Monday, August 31, 2009

Weil Really Gotthem & Mangled Them

Recently a colleague of mine, Susan Hauser, who writes extensively in the area of bankruptcy, sent me a copy of Weil, Gotshal & Manges, LLP’s “Second Interim Fee Application” detailing their fees from the handling of Lehman Brothers’ liquidation. The fee schedule ONLY included fees from February 1, 2009 through May 31, 2009, yet the “total fees allowed” almost totaled $50,000,000.00. Several partners at the firm posted billable hour rates in excess of a $1000.00 per hour. Moreover, there were 2009 grads, without licenses, billing at $355 per hour and paralegals billing at $250 per hour. Even more interesting was the fact that this was the second fee application. The first fee application was approved by Judge James Peck in the amount of almost $55,000,000 from work completed from September of 2008 through the end of January 2009. According to Professor Lynn LoPucki at the University of California, Weil may generate more than $200,000,000.00 in fees from this case.

After thinking about this situation in greater detail, I have come to question whether these types of fees should be awarded in bankruptcy cases. Surprisingly, while some bankruptcy experts have commented on the high amount of the fees, few of these experts have considered the fees excessive. As such, there should be a complete reconsideration of how bankruptcy legal fees are approved as the current approval of such fees highlights a critical flaw in the way in which bankruptcy lawyers are paid. As Professor LoPucki notes, firms representing other interested parties in a bankruptcy case are reluctant to challenge another firms fees, considering the fact that the roles may be reversed in another case. In addition, while a judge must approve of the fees, it is very difficult for her to closely scrutinize the entire bill given the limited resources of the judge’s staff.

Given these issues, the question is whether the law should impose caps on the fees awarded in bankruptcy cases. One argument against the imposition of such caps is that there are only a few firms that are able to do this type work. Thus, if caps are placed on the allowable fees that law firms charge, these firms will be unwilling to do the work which may impair the quality of legal services. Even if there are few firms that can do this type of work, the imposition of caps will not stifle the overall quality of legal service because new law firms will enter the market that are willing to do the same work at the capped fee amount. Over time, these lawyers will develop the same level of experience and expertise as the firms that currently handle the overwhelming majority of the large bankruptcy cases.

Friday, August 28, 2009

shareholder primacy?

One response to the financial market meltdown is a proposed rule by the Securities and Exchange Commission that would allow greater control over corporate board of director nominations by firm shareholders (proposal here). This proposed rule would ostensibly make it easier for shareholders to nominate and elect individual directors to various corporate boards. This rule change seeks to address the criticism that in light of the reckless risk taking engaged in my executives and boards of such companies as AIG, Bear Stearns, Lehman Brothers, Citi, etc., shareholders have very little ability to realistically hold board members accountable for allowing executives to engage in breathtaking risk.

In short, the SEC proposes changes to the proxy rules which would require corporations to include in their proxy materials shareholder nominees for director positions that could make up to 25% of all board members. The SEC summarizes its proposal as follows:

"We are proposing changes to the federal proxy rules to remove impediments to the exercise of shareholders’ rights to nominate and elect directors to company boards of directors. The new rules would require, under certain circumstances, a company to include in the company’s proxy materials a shareholder’s, or group of shareholders’, nominees for director. The proposal includes certain requirements, key among which are a requirement that use of the new procedures be in accordance with state law, and provisions regarding the disclosures required to be made concerning nominating shareholders or groups and their nominees. In addition, the new rules would require companies to include in their proxy materials, under certain circumstances, shareholder proposals that would amend, or that request an amendment to, a company’s governing documents regarding nomination procedures or disclosures related to shareholder nominations, provided the proposal does not conflict with the Commission’s disclosure rules – including the proposed new rules. We also are proposing changes to certain of our other rules and regulations – including the existing exemptions from our proxy rules and the beneficial ownership reporting requirements – that may be affected by the new proposed procedures."

Supporters of the rule change argue that providing shareholders with the right to place director candidates directly onto the proxy card (voted on by all shareholders) would significantly improve director accountability.

Not surprisingly, this rule change proposal has engendered significant opposition from Wall Street. In an unusual move, responding to the Comment period requested by the SEC, seven of the nation's most prominent law firms representing most major corporations, submitted a joint letter opposing the rule change. Mega firms, Cravath, Wachtell, Sullivan & Cromwell, Skadden Arps, Simpson Thatcher, Davis Polk and Latham & Watkins, jointly urged the SEC to proceed with caution in prescribing a "one-size-fits-all" approach to allowing proxy proposals to include director candidacies.

The Comment period for this rule change is now closed.

