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!

Bernanke Testifies on Federal Reserve Programs

Ben Bernanke, Federal Reserve Chairman, testified today before the House Financial Services Committee about the Federal Reserve's emergency assistance to the financial markets. Stressing the difficulties to policy makers around the world, Bernanke warned in his opening statement that "[a]lthough the provision of ample liquidity by the central bank to financial institutions is a time-tested approach to reducing financial strains, it is no panacea." Bernanke also fielded questions on the appropriate role of the Federal Reserve and whether it has too much power. Specifically, the Committee questioned the lack of oversight on transactions entered into by the Federal Reserve.

The question of the appropriate limits on Federal Reserve power is a fair one. How much restrictions should be imposed on the Federal Reserve in its position as a central bank to intervene in a financial crisis? The Federal Reserve might wield power responsibly, but that does not mean the power should be without limit. The lack of accountability and oversight for specific Federal Reserve decisions is a valid point, but it is hard to argue that the Federal Reserve operates with complete autonomy either. Bernanke does get to testify about decisions made (albeit after the fact). Bernanke did stress the efforts that the Federal Reserve is taking to keep Congress and the public involved in its decisions and programs.

Further, the Treasury provided funding for some of the extraordinary measures the Federal Reserve has undertaken. The increase in the balance sheet of the Fed has not occurred without the involvement of the Treasury. As such, the Federal Reserve must act in concert with the Treasury Department in order to accomplish significant new programs. The Federal Reserve's autonomy is certainly large for the new programs it administers, but it still must act within the program limitations. Moreover, other measures, such as announcing interest rates, are expected from the Federal Reserve without congressional intervention in its role as the central bank.

It is easy to see why Congress would be uncomfortable with the Federal Reserve having a great deal of autonomy. But, it is a central bank. On the whole, a certain amount of autonomy appears appropriate for the Federal Reserve in this capacity. Will we eventually arrive at a point where the role is too great? Perhaps.

— JSM

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.

Class Action Waiver in Credit Card Merchant Agreement Held Invalid

In In re: American Express Merchants' Litigation, 2009 WL 214525 (2nd Cir. 2009), the Second Circuit recently held that American Express cannot enforce a class action waiver provision in its contracts with merchants that accept AmEx cards. The so-called collective action waiver purports to compel merchants to individually arbitrate any claim arising from their contracts with American Express. A group of small merchant plaintiffs had filed an antitrust action alleging that American Express unlawfully tied acceptance of its corporate and charge cards to acceptance of credit cards issued by AmEx and its bank partners. The merchants argued that American Express's relatively higher merchant fees were originally secured because its corporate and charge card holders were particularly valuable to merchants. AmEx's credit card holders, and particularly those of AmEx's bank partners, by contrast, are indistinguishable from Visa and MasterCard cardholders. Forcing merchants to accept the credit cards to get access to the corporate and charge cards, the merchants allege, violated the antitrust laws. American Express responded by invoking the arbitration provision. Although willing to arbitrate, the merchants objected to the prohibition on class adjudication, arguing that it would effectively eliminate their statutory rights. No individual merchant, they contended, could justify the cost of complex antitrust litigation given the relatively small individual damages suffered by each merchant. The district court held that the validity of the class action waiver was a matter for the arbitrator, and that eliminating class adjudication did not effectively prohibit the merchants from advancing their claims, because the Clayton Act permited the recovery of costs and attorneys fees. The Second Circuit reversed, holding that the validity of the class action waiver raised a question as to the validity of the arbitration clause itself and was thus subject to the federal substantive law of arbitration. That law, the court held, barred arbitration provisions that as a practical matter would prevent the enforcement of statutory rights. The court concluded that the class action waiver in AmEx's merchant contracts had this effect. It explained that the District Court erred in its interpretation of the Clayton Act's remedial provisions, because that Act would not permit individual plaintiffs to recover the extensive expert witness costs that would be required to litigate a complex antitrust case. Because of those costs, individual merchants would effectively be barred from enforcing their rights if class adjudication were not permitted. The Second Circuit cautioned that it was not holding that class action waivers were either "void or unenforceable per se," even in antitrust cases. Rather, a court must decide on a case-by-case basis whether a class action waiver effectively bars the enforcement of statutory rights. Because the merchants had expressed a willingness to litigate the claim, and AmEx had indicated that it might not invoke the arbitration clause if class treatment were permitted, the Second Circuit remanded the case to determine the forum. Plaintiffs' counsel issued a statement following the ruling that suggested the case could have broad applicability. “The policy of putting anti-class action rules in consumer and merchant agreements," the statement claimed, "has been growing enormously in recent years. . . .The decision will no doubt be used by plaintiffs in dozens of other cases where defendants have attempted to ban class actions.”

