Governor Randall S. Kroszner testimony

Federal Reserve Governor Randall S. Kroszner recently testified on the effects of the credit crisis on small businesses at the House of Representatives Committee on Small Business. Not surprisingly, Kroszner said that small businesses are finding that loans are available on less favorable terms and subject to tightened standards. Kroszner seemed hopeful that the variety of programs recently implemented, though uncertain, should help small businesses.

Krozner's more extensive comments are available on the Federal Reserve website. Both written and verbal comments reflect an honesty about the uncertainty of our economic times and how this might impact small business. Although a "Black Friday" sale at a Wal-Mart in New York lured 2000 persons who trampled one man, small retailers were less busy on what should have been a busy day. Small businesses are struggling with a slow economy and credit crunch (see National Small Business Administration Mid-Year Economic Report 2008).

The common theme that I see with the Treasury and Federal Reserve programs so far is that the programs are designed to re-building our economy without tackling the choices that landed us here. The programs are also targeted at the broader markets as a whole, hoping that they will have positive effects on consumers, homeowners and small business. As Kroszner mentioned, this has not happened yet. While many of us are harsh on the auto execs for their handling of the proposed Big 3 bailout, perhaps they really do have a point to make. Individual companies and industries beyond banking have also been hit hard by the financial crisis as a whole. We might be willing to allow the Big 3 to enter bankruptcy, but they won't be alone in ending up there.

— JSM

SNL Detroit Skit

Since we've been blogging about the proposed auto bailout, I wanted to post the SNL opening skit on the proposed bailout of the auto industry. Unfortunately, NBC did not post this skit on its site. I did find part of the skit, in case you missed it.

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Although the skit is a tad harsh, it does bring home the message that the U.S. auto industry must address regarding the perception of lagging quality of automobiles produced by the Big 3. As I said before, this really is about cars. Over at the National Small Businesss Association (NSBA), 80% of respondents said "no" to an auto manufacturer bailout. Without convincing Congress that the manufacturers have a solid plan, a bailout seems unlikely. Either the auto manufacturers will find a way through without federal help, or bankruptcy seems more likely than ever.

— JSM

Bankruptcy Bill

For those needing a little humor this holiday season, check out the comic strip Bankruptcy Bill.

Happy Thanksgiving to all!

— JSM

Call for papers: Searle Center

CALL FOR PAPERS
SEARLE CENTER ON LAW, REGULATION, AND ECONOMIC GROWTH:
SECOND ANNUAL RESEARCH SYMPOSIUM ON ECONOMICS AND LAW OF THE ENTREPRENEUR

The Searle Center on Law, Regulation, and Economic Growth is issuing a call for original research papers to be resented at the Second Annual Research Symposium on The Economics and Law of the Entrepreneur at Northwestern University School of Law. The Symposium will run from approximately 12:00 P.M. on Thursday, June 11th to 3:00 PM on Friday, June 12th, 2009.

The goal of this Research Symposium is to provide a forum where economists and legal scholars can gather together with Northwestern's own distinguished faculty to present and discuss high quality research relevant to the economicsand law of the entrepreneur.

SUBMISSIONS/PARTICIPATION: Authors should submit their papers at:
Email: MAILTO:searlecenter@law.northwestern.edu

Potential attendees should indicate their interest in receiving an invitation at: MAILTO:searlecenter@law.northwestern.edu

Authors will receive an honorarium of $1,500 to cover reasonable transportation expenses. Discussants will receive an honorarium of $500 to cover reasonable transportation expenses. Government employees and non-US residents may be reimbursed for travel expenses up to the honorarium amount. Authors and discussants are expected to attend and participate in the full duration of the symposium.

The Searle Center will make hotel reservations and pay for rooms for authors and discussants for the night of Thursday, June 11th. The conference is organized by Professor Daniel F. Spulber, Research Director, Searle Center Research Project on Innovation, Entrepreneurship, and Growth, and Henry N. Butler, Executive Director, Searle Center on Law, Regulation, and Economic Growth, Northwestern University School of Law.

REVIEW PROCEDURE AND TIMELINE:

Conference Papers Submission Deadline: To ensure that attachments get through, papers for the conference should be submitted to both of the following email addresses:

Email: MAILTO:searlecenter@law.northwestern.edu

Email: MAILTO:d-gundersen@law.northwestern.edu

by March 15, 2009

Notification Deadline: Authors will be notified of decisions by April 1, 2009 Honoraria will be paid to conference presenters upon submission of a revised paper that the author is willing to put on the Searle Center website.

Potential attendees, potential discussants, or panel members should send a message indicating their interest to:

Email: MAILTO:searlecenter@law.northwestern.edu by March 15, 2009. The conference is organized in cooperation with the Journal of Economics & Management Strategy (JEMS). JEMS encourages submissions on the economics of the entrepreneur. Submissions are independent of the conference. Authors are free to publish their work in other venues (with appropriate acknowledgement of the Searle Center). To submit to the Journal of Economics & Management Strategy, send the paper in pdf form to: CONTACT: Alice Schaller Email: MAILTO:editjems@kellogg.northwestern.edu

Papers prepared for the Research Symposium on "The Economics and Law of the Entrepreneur" will be permanently hosted on the Searle Center website: http://www.law.northwestern.edu/searlecenter

The Searle Center on Law, Regulation, and Economic Growth at Northwestern University School of Law was established in 2006 to research how government regulation and interpretation of laws and regulations by the courts affect business and economic growth. Information on the Searle Center's activities may be found at: http://www.law.northwestern.edu/searlecenter

— JSM

A New Federal Reserve Program: This Time for Consumers

Today, the Federal Reserve also announced the Term Asset-Backed Securities Loan Facility (TALF), another program in the line of snappy acronyms. The Fed intends the TALF to help market participants to meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA). The aim here is that if the Fed buys up some new and recently issued ABS, then lenders will turn around and relend the money to consumers who desire a student loan or a new car. Now, this program probably won't get really going to perhaps February, so consumers should not be expecting credit markets for consumer loans to ease in the immediate future. That said, some program for consumer credit is needed. But, is this the right one?