One thing seems certain now that regulatory overhaul is on the table in light of the economic meltdown: controversial calls for change will be challenged at every quarter. Status quo will be protected at every turn. The United States system of corporate governance and securities regulation is a cottage industry that will be protected fiercely. The Obama administration's attempts to layer the industry with new regulation and the SEC's efforts to propose new proxy rules to improve director accountability will be challenged by the powerful and the entrenched.

At one point, I suspected (hoped) that a silver lining of the economic crisis might be a new impetus to systematically and carefully review U.S. corporate governance and our nations regulation of securities, commodities, derivatives, over-the-counter trading and so forth, with an intended outcome of modern, efficient, investor-protecting reform. Will the powerful allow this regulatory modernization? Will the Obama administration have the steely reserve to challenge the entrenched? Are the right people in place to conduct the systematic and careful review? Will regulatory reform truly occur, or just pacifying window dressing?

This is a story that continues to unfold.

Thursday, August 27, 2009

Honoring Ronald H. Brown: Symbol of Economic Justice

Ronald H. Brown, the first African American to become U.S. Secretary of Commerce and Chair of the Democratic National Committee, graduated from St. John’s University School of Law in 1970. The Ronald H. Brown Center for Civil Rights and Economic Development, named after the former Secretary, will celebrate the 40th anniversary of Brown’s graduation from St. John’s by hosting symposia and other events during the upcoming academic year. The first of these events will be a symposium on November 13th and 14th featuring the scholarship of St. John’s Law School faculty writing on themes relating to civil rights, economic development and social justice. The symposium will be held at St. John’s Law School on the Queens campus.

Professor Leonard M. Baynes is Director of the Ron Brown Center. Under his direction, the Center has sponsored symposia focusing on civil rights and economic development, along with extraordinarily successful pipeline programs aimed at increasing racial and socioeconomic diversity on law school faculties and among law students. The Center’s most recent symposium, organized by Professor Baynes and the Center’s Assistant Director Janai Nelson, was entitled Making History: Race, Gender, The Media and the 2008 Elections.

Brown and the Rule of Law

I have always been astounded that a significant number of legal academics suggest that the Brown v. Board of Education decision was somehow contrary to the rule of law.

As Brian Tamanaha states in his excellent text On the Rule of Law the case "plagues mainstream legal theory to this day." Tamanaha quotes Raz: "The law. . .may institute slavery without violating the rule of law."

I posit this: the ultimate lawlessness is the wanton and pervasive destruction of human potential implicit in all forms of oppression, particularly racial oppression, which we know is an irrational basis for classifying individuals. The suggestion that slavery or Jim Crow segregation is somehow consistent with the rule of law renders that concept useless. If law fails to constrain those with power from the destruction of human dignity and potential then it both unjust and economically pernicious. In other words, it is evil and self-destructive all at once.

The rule of law thankfully began to end American apartheid on May 17, 1954. Prior to that date the American legal system was marked by deep seated lawlessness where individuals were unconstrained by law to irrationally destroy the potential of others. Brown strengthened the rule of law in America.

Either the law appropriately restrains power or it does not. That is the ultimate test of a well-functioning rule of law.

What does this have to do with corporate justice?

The consolidation of economic power at the apex of corporate America has also become unjust and economically pernicious.

The answer is the imposition of a rule of law to constrain the currently unbridled exercise of economic power through the domination of the public corporation by a small hyper-elite.

Politically the separation of powers implicit in the US Constitution created the possibility of the rule of law prevailing in the political sphere. We need an economic constitution that fragments corporate power far beyond the capabilities of Delaware and the current system of politicized corporate governance.

Whatever term is used, the law must operate to constrain those with economic and political power from abusing their power by profiting through the domination of the legal system. Individuals must be disempowered from imposing huge costs on society generally in order to achieve personal ill-gotten gains; gains that frequently are much less than the cost to society. If law fails to adequately constrain power, then it cannot be operating as the rule of law.

Wednesday, August 26, 2009

Capital University Law School Brings Distinguished Alumnus Ronald Shuff, Flowserve SVP/GC, to Visit Law School as Second Alumnus-in-Residence

On October 24 and 25, Ronald Shuff, Senior Vice President - Secretary and General Counsel of Flowserve Corporation will visit his law school alma mater, Capital University Law School, as the second Alumnus in Residence. Capital's Alumni-in-Residence program brings distinguished alumni to the law school to reconnect with faculty and to share career insights with students. Mr. Shuff will engage with students, faculty, staff and alumni through a variety of activities including student organization meetings, attending classes, and delivering a public lecture on his tips for a successful legal career. Mr. Shuff, who also holds an MS from the MIT Sloan School of Management Sloan Fellows program, has over 25 years of significant, personal interaction with board members and over 30 years experience in managing corporate legal and non-legal staff.

