Consumer Law & Policy Blog

What happens when lenders don't care if they are repaid?

by Christopher Peterson

In today's Wall Street Journal, Ted Frank, with the American Enterprise Institute, argues that the current meltdown in the subprime mortgage market justifies neither legislative nor judicial reform. In his view the market is currently adjusting to the problems in mortgage origination.  Everything will work out if we just leave the markets alone because "lenders have every incentive to lend only to those who can repay."

I disagree.  The current legal system creates the incentive for loan brokers and originators to (1)take large commissions and closing costs, (2) pass off bad loans to the secondary market, (3) distribute the revenue from lots of closings to management and employees, (4) wait for the bankruptcy code's preference window to close, then (5) declare bankruptcy when the secondary market tries to exert its recourse options.

Mr. Frank’s analysis ignores the agency costs of front line players in the industry, and it conflates the profitability of loan originating companies with the profits kept by the management of those companies.  While there is nothing inherently wrong with securitization of mortgage loans, or other financial assets, we must accept the reality that the current system of funding subprime mortgages does not preserve the traditional mortgage market’s underwriting incentives.  Instability and predatory lending will persist as long as the secondary market, and in particular, the investment banks that package mortgage backed securities can pass off bad loans to investors without fear of liability.

Two Consumer Lending Articles of Interest

I wanted to alert readers to two articles in today's USA Today, both concerning consumer debt.  This article is about the serious legal and practical difficulties faced by sub-prime mortgage borrowers who want to restructure their debt and avoid foreclosure.  And this article concerns New York Attorney General Andrew Cuomo's on-going antitrust investigation into the student loan market.  The investigation apparently focuses on unearthing exclusionary relationships between colleges and lenders.

Senate Committee Investigates Credit Card Company Practices

The Permanent Subcommittee on Investigations of the U.S. Senate’s Committee on Homeland Security and Governmental Affairs today held a hearing on “Credit Card Practices: Fees, Interest Rates, and Grace Periods.”  The hearing was, the committee promised, ”the first of several Subcommittee hearings that will examine a variety of credit card practices that raise concerns.”  Yahoo news has this lively report on the hearing.  The Senate Committee's website contains all of the testimony at today’s hearing.

Cleaning Up a Consumer Lending Mess

By Christopher Peterson

WHEN THE CEO of HSBC, one of the world's largest banks, and legal aid attorneys who represent poverty-stricken Americans find something to agree on, it is no small event. Recently, CEO Michael Geoghegan explained that massive losses in HSBC's home mortgage lending business were caused by the mistake of "going for volume." The nation's legal aid attorneys have a different description. They call it predatory lending.

Continue reading Boston Globe Op-ed   ...

New Jersey Supreme Court Issues Important FDCPA Decision

    By Brian Wolfman

    In Hodges v. Feinstein, Raiss, Kelin & Booker LLC, No. A-113 (1/31/07), the New Jersey Supreme Court held, by a vote of 4 to 2, that lawyers who regularly file summary dispossess (eviction) proceedings are “debt collectors” subject to the Fair Debt Collection Practices Act.  The majority opinion is worth reading for a number of reasons.  The key holding rejected the defendant law firm’s argument that the firm was not an FDCPA “debt collector” because “the sole remedy available in a summary dispossess proceeding is possession, not money damages.”  The court agreed that possession was the sole statutory remedy, but responded by relying, of all things, on reality: “We do not question the legislative intent to provide landlords a remedy of expedited possession. However, in practice, the summary dispossess action is also a powerful debt collection mechanism.”  Two justices dissented, agreeing with the law firm that because the only remedy sought was possession, the firm was not a “debt collector” under the FDCPA.

20/20 Takes on Credit Card Debt; Payday Lenders as Lions in the Economic Jungle, and More

by Deepak Gupta

Tonight, at 10pm EST, the ABC News Program 20/20 will air an episode entitled "Flat Broke: Begging And Borrowing In America."  I'm reliably informed that the segment will include interviews with prominent consumer advocates, including Professor Elizabeth Warren of Harvard Law School and a NACA member or two.  You can read one of the stories that will be featured tonight here.   The episode looks promising and seems to be part of a noticeable upswing in mass media coverage of credit and debt issues.

On the other hand, if you're familiar with the work of the conservative ABC News correspondent John Stossel, you won't be surprised to hear that--despite every indication that the rate of complaints against abusive and out-of-control debt collectors is skyrocketing--he was somehow able to muster a story that's largely sympathetic to the collection agencies; debt collectors, it turns out, are people too.  ("Is Debt a Four Letter Word?  Why Some Americans Need to Learn to Pay Up").  Along similar lines, The New York Times yesterday ran an astonishing column by the Cornell economist Robert Frank, comparing payday lenders to blameless lions in a jungle of lax credit--moral outrage against the industry, the author suggests, is misdirected; they're just following their Darwinian role preying on weaker members of the community.

Not So Cute Anymore

by Christopher Peterson

Gary Coleman endeared himself to Americans as a child actor staring in the 80's sitcom "Different Strokes". His cherubic face and affably excitable character reliably delivered punch lines, including especially his signature catchphrase "Whatchoo talkin' 'bout, Willis?"  When his television show ended, Coleman found that his parents and manager had mismanaged his multi-million dollar trust fund, eventually leaving him penniless.