As a law professor, I can say that I want students to be able to get their student loans without too much hassle. Although I am not a big fan of excessive consumer debt, there is a need for credit to be available. The Fed's TALF program in its announced form is a continuation of the ABSs that have helped us to arrive at the financial crisis that we are in now. Some time ago, Alan Greenspan mentioned the problems arising from lenders incorrectly pricing ABS when they retain no stake in the ABS after sale. Basically, the risk models are prone to error in these cases. Though we don't have the details of the TALF program, I don't see any indication that the Fed is tackling this problem. This means that the risk problems inherent in our current financial crisis from securitization may remain with the TALF program as well.

So, for the next few months while credit remains tight, perhaps Americans will pay down those credit cards. Adding new credit come February when the Fed's TALF takes hold? Perhaps, but let's think carefully about it.

— JSM

Help for Housing?

Today's housing news is grim. The S&P Case-Shiller Home Price national index reports a whopping 16.6% decline in the third quarter (compared to last year same time). The happy news here is that the Federal Reserve has just announced another program, this time to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs). That is: Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Not surprisingly, the aim here is to lower the cost of home mortgages and increase availability in an attempt to stabilize the housing market. Not much on details yet, but this is the first major effort towards housing. Although much effort and attention has been on the health of the banks, the housing market has been waiting there, problematic as ever, needing attention. The Federal Reserve is overdue in tackling housing, but its not like they've not been busy.

— JSM

Bankruptcy as "Digging a Hole Far Too Deep"?

Photo by coljay72

People just don't seem to understand bankruptcy. Given the smear campaign of recent years, it's not surprising that consumers would fear and distrust a "bankruptcy" filing by GM and Chrysler. But today, a key leader with decision-making authority on the future of the U.S. auto industry seems to have revealed her own misunderstanding. House Speaker Nanci Pelosi rejected a GM/Chrysler bankruptcy as "digging a hole far too deep."

I've got news for Nanci and others who might feel this way: GM and Chrysler are already in a "hole far too deep." Bankruptcy is not the cause of financial ruin; it's a response to the financially ruinous situation in which debtor-companies already find themselves. Indeed, bankruptcy in the form of U.S. Chapter 11 (and a growing number of similar laws around the world) is a response designed to overcome the problems that GM and Chrysler face, to facilitate a rehabilitation and get them out of the hole. It accomplishes this, in part, by making it starkly apparent that the end is nigh unless everyone stops playing chicken and seriously considers the shortest "haircut" they're willing to take (that is, the best concessions they're willing to offer to save the company), and irrational holdouts can get a deal "crammed down" on them by a majority vote of the more deal-welcoming creditors. Lenders, bondholders, suppliers, employees, retirees, shareholders, etc., all are forcefully seated at a "no B.S. zone" bargaining table and sternly instructed that if they leave, there's a cliff on the other side of the door.

The "hole far too deep" is where GM and Chrysler are now and where they and their various constituencies (not the least of which the U.S. economy) will be if solutions like a bankruptcy-like workout are not seriously considered . . . and soon.

That being said, for the reasons I mentioned before, I'm afraid an irrational overreaction by the market for GM/Chrysler's products might well scuttle its business if a Chapter 11 filing is made. The solution points up the misunderstanding inherent in Pelosi's comment: GM and Chrysler are already in what might be called informal bankruptcy. Either they respond to Harry Reid's demand to produce a workout proposal that the Treasury can fund by the beginning of December (an out-of-court workout, an informal "bankruptcy" that keeps that psychologically troublesome word out of the press), or they face literal "bankruptcy," which would strengthen the debtor-companies' hands with respect to their creditors, but might well destroy the "goodwill" upon which their business depends. Either way, GM and Chrysler are already in a "bankruptcy" hole, and their leaders and advisers need to go back to Capitol Hill, this time with a serious proposal for a sustainable workout, not just a handout.

The Rising Islamic Finance

Islamic Finance: A Guide for International Business and Investment (November 2008). This new book produced in association with the Institute of Islamic banking and Insurance, London, and released this week, provides valuable information to international investors and finance professionals about opportunities in the Islamic Finance sector, which is steadily growing at an annual rate of 10 to 15% and commands investments of nearly $800bn.

Islamic financing, still in an early developmental stage, departs from conventional financing in three fundamental ways. First, Islamic financing refrains from investing monies in interest-bearing instruments. This is so because the Quran prohibits charging interest on loaned monies. Second, Islamic financing refrains from investing in speculative investment products, such as options, futures, and derivatives. Third, Islamic financing refrains from investing in companies that manufacture or distribute socially harmful products, which may include weapons, liquors, and contrabands. Although these principles carry several exceptions, Islamic financing is markedly distinguishable from conventional financing. "And, at a time, when derivatives-based markets have failed, Islamic financial instruments, based on the firm establishment of underlying assets are going to be ever more popular."

The book introduces Islamic Finance, explains investment products including mortgages, trade finance, investment banking, Islamic insurance, and explores important regulatory issues. AK-IF

About cars and airplanes

I am guessing you've heard the whole business about the auto executives using private jets to fly to Washington, D.C. for hearings on the bailout of the auto industry. Yesterday, Jason Kilborn blogged about the problems of encouraging bankruptcy when we normally avoid it at all costs in his post Little Guys v. Big Three in Bankruptcy. Things got beyond the issue of bankruptcy v. loan yesterday for the auto execs on Capital Hill making their plea for a $25 billion bailout. At the House of Representatives, Gary Ackerman (D) and Brad Sherman (D) blasted the executives for flying on private jets, rather than taking commercial flights.