Flowserve is a pump and valve manufacturer serving the oil, gas, power generation, chemical processing, water resources and other industries. Flowserve’s common stock is traded on the NYSE. More information will be available in the near future here.

Federal Reserve Bank Leadership Remains Intact Despite the Collapse of the Financial Markets

President Obama nominated Ben S. Bernanke to a second four-year term as chairman of the Federal Reserve Bank, which is the central bank of the United States. Chairman Bernanke has led the biggest expansion of the Federal Reserve Bank’s power in its 95-year history to handle the current financial crisis which many claim is the worst economic crisis since the Great Depression.

The financial industry is thrilled with the decision that Bernanke will remain as Chairman of the Federal Reserve. Morgan Stanley’s Richard Berner who serves as head of Global Economics stated that “it’s not just that he’s done a great job of dealing creatively with the financial crisis but that he brings certainty.” The financial industry applauded President Obama for maintaining the stability of the Federal Reserve by nominating Bernanke for a second term. However, there are many in Congress that are displeased with Bernanke’s decisions especially in terms of the independence that Bernanke has displayed. Bernanke decided to cut the main interest rate almost to zero, he decided to funnel $1 trillion into the crippling banking system and he decided to rescue Bear Stearns Cos. and American International Group Inc. from collapse, although he permitted Lehman Brothers to collapse.

Many members of Congress believe that Bernanke overstepped his authority as Chairman of the Federal Reserve and used “emergency powers” to deviate from sound monetary policy. Bernanke was also criticized as too slow to respond to the housing crisis and inaccurately referred to the housing crisis as “contained” before reversing course in August 2007 and cutting interest rates. As a result, there is pending legislation in the House which would subject the Federal Reserve’s monetary policy to audits by the Government Accountability Office. If the legislation is adopted, the Federal Reserve would need the Treasury Department’s approval before invoking the emergency powers that Bernanke used to coordinate the financial bailouts and to make loans to non-bank financial institutions.

President Obama believes that Bernanke has provided extraordinary leadership during the most difficult financial crisis that America has faced since the 1930s. The President further believes that Bernanke is the person to guide America through renewed growth in the years to come. Recently, at the Federal Reserve Bank’s annual symposium, Bernanke stated that “prospects for a return to growth in the near term appear good.” However, “we have an enormous amount of work to do.”

Saturday, August 22, 2009

Systemically Important Financial Institutions: The Cleveland Federal Reserve Turns To YouTube To Show The Way Forward

What should we do about systemically important financial institutions moving forward? Consider implementing a three-tiered regulatory system. Well, that is the approach recently advanced by James Thomson, a Vice President and Financial Economist at the Cleveland Federal Reserve Bank. In an amusing and simple drawing board presentation on YouTube, Thomson spells out and outlines the regulatory approach he deems best for regulating systemically important financial institutions. Yes, the Federal Reserve Bank of Cleveland is turning to YouTube to show us the way forward!!!

In recent months, the term “systemically important financial institution” has garnered a great deal of media attention and news coverage. What is a systemically important financial institution? It is a financial institution that is so large, or interconnected with other institutions, or unique that it poses the risk of pulling the entire financial system down with it should it fail.
How do you gauge whether an institution is systemically important or not? The Federal Reserve Bank of Cleveland has proposed looking at the institutions size and four additional criteria to determine systemic importance. The Federal Reserve Bank of Cleveland calls these additional requirements the four C’s: contagion, correlation, concentration, and context.

How do the four C’s play themselves out? “Contagion” refers to the “too connected to fail” syndrome. For example, if you have swine flu and go to work, church, or a professional baseball game the “bug” can spread rapidly. The same goes for financial institutions: when one is sick it can spread a “bug” that infects other institutions that are interconnected through loans, deposits, or insurance contracts. “Correlation” refers to the “too many to fail” syndrome. If financial institutions see their peers doing risky things, they decide to join the party. Financial institutions assume if everyone is doing something risky then there is no way the government will let the entire industry fail; regulators will step in to offer a bail-out to all. Under this scenario moral hazard is eroded. “Concentration” refers to the “dominant or essential player” syndrome. If a financial institution dominants a particular business or has a high percentage of money leveraged in a particular area that is risky, this could make the financial institution a systemically important institution. AIG is a prime example of such a firm, in relation to AIG’s dominance of the credit default swap market. The final of the four C’s stands for “context.” This is known as the “conditions matter” syndrome. Let’s assume the financial market is antsy or jittery. The failure of one large firm in the system might be interpreted by investors as a bad omen or sign of things to come, or as a harbinger that underlying market conditions will soon erode. Under such a scenario the financial market collapses. The collapses experienced at Bear Stearns and Lehman Brothers illustrate types of "context" failures.