Problems for Secondary Lenders?

I received a call today asking whether a local company in Louisville should be worried that its secondary lender on its real estate filed a lawsuit to foreclosure due to default. In some ways an odd question, but perhaps not. Imagine this, Company X owns real property worth $750,000 at the time of financing. First Bank holds a mortgage for $500,000 and Second Bank holds a mortgage for $225,000. If both banks have properly recorded their mortgages, all would seem to be in order. But, in a declining real estate market, we could imagine the property now being worth about 20% less (here, just $600,000). First Bank is still secured, but Second Bank is now undersecured. If Company X stops paying Second Bank, but is in good standing with First Bank, then what are Second Bank's options? Foreclosing on the real estate might ordinarily be a good call, but what happens in a declining market if the real estate has to be sold at auction?

Second Bank seems now to be undersecured. If real estate values have fallen dramatically, Second Bank could be in even worse shape. Its options? Perhaps Second Bank might try to renegotiate the terms of the mortgage to get Company X back on track. Alternatively, the loan might be sold to First Bank at a deep discount if First Bank is interested. If Second Bank obtained any guarantys from the owners of Company X when it issued the loan, that might help . . . if the individuals have enough assets to cover the loan. Forcing Company X into bankruptcy also might not work out so well if there are not sufficient assets to pay the creditors.

In the end, should Company X be worried about any lawsuit by Second Bank? It is a tough market out there. Secondary lenders on real estate may as a group be finding themselves with less bargaining power than in the past. If Company X is not worried about the situation about Second Bank it could be that good corporate news is around the corner that will allow them to pay the lender. In this market, though, Company X might know that Second Bank has rights, but little to enforce them against.

— JSM

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?

Update on Home Mortgages

Thanks to the Federal Reserve, the benchmark interest rate will remain near zero. LIBOR remains around 1.17 percent. Home prices in twenty American cities dropped 18.2% in November from the prior year (this rate is lower for areas below the conforming mortgage rate of $417,000). Mortgage rates are at about 5.48% in the last week. What does this mean for home buyers? For mortgages? As we've said here before, the indicators suggest mortage rates should be lower than ever leading to more people buying homes and refinancing (see More Trouble For Home Refinancing; Refi No Good --- A Lesson in "LTValuation").

So, what does the mortgage news really mean? There is talk that the Senate will include housing relief in the economic stimulus plan. The discussion includes: (1) making available to home owners a 4% 30 year mortgage, either for buyers or refinancers; (2) increasing the first time home buyer credit; and (3) a ninety (90) day moratorium on foreclosures. Yippee! At least for my home, lenders cannot do too much better than the mortage we already have. So, the strategy for some home owners is shop around for better rates and wait. As much as I might like to see a 4% mortgage rate, though, the cost of this housing relief may become quite expensive. The cost for such a government program hasn't yet been publicized, but is likely to be the impediment to my dreams of a 4% mortgage rate.

Home purchase credits might help to encourage those who have been staying out of the market to buy a home. The structure of the credit needs to have the effect of home purchases by those who would not purchase otherwise. Timing and limits on eligible purchasers are also issues. Moreover, the word of caution with encouraging home purchases is avoiding the same problems that led us to the current crash. That is, to what extent should we encourage purchases of homes if some purchasers would not have their downpayment but for the credit? The same concerns about lenders repeating policies that created the housing crisis apply to home buyers. Throwing money at the housing crisis may well help in the short to medium term, but the stimulus plan should not forget the lending and borrowing implications for the longer term.

As to moratoriums on foreclosures? There are many open questions on the housing crisis. A little more time is probably warranted.

— JSM

IMF annouces "virtual standstill" in global economy

Yesterday's press conference at the IMF, Olivier Blanchard,Economic Counsellor and Director of the Research Department, began with an acknowledgment that he is a bearer of bad news: global output and trade are decreased; growth forecasts are being revised continually downward. As far as outlook, Blanchard reported that the global economy will come to a "virtual standstill" with just 1/2% of growth for 2009. The global financial crisis has taken a toll on different economies in different ways. In terms of developed economies, investor and consumer confidence is lower, making the cost of credit higher and less available. In emerging economies, the effect is different: (1) there is weaker external demand from developed countries for goods; (2) the global credit crunch has limited credit and increased the cost of credit; and (3) there is a decline in cost of goods exported.