Although the private jet expenditure might be unwarranted, this has become a distraction from the real issue. As Jason mentioned, there are questions about whether the auto makers can be competitive in the long term such that the $25 billion bridge loan requested is not just wasted. Loan terms are really a matter of contract. If the big three are really in dire straits, the government can (should be able) to dictate loan terms at will, from management changes and limits on compensation to forcing renegotiation of union contracts to more fuel efficient cars. Yes, this is really about cars, not planes.

— JSM

Commercial Law Welcomes L. Ali Khan as Guest Blogger

Commercial Law is pleased to welcome L. Ali Khan as a guest blogger. Khan is a professor of law at Washburn University School of Law School where he teaches Payment Systems, Secured Transactions, International Law, International Business Transactions, Arbitration and Law and Human Rights. He has published books in the series Developments in International Law and much of his academic scholarship raises issues under Islamic law and conflicts involving Muslim communities. Ali also is the founder of the Islamiclawblog. One of his most recent articles, A Theoretical Analysis of Payment Systems, which will appear in the South Carolina Law Review, argues that modern payment systems, though different, should share a common theoretical basis.

We welcome Ali's insights on payments doctrine, Muslim communities and other issues.

— JSM

Little Guys v. the Big Three in Bankruptcy

Photo by gemsling

We've really wedged ourselves between a rock and hard place with all the bankruptcy reform rhetoric of the past few years. Now that we've convinced many consumers that bankruptcy is to be avoided at all costs and can never be an acceptable part of responsible financial administration, we really need to convince them that a bankruptcy by GM and/or Chrysler would be an O.K. thing--indeed, a normal market mechanism for regulating their financial distress, far superior to government intervention. As far as I can tell, the only real problem with using the world-famous Chapter 11 to solve GM/Chrysler's problems (just as we did successfully for Continental airlines, for example) is that consumers would react irrationally, equating a Chapter 11 filing (reorganization with a view to renewed financial health) with "going belly up" or some similar rhetoric of "failure." So bankruptcy is no good for David, but it's O.K. (probably essential) for Goliath, but in an ironic twist, Goliath's business depends upon lots of Davids buying Goliath's goods, and policymakers have bent over backwards to convince David that a bankruptcy filing always reflects poorly on the filer. What a mess!

O.K., there's one more big problem. Businesses are finding it harder and harder these days to reorganize in Chapter 11 because they can't find debtor-in-possession (DIP) financing to support their turnaround efforts. If average businesses can't find DIP financing, where do you think GM/Chrysler can turn for a loan . . . ? The Treasury, of course!

So at the end of the day, lawmakers on Capitol Hill have been loudly rejecting calls for a non-bankruptcy workout loan (or other rescue infusion of cash) for GM and Chrysler, but the Treasury would be the most likely (perhaps only) financier of a GM/Chrysler bankruptcy . . . and going into bankruptcy would produce (arguably) irrational resistance by customers who would be repulsed by a GM/Chrysler bankruptcy filing.

Seems to me we ought to get off of this merry-go-round with an out-of-bankruptcy restructuring for GM/Chrysler, funded by loans from Uncle Sam, assuming Uncle Sam's analysts can conclude that GM and Chrysler have some hope of a sustainable, competitive business down the road. That's the big question, and an interesting article in today's W$J on the latest report concerning residual value suggests that GM and Chrysler have a serious burden to carry in convincing Uncle Sam that they can make decent cars and government financial support for their business in or out of bankruptcy is warranted.

Paulson and Bernanke on Capital Hill

It was a big day today as both Henry Paulson and Ben Bernanke testified about the $700 billion bailout. Bernanke's testimony is available through the Federal Reserve. Bernanke highlights the actions taken and specific programs put in place, as well as the recent statement on lending to creditworthy borrowers. I don't have the full video of the proceedings yet, but here is a piece of it.

— JSM

Faster Check Processing in the 7th District

The Federal Reserve today announced that the Des Moines branch office would no longer be processing checks for collection. Instead, the checks will go directly through the Chicago head office for the District. An interesting twist for us teaching check collection is how this affects the time in which banks must make funds available to depositors under Regulation CC. As a result of the change, some checks that would be considered "nonlocal" will now be "local" checks subject to a more speedy funds availability rule. Under 229.12 depositary institutions must make funds available for withdrawl not later than the second business day following the banking day of deposit for local checks. For banks using a delayed availability policy, this change will mean depsitors will get access to money earlier.

This change is not the first of this type, as the Federal Reserve has already begun consolidation of check processing offices. In the end, the Federal Reserve will retain only four check processing regions, making many deposits available earlier as more checks will be "local."

— JSM

Would the "Current" Article 3 Please Stand Up!

Time for a hard-core commercial law teaching post. This week, I'm covering suretyship defenses, including those available to accommodation parties under UCC § 3-605. The problem is that the statutory supplement and book that I use refer to the 2002 revised version of UCC Article 3, especially § 3-605, as the "current" version. One would think a 6-year-old revision would be "current," but the problem is that only 7 states have adopted the revision. My state (Illinois) is not one of those (they are Arkansas, Kentucky, Minnesota, Nevada, South Carolina, Oklahoma, and Texas). The "old" and "current" versions of § 3-605 are quite different in at least one important respect (release of principal obligor), so what to do?

I've decided to compare the real "current" version (the pre-2002-revision one) with the "revised" version of § 3-605 (see Class no. 24). This is a lot of work, because the section is complex, but I think it's useful to emphasize the separation between the UCC as model law and the state-adopted form of the model, which are not always the same. To make matters worse, Illinois (and 18 other states) use the Multistate Essay Exam instead of testing specific state commercial law. It is not clear whether the Illinois examiners want students to apply the pre- or post-revision version of § 3-605, and wouldn't you know it, a question on this very point appeared on the bar exam relatively recently. Grrrrrrrrrr!

