general spending cards). The first part of the paper also marches through the key differences among (and complaints about) the various payment devices. There's even a rare discussion of funds availability and Reg CC--how often do you see that?! For teachers and students of modern payments law, this paper is a strong buy!

While I hate to end on a sour note, I feel a duty to my fellow Payments teachers to point out an annoying aspect of the latest edition of a book I know many of us use. Ronald Mann did all of us a great favor by enlivening and bringing down to earth the study of payments law and practice in his book Payment Systems and Other Financial Transactions. I adopted the book in my first year of teaching, and I have loved it . . . until now. I still like it, but the fourth edition is a major step back. First, unlike the careful and detailed transition guide for Warren & LoPucki's book on Secured Transactions (and Warren & Westbrook's book on Bankruptcy--all of which are in new editions!), Mann's TM contains a rather weak transition guide. It refers to the third edition when it means the fourth, it refers to an incorporation of electronic commerce materials, which happened in the previous edition, not this one, and while it mentions a number of new or edited problems, it doesn't mention all of them! For example, the location of the second bank in Problem 3.1 is different in the latest edition, with no warning in the TM, and the TM discussion refers to a third location for that same bank! More seriously, Problem 23.4 (former Problem 26.4) now has four subsections (a-d), as opposed to three before, and the subsection (c) now elminates the discussion of anomalous indorsements (which I rather liked). Neither the transition guide nor even the introduction to assignment 23 in the TM mentions this (indeed, the intro to assignment 23 in the TM still indicates that problem 23.4 has three parts). Moreover, Mann has eliminated former assignments 19, 20, and 21 altogether, with no explanation. I very much liked these assignments, and students year after year have thanked me for covering this material on interest rates, usury, and pre- and late payments. Nothing is added to fill the void left by these assignments' omission (the total page count is more or less the same, it appears, thanks to more cases). In addition, while the TM offers detailed notes for how most of the problems should play out in class, for the new ones, Mann often simply notes, for example, "This problem was added for the Fourth Edition. It is designed to underscore the way that the notice requirement limits opportunistic reliance on the availability exceptions. It is a true story (with names changed)." No elegant explanation of how the law achieves this limitation, as with other problems. New Payments professors beware--the latest edition is not as user-friendly as earlier ones. And some of the problems contain funny holdover errors. On p. 23, the character's name in Problem 1.1 is Terry, while on p. 24 (in the middle of the same problem), his name changes to Tertius (his name in the earlier edition). While I'm not ready to abandon this book yet (I know others who have), I'm now on the lookout for a reasonable replacement that contains nice textual explanations of the systems and fun problems. Any suggestions?

Yet Another Card Data Breach

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Watch your credit card and bank debit statements carefully over the next few months. The New York Times reports that a major processor of card transactions (Heartland Payment Systems) has disclosed that unencripted data was "sniffed" by thieves over the past several months at the point in transactions where the processor asks for authorization from the issuer network (VISA, MasterCard, Discover, AmEx). Tens of millions of credit and debit cardholders are potentially exposed to card data theft and subsequent fraud.

Heartland has set up a website explaining what happened and noting that "Cardholders are not responsible for unauthorized fraudulent charges made by third parties." Recall that the Truth in Lending Act (TILA) § 133 (codified at 15 U.S.C. § 1643) shields credit card holders from liability for unauthorized charges beyond the first $50, and I suspect Heartland's release reflects the credit card issuer networks' near universal policy these days to waive even the first $50 of liability. As for debit card fraud, at least for consumer accounts, the Electronic Fund Transfers Act (EFTA) § 909 (codified at 15 U.S.C. § 1693g) provides more or less parallel protection, though with some complicated expansions of liablity for consumers who are not vigilant about reporting fraudulent activity. Though the Heartland release mentions only "charges" (not debits), I understand that the major debit processing networks have a similar "zero liability" policy for fraudulent debits, waiving the first $50 and perhaps the expanded liability, as well.

All of this does the victimized consumer little good, though, if s/he doesn't notice and report the fraud (either to avoid paying a fraudulent charge or to request a refund of a fraudulent debit). So watch your statements carefully, and be thankful we're not in Europe, whose laws generally do not protect consumer card users as generously as TILA and EFTA.