The IMF's solution? Simply restoring financial health. Easier said than done, it would seem. The difficulty is one that still eludes us regarding the toxic assets that are still present on the balance sheets of banks. Much is said about the fiscal policies and government stimulus efforts, with a recommendation for proposals that emphasize government spending, rather than tax relief to have the quickest effect. Of course, the long term concern is the ability for governments to reverse the deficits that are created in the near term. Thankfully, the IMF is expecting the United States to return to a low level of growth (1%) by 2010.

The full press conference is available through the IMF.

— JSM

Fortune's Best Companies to Work For

. . . with no layoffs.

Lately, there has been a daily dose of bad news with company layoffs. Today's news was of 13,000 job cuts today and 110,000 for the week. Today's casualties include AstraZeneca, Eastman Kodak, Cessna, Oshkosh and Charles Schwab.

Some good news: here are 9 of Fortune's Best Companies to Work For that have never had a layoff (so far, of course).

Best Companies rank Company U.S. employees
10 Nugget Market 1,536
13 Devon Energy 3,752
26 Aflac 4,493
27 QuikTrip 10,159
32 Container Store 3,286
44 NuStar Energy 1,319
53 Stew Leonard's 2,219
60 Scottrade 1,946
88 Publix Super Markets 141,314

From the Fortune February 2, 2009 issue

— JSM

Court Holds Discover Card Arbitration Opt Out Can't Be Evaluated on the Pleadings

In November, I posted about a case alleging that credit card issuers violated the antitrust laws by agreeing to include arbitration provisions in all of their cardholder agreements. Judge William Pauley, in the Southern District of New York, initially dismissed the suit for lack of standing, reasoning that any injury would be contingent on future disputes that cardholders might be forced to arbitrate. The Second Circuit reversed, holding that an agreement not to compete on a critical contract provision deprived the plaintiffs of a meaningful choice and thus resulted in injury in fact. Ross v. Bank of America, N.A., 524 F.3d 217 (2nd Cir 2008).
Discover responded by moving to dismiss the complaint against it on the ground that its arbitration provision permitted cardholders to opt out within 30 days, and thus its cardholders were not compelled to artibitrate claims as a result of any anticompetitive agreement. The language of the agreement is available here, but you’ll have to scroll down a little to find it.
On January 22, Judge Pauley rejected Discover’s motion, reasoning that whether Discover cardholders had a meaningful opportunity to reject arbitration provisions could not be resolved on the pleadings. “Accepting the plaintiffs allegations as true,” the court explained, “an opt out provision may be illusory [and t]he issue requires discovery.” This is particularly true, the court reasoned, because the plaintiffs alleged that the defendants conspired to prohibit their cardholders from challenging card issuer behavior through class actions. Interestingly, the court recognized that the plaintiffs were harmed because without the class action option, cardholders could not rely on the class action plaintiffs bar to monitor card issuer conduct. The court also held that by citing meetings between Discover and American Express, the plaintiffs brought their conspiracy allegations beyond the Twombly specificity threshold required to support a class action complaint. The court did deny plaintiffs request for a jury trial on the ground that the relief sought was entirely injunctive in nature. In re Currency Conversion Fee Antitrust Litigation, 2009 WL 151168(S.D.N.Y. 2009).

EC Considers Cross Border Interchange for New Debit Program

Visa, MasterCard, and the European Commission have been jockeying for over a year with respect to cross-border interchange fees. The EC's desire to spur on the introduction of the Single Euro Payment Areas ("SEPA") direct debit program may help bring about an agreed solution.

Interchange fees are charges paid by merchants to accept credit cards. Although these fees are imposed by the card systems, they do not compensate the systems for any service provided. Instead, they are passed on to the bank that issued the card to help support its card-issuing business. The EC has focused particularly on the charges imposed when a card is used outside the country in which it was issued.
Interchange fees have raised competitive concerns in the US and Europe for decades. Card systems have long argued that these fees are necessary to provide a sufficient return to card issuers. In recent years, however, that justification has been attacked on multiple fronts. A multi-district class action filed by U.S. merchants is on-going, and, in other countries, competition regulators have struggled to find viable alternatives.

The concern with interchange fees stems from two market factors. First, the merchants are generally unable to pass the fees on to card users. In some cases, merchants are legally prohibited from surcharging card transactions; in others card systems’ rules prohibit surcharging; and in any event, surcharging may not be practical for many merchants. Because merchants cannot assess these fees only on card users, they may simply increase their prices across the board. All consumers would thus pay higher prices to enable some to use cards. And, even those who use cards might not if they were required to bear the full cost of card use.
Second, system rules and competitive considerations require many merchants to accept all cards issued on the largest systems, Visa and MasterCard. As a result, individual card issuing banks within the Visa and MasterCard systems need not compete on interchange fees to attract merchants to accept their cards.