I always felt sympathy for the actor, who suffers from a congenital kidney disease, as he tried to break out of his childhood typecasting and find a satisfying path in life. Still, it raised my eyebrows when I learned that Mr. Coleman had accepted a job as a spokesperson for Cash Call, Inc., a California based finance company that makes high-interest, unsecured loans to consumers in California, Idaho, Nevada, New Mexico, and Utah. In most other states Cash Call also acts as a solicitation agent for First Bank & Trust, Milbank, South Dakota.

This three-way relationship brought a couple of thoughts to mind:

First, lenders have a tendency to focus on economics when they talk about public policy. Discussions of usury law, disclosure law, and bankruptcy seem to inexorably turn to concepts like opportunity costs, Pareto optimal outcomes, and regulatory distortion. The intellectual contributions of behavioral economists are generally scorned or minimized. But lenders do seem to rely on psychology when they talk to their customers. Mr. Coleman is valuable to Cash Call and First Bank & Trust because of his notoriety. It is not as though loans from by a firm endorsed by Gary Coleman are better or cheaper loans. Rather they employ him because he is salient in the minds of millions of people who watched him on television back in the good-ole’ days. Mr. Coleman reminds us that things don’t always work out, and that even former TV super-stars do not need to feel bad about borrowing money from a shady company like Cash Call now and then. (Go to ripoffreport.com and search under "Cash Call" for a long list of upset customers, including this one or this one.) Mr. Coleman is an ideal spokesman for a company that wishes its customers to lower their guard. After all, who wouldn’t trust cuddly, little "Arnold" from TV?

A second point. In an essay forthcoming in the American Law Review, I question the wisdom of granting federal preemption to agents of chartered depository institutions. According to the Office of the Comptroller of the Currency and the Office of Thrift Supervision, independent agents of national banks and thrifts should be regarded as beyond the regulatory and legislative oversight of state governments. The FDIC is considering an attempt to grant similar powers to state banks, such as First Bank & Trust, Milbank, South Dakota. Federal regulators have explained that state governments should not be allowed to regulate national banks and thrifts simply because the financial institutions chose to deliver services through an agent. But as Cash Call’s relationship with First Bank & Trust demonstrates, non-depository agents will always tend to have less incentive to forego predatory behavior than a depository institution with closer oversight, greater capital requirements, and relatively greater investment in reputational capital. If First Bank & Trust wants to use Gary Coleman to peddle their high-interest loans, shouldn’t they be required to hire him directly, rather than hiding behind an agent?

In the end perhaps Mr. Coleman still deserves our empathy. I suspect he is being used yet again.

Does Serving a Summons Trigger the FDCPA's Validation Notice Obligation?

by Jeff Sovern

Earlier this month, Richard Alderman blogged about the amendments to the Fair Debt Collection Practices Act that have since been signed into law.   In particular, he noted that one of the provisions amends § 1692g, the validation provision, to add a new subsection(d) which provides that a “communication in the form of a formal pleading in a civil action shall not be treated as an initial communication for purposes of subsection (a).”  The effect  is to provide that attorneys serving a complaint need not provide the validation notice because the obligation to supply the validation notice is triggered by “the initial communication.”  OK, that's it for complaints.  But complaints are often accompanied by a summons.  Does the exception include a summons?  A summons is not usually thought of as a pleading, much less a “formal pleading,” and the definition of “pleadings” in Federal Civil Rule 7(a) does not include a summons.  The FDCPA does not define “pleadings.”  It would make little sense to have an exception for complaints and not a summons, and yet that seems to be where the text of the statute takes you.

The issue arises only if a summons is an initial communication.  Before the recent amendment, courts had split on whether a complaint qualified as an initial communication.  Compare Vega v. McKay, 351 F.3d 1334 (11th Cir. 2003) with Thomas v. Law Firm of Simpson & Cybak, 392 F.3d 914 (7th Cir. 2004).   Communication is defined in the statute as “the conveying of information regarding a debt directly or indirectly to any person through any medium.”  A plain meaning interpretation would, it seems to me, regard a summons as a document that communicates information.  I suppose it could be argued that the summons in a suit based on a debt conveys the information that a case has been commenced rather than information about a debt, but this strikes me as a stretch, especially given the word "indirectly."   

If an attorney did include a validation notice with the summons, might the summons overshadow the validation notice?  See In re Martinez, 266 B.R. 523 (B.S.D.Fla.), aff’d, 271 B.R. 696 (S.D.Fla. 2001), aff’d 311 F.3d 1272 (11th Cir. 2002).  Another interesting feature of the statute is that it codifies the overshadowing rule, in a new last sentence of § 1692g(b).

Update on FDCPA Amendments

The amendments to the Fair Debt Collection Practices Act that Richard Alderman blogged about here have been signed into law and can be found at Title VIII of Public Law No.109-351.  Here is the final text of the amendments.  (A side note: Co-blogger Deepak Gupta will be speaking about these amendments at the National Consumer Law Center's annual conference in Miami next month.)

ABA eJournal Report on Brown v Card Service Center

Last week, Brian Wolfman blogged on Brown v. Card Service Center here.  Now the ABA eJournal has weighed in with an article as well.