Are others encountering this problem, and if so, what do you do?

IMF's Post-Crisis World Economy

John Lipsky, First Deputy Managing Director, International Monetary Fund, has been a pretty busy guy these days. His speech "Towards a Post-Crisis World Economy" at John Hopkins today is no exception to his assessment to the "seriousness" of the financial crisis. The text of his speech can be read on the IMF web site. Importantly, Lipsky remarked:

[T]here is no sign yet of a fundamental reversal of the financial market dislocation and deleveraging that represents both a sign of and a contributor to the still unfolding global economic strains. To the contrary, the virulent combination of financial stress and shrinking advanced economy demand is impacting emerging economies, with potentially significant negative effect.

Lipsky has previously stressed the involvement of the United States in the world economy with a "coherent approach" by the countries as a whole. The crisis has presented particular problems for emerging economies.

Perhaps this was to soften Today's news about emerging economies. We've already blogged here about the problems of Hungary and Iceland (See Hungary Following the Way of Iceland). Iceland's economic woes have continued to grow in the wake of problems with European regulators over guarantees for depositors who lost money after Iceland banks failed last month. As mentioned before, Iceland is not alone. Pakistan can be added to the group of countries receiving aid from the International Monetary Fund with its deal for a $7.6 billion loan to help stabilize its economy, but may need double that amount.

Like the United States Treasury these days, the IMF seems to be giving out loans at an unprecedented rate. John Lipsky is busy for a pretty good reason. The emerging economies are in considerable difficulty with the financial crisis. The financial crisis has revealed perhaps more than ever the important work that the IMF does and its role in crisis response. This is by my estimation an important time for the IMF to establish itself as a key policy maker both in terms of helping to shape economic policies going forward through its loan restrictions and in working with the G-20 to respond to the financial crisis. It is too early to tell the strength of the role the IMF may have in the world economy following the financial crisis, but I suspect its influence will be expanded.

— JSM

University Endowments and the Financial Crisis

As a Vanderbilt University Law School alumni, I receive all sorts of miscellaneous emails related to the university. Recently, I received an email titled "A Message on the Economy from Chancellor Zeppos." Chancellor Zeppos, who I had for Civil Procedure as a first year law student, commented:

Vanderbilt is strong and sound, and [that] our progress will continue. In fact, a number of leading analysts have noted in public reports that, among our nation's great universities, Vanderbilt has set the standard for managing with clarity and speed the potential impact of unforeseen gyrations in the stock and credit markets.

Zeppos referenced his message to the Vanderbilt community. Surprisingly, despite the economic turmoil, Vanderbilt's endowment has returned 2.1% this year. This may be small compared with the prior two years' returns of 14.6% and 15.2%, but a small positive number is always better than negative.

So, how are university endowments faring in this financial crisis?

1. University of Texas has reported losing $1 billion so far in 2008.


2. Harvard has not said how much it has lost, but that it will be reassessing expansion plans.


3. Dartmouth has lost $220 million.


4. Yale will either have slow growth or maybe "post a loss" for 2008 and is recommending budget plans be conservative.


5. Cornell announced a "loss of revenue" in a general sense.


6. Columbia's endowment has "suffered" and will have to "make some choices" about resource allocation.


7. Loyola University - Chicago reported losses to its endowment back in early October of more than $30 million


8. University of Chicago will post a "serious decrease" on its endowment.


9. Northwestern reports its endowment being "hurt" by recent market declines.

So what does all this mean? Most of these schools were careful not to deliver all the bad news about the endowments right away. Probably a good thing, as the depth of the decline may not even be fully known now. Happily, the same university reports of declining endowments, though, are being met with what appears to be fiscal conservatism. That is, universities are reassessing new plans and looking over budgets to trim costs. This all sounds good to me in economic hard times.

But then today, I read in the Wall Street Journal that the compensation of university presidents was actually on the rise. The top ten list goes from Carl Patton at Georgia State University making $727,487 to E. Gordon Gee at Ohio State University making $1,346,225 for 2007-08. Even public university presidents were up about 7.6 percent over the prior year. Although retention of key personnel is important to universities, the current financial crisis should be a call to universities to trim compensation when faculty and staff salaries are remaining flat.

Today's announcement by Goldman Sachs key executives to forgo their 2008 bonus compensation should be a message to all that hard economic times are here. Certainly, universities will be trimming budgets to meet the financial crisis and declines in endowment value and revenues. Following the lead of Goldman, some university presidents might find themselves following suit on compensation.

— JSM

Bailments

A post on teaching bailments as an aspect of agricultural law appears on the Agricultural Law Blog, here.

Paulson says more is needed

Treasury Secretary Henry Paulson spoke this week. Jason Kilborn's post on Ray of Light for Those Feeling Grouchy does a good job of calling Paulson on the rhetoric about lending. That said, the government is clearly worried that targeted action has been taken without results. Credit markets are still tight, enough that the Federal Reserve issued a joint statement with the FDIC, Comptroller of Currency and Office of Thrift Supervision reminding banks of their important position in the economy as lenders recently in their Interagency Statement on Meeting the Needs of Creditworthy Borrowers. This seems a simple principle, but as Jason Kilborn remarked here lately, What's the Holdup?

Paulson's talk was quite lengthy, but he did deliver the message that the problems of the auto manufacturers are not within the scope of the TARP (Troubled Asset Relief Program). This leaves a pretty big issue on the table, which must be addressed. If auto is not in the scope of TARP, then separate intervention is inevitable and necessary. That does not mean, though, that it will actually happen. It seems politically difficult, at least under the Bush Administration as many Republicans oppose aid for the automakers.

In case you missed Paulson's talk, here it is:

— JSM

Rays of Light for Those Feeling Grouchy

Photo by willgame

If continued rockiness in the credit markets and broad economy have you (like me) feeling a bit grouchy, the convergence of a few news stories recently seems to offer cause for a bit of optimism.