Banker's Cognitive Dissonance

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Jamie Dimon just doesn't get it. I suppose it's his job as CEO of JPMorganChase not to get the point about the need for reasonable mortgage modification to avoid unnecessarily wasteful foreclosures that are deepening (causing?) the current economic mess we're in. The Financial Times reported yesterday that Dimon strongly opposes--surprise, suprise--current bills in Congress that would allow bankruptcy judges to value claims secured by principal residences at the realistic, current value of the home, rather than the fanciful, contrived value on which the mortgage was based. This isn't the place for a drawn-out explanation of "mortgage strip-down," but suffice it to say that the current bills bring the treatment of principal residence mortgages into line with the treatment of other secured claims (it's actually more involved than this, but this is the takeaway point for non-specialists).

As a policy matter, thess bills essentially punish banks (and MBS securitization trustees and servicers) for unreasonably refusing requests for modifications of distressed mortgages (that in most cases help the banks/investors to avoid major losses in foreclosure). If the lending industry had responded to Congress and supported reasonable modifications before, these bills wouldn't be in the hopper. But these banker folks are now infamous for their unreasonableness (recall, these are the same rocket scientists who valued my home at a discount to actual recent sales prices for identical homes in my townhome association because the other places had been on the market too long!). Now, Dimon will have to lie in the bed that he and his like have made. One of these bills very likely will pass, probably the Durbin bill, behind which even Citigroup and other lenders have thrown their support.

Dimon invites us to feel sorry for the banks, whom this bill would put "at the mercy of the vagaries of the courts." This is ridiculous, as the bill does no such thing--the market value of the property defines the value of the bank's claim. There's no judge discretion or beating up on mortgagees going on here; it's simple market economics. And by the way, Dimon clearly has no problem with borrowers being at the mercy of the vagaries of the market . . . What goes around, comes around.

Dimon's main argument against this bill is the same old, tried-and-true argument that every economist/banker/fill-in-the-conservative-blank levels against any kind of consumer protection or market regulating legislation: it will make banks less willing to lend for fear that loans will be modified or destroyed in bankruptcy. For Heaven's sake, when will bankers stop making this utterly ludicrous argument. First, perhaps a bit less lending is exactly what the doctor ordered, at least less lending to the droves of people who should never have received loans on the terms that these banks and brokers foisted on them in the past several years (leading to our current predicament). Second, no amount of consumer protection has ever inhibited banks from lending, either here or in other countries, even after banks have made their "sky is falling" arguments before passage of legislation (see, e.g., the broad-ranging adoption of consumer bankruptcy in Europe over the past 20 years--lending certainly hasn't ground to a halt there!). Finally, the Durbin bill (as amended in the deal to secure Citigroup's support) applies only to mortgages already existing--not to prospective mortgages. This tired argument about "we will be hesitant to lend if you pass this law" is totally off the mark with respect to the Durbin bill.

My favorite comment: Dimon warns that passage of the bill will "lead to an increase in personal bankruptcies." Well, no @#$%, Sherlock! That's the whole point. We wouldn't need more bankruptcies if the bankers would act reasonably in dealing with the foreclosure crisis, but since they've amply demonstrated that they're incapable of dealing with it responsibly, Congress is stepping in. This is like criticizing the release of a new cancer drug for fear that it will lead to more doctor visits by sick people. Indeed!

Economic Trouble Hits the Little Blue Guys?

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This post is both silly and serious. On the silly side, I just couldn't resist noting that the W$J today announced that Smurfit-Stone has warned its lenders that it may seek bankruptcy. I can't see that name without thinking of the little blue guys of my youth (I had a small collection of the cute little characters). On the serious side, Smurfit is a sort of bellwether for the economy, as it produces cardboard boxes of every size and shape. When consumers stop buying things that go in boxes, companies like Smurfit are on the other end of the chain of businesses that suffer. When the pain reaches that far, we know we're really in serious economic trouble (as if that weren't clear already). Brace yourself for many more announcements like Smurfit's in coming months.

Bracing for the Wave of Retail Bankruptcies

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I don't want to seem too gleeful about this, but we insolvency professionals are likely to be in the spotlight for a while during this Year of the Bankruptcy. I'm surprised it took so long for the W$J to come out with the first such story of 2009, but today's Marketplace section (on B1) announced a Wave of Bankruptcy Filings Expected From Retailers in Wake of Holidays. The current period, unprecedented in so many ways, will likely see an unprecedented and massive restructuring of the U.S. retail sector. Much of the activity will be liquidations, it seems to me, whether out of bankruptcy altogether, under Chapter 7, or even in liquidating Chapter 11 plans. Our unsustainable reliance on out-of-control consumer spending seems to have met its demise. Or maybe this will be a temporary lull, with consumers pulling out the stops once the job market rebounds. One way or another, 2009 will be a rough one for many. Here's hoping that this year can also be marked as the Year of the Great Recovery.

