Law on Rice

Looks like consumers really are deleveraging. Or maybe the skyrocketing number of chapter 7 filings account for it. What’s “it,” you ask? This chart from SeekingAlpha, of course.

I think of the consumer credit agencies as an extremely potent species of leverage. Maybe they are the ultimate leverage beast because a creditor who reports can deny all future credit to a slow paying consumer.

While they’ve been the subject of both debate and consternation, I’ve never seen a proposal to regulate HOW credit agencies generate their reports. One commentator on SeekingAlpha, Mark Sunshine, just made such a proposal.

It sounds like an incredibly complicated task. And I’m not sure whether I would require a certain way of calculating a consumer’s credit risk or simply require them to disclose how the risk was assessed–if I agreed to regulate at all.

Still, it’s an intriguing proposition made on the very day that regulations for commercial rating agencies were announced. You can read Mr. Sunshine’s full proposal here.

There’s an interesting article in the New York Times (front page above the fold, no less) about industrial banking. Click here to read it.

Mr. Geithner plans to bring the banks within the Federal Reserve’s ambit. Of course, there are arguments on both sides:

A few industry observers go further in their complaints. Some companies intentionally chose an industrial bank charter — where they could raise money through brokered C.D.’s, investor funds in cash accounts and funds from business clients — so that they could take riskier bets and have higher leverage in their other business units, argued Raj Date, who leads a nonprofit industry research group, Cambridge Winter.

I’m just copying the text of the following press release from the FDIC verbatim:

The FDIC has signed a bid confirmation letter with Residential Credit Solutions (RCS), the winning bidder in a pilot sale of receivership assets that the FDIC is conducting to test the funding mechanism for the Legacy Loans Program (LLP). The pilot sale was conducted on a competitive bid basis, and final bids were received on Monday, August 31, 2009. A total of 12 consortiums bid to purchase an ownership interest in a limited liability company (LLC), to which the FDIC will convey a portfolio of residential mortgage loans with an unpaid principal balance of approximately $1.3 billion owned by the FDIC as Receiver of Franklin Bank, SSB, Houston, Texas. The pilot sale involves financing offered by the receivership to the LLC using an amortizing note guaranteed by the FDIC. Bidders for the pilot sale were given the chance to bid two different leverage options, 6-to-1 or 4-1, or to submit a cash bid for a 20 percent ownership interest.

The bid received from RCS for the financed sale of assets to the LLC using 6-to-1 leverage was determined to be the offer that would result in the greatest return for the receivership of all competing bids. RCS will pay a total of $64,215,000 in cash for a 50 percent equity stake in the LLC, and the LLC will issue a note of $727,770,000 to the FDIC as Receiver. The note will be guaranteed by FDIC in its corporate capacity. Based on the FDIC’s analysis and assumptions, the present value of this bid equals 70.63 percent of the outstanding principal balance of this portfolio. The FDIC received various other bids that were very competitive. The FDIC anticipates selling the note at a future date. After the closing, which is expected to occur later this month, RCS will manage the portfolio and service the loans under the Home Affordable Modification Program (HAMP) guidelines.

The LLP is part of the Public-Private Investment Program announced in March by the Secretary of the Treasury, the Federal Reserve, and the FDIC, and is being developed to help banks remove troubled loans and other assets from their balance sheets so that banks can raise new capital and be better positioned to provide lending to further the recovery of the U.S. economy. FDIC conducted the pilot sale to test this funding mechanism as part of the development of the LLP. The FDIC will analyze the results of this test sale to determine whether the LLP can be used to remove troubled assets from the balance sheets of open banks, and in turn spur lending to further support the credit needs of the economy.

I hadn’t really gone to look, but my impression was that the PPIP wasn’t really going anywhere. This looks a little encouraging anyway.

In the aftermath of hurricane, the US Trustee suspended the pre-filing credit counseling requirement in Louisiana. Today, September 16, 2009, that suspension is lifted and debtors will need to go through credit counseling.

I’m reading two cases that came out of Texas in the 1980s: In re Reed, 12 B.R. 41 (Bankr. N.D. Tex. 1981), and In re Reed, 700 F.2d 986 (5th Cir. 1983). I think the two cases express the difference between a fluid and a snapshot view of the bankruptcy estate.

In the district court case, the bankruptcy judge allowed the debtor to move assets from nonexempt to exempt categories even though the judge was a little hesitant about the debtor’s motives. I think of this as something like a fluid approach. That is, the debtor’s assets can change and shift and morph up until the time the petition is filed. This could be very bad for creditors, but it might also give them a sense of certainty when planning the transaction in the first place.