James Thomson proposes a three-tiered approach to deal with systemically important financial institutions. Tier One would cover high-risk institutions. Potentially, the failure of these institutions would pose the greatest risk to the financial system. Tier One would include complex financial institutions like large interstate banks and multi-state insurance companies. Tier One institutions would be subject to the most stringent regulation.

Tier Two would include moderately complex financial institutions. These institutions would be chosen based on their interconnectivity, involvement in critical market functions and activities, and the affect of stress in the overall economy on their condition. Large regional banks and insurance companies would be the market players regulated under Tier Two. In a sense, Tier Two financial institutions would undergo a more moderate level of regulatory scrutiny.

Finally, Tier Three would cover remaining non-complex financial institutions. Community banks would make up the market participants covered by Tier Three. Tier Three institutions would fall outside the watchful eyes of systemic institutional regulators like the Federal Reserve. The notion is that if a Tier Three institution failed it would be unlikely to cause any widespread ripples in economic markets.

The goal of the three-tiered system Thomson proposes is to equate oversight and regulatory activity with the degree of risk involved with the type of financial institution. Thomson hopes that the risk of being a systemically important financial institution may be mitigated. We shall see. YouTube and the Federal Reserve Bank: what a combination we have unleashed!!!

Friday, August 21, 2009

The Financial Crisis: Regulatory and Corporate Governance Critiques and Reforms

The University of Utah S.J. Quinney College of Law will host a financial crisis symposium on September 25, 2009. The event "The Financial Crisis: Regulatory and Corporate Governance Critiques and Reforms" will feature experts on financial regulation and global economies discussing and debating recent efforts to reform the financial industry in the wake of the 2008-09 meltdown.

Per Professor Wade's post yesterday, recent events and commentary from the Obama administration have signaled an end to the broader economic crisis as many are now on record that we have "reached the bottom" of the economic free fall and have begun a real recovery. The capital markets have rebounded in some small measure. This conference will seek to evaluate the measures adopted by the current administration in an attempt to stave off a global economic meltdown and will consider whether these policies offer long-term assurances or protections against a recurring subprime debacle. In addition, this conference will explore the deeper causes of the crisis and will explore whether true reform is taking place that will address the fundamental weaknesses that allowed or enabled the economy to crumble.

Scholars from around the country will seriously debate the merits of suggested reforms, evaluate the actual proposed legislation and enacted policies, and suggest additional solutions to protect against future crises. These scholars have testified before congress, consulted with senators and congresspersons throughout the crisis, and have written aggressively and appeared often in the pages of law reviews and leading newspapers across the world.

More information to come, including webstream details.

Thursday, August 20, 2009

Will talk of economic recovery preclude consideration of the causes of the financial collapse?

In the last few months, some have asserted that the economic downturn is slowing. And, this month, The Federal Reserve announced that the economy is improving. Most predict that the recovery will be slow.

The recovery will be slowest in minority communities that were financially vulnerable long before the recent financial collapse. We should not allow the rosy forecasts about the beginnings of an economic recovery to obscure our understanding of the conduct of the corporate actors who precipitated further financial decline in African American and Latino communities.

Nonbank lenders, some of them public companies, targeted minorities for predatory lending schemes during the height of the subprime lending debacle. Their conduct violated Title VIII of the Civil Rights Act of 1968 – The Fair Housing Act (“FHA”). The FHA prohibits discrimination on the basis of race and other factors when making or purchasing loans for purchasing, constructing, or improving a dwelling. We should also examine the governance systems of the financial institutions that did business with the lenders that violated the FHA. To what extent did lax corporate governance prevent Wall Street from engaging in the kind of oversight and decision making that would have avoided the excessive risks that were undertaken in the height of the subprime mortgage market?

Most Wall Street firms did not employ the people who dealt with borrowers and approved predatory mortgage applications. This work was outsourced to independent companies in order to keep costs down. What responsibility did the financial institutions have to ensure that the companies to whom they outsourced this work complied with the FHA? Did financial institutions such as Lehman Brothers, Bear Stearns, Wells Fargo and others owe a duty to ensure that the brokers and nonbank lenders who sold them mortgages complied with the FHA?