LIBOR continues its downward trend, with the 3-month dollar rate setting this morning at 2.13%. On the one hand, this is oddly high, especially given that the money markets seem to be awash in liquidity, with investors shying away from auctions of year-end money from the Treasury! On the other hand, this is almost 275 bps better than during the vertigo-inducing days of the recent past. Incidentally, 3-month LIBOR has fallen in surprising parallel with gas prices, with the national average per gallon settling at a 21-month low yesterday of $2.20 per gallon. Good news already!

Despite this improvement, as I noted earlier, banks still are not passing this greater liquidity through to the markets that need it. Paulson today exhorted banks to step up and "play their necessary role to support economic activity," but one wonders how powerful this kind of rhetoric can be. If the banks took hundreds of billions from Treasury and hoarded it, knowing full well that the money was passed out to stimulate lending and offer the economy a much-needed liquidity infusion, what makes Paulson think his telling banks to lend will make a difference? I hope I'm wrong, and the banks will react to Paulson's entreaty, but call me a skeptic.

While Paulson's words don't offer me much hope, his deeds offer a little. He announced that the TARP program in its original design will be more or less scrapped, which looks a really good development. If banks want to deal with their "toxic" mortgages and MBS, they (and the servicers on the front lines of battling the foreclosure crisis) need to take a big, bitter dose of reality and start modifying mortgages to keep these properties out of foreclosure. Recent initiatives on this front announced by the biggest banks seem to represent a very positive step, as does the Freddie/Fannie push for modifications announced yesterday (though Alan White's criticism of that program seems compelling). In another great post, Alan points out why servicers, investors, and banks really need to get in line for a realistic haircut on these troubled loans, take responsibility for minimizing their own (and the broader economy's) losses, and clean up their own mess without externalizing these problems onto taxpayers and the economy.

Paulson's new plan for using the TARP facility seems to me to be better targeted toward fixing what really ails the U.S. economy now--consumer confidence, closed pocketbooks, and inability to get loans to leverage future earning capacity to support smoother current spending. This kind of consumer investment (spending) represents 2/3 of our economy, so juicing this sector sounds like a great idea. Again, more careful underwriting of consumer credit extension is clearly needed, but if liquidity is to find its way into the system to do the most good, the consumer portal seems like a more direct and immediately effective point of entry.

I am impressed by the agile and flexible way in which Paulson and the other managers of this rescue plan have considered options, quickly abandoned ones that didn't seem to work, and moved on to alternatives that offered better prospects. This resistance to getting bogged down by sunk costs and inertia is, it seems to me, the heart of vibrant entrepreneurialism. This kind of pragmatic flexibility is what has made the U.S. economy so great, in my view. I am hopeful that this kind of agile entrepreneurialism will bring us through these tough times.

Circuit City's Gift Card Redux!

Earlier this year, we heard lots about gift cards when Sharper Image went into bankruptcy. In the end, customers only partially lost out: to use a gift card they had to make double the purchase. So, a gift card for $50 could be used on a purchase of $100 or more.

Today, Circuit City, one of my favorite stores for customer service and service plans, filed for Chapter 11 bankruptcy. Of course, many consumers own gift cards for Circuit City and other troubled retailers. Gift cards may look like everything else in our wallets, but are not. Gift cards are really just unsecured debt. The consumer gives Circuit City money in exchange for the gift card, which is merely a promise to supply goods later. The consumer is just an unsecure debtor of Circuit City, which means if the company goes bankrupt the consumer may lose out. Circuit City has asked the Bankruptcy Court for permission to honor the gift cards. With the holidays looming ahead, gift card sales can be an important sales tool for a retailer whose customers want the chance to take advantage of after holiday sales by purchasing gift cards for loved ones. Circuit City's bankruptcy should remind consumers of the fragile state of gift cards at a time when credit is already tight. Consumer's desire for low cost gifts for family will be pitted against the risk of company failure that might make a gift worthless. Cash, as impersonal as it is, may win out over gift cards this year. Let's add to the many things needing attention is some protection for consumers who are lending to companies through the use of gift cards.

On a broader note, history shows that unless the credit markets unfreeze, consumer confidence is restored and consumers have money to spend, we will see more like this. The past week has revealed to us:

• U.S. auto makers on the brink of failure with GM stock trading at 60 year lows,
• more money needed for the AIG bailout (now at $150 billion),
• Amex becoming a bank holding company to better weather volatility and gain access to bailout funds,
• Bank of America announcing that it is assuming $16.6 billion of Country Wide's debt as part of its purchase of the troubled lender,
• Fannie Mae lost $29 billion this quarter,
• Google stock down 55% this year, and
• Starbuck's, my favorite home of the perfect coffee, reported weak earnings and will close some stores.

I could go on with more, but the point is that it is a tough world out there right now. The bailout needs more time to take hold, but for now we all better hang on for more bad news.

— JSM

Port 121 at Seabridge Marina - Oxnard, CA

Port 121 at Seabridge Marina

Port 121 is part of the master planned community at Seabridge Marina. It is probably one of the last major residential communities to be approved by the California Coastal Commission for the foreseeable future. The Seabridge Marina takes advantage of breath-taking mountain views, easy ocean access and world class shopping, culture, and recreation within a few minutes drive.
The Channel Islands National Park is a 20 mile boat ride off the coast to the West.

As I write this on 8 November, 2008 the Weather Channel is reporting over 12 inches of rain in parts of Washington State, near-record snow fall in South Dakota with drifts high enough to trap home owners inside, and cold winds blowing through Chicago. Here in Ventura County we are enjoying clear, sunny skies, with temps in the high 70’s and low 80’s. It is not difficult to understand why people move here from all over the world.