In the U.S., merchants have sought the right to surcharge and an injunction against card issuers setting interchange fees cooperatively through Visa and MasterCard. In other countries, regulators have 1) permitted surcharging and/or 2) limited interchange fees to an amount necessary to cover only certain costs of card issuing.
The EC recently found that MasterCard’s method of setting cross-border interechange fees was anticompetitive, holding that an open card system must limit interchange fees to the extent that they “contribute to technical and economic progress that benefits consumers.” The Commission has been investigating Visa’s fees as well. While MasterCard is fighting the determination against it, Visa has been seeking to negotiate an acceptable interchange fee with the EC.

The EC has likely entertained Visa’s efforts because it is struggling to determine an appropriate method of interchange fee setting. Although current fees may be supra-competitive, eliminating interchange fees entirely could result in an inefficient drop in card issuance.

Recently, the negotiations have been impacted by the EC's desire to encourage a European-wide direct debit system in which cardholders could 1)use cards across Europe and 2) have the cost of the transaction deducted directly from their home bank. The banks claim that they are reluctant to support the direct debit plan if a cloud of uncertainty continues to hang over the interchange issue. EC competition commissioner Neelie Kroes recently recognized the need for an interchange system to get the direct debit program off the ground. “It may prove necessary,” she said, “to have a multi-lateral interchange fee for cross border SEPA Direct Debits.” But she wants to limit those fees to the “very initial stage” of the program. Whether that will be enough for many banks to back the debit system remains to be seen.

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.

David Brooks on Economic Theory

David Brooks of the New York Times has of late been a big advocate of behavioral economics, as this column from October initially laid out. Last week, Brooks again raised his argument that the economic collapse has irreversibly exposed the flaws in classical economic theory:

Once, classical economics dominated policy thinking. The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse. Sometimes people do stupid things, but generally the rider makes deliberative decisions, and the market rewards rational behavior.

While the classical model is hardly the quaint ancient history that Brooks' rhetoric suggests, I do agree with Brooks that the current crisis can be traced in part to a fantastical belief about both the nature of persons and of markets. It is also nice to see that others are moving toward acceptance that there may be a significant role for government and law to play in market regulation. It would have been much nicer to see that move occur prior to the complete meltdown of the economy, the destruction people's lives and livelihoods, etc. That's an argument for ex ante versus ex post regulation, I guess.

Even if the King is dead, I am less certain than Brooks seems to be that the natural successor to the throne is behavioral law & economics. Such a move could be seen as simply a mere substitute of a new mode of "mechanistic thinking" (to paraphrase Brooks' criticism) to address the problem. I guess it could be argued that the crisis has exposed the weaknesses not of one economic model for regulation, but of all economic models for regulation. But, if that is the case what are we left with? In any event, we are no doubt in the midst of a major shift in attitudes toward legal intervention into markets, and it will be interesting to see what insights behavioral economics has regarding solutions to the problems.

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!

Oops!

Law.com reports that Bank of America and Citibank stand to lose in excess of $51 million because Bank of America, acting on its own behalf and as Citibank's agent, terminated both banks' financing statements against the former law firm of Heller Ehrman in August 2007, some 14 months before Heller Ehrman filed bankruptcy. As we all know, UCC § 9-317(a)(2) and 11 U.S.C. § 544(a)(1), collectively, generally give a bankruptcy trustee (or a debtor-in-possession) priority over any security interests that were unperfected when the debtor filed bankruptcy. That's bad enough news for Bank of America's and Citibank's apparently unperfected-at-filing security interests. (Bank of America and Citibank have argued that an October 2008 "correction" revived their perfection well before Heller Ehrman filed bankruptcy and had the effect of making the banks perfected when Heller Ehrman paid them. Heller Ehrman counters that the "correction" did not cure the banks' lapse in perfection.)

But, wait, it appears to get worse. Less than 90 days before Heller Ehrman filed bankruptcy, and well after Bank of America terminated its and Citibank's filings, Heller Ehrman paid the banks $51 million of the firm's outstanding debt. Under 11 U.S.C. § 547(b), the payment looks like an avoidable preference, which the banks may have to refund to the bankruptcy estate.

With Pillsbury Winthrop Shaw Pittman on one side and Greenberg Traurig on the other, this dispute figures to be hotly contested and should be interesting to follow.

(Hat tip to Scott Burnham.)