We should also take a critical look at the discourse generated by conservatives about the relationship between lending to minorities and the financial collapse. Many conservatives blamed the financial crisis of 2008 on the enactment of the Community Reinvestment Act of 1977 (CRA”). The CRA was enacted to require banks covered by the FDIC to refrain from the discriminatory practice of redlining under which they refused to lend to specific minority and low-income residents. Conservatives argued that the quest for increasing home ownership among minorities and working class Americans caused the economic crisis. This focus on the alleged inadequacies of minority and working-class borrowers eclipses the role that financial and lending institutions played in causing the financial collapse. It precludes consideration of ways to improve the governance and best practices of financial and lending institutions.

Tuesday, August 18, 2009

Proposed Legislation Will Allow CFTC and SEC to Regulate Derivatives Market

A few years ago, I wrote an article entitled Controlling a Financial Jurassic Park which analyzed the unregulated Forex market, derivative trades, and fraud. The article discussed the cause of Forex derivatives fraud, its rampant increase in the last 10 years, and recommended proposed legislation to regulate and prevent fraud in the Forex derivatives market. One recommendation was for Congress to provide the Commodity Futures Trading Commission(CFTC) and the Securities & Exchange Commission (SEC) expanded authority under the Commodities Exchange Act and the Securities Exchange Act to aggressively regulate and prosecute derivative traders that defraud the public.

Imagine my elation when the Obama administration formally proposed legislation to regulate derivatives. The administration proposed that most derivatives should be traded on regulated exchanges similar to the way stocks and bonds are currently traded. The legislation also proposed tightening the banking regulations that inter-connect with the proposed derivative trading regulations. Additionally, the SEC, the CFTC and the banking regulatory agencies would share responsibility for oversight of the derivatives market. Shared regulation is a crucial element for preventing fraud in the market. As various federal agencies work through complex and sophisticated derivative transactions their shared analysis will allow for a better understanding of the transactions, and will create a better synergy to prevent fraud in the future.

Monday, August 17, 2009

The Rule of Law and 9/9/09

On September 9, 2009, the Supreme Court of the United States will hear re-argument in the case of Citizens United v. Federal Election Commission, which involves the congressional power to limit corporate campaign activities. The Supreme Court ordered re-argument in order to address whether two of its precedents upholding legislation limiting corporate campaign activities should be overruled. The case has aroused much controversy, and many amicus briefs have been filed. The mainstream media has reported on the case to some extent, but most in-depth coverage appeared only in places like the New York Times or specialized publications.

Professor Richard L. Hasen suggests that if “corporate limits fall . . . we may well look back on the 2008 election as a quaint time when the amounts spent on elections were relatively modest.” Professor Michael Dorf argues that the American people already suspect that American politics is a rigged game. If the Court overrules its prior cases limiting corporate campaign activities “the American people could be excused for thinking that the Court too is part of the rigged game.”

Overruling its prior precedents upholding reasonable limitations on corporate campaign activities will subvert the rule of law and further concentrate economic and political power in a corporate elite that has proven itself inept and inadequately constrained by law. It would cripple a great democracy that endured for years on the principle of one person, one vote. The nation already is struggling to avert a government of elites, by elites, and for elites.

Moreover, under our current system of corporate governance, breaking down limits on corporate campaign support would only serve to empower CEOs, at the expense of the corporation and its shareholders. CEOs have proven themselves capable of indulging their own short term interests at the expense of shareholders, most recently in the subprime debacle. Giving CEOs more power to dominate their firms (as well as society generally) is not vindicating free speech—it is entrenching CEOs to coerce shareholders to expend funds for the benefit of the CEO’s interests. Simply put, under the current regime of CEO primacy, CEOs have hijacked corporate speech. Only if the interests of the shareholders and the corporation itself are secured against CEO domination can corporate speech colorably be termed free speech.

Perhaps the Supreme Court should rule that only corporations that charter an independent subcommittee of the board to supervise all lobbying and campaign activities of the firm to assure those activities are for the benefit of the firm (with substantial shareholder input) can expect to enjoy free speech rights. Otherwise the Court is simply cloaking CEO subversion of the firm in First Amendment protection.

The Corporation exists to enrich shareholders. It is chartered to pursue business interests and profits. It was not created to give voice to unbridled CEO power, without disclosure nor authorization of the shareholders. Under this reality corporate speech is no more "free" speech than the words uttered by a tortured individual with a gun to their head.

Sunday, August 16, 2009

Just what the doctor ordered: corporate accountability

It appears, at least at some companies, that the bailout plan has caused some boards of directors to more closely securitize the actions of their CEOs. In a recent business week article, it was noted how GM’s new board has placed increased expectations on its recently installed CEO, Frederick A. "Fritz" Henderson. The old board gave a substantial amount of deference to former CEO Rick Wagoner. Because of GM’s excessive cost, Wagoner was more focused on cutting cost rather than building market share and increasing profit. In essence, the board and the CEO were solely focused on keeping GM afloat.