Seabridge Marina new home communities are being offered at very competitive prices compared to the older harbor side communities in the LA Basin. If you like yachts, backdoor mooring for your yacht and a fabulous clubhouse / pool complex – Seabridge Marina is a real eye-opener. If you want a luxury loft style living space, Port 121 at Seabridge Marina is really the only game in town.

Port 121 is a Townhome complex made up of two buildings – Phase 1 and Phase 2 - fronting on the Marina Village area of Seabridge Marina. The first building – Phase 1 - is rapidly nearing completion with 35 units. Sales began in July and there are 24 units still available as of early November 2008. That means these homes are selling at a rate of about 3 a month. None of the units will be available for move-in until early 2009. These first 35 units are scheduled for completion sometime between January and March.

Phase 1
Phase 1 is a three story building with keypad security and elevator access. There are 8 floorplans which include first floor live/work units combining business office space with second floor quarters. The office units have already sold out in Phase 1. The majority of the units are residential and include single story and two story loft homes. These homes are being offered with a long list of luxury upgrades included standard. A few of these upgrades include:

- “Metro Maple” European style cabinetry
- Living Room and Master Bedroom pre-wired for plasma tv’s
- Video/Audio system including interior inside monitor for visitor communication and access
- Category 5 high speed data transmission wiring at all Bedrooms, Loft, Living Room and
Kitchen (per plan). Fiber optic cable with central hub included in each residence

Gourmet Kitchens include:
- Whirlpool Gold stainless appliance package, including:
- Self-Cleaning slide-in Gas Range
- 1.7 cubic ft. family capacity microwave hood combo
- 4-cycle, 5-level dishwasher with optional settings
- Granite Countertops with 6” backsplash
- Australian stainless steel sink with stylish Delta Chrome faucet
- In-Sink-Aerator disposal
- Spacious Pantries (per plan)
- Convenient Center Island (per plan)

Master Suite Baths include:
- Granite Countertops at both bath vanities.
- “Laguna” square sinks with striking chrome bath hardware and accessories
- Attractive tile shower/tub surrounds including shower enclosure with matching chrome
Accents.
This is just a very small sampling of the many upgrades included as standard with Phase 1. The cost of these upgrades has been heavily subsidized by the builder to get people interested.
Not all of these upgrades will be included as standard in Phase 2 !!!!

Also, it is important to know what is not included in either phase:
- You must buy your own Refrigerator
- Washer and Dryer - The washer and dryer must be a stackable unit.


Phase 2
Phase 2 will be twice as large as Phase 1 with 75 units and 4 stories. Where Phase 1 had only 2 water view units, Phase 2 will have 17 water view units. Phase 2 construction has been halted at the foundation and will not resume until sometime near 2011. These units are premium locations at Seabridge and the hope is to be able to offer them when the market is stronger and the builder can more easily justify higher prices and recoup some of the massive investments made prior to the current market slump. Prices will be anywhere from $100,000 to $200,000 more for the same floorplans currently available in Phase 1!

Phase 2 has been built immediately adjacent to harbor boat slips and features gated underground parking the same as in Phase 1. A fabulous harbor walkway runs immediately behind the property. Owners may have 1 or 2 parking spaces depending on the unit they purchase above them.



What is all this going to cost?

On the face of it, this community is a real bargain. You can actually buy a 1 bedroom, 1 bath for less than $350,000 ($349,990). The 6 plans still available in Phase 1 are priced from the $350,000 range for a Plan A on up to $599,990 for a Plan F single bedroom. You can also get a premium two bedroom Plan J with up to 1,732 sq ft for $550,990. The 3 other plans fall somewhere in between. So what we are talking about is a unit priced somewhere between $350,000 and roughly $600,000. Not bad at all for the seaside location, luxury amenities and brand new everything. But there are a few more considerations…

Mello-Roos
This is a new development. That means we can automatically expect a Mello-Roos (see my Mellos-Roos blog). When Proposition 13 passed in 1978, it severely limited the abilty of state and local governments to use property taxes to construct public facilities and services. Things like road maintenance, traffic lights, street lights, storm sewers, water mains, etc for new home developments. The Mello-Roos Community Facilities Act of 1982 enables “Community Facilities Districts (CFD’s) to be established by Counties, Cities and School Districts as a means of obtaining this community funding.

Simply put, a Mello-Roos allows local CFD’s to collect a monthly tax from new home buyers instead of through state property taxes. The developer does not have to pay for these services so they don’t usually include their cost in the home price. That allows the homebuyer to purchase their home at a lower price from the developer. The CFD Mello-Roos just makes sure that the new home buyer does pay for these services without violating state law or impacting the bottom line for the developer. This is a 30 year Mello-Roos at Port 121.

HOAs
HOAs are Home Owner Association dues for the upkeep and maintenance of the landscaping, security systems, walkways, recreation center, pool – you get the idea. These fees are based on the square footage of the units purchased and can range from $290/month for a plan A to as high as $381/month for a plan J. These are “developer subsidized for the first 4 years of home ownership,” after which the community HOA’s will revert to an additional $100 dollars a month for each plan.
It is also interesting to note that these HOA costs are actually inclusive of a Seabridge Marina HOA and a Port 121 HOA. The two are separate HOA’s paid concurrently by the new home owner.

Besides your principal and interest for your mortgage, there is a 1.25% Annual Ventura County Property Tax based on your Home Sales Price. Amount / 12 for monthly cost.
Mortgage Insurance is .0026 times the Loan Amount / 12 for monthly cost.


Plan Costs

Here is a little break down of the plan costs and parking available for Phase 1 units.

Plan/ HOA/ Mello-Roos/ Total/Month/ # Parking Spaces

A/ $290/month/ $223/month/ = $513/month/ 1 space
B/ $335/ $263/ = $598/ 2
E/ $350/ $263/ = $613/ 2
F/ $335/ $263/ = $598/ 1
G/ $365/ $263/ = $628/ 2
J/ $381/ $340/ = $721/ 2



So what does all this add up to?