On the other hand, the appellate decision rejected this approach when it ruled the same conduct–even though it was overt–was fraudulent. This seems to me to be kind of a snapshot approach. That is, there is some moment in the debtor’s life where he or she realizes that the debtor’s financial circumstances are dire (“insolvent” in the parlance of fraudulent transfer law) and he may be considering some kind of protective measures. The law of the Fifth Circuit seems to suggest that the creditors may be entitled to a snapshot of the debtor’s financial affairs right at that moment–kind of like balance sheet right at that moment–and that the debtor may be locked in right at that moment.

I think the snapshot approach creates a special kind of legal leverage called uncertainty, or more precisely a threat of expensive litigation. I’m not saying it’s wrong, just that it is uncertain.

For my independent study project, I’m researching United Student Aid Funds v. Espinosa. So I pulled the amicus briefs filed thus far. Unsurprisingly, I found a handful in support of the creditor. Money buys a special kind of leverage in the form of hotshot Supreme Court lawyers.

So imagine my suprise when a professor from my law school, Prof. Pardo, showed up in the list of amici. It was especially surprising since I initially approached him to supervise my independent study, only to find out that he is on sabbatical this year.

I’ve only skimmed his brief, but he seems to argue that the failure of the creditor to object to the chapter 13 plan’s confirmation within the timelines prescribed by 1330 had the effect of removing federal jurisdiction. Yeah, that made my head spin a bit too. I’m going to have to read his brief a lot more carefully to do it justice.

I also noticed that there aren’t too many briefs in support of the debtor, Espinosa, in this case. See what I mean about leverage?

I’m reading for class next week. We’ll be talking about the means test created in 2005. Much smarter people have already analyzed it, so I won’t do it here. Instead, I have an idea.

Let’s accept that it’s better for people to be in chapter 13 for argument’s sake. During a period of high employment, it may even have been a great idea.

Today, however, many people are in a paradox–their prior incomes disqualify them from a chapter 7 and they don’t qualify for a chapter 13 because they’re out of work. They probably will be for some time to come.

So here’s my idea: Congress should enact temporary legislation that would allow people to file chapter 13 petitions, but delay a hearing on confirmation for, say, one year if they are out of work and can’t obtain new work.

That way, they’d get protection, but still be on the hook to try to repay their debts. The three year plan would turn into four and the five year plan would turn into six.

If they fail to find work or the new work won’t support a plan, then the trustee can move to dismiss using the normal procedures–a year from now.

At the time ECF “stamps” the petition, 11 USC 541 creates a bankruptcy estate. This fictional estate consists of “all legal or equitable interests of the debtor in property.” 11 USC 541(a)(1). Once the legal fiction is created, it implies that the trustee is instantly responsible for the estate, even though he or she has never heard of the debtor.

For some reason, something doesn’t seem conceptually right about this approach to me. It seems unrealistic and confusing to both debtor and trustee. It seems to leave the estate suspended in some kind of surreal “no man’s land.”

So why not bifurcate responsibility for the estate into two steps? That is, let’s retain the magical estate of 541, but let’s make the debtor the estate’s trustee for a while (kind of like a debtor in possession). Then give the assigned bankruptcy trustee an opportunity to formally and explicitly “move in” and take over that role, after the bankruptcy trustee has been assigned to the case and has had time to review the case.

This would create an extra step between the filing of the case and the 341 meeting. I’m visualizing a meeting between the debtor and the trustee to talk about the schedules. Indeed, it might even mean that the schedules get filed much later, at the time the trustee has formally taken control of the estate (and perhaps make section 542′s timing a little more clear).

I think the benefit would be that the debtor would have a stronger sense of his role (and even some increased liability), would take a more active role in his or her bankruptcy, and the process could be a little more collaborative between the trustee and the debtor. I guess I sometimes feel like there is too much of a sense that once the case has been filed everything is pretty much done.

I can’t think of any pressing reason why such a thing needs to be done right this moment. Still, I thought I should write up my idea since it’s fresh in my studies.

If you recall, the banks had a mixed leverage story over the past year (that is, there were clearly some winners and clearly some losers).

In case you are having trouble keeping track of “who all got what,” the reports are right here: http://www.financialstability.gov/latest/reportsanddocs.html

This is Friday’s version of the report from the Treasury (click the toggle full screen button to see it better):

TARP Transactions Report 09042009