Under the new regime, this is not enough. In fact, Henderson has already come under fire by the board, as the board has “said that GM’s revised recovery plan filed on Apr. 27 isn't quite good enough.” “That plan, which cut four brands, downsized the company and its dealer network, and led the way into bankruptcy to clean up the balance sheet, only keeps GM above water. It doesn't show growth. Some directors were concerned GM wouldn't push to grow beyond the sales and market share laid out in the plan, say two sources familiar with the discussion.” The current board is chiefly concerned with paying the bailout money back and making GM a profitable going concern; however, in order “for taxpayers to break even, GM will have to eventually issue new stock and the company's value will need to reach $69 billion, more than it has ever been valued.”

To maintain this type of accountability, two things mush happen, boards must put more pressure on their officers to perform, and the law must put pressure on boards to remain focused on this goal. In regards to the first consideration, because of the current market conditions, it is likely that boards will continue to put this type pressure on their CEO’s; however, as the economy improves, it is less certain whether this will continue. As to the second consideration, to ensure that boards remain accountable, there must be a better system for watching the watch dogs (the board). Under the current legal framework, the officers are kept in check by the board. The officers have the greatest level of accountability under the current frame work considering that business judgment protection generally does not extend to them. As such, with the current market conditions, increased board oversight, and lack of business judgment protection, CEOs will be under an increased pressure to perform and they will finally have to prove that they are worthy of their exorbitant salaries. Conversely, the law does not put the same level of pressure on the board. Since the board’s decisions are protected by the business judgment rule, they have less accountability than the officers. This is extremely problematic considering that the board is the critical lynchpin in increasing corporate accountability and responsibility. Without greater levels of board oversight or a less deferential business judgment standard, history is bound to repeat itself.

The Subprime Mortgage Crisis: Debunking Myth and Reality?

Recently, Yuliya Demyanyk, a Senior Research Economist, at the Cleveland Federal Reserve Bank issued a very interesting Economic Commentary entitled “Ten Myths about Subprime Mortgages.” Demyanyk contends that many of the popular explanations for the subprime crisis were in reality myths. Further, Demyanyk takes the position that empirical research proves that the causes of the subprime crisis are multifaceted and complicated; going far beyond mortgage rate resets, declining underwriting standards, or declining home values that we typically are quick to point a finger towards.

In addressing and debunking the ten myths she perceives about the subprime mortgage crisis, Demyanyk makes the following observations:

* Subprime mortgages went to all kinds of borrowers, not just borrowers with damaged or impaired credit.

* Subprime mortgages did not promote homeownership.

* Declining home prices and values did not cause the crisis. Declining home prices served to reveal the quality of subprime mortgages that had been deteriorating for years.

* Declining underwriting standards did not trigger the subprime crisis. Yes, standards were declining, but not to a level to account for the enormous rise in mortgage defaults.

* Borrowers did not use their homes as ATM’s to extract cash from home equity loans and lines of credit. Data shows that mortgages originated for refinance performed better than mortgages originated solely to buy a home.

* Mortgage rate resets did not solely cause the subprime crisis. Fixed rate mortgages showed all the signs of distress that adjustable-rate mortgages showed.

* Subprime borrowers with hybrid mortgages were not offered low “teaser rates.”

* The subprime mortgage crisis was not totally unexpected.

* The subprime crisis in the United States is not totally unique; it follows a classic cycle of boom-and-bust that has been observed historically in many countries.

Demyanyk’s Economic Commentary makes for an interesting read to better understand the complicated causes of the subprime mortgage crisis. I tend to agree with some of Demyanyk’s assertions. On the other hand, I tend to disagree with some of Demyanyk’s assertions. Again, Demyanyk’s Economic Commentary is an insightful and thoughtful piece. Do you agree or disagree with Demyanyk’s perspective? I look forward to hearing what you think about the causes of the subprime mortgage crisis.

Friday, August 14, 2009

Predatory Lending and the Racial Wealth Gap

Disparities in wealth between white Americans and people of color have grown in the last thirty years in spite of dramatically increasing levels of educational attainment on the part of African Americans and Latinos. For every dollar the median white family owns, the median Latino family owns twelve cents. For every dollar the median white family owns, the median Black family owns ten cents. Many have written about and discussed the fact that African Americans and Latinos have less wealth than white Americans. But, to the extent this wealth gap is discussed, it has been without the benefit of context. It is time to add context so that we understand at least one of the underlying causes of the racial wealth disparity. The predatory lending that occurred during this decade provides the context that illustrates the type of structural and institutional racism that impedes the economic advancement of people of color.