2009 AALS Commercial and Related Consumer Law Section Officers

At last week's AALS annual meeting in San Diego, those attending the AALS Section on Commercial and Related Consumer Law's Friday business meeting voted our own Keith A. Rowley (UNLV) to be the section's chair-elect and fellow blogger A. Brooke Overby (Tulane) to be an at-large member of the section's executive committee. Amelia H. Boss (Drexel) is the new section chair and immediate past chair Kevin E. Davis (NYU) and at-large members Neil B. Cohen (Brooklyn) and Gregory E. Maggs (GWU) round out the executive committee.

UPDATE: The AALS informed us that Amy Boss was ineligible to serve this year because Drexel is not yet a member school. Consequently, Keith Rowley becomes chair a year earlier than planned, Greg Maggs is the chair-elect, and Emily E. Kadens (Texas) is our new at-large member.

Economic Trouble Hits the Little Blue Guys?

Photo by unfolded

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

Photo by jurvetson

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.

Obama Speech at George Mason on Economy

In case you missed it (especially for those at the AALS Conference), here is Obama's speech today at George Mason University on the economy. Obama calls immediately for an American Recovery and Reinvestment Plan (the "Plan"). The Plan will create up to 3 million new jobs for Americans over the coming years, focusing on investment in energy, education and healthcare to help America remain competitive. The Plan will include infastructure projects, tax cuts, and extension of unemployment benefits. Obama acknowledged the cost of economic recovery, but stressed greater accountability for government spending.

Obama asked people to consider not what is good for me, but "what is good for the country my children will inherit." A very good speech. Now, hopefully action is not far behind. What exact form that action will take is probably the biggest unresolved question. There is sure to be political wrangling about what projects are most important and the cost.

Part I:

Part II:

— JSM

University of Memphis Law Review Spring Symposium 2009

Rethinking the U.S. Regulatory Structure Governing Financial Institutions: 21st Century Solutions for a 21st Century Marketplace
Friday, February 20, 2009
8:00 a.m. - 5:00 p.m.
The University of Memphis, FedEx Institute of Technology
Co-Sponsored by:
and
First Horizon National Corporation

"The U.S. regulatory structure reflects a system, much of it created over seventy years ago, grappling to keep pace with market evolutions and, facing increasing difficulties, at times, in preventing and anticipating financial crises."

-The Department of the Treasury Blueprint for a
Modernized Financial Regulatory Structure
(released in March 2008)

The University of Memphis Law Review is pleased to announce its annual Spring Symposium to be held at The University of Memphis in Memphis, Tennessee. This symposium will explore the myriad legal and policy issues surrounding federal regulatory reform governing financial institutions. In early 2008, the Department of the Treasury issued a Blueprint for a Modernized Financial Regulatory Structure, which is the most recent of a long line of careful studies addressing the Federal regulatory structure applicable to financial institutions. The Blueprint was a response to mounting concerns about the performance, safety and health of financial institutions. It was intended to modernize government’s approach to preserving market stability, enhancing U.S. competitiveness in the global marketplace and promoting consumer protection.

Since the Blueprint's release, turmoil in world financial markets has grown significantly. The U.S. economy is in the midst of perhaps its most severe contraction since the Great Depression. Many in government, business, the press and the academy blame the current financial crisis on excessive governmental deregulation of financial markets. Others point the finger at negligent regulators, meddling political players, faulty assumptions and underlying structural failures. Regardless of where fault can best be rested, it is clear that today’s regulatory framework for financial services needs serious reexamination and perhaps deep reform, both to correct current ills and to guard against future problems.

This symposium will focus on a broad range of topics concerning the short and long term goals of and approaches to financial services reform, including those set forth in the Blueprint and others surfacing since it was released. Presenters will discuss their ongoing scholarship in areas pertinent to today’s financial markets crisis. The specific topics of that scholarship (risk-based regulatory objectives, the impact of unfolding Federal bailout legislation, accounting and financial reporting, consumer protection) will afford springboards throughout the day for broader-ranging discussions and commentary by panelists.

CLE Credits

The Law Review has requested CLE credit approval for 4.5 general hours from Tennessee, Mississippi, and Arkansas.

Registration Fees
MBA Member: $200.00
Non-MBA Member: $260.00
Governmental Attorney: $140.00
Non-attorney or no CLE needed: $140.00

The registration fee covers the conference sessions, parking, breakfast, and lunch.

For more information please contact:

Jera L. Bradshaw
Symposium Editor
The University of Memphis Law Review
E-mail: jlbrdshw@memphis.edu
Telephone: (901) 581-3539

— JSM