Why Are Credit Card Issuers Undermining the Economy?

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More evidence that the financial sector is squandering the hard-won rescue funds from Congress: Not only are banks not lending to rejuvenate business, especially to the small-business backbone of the American economy, they're making existing loans rapaciously expensive for good borrowers. This can have no other effect than to drag down our struggling economy further. The story linked above observes that the banks' lame excuse for raising rates on small businesses and individuals is a vague reference to "economic reasons." What reasons? That the banks need more money from good risks because they've so messed up their investments in bad risks? I can't believe Congress hasn't jumped on this kind of thing more aggressively . . . yet.

The idea of nationalizing the banking sector is sounding better and better. The W$J reported yesterday that regulators have become more involved in internal strategy for struggling Citigroup. Perhaps this (and the FDIC's role in managing IndyMac's troubled mortgage portfolio) will be a model for the future. Even if you believe that "Socialism" is bad, some form of level-headed government oversight HAS to be better than the foolishness we're seeing from these banks.

GM, Chrysler & Tribune Creditors Go to "The Barbershop"

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As predicted, at least two of the Big Three auto makers are headed into an out-of-court workout orchestrated and likely financed by the U.S. government. My new favorite quote is from Nancy Pelosi: "We call this the barbershop. Everybody's getting a haircut here . . . ." She included management in the list of parties who will be called on to make concessions--including dumping those fancy corporate jets (talk about bad PR!)--in exchange for government financing of the workout (let's just call it DIP financing, shall we). The W$J story aptly compares the workout procedure to bankruptcy, which is, of course, exactly what's going on here, though the informal process will lack both the psychological stigma of "bankruptcy" and the muscle that the Bankruptcy Code would provide in dealing with leases and intransigent holdout creditors. The primary purpose of Chapter 11, in my view, is to allow a majority-approved workout plan to be forced--"crammed down," as we say--on dissidents. I guess the gravitas of the U.S. government will be the 800-pound gorilla in this deal.

I'm getting closer to figuring out who will be sitting in the barber's chair in the Tribune Company bankruptcy, too, especially in terms of employee retirement and other claims. It seems that we have good news and bad news.

The good news is that, while 100% of the company's stock is held by an Employee Stock Ownership Plan (ESOP), very little time has passed since that plan took over the compay's equity, so employees apparently have made no concessions or contributions to the plan, which will now likely be wiped out in the bankruptcy. While the employees are technically the beneficiaries of the stock held by the ESOP, the trust obtained the stock through a $250 million loan from the company, so employee rights in the stock would have vested only over time as the the company reduced the ESOP trust's debt by making annual contributions to the ESOP. Since this hasn't happened yet, the employees will really lose next to nothing in terms of retirement assets--thank goodness. Most of this is explained in a wonderful note by Corey Rosen, executive director of the National Center for Employee Ownership. Ironically, from the employee retirement assets perspective, it's probably actually a rather good thing that the company sought bankruptcy earlier rather than later (before it put lots of employee retirement contributions into the ESOP black hole). The compay's "pension plan," which closed last year, seems to be safely outside the bankruptcy case in a fully-funded $1.8 billion trust (beneficiaries with "frozen" pension rights should be safe). The same is true of the 401(k) plan set up by the company, but to which the company discontinued making employer contributions when the ESOP was set up.

The bad news seems to be that the the primary part of the three-part Tribune employees' future retirement plan seems to be up in the air now. The first, a "cash balance," low-risk money fund that will hold planned 3% annual cash contributions (the first to be made in 2009), will apparently be unaffected (though one wonders what future contributions will be). As for the second part of the plan, employees can continue to contribute themselves to a 401(k) account (though employer contributions were suspended last year). The cornerstone of the company's post-2008 retirement plan, however--the ESOP--will in all likelihood be gutted in the bankruptcy. In addition, as described in this fantastic New York Times summary of the situation, the "little guys" with the most to lose are those who recently accepted buy-outs and severance deals. This includes folks like a reporter mentioned in the NYT story who just sent in his paperwork to accept a buy-out equal to 49 weeks' pay (severance for more than 24 years of work)--a deal that is now in jeopardy as these types of people join the ranks of unsecured creditors. Luckily for these folks, up to $10,950 per person of such claims, earned within 180 days of yesterday (the filing date), will be § 507(a)(4) "priority" unsecured claims, which get to budge in line ahead of the general unsecured creditors (probably including the banks and bondholders).