Predatory lending and mortgages should be distinguished from subprime lending. Subprime mortgages and loans extended to low-income borrowers have enabled many to purchase homes and other consumer goods that would otherwise be out of reach. The interest rates of subprime loans are higher than the rates on prime loans to account for the risk that lenders would not be repaid when a borrower’s income is low or her credit history is weak. Predatory lending, however, involves excessive and unnecessary fees. Predatory lenders steer borrowers into expensive loans even when they qualify for more affordable credit.

Local, state and federal investigations across the nation have revealed that real estate professionals targeted people of color for predatory loans. Even middle and upper income African Americans and Latinos were led into subprime loans and mortgages even though they qualified for prime loans with much lower interest rates. In 2006, the National Community Reinvestment Coalition reported that in more than 70% of the neighborhoods it investigated, middle and upper income people of color were twice as likely as middle and upper income whites to receive high cost loans. The high rate of foreclosure caused by predatory mortgage lending has drained almost $200 billion from African American and Latino households.

Some of the lenders that engaged in predatory lending were public companies. And, we should also understand the relationship between predatory lenders and the financial institutions that did business with them. The relationship between Wall Street firms such as Lehman Brothers, Bear Stearns, and Merrill Lynch, on one hand, and predatory mortgage lenders and brokers, on the other, involved two aspects. First, Wall Street firms provided large loans to nonbank mortgage lenders that enabled them to make the predatory loans to prospective homeowners. Second, nonbank lenders were funded when they sold mortgages to major financial institutions as part of a securitization process in which investors purchased interests in pooled mortgages. In other words, the mortgage lenders and brokers who engaged in fraudulent and predatory lending could not have been in business without the help of Wall Street’s financial institutions.

Many of the predatory lenders and the financial institutions that did business with them have failed. But, it is important to understand the role of these companies in draining billions of dollars in wealth from communities of color. Understanding their role is essential to comprehending one of the most salient causes of the widening wealth gap between white Americans and Americans of color. Articulating the fact that there is a racial wealth gap without discussing the reasons it exists implies that the gap is attributable only to some deficiency in the financial acuity of people of color.

Thursday, August 13, 2009

Symposium in Central Ohio: The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result

On Friday, October 16, 2009, Capital University Law School Graduate Law Programs will present a conference on “The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result.” The goals of the conference are to educate the audience on the corporate governance issues that arose from the recent financial crisis in the financial industry, and to instruct the audience on financial transaction options that distressed companies may use in the current recessive and turbulent economic environment. Speakers and panelists include nationally recognized practicing attorneys, business financial advisors and academics.

The conference’s morning portion will focus on the financial crisis and the governance of private and publicly held for profit and nonprofit corporations. The morning will begin with a presentation and discussion of directors’ and senior executives’ respective duties and responsibilities. Then the focus will shift to the financial crisis and whether the crisis resulted from a failure in corporate leadership or from a confluence of low probability, market-driven events. The next segment will address potential federal legislation that may impact board governance. The presentation will shift to examine beliefs underlying corporate governance (e.g., “pay-for-performance requires equity-based compensation,” “managers must think like owners”) and to challenge whether these and other beliefs lead to corporate governance practices that are in the best interests of the corporation.

The conference’s afternoon portion will address financial transactions for distressed companies, including bankruptcy, restructuring and raising capital. This portion will touch on the responsibilities of management of distressed companies as well as offer practical advice on the restructuring tools available for distressed companies. In addition, one segment will provide insights and pointers on how corporations may proceed smoothly through the business bankruptcy process. The afternoon will conclude with a presentation highlighting the new Department of Justice antitrust enforcement policy and its impact on business combinations designed to help financially troubled business organizations.

Additional details regarding the program will be forthcoming here in the near future.

Tuesday, August 11, 2009

North American Leaders Summit Raise Concerns Regarding Trade, Public Health, and Human Rights

President Barack Obama and Canadian Prime Minister Stephen Harper joined President Felipe Calderon in Guadalajara, Mexico for the annual North American Leaders Summit to discuss increased cooperation amongst, and the future of the three North American nations under the auspices of the North American Free Trade Agreement (NAFTA) which was enacted in 1994 presumably to relieve trade barriers between the United States, Canada and Mexico.

