Author Archives: David Reiss

Financial Literacy Literacy

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Personally, I was disappointed by the CFPB’s Financial Literacy Annual Report. It seems to me that the Bureau’s Division of Consumer Education and Engagement is thinking too small in setting forth its research agenda. For its financial education evaluation project,

The Bureau is conducting a quantitative evaluation of two existing financial coaching programs. Financial coaching generally involves one-on-one sessions with clients to increase clients’ awareness of their financial decisions and to provide support for clients to reach financial goals mutually set by the coach and client. (46)

Seems to me that there are some fundamental questions about financial literacy that need to be studied before small, resource-intensive projects like financial coaching are. I have blogged about these issues before, but the bottom line is that there is no solid empirical evidence that financial education achieves good results in general. So why study particular initiatives?

I would like to see the Bureau engage in a broad survey of financial literacy first and then develop a research agenda that reflects the big issues, including

  • do improved disclosures improve outcomes for consumers?
  • do consumers have the basic math skills to take advantage of disclosures?
  • what useful metrics exist for measuring the impact of financial literacy initiatives?

These are just a few big questions that I would want to answer before I looked at particular programs.

The Bureau should start from the premise that we have little reason to believe that financial education works.  Let’s build up a body of knowledge from there. If we assume that it works, as the Bureau’s current research agenda implies, then that assumption can lead us on a wild goose chase as we study program, after initiative, after project, looking for that golden-egg laying goose.

Cuomo and Lawsky: Mind The Gap Authority

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Law360 quoted me in a story, NY’s Powerful Financial Regulators Poised To Extend Reach (full story behind a paywall). The story reads in part,

New York’s proposed tougher standards for debt collectors marked state regulators’ first use of their unusual authority to fill gaps in financial regulation, proving state officials will use that power to take charge of the few areas of consumer finance they do not already oversee, attorneys say.
The New York Department of Financial Services has already proved to be an aggressive and creative regulator in its nearly two years of operation, taking on alleged money laundering at Standard Chartered PLC and force-placed insurance, among other moves. Until now, though, Gov. Andrew Cuomo and Financial Services Superintendent Benjamin Lawsky had not fully exploited the state’s “gap authority,” which allows them to regulate areas they feel aren’t sufficiently policed by existing state or federal laws.

* * *

That power makes New York state unique. In most other jurisdictions, state regulators can only regulate financial products and institutions based directly on statute. New York’s regulators can simply decide to enact rules where none exist, and do it quickly, said Brooklyn Law School professor David Reiss.
“You now have an activist government in New York saying, ‘We’re going to look broadly at using this authority we have. So if we hear about problems we can respond to them in six months, not three years,'” Reiss said.

* * *

In addition, there may be some confusion about where the lines between regulations set by the Consumer Financial Protection Bureau — which is considering its own rules for debt collectors — and the DFS may overlap. Technically, the DFS can only extend its gap authority into areas where it feels appropriate rules do not exist, either from state or federal regulators.
The CFPB has consistently asserted that it does not intend to preempt state regulations, and that its rules are merely a floor, Reiss said.

* * *

“We have a governor who has a strong view of gubernatorial authority. He’s appointed an active former prosecutor to a sleepy office and given him a lot of authority, and Lawsky has run with it,” Reiss said.

Fannie/Freddie Take Down 3: Washington Federal v. The U.S. of A.

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This should catch us up on the Fannie/Freddie preferred stock Takings litigation (see here and here for two other suits).  Washington Federal et al. v. United States was filed June 10, 2013 and is a class action complaint. The theories are pretty similar in the three cases. I had earlier written about the importance of narrative in these Takings cases. Having lived through this history myself and having read the “first draft” of history carefully in the pages of the New York Times, the Wall Street Journal and many trade periodicals, I am somewhat taken aback by this revisionist history. For instance, the complaint states that the companies were not “likely to incur losses that would deplete all or substantially all of” their capital. (38) News to me!

But what is most striking about the complaint is this notion that if the government had just taken this action (allowing the companies to buy more subprime mortgages) or not taken that action (strong arming the board to accept the conservatorship) or not deferring taking this other action (waiting to raise the guarantee fee), then everything would have worked out for the companies and their shareholders.  Maybe so, but it sure will be hard to categorize each of the government’s actions as either totally okay or completely inappropriate for the companies’ health in the context of the financial crisis. This leaves the plaintiffs with some tough work ahead. They are going to need to show a judge just how to categorize each of those facts and ensure that the categorization does not interfere with their theory of the case.