The least expensive Port 121 unit is the single bedroom Plan A. Your mortgage amount will depend upon the amount you borrow to finance this home. There are a number of conventional and FHA programs to help first time home buyers into a mortgage. Some will pay a portion of the down payment and even most of the closing costs when combined with CAL-HFA programs. They probably won’t beat the incentive offered by the developer.

The developer is working with DHI Mortgage www.dhimortgage.com to offer an interested buyer several incentives. They will pay closing costs. These are costs which cannot be financed into the loan itself and can be considerable. Roughly $4,000 to $8,000 or more depending on your purchase price, credit rating, etc. (This is a shoot from the hip value – check with your lender.)
Another developer incentive to buy down the interest rate for purchasers to “around 6%”. Interest rates fluctuate daily, so this is a very rough rate.


These numbers will certainly rise over time with a $100 increase in the HOA guaranteed after 4 years. These are Phase 1 numbers only. Phase 2 purchase prices and associated monthly HOA and Mello-Roos will most certainly be much higher.

-All offers must be accompanied by a $7500 deposit.
-No contingent offers will be accepted. If you need to sell a property in order to
purchase this one. It cannot be a contingency of purchase.
-There is a normal (required by law) 3 day right of recission on any offer made.


Summary

This is a luxury community and it really is going to be tough for a first time home buyer to manage. For a larger family, Port 121 is going to be a tight squeeze with only 1 or 2 bedrooms. However, if you don’t want to mow your lawn or do any home maintenance at all, this is a very user friendly opportunity. If you are not concerned by the monthly costs, the homes are very comfortable. I’m told many are being purchased as second homes by investors and folks wanting a scenic get-away retreat from LA.

Make no mistake though, these are not economy homes by any definition.

I would hazard a guess that if you believe real estate is a cyclic market that will generally trend upwards in value, that land is not an unlimited quantity in Southern California, and that seaside properties are often in greater demand than similar homes further inland, you will find these homes to be a good value. Maybe a good long term investment as well.

Warmest Regards,
Mark Thorngren

mark@markthorngren.com
www.markthorngren.com
Free Realty Times Video Newsletter
(805) 504-0228


All of the figures used in this report were current as of the day written. I cannot guarantee the accuracy of any of the information presented beyond today. All prices and fees are subject to change without warning.

What's the Holdup?

Photo by wharman

The pessimists' position seems to be gaining ground as we look back at the effects of the liquidity infusion into the banking system. They feared that banks would take Treasury's $250 billion and hoard it, rather than lending it to businesses to get the economic machine running again. Today's depressing jobs report (1.2 million jobs lost in 2008, unemployment at 6.5%) illustrates the real economic harm that the continuing lack of liquidity in the lending markets is having. Very sad.

Watching the interest rate trajectories, one would think the problem was nearing a solution. 3-month dollar LIBOR is down 253 basis points (2.53%) over the past month, and overnight LIBOR has plummeted 655 basis points (6.55%)! Note, by the way, the misleading way in which these lower rates are being described in the media: 3-month LIBOR at its lowest rate since November 2004--well, in Nov. 2004, the Fed Funds rate was much higher, so comparing one rate with its historical antecedents is almost entirely unhelpful without reference to the driver-rates, like the Fed Funds rate, as I suggested earlier. The Bloomberg story linked above makes this point, noting that the spread between 3-month LIBOR and the Fed's target lending rate continues to be much wider than historical averages, by about 100 bp, or an entire 1%. Nonetheless, LIBOR's freefall is good news in and of itself, as lots of adjustable loans pegged to LIBOR will reset to more reasonable rates as LIBOR falls. But it's not as good news as we might have hoped.

Though banks are apparently quite willing to lend to each other (at 0.33% in the overnight market), they remain reticent to lend to businesses and individuals. This is very frustrating. While more careful underwriting is a positive thing, continued blockage in the financial markets is apparently a tough nut to crack.

This post by David Zaring (particularly the comments) over at the Conglomerate offers a nice insight into why this is happening. Rate cuts by central bankers can only go so far to encourage subsequent lending when the real economic fundamentals of the market for potential borrowers are weak. Fears of a long and deep recession probably should make banks hesitant to lend to borrowers who might not make it through, though this is a vicious cycle. Uncertainty with respect to the economic plans of President-elect Obama (boy, it feels good to write that!) also puts a damper on lending markets.

Let's hope the brilliant inspirational oratory skills of our new President-to-be can convince the financial markets that brighter days are on the horizon . . . and soon!

Contesting Arbitration Clauses in Credit Card Agreements

Cardholder credit card agreements typically include an arbitration provision requiring that “[a]ny dispute, claim, or controversy ... arising out of or relating to relating to this Agreement” be settled in an arbitral, not a judicial, forum. These provisions have been under attack in two on-going antitrust conspiracy cases before Judge Pauley in the Southern District of New York. In the first case, the plaintiffs alleged that Visa, MasterCard, American Express and several large credit card issuers, conspired to inflate foreign currency transaction fees. (Visa, MasterCard and the issuer defendants have reached an agreement in principle to settle the case that is currently being reviewed by the court.) Although the plaintiffs are not American Express cardholders, AmEx has argued that they should be bound nonetheless by the arbitration provisions in their cardholder agreements. The plaintiffs should not be permitted to circumvent their arbitration agreements, AmEx claims, by joining an outside party to a conspiracy claim.

Judge Pauley agreed with AmEx on that point, finding that principles of equitable estoppel prohibited the plaintiffs from refusing to arbitrate. The court further recognized, however, that the arbitration agreements might nonetheless be unenforceable as a product of the antitrust conspiracy. It ordered a trial on the validity of the agreements before reaching a final decision on whether the plaintiffs could be compelled to arbitrate.