It's a sad, rainy day in Chicago today. One of the most beloved institutions in town is in bankruptcy, and our governer was arrested by the FBI this morning, charged with corruption (more "pay-to-play" allegations leveled at yet another Illinois governer). I, for one, am looking forward to a brighter 2009!

Tribune Company List of Creditors--Where's Zell?

The plot thickens? The Tribune Company's bankruptcy petition and related statements are online, courtesy of the L.A. Times. As I mentioned in my earlier post, Zell's stake in the company is reportedly represented primarily by a $225 million 11-year subordinated note. I went hunting for this obligation in the "Consolidated List of Creditors Holding the Thirty Largest Unsecured Claims Against the Debtors," and I couldn't find it. The range of claim amounts is quite broad, from the $8.57 billion owed on the senior bank facility all the way down to a $1.69 million claim by Paramount Pictures Corp. for "trade debt" (maybe licensing fees or something?). Where's Zell's $225 million note? I wouldn't expect to find Zell's name on the list--doubtless, he made the loan through one (or more) of his companies. But of the several mentions of "subordinated promissory notes due 2018" (which would precisely describe the notes I would expect to find reflecting Zell's stake), all five are listed as much smaller amounts ($3.3 million, $2.8 million, down to $2.16 million). These notes are held by companies named "Tower XX, LLC" (where XX is a two-letter combination that differs for each company), c/o Equity Group Investments (which I believe is Zell's company). The five notes add up to only $13.4 million--a far cry from the $225 that the reports I had seen suggested for Zell's position. Is the remainder broken into dozens of notes for less than $1.691 million (the smallest claim on the list)? Curious.

Tribune Bankruptcy and Absolute Priority

Photo by matt1125

The Tribune Company, owner of the flagship Chicago Tribune, as well as the L.A. Times, Baltimore Sun, WGN News, and other assets (including the Chicago Cubs) has finally entered Chapter 11 bankruptcy--a destination toward which it has been slouching for months. It thus seems to have become the latest victim of private equity's debt-fueled LBO rampage, joining Mervyn's and perhaps Bally. Tribune Company Chairman and CEO (and architect of the recent ill-fated going-private deal) real estate tycoon Sam Zell said that he expects creditors to take a significant haircut: "[s]ome elements (of the credit structure) will have no recovery."

As mad as the creditors are likely to be about this, the shareholders--especially the employees--are likely to be hopping mad when the facts emerge about how this company will restructure. Tribune Company is "America’s largest employee-owned media company," and many employees were unhappy about Zell's takeover/privatization of the company, as well as his capitalism-heavy-journalism-lite management refocus, and now they'll have reason to be really upset. While Chapter 11 may well not mean the demise of the company, it will almost surely mean the complete or near complete destruction of whatever value the employee's ownership stake (equity) might have had before the filing. The reorganization will almost certainly result in a debt-for-equity exchange, where current equity gets squeezed out (at least for the most part) and big debtholders take over that equity in exchange for discharge of debt. The absolute priority rule will almost certainly prevent equity (shareholders) from retaining any significant stake if some significant group of creditors will have "no recovery." Unless every creditor class can be convinced to vote in favor of a plan that leaves some value for equity, the company will be unable to confirm a Chapter 11 plan. Indeed, one wonders what Zell plans to do about his own equity stake.

Maybe there are more surprises waiting in the wings here, but this is yet another sad day in a long string of sad days for the Tribune Company's employees, who seem to have been largely involuntary passengers on Zell's pirate ship to Chapter 11.

Update: A little surfing answered my question about Zell's personal stake and added an interesting twist to the case. Zell's $315 million (!) investment in the going-private deal was structured as a $225 million subordinated 11-year note and a $90 million warrant to purchase up to 40% of the company's shares within 15 years from the Employee Stock Ownership Plan that now owns 100% of the Tribune Company's equity. Thus, Zell's $90 million warrant is likely worthless (or nearly so) after the bankruptcy filing (for the reasons discussed above), but his $225 million note is debt, which will likely be promised some distribution in a Chapter 11 plan. I intend to follow this (for me, local) case in the days ahead, focusing on the word "subordinated." While Zell's note now is likely subordinated only to the other company debt (both public bonds and bank loans), it might well ultimately be equitably subordinated under Bankruptcy Code § 510(c)(1) to the ESOP's share interest, which Zell's going-private transaction has now all but completely destroyed. Stay tuned!