All of this raises a bigger, more interesting question. What role should these types of lawsuits play after a crisis has passed? Some would say that they are an outrage — second-guessing what are leaders did to avert financial ruin. Others might say that this is an efficient way to respond to crises: allow the government to do what it needs to do during the crisis, but use litigation to make an accounting to all of the stakeholders once the situation has stabilized. I don’t have a fully thought out view on this, but I am struck by the dangers of each approach. The first allows for various kinds of scapegoating (as Hank Greenberg argues in the AIG bailout litigation) while the second allows for the kind of revisionism that favors the wealthy and powerful (as with these Takings suits by powerful investors who bought Fannie and Freddie preferred shares on the cheap as a sort of long shot bet on what the two companies will look like going forward). Tough to choose between the two . . ..

The Taking of Fannie and Freddie 2

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Today, I look at one more complaint filed in response to the federal government’s amendment to its Preferred Stock Purchase Agreements with Fannie and Freddie (the PSPAs).  Cacciapelle et al. v. United States, filed July 10, 2013, is another takings clause case like the one filed by Fairholme the day before. The facts alleged in the complaint should be familiar to readers of REfinblog.com (here, here and here), although this is a class action complaint.

The plaintiffs state that the members of the class “paid valuable consideration to acquire these rights, and in doing so helped provide financial support for Fannie and Freddie, both before and after the conservatorship, by contributing to a viable market for Fannie’s and Freddie’s issued securities. Plaintiffs certainly had a reasonable, investment-backed expectation that the property they acquired could not be appropriated by the Government without payment of just compensation.” (4-5)

Now having read four complaints dealing with the same issue arising from the financial crisis, I am struck by the importance of narrative in litigation. Given that the federal government saved the Fannie and Freddie from certain financial ruin, we may label the Cacciapelle narrative the “Have Your Cake and Eat It Too” storyline.

One can well imagine the government’s version of events in its inevitable motion to dismiss.

Fannie and Freddie were at the brink of ruin.  We swept in, provided unlimited capital and rescued the companies, the housing market, the country and the world from the Second Great Depression.  To have the private preferred shareholders engage in Monday Morning Quarterbacking and focus on the details from the crisis response that harmed them, to have them ignore the competing concerns that were at stake for each of these critical decisions, adds insult to this injurious lawsuit.  Judge, do not succumb to this hindsight bias!

Let’s label this the Corialanus storyline.

These lawsuits have caught reporters’ eyes and will be well-covered in the press. I would look to see which narratives resonate and I wouldn’t be surprised if the dominant narrative finds its way into the judicial opinions that decide these cases.

Federal Government’s a Fairholme-weather Friend?

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Following up on my posts (here and here) about other suits against the federal government over its amendment of the terms of the distribution of dividends and other payments by Fannie Mae and Freddie Mac, I now look at Fairholme Funds, Inc. et al. v. FHFA et al., filed July 10, 2013.  The suit alleges very similar facts to those found in Fairholme Funds, Inc. v. United States, filed July 9, 2013, but the claims for relief are more similar to those found in Perry Capital, LLC v. Lew et al.

Here are some of the key claims made by the plaintiffs (owners of Fannie and Freddie preferred shares):

  • While the FHFA is the conservator of the two companies, it is acting acting like a receiver by “winding down” Fannie and Freddie’s “affairs and liquidating” their assets, while conservatorship should aim to return a company “to normal operation.” (15) The goal of the conservator, claim the plaintiffs, is to return the company “to a safe, sound and solvent condition.” (15, quoting Conservatorship and Receivership, 76 Fed. Reg. 35, 724, 35, 730(June 20, 2011)) As a result, plaintiffs argue that the Net Worth Sweep (which gives to the federal government substantially all of Fannie and Freddie’s profit) “is squarely contrary to FHFA’s statutory responsibilities as conservator of Fannie and Freddie” because it does not put them in “a sound and solvent condition” and it does not “conserve the assets and property” of the two companies. (25, quoting 12 U.S.C. section 4617(b)(2)(D))
  • “Neither Treasury nor FHFA made any public record of their decision-making processes in agreeing to the Net Worth Sweep.” (29) The plaintiffs argue that the FHFA’s “authority as conservator of” Fannie and Freddie “is strictly limited by statute.” (31, citing 12 U.S.C. section 4617(b)(2)(D)) As a result, the FHFA’s actions were “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” (33, quoting the APA, 5 U.S.C. section 706(2)(A))
  • The plaintiffs’ relationship with Treasury as Fannie and Freddie’s controlling shareholders is governed by state corporate law and thus Treasury owes “fiduciary duties to minority shareholders.” (38)
  • “Implicit in every contract is a covenant of good faith and fair dealing. The implied covenant requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.” (41) Plaintiffs argue that their contractual rights pursuant to their preferred shares have been breached by FHFA’s consent to the Net Worth Sweep.