During this year’s summit, President Obama commented on the strong trading partnership among the three North American nations and that he intends to expand commerce between the three nations. Canada is America's top trading partner. China is America’s second top trading partner and Mexico is America’s third top trading partner. Given President Obama's intent to increase commerce between the three North American nations, the Buy American provision in the $787 billion economic stimulus package, which require many of the public works projects paid for by the U.S. economic stimulus plan to use materials made in the United States, has drawn criticism from Canadian Prime Minister Harper. However, President Obama stated that every effort will be made to implement the Buy American provision in a manner consistent with U.S. international obligations, while minimizing disruption to trade. As a result, Congress has made changes to the bill to include various exceptions. To date there has been no statistically significant change in trade between U.S. and Canada. The three leaders agreed to a shared recovery, to reform the international financial institutions, and to lay the foundation for future growth between the three North American nations.

With regard to public health, the three North American nations agreed to a "joint, responsible and transparent" response to the swine flu threat. President Obama noted that although, the Canadian health care system is fundamentally different from the U.S. system. He expects that "more sensible and reasoned arguments will emerge" regarding the U.S. national healthcare program.

Despite the lofty trading terms in NAFTA, NAFTA has drawn much criticism including, the loss of American jobs to Mexican workers, the collapse of small American and Mexican farmers, and a significant increase of illegal immigration from Mexico to the United States. Additionally, trade disputes have also arisen with Mexico alleging that the U.S. violated a NAFTA accord when the U.S. canceled a program allowing some Mexican trucks to operate in the U.S. Mexico responded by imposing retaliatory tariffs of $2.4 billion on U.S. goods back in March.

Not everyone was pleased with the North American Leaders Summit, approximately 400 people marched outside of the meeting place for the summit to protest the negative effects of free trade and to demand benefits for retired Mexican laborers who worked in the U.S. The protesters also demanded immigration reform in the U.S. and that Mexican laborers who work under the World War II guest-worker program receive the money withheld from their paychecks.

Human rights concerns in Mexico persist, particularly at the state level where violence surrounds local elections and misuse of the judicial system. However, President Calderon stated that the Mexican government has an "absolute and categorical" commitment to human rights.

Lydie Nadia Cabrera Pierre-Louis
Assistant Professor of Law
St. Thomas University School of Law

Monday, August 10, 2009

Corporate CEOs are the New Potentates

Friedrich Hayek stated the following with regard to the rule of law in 1961: “By ‘law’ we mean the general rules that apply equally to everybody… As a true law should not name any particulars, so it should especially not single out any specific persons or group of persons... the rules must apply to those who lay them down and those who apply – that is, to the government as well as the governed – and that nobody has the power to grant exceptions.” Aristotle and Plato cast the rule of law in terms of legal autonomy—meaning that government is the servant of law, not that law is the servant of the government. Indeed, the difference between the rule of law versus rule by law amounts to the abuse of power wherein law is reduced to a mere instrumentality of oppression, unfair advantage, and the arrogation of legal immunity.

In the US, our legal system has devolved from a rule of law system to a rule by law system. I posit that this transition is the direct outcome of rising inequality, with a very high concentration of resources at the very top of the income distribution. When a small percentage of the population accumulates vast resources then they will naturally seek to influence the law with money to entrench themselves and insulate themselves from competition and even basic accountability. Note from the chart above, that the income share of the top 0.01 percent of our population has soared in recent decades, eclipsing even the 1928-1929 high by a significant amount.

This spike in inequality at the very high end coincided with an assault on the rule of law in the corporate arena. In 1986-1988 corporate elites abolished the duty of care for corporate directors. In 1995 and 1998 those same elites insulated themselves from liability for securities fraud. In 1999 they freed themselves to become too big to fail by repealing the Glass-Steagall Act, the last remaining legal cap on the size of banks. Now they have secured government guarantees for their bonus payments and golden parachute payments. All of these legal indulgences directly contributed to the subprime fiasco.

It makes sense that elites would immunize themselves from corporate laws that imposed accountability or constrained their accumulation of power. First, it is clear that a significant number of the families in the top 0.01 percent of the income distribution are CEO families from the data on executive compensation, above. Second, in addition to their own prodigious resources they can also muster the lobbying efforts of the corporation, as well as the wealth of other senior officers within the corporation. Thus, corporate wealth services the political goals of management not the shareholders. Third, CEOs are a small group of 500 or 1000 individuals (depending on how you count) which means they can act collectively with little cost of free-riders.

The picture is fairly grim. It runs from inequality to executive compensation to an assault on the rule of law. Moreover, since this is a bi-partisan dynamic it is unlikely that either party is likely to roll back the immunities, subsidies and exceptions to accountability corporate executives have garnered. The financial sector lavishly supported both Obama as well as McCain. The law now quite clearly serves the interests of the CEOs.