The plaintiffs appealed, and the Second Circuit reversed. Recognizing that a non-party to an arbitration agreement may in some cases rely on principles of collateral estoppel to compel arbitration, the court held that a more significant connection between the parties was required than AmEx could show with the plaintiffs. For example, the Second Circuit pointed to cases dealing with corporate affiliates or others with whom the plaintiff had interacted directly. Since the plaintiffs were not American Express cardholders, and they had no reason to anticipate any direct interaction with AmEx when they entered their cardholder agreements, the plaintiffs could not be compelled to arbitrate. Ross v. American Exp. Co. --- F.3d ----, 2008 WL 4630314 (2nd Cir. 2008).

In the second case, cardholder plaintiffs allege that card issuers have violated the antitrust laws by agreeing to include arbitration provisions in all of their cardholder agreements. Judge Pauley 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. Again, however, 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.

Discover now argues that the claim against it should be dismissed because its arbitration provision permits cardholders to opt out within 30 days. The plaintiffs have responded that the opt out provision is inadequate because it places too high of a burden on cardholders. The court is currently considering Discover’s motion. Ross v. Bank of America, N.A., 524 F.3d 217 (2nd Cir 2008).

Letterman's Top Ten Sarah Palin Excuses for Spending $150,000 on Clothes

In case you missed Letterman's top ten last week, here it is. With retailers struggling and worried about sales and already promoting holiday sales through discounting earlier in November than usual, Letterman could also add to the top of the list that she "wants to do her part for the economy!"

— JSM

Battle of the Forms

Over at the ContractsProf Blog Jeremy Telman posted his Battle of the Forms Limerick:

To rhyme on the battle of forms
Would intrude upon poetic norms.
2-207 in verse
Might even be worse
Than an ode to the new tax reforms.

Battle of the forms cases are still routine fare, with the recent case of NIC Holding Corp. v. Lukoil Pan Americas LLC, 2008 U.S. Dist. Lexis 74034 (S.D.N.Y. 2008) adopting a textbook application of the rules. In the NIC case, NIC, a petroleum trader, sought damages for Lukoil's failure to deliver gasoline at the appointed time. Although the court denied NIC's motion for summary judgment, the Court did find that a warranty requiring the delivery vessel to have an international carrier bond was part of the contract between the parties because NIC's form reply to Lukoil's form contract contained the warranty provision which Lukoil did not "object to" and did not "materially alter" the contract as was not a "surprise" or "hardship." This is the type of classic fact-pattern which makes me think of examinations!

— JSM

The New Deal for the American People

Much about the economic issues of this election season is reflective of the pledge of "a new deal" made by Franklin D. Roosevelt (FDR) when he entered office in 1933. FDR's initiatives to tackle the Great Depression, including the creation of the Federal Deposit Insurance Corporation (FDIC), Tennessee Valley Authority (TVA), and the United States Securities and Exchange Commission (SEC) continue to have important roles in our economy today. Whether McCain or Obama wins the election tomorrow, the new President will face economic challenges that bear resemblance to FDR's time. The financial crisis will test the President from the outset and give him an opportunity to create lasting changes of the type that FDR initiated (see Crisis Creates Opening).

The credit crisis has eased, but not gone away. Even with LIBOR rates declining and the numerous programs that the Federal Reserve has initiated (see my post on the Federal Reserve's Money Market Investor Funding Facility), banks nevertheless remain cautious and have imposed higher credit standards for consumer mortgages and credit cards. Couple this with the record $1.4 trillion that analysts expect the government will borrow over the next year alone. The credit crisis has put pressure on business enterprises, especially manufacturing which has faced a substantial downturn. Both Bernanke and Greenspan have warned us that substantial economic problems will remain for some time (see earlier posts of Bernanke and Greenspan speeches)

The economy has been much on the minds of voters. Political rhetoric aside, we all want to know the details of who will do what and how. This is the part that is lacking during a political season. One of the early signals to the economy about direction that the business and financial reforms will take is what key cabinet members the President will choose to address these critical problems. FDR's words remind us that economic problems are much of our own creation:

While they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings.

The economy will have to wait a short time to see who the next President will be. Let's hope that action is decisive and effective.

— JSM

Bernanke on the Mortgage Meltdown

Federal Reserve Chairman Ben Bernanke spoke recently at the UC Berkeley/UCLA Symposium: The Mortgage Meltdown, the Economy, and Public Policy, Berkeley, California. Although Bernanke spoke in general terms about the importance of mortgage securitization, he did not say much about short term initiatives or what should really become of Freddie Mac and Fannie Mae.

— JSM

Mandated Financial Counseling--Some Initial Empirical Results

In 2005, as a response to concerns over predatory lending, Illinois began to require financial counseling for a very limited number of high-risk mortgage applicants (generally those with a FICO score of less than 620) in a limited number of Chicago zip codes. Although the pilot program was quickly suspended, there was the opportunity to test the program's effect, as Sumit Agarwal et al. do in a new paper just released on SSRN, here.

The study concludes that counseled borrowers appeared to take on less risky mortgage obligations than non-counseled borrowers. Although counseling appeared to reduce the supply of credit and demand for credit among affected borrowers, property values increased and lower foreclosure rates were documented in affected areas. What is especially interesting to me is that, of the borrowers receiving counseling, "an overwhelming majority" of borrowers did not understand that their ARM rate, often a teaser rate, was not fixed over the period of the loan (p. 6) and that over half of applicants received a recommendation from the counselor that they could not afford the loan under consideration (p.7). Albeit limited, the results do illuminate the extreme informational deficit that likely characterized some high risk borrowing in the last few years, and the limits to disclosure as a consumer protection mechanism. While mandated counseling raises a host of other legal & policy concerns (paternalism, discrimination, costs of implementation, just to name a few), the study does present some data that it at least does lead to better-informed borrowers.