The validity of these claims should not be assessed superficially. The courts will need to read HERA in the context of the APA and the amendment to the terms of the government’s preferred shares in the context of the contractual obligations found in the private preferred shares. The court will also need to assess the extent to which state corporate law governs the actions of the federal government when it is acting in the multiple capacities of lender, investor, regulator and conservator.  Let the memoranda in support and in opposition to motions to dismiss come forth and enlighten us as to how it should all play out . . ..

 

 

 

Fairholme or Foul? Investor Complaint Over Fannie and Freddie Preferred

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I recently reviewed the complaint filed by former Solicitor General Olson in Perry Capital LLC v. Lew and today I review the complaint in a similar lawsuit, Fairholme Funds, Inc. v. United States, filed July 9, 2013.  Fairholme filed another lawsuit the next day, Fairholme Funds, Inc. et al. v. FHFA et al., which I will review tomorrow. Whereas the Perry case alleged violations of the Administrative Procedures Act and the Housing and Economic Recovery Act of 2008 (HERA), the July 9th Fairholme case alleges that the United States must pay just compensations pursuant to the Fifth Amendment of the US Constitution for taking the plaintiffs’ property, by gutting Fannie Mae and Freddie Mac preferred shares of all of their worth.

As with the Perry case, the Fairholme complaint turns on whether an amendment to the government’s preferred stock documents which gave to the government all of Fannie and Freddie’s profits created a new security in violation of HERA.  In particular, the complaint alleges that by “changing the dividend on its Government Stock in this manner, FHFA actually created, and Treasury purchased, an entirely new security.” (5) This, it appears to me, is a highly contested claim.

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Evoking a famous Supreme Court case, the complaint also states that just “as the Federal Government cannot seize the assets of corporations (for example, the nation’s steel mills) for a public purpose without paying just compensation, so too it cannot seize the shares of stock in corporations to accomplish the same end.” (23) This implicit comparison to the Youngstown Steel case does not work as far as I am concerned.  In Youngstown Steel, the Supreme Court struck down President Truman’s exercise of his inherent authority to seize steel mills in order to support the Korean War mobilization.  Here, we have the federal government already knee deep in the affected companies.  Fannie and Freddie are government-sponsored enterprises; were placed in conservatorship; and have the federal government as their majority shareholders.

While the issues here are complex, my first read of the complaint is that the plaintiffs have a tough row to hoe even though the federal government may have upended preferred shareholders’ settled expectations.

Shadowed by the Shadow Inventory

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My former colleague at Seton Hall, Linda Fisher, has posted Shadowed by the Shadow Inventory:  A Newark, New Jersey Case Study of Stalled Foreclosures & Their Consequences on SSRN. The paper presents the findings of a small, but interesting empirical study.  The study “tests the extent to which bank stalling has contributed to foreclosure delays and property vacancies in” one neighborhood in  Newark, New Jersey. (6) Fisher states that this “is the first study to trace the disposition of each property in the sample through both public and private sources, allowing highly accurate conclusions to be drawn.” (6)

Fisher reaches “a similar conclusion to the previous studies with respect to stalling: without legal excuse or ongoing workout efforts, banks frequently cease prosecuting foreclosures.” (7) Fisher also finds that the stalled foreclosures in her study “do not strongly correlate with property vacancies.”(7)  Fisher claims that her findings “are generalizable to similar urban areas in judicial foreclosure states,” but I would like to have seen more support for that claim in the paper. (45)

As a side note, I found her description of foreclosure in New Jersey interesting:

The New Jersey foreclosure system provides a representative example of a judicial foreclosure regime, albeit one with heightened procedural protections for borrowers enacted into the state’s Fair Foreclosure Act. For instance, lenders must file a notice of intention to foreclose containing information about, inter  alia, the lender, servicer and amount required to cure, before filing a foreclosure complaint in court. Once borrowers are served with process, they may file a contesting answer and litigate the matter, as with any civil case. Because ninety-­‐four percent of New Jersey foreclosures in a typical year are not contested, the process is largely administrative and handled through a statewide Office of Foreclosure. Court personnel scrutinize bank evidence in support of default judgments. Borrowers may file late answers, and are responsible only for curing arrears and paying foreclosure fees up until the time of judgment. (14-15, emphasis added, citations omitted)

Because this blog has as one of its main focuses downstream litigation judicial opinions, it is important to remember how few cases actually reach a court room, let alone result in a written opinion by a judge.