Time to Restructure Debts of Chicago and Illinois is Now, published by The Bond Buyer By William M. Isaac

Time to Restructure Debts of Chicago and Illinois is Now, published by The Bond Buyer By William M. Isaac

Both the State of Illinois and the City of Chicago are in dire fiscal straits. Taxes keep rising, while staggering amounts of red ink are projected as far as the eye can see.

The city and the state should act now to restructure their liabilities and put the fiscal mess behind them. This can be accomplished by utilizing Chapter 9 and other tools Congress just gave Puerto Rico. The process would entail about two years of unpleasant headlines, but the city and the state will rebound far sooner and less painfully than if they stay on their current paths.

Illinois has the worst credit rating of any U.S. state. Republican Governor Bruce Rauner was elected in 2014 with a mandate to get the state’s financial house in order, but he and the Democrat-controlled legislature are at an impasse. Illinois is overdue on about $8 billion owed to healthcare providers and other vendors. If spending growth follows its 10-year average, the State projects a cumulative deficit of $17.5 billion over the next three years alone.

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Bring Back Glass-Steagall? No Thanks, By WILLIAM M. ISAAC and RICHARD M. KOVACEVICH published by The Wall Street Journal on August 8, 2016

Bring Back Glass-Steagall? No Thanks, By WILLIAM M. ISAAC and RICHARD M. KOVACEVICH published by The Wall Street Journal on August 8, 2016

The convention platforms of both political parties call for restoring the widely discredited Depression-era Glass-Steagall Act, which separated commercial from investment banking. What could they be thinking? Have they already forgotten the causes of the panic of 2008-09?

Some people mistakenly believe that investment banking is so risky that it should be separated from commercial banking. In truth, traditional investment banking entails very little risk and certainly less than traditional commercial banking.

Traditional investment banks engage primarily in underwriting debt and equity for corporations; providing advice on mergers, acquisitions and divestitures; buying and selling securities for institutions; and helping clients hedge their interest rate, commodity and foreign-exchange risks. Investment banks accept very little risk on their books in carrying out these activities.

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Forcing Creditors to Take Losses Is How We’ll End TBTF By William M. Isaac and Richard M. Kovacevich published by American Banker on August 5, 2016

Forcing Creditors to Take Losses Is How We’ll End TBTF By William M. Isaac and Richard M. Kovacevich published by American Banker on August 5, 2016

It seems like politicians, regulators and economists — from Sen. Elizabeth Warren to Federal Reserve Bank of Minneapolis President Neel Kashkari — have a new proposal almost daily for how to deal with the big banks.

Some urge breaking up the largest banks, while others suggest imposing punitive and unworkable levels of required capital. At least one academic, John Cochrane of the Hoover Institution, believes banks should be financed 100% with equity. But none of the critics are suggesting a realistic way to end “too big to fail” without inflicting serious damage to economic growth.

There have always been bank failures and always will be. The trick is to allow sufficient risk-taking to promote economic growth but not so much that it leads to widespread bank failures and panic.

Given the long history of financial crises, we should acknowledge that regulators, by themselves, are not capable of preventing failures without turning banks into public utilities — inhibited from taking sufficient risks to support essential economic growth. The failure to recognize this simple truth is a fatal flaw in the Dodd-Frank financial reform law hastily thrown on the books in an emotional pique following the housing crash of 2008-2009.

This most recent crisis was absolutely not caused by America’s mainstream commercial banks. The primary perpetrators consisted of a handful of large investment banks and S&Ls.

We need a system that assumes bank failures will occur and requires that the failures be handled in a way that punishes excessive risk-taking without devastating the economy or resulting in taxpayer bailouts.

Requiring large firms to increase their equity capital to breathtaking levels, say above 10% of assets, is not the answer. That will lower return on equity to the point that banks will be unable to raise sufficient capital to support growth and will be forced to shrink their balance sheets. This will result in the very companies and individuals who most need bank loans being denied access to banks. This is already happening throughout Europe and the U.S. today.

Here is the link to the full article

CFPB Small-Dollar Plan: Some Good Ideas, But Not Enough By William M. Isaac published by American Banker on July 22, 2016

CFPB Small-Dollar Plan: Some Good Ideas, But Not Enough By William M. Isaac published by American Banker on July 22, 2016

Prior to the Consumer Financial Protection Bureau’s proposal last month on payday, title and high-cost installment loans, I was both hopeful and concerned about the upcoming rules.

In crafting the proposal, the CFPB had the potential actually to help tens of millions of Americans who rely on these forms of credit. Ultimately, the CFPB plan could eliminate regulatory uncertainty, which might have helped spawn innovation and improved lending options. However, I was also concerned that the CFPB might overreach and the rules could have negative, unintended consequences.

I support the mission of the CFPB and believe that CFPB Director Richard Cordray is a thoughtful and intelligent public servant with a tough job to do. That said, the proposed rules appear to contain both things I hoped for and feared.

The main problem with the proposal is the likely impact on the lenders and customers who rely on single-payment payday lending. While far from perfect, payday loans are the only real-world source of short-term credit for lower-income Americans in many states. In the 35 states that allow single-payment payday loans, the proposed rules will eliminate access to credit for millions of working Americans, negatively impacting on people who rely on payday loans for unexpected expenses such as auto repair and healthcare.

 

Here is the link to the full article

 

A ‘get out of jail free card’ for Puerto Rico? Subordinating bonds to pension liabilities would violate the law By William M. Isaac published by The Washington Times on May 17, 2016

A ‘get out of jail free card’ for Puerto Rico? Subordinating bonds to pension liabilities would violate the law By William M. Isaac published by The Washington Times on May 17, 2016

Most state and local governments provide defined-benefit pensions to their employees. An employee earns his or her pension benefits over many years of employment, and then receives the benefits throughout retirement. It is “Pension 101” that the employer should set aside enough money throughout the employee’s years of service to ensure that the money will be there to pay the pension benefits during retirement.

Unfortunately, many state and local governments have been cheating big-time. They have not been setting aside nearly enough each year to fund their pension commitments. The resulting shortfall can be staggeringly large.According to a recent report by the Federal Reserve Board, state and local governments have $1.7 trillion of unfunded pension liabilities — up a whopping 22.4 percent from just a year earlier. To put this into perspective, state and local governments have $3.0 trillion of municipal debt — incurred to fund things like schools, highways and other infrastructure.

Elected officials are primarily to blame for this problem by allowing it to go unattended for so long. If the appropriate pension contributions had been made annually, the true cost of the pensions would have been factored into each year’s budget. Doing so would have required that taxes be increased, funds be diverted from other programs, or pension benefits be negotiated to more affordable levels. These options are always unpalatable, but they are the only responsible ones.

Instead, many elected officials have been kicking the can down the road for years, which is bad for everyone else. Future officials inherit a far greater challenge, public employees cannot count on receiving their well-deserved pension benefits, and taxpayers are potentially facing a very big bill.

Here is the link to the full article

The CFPB’s Overly Simplistic Approach to Loan Underwriting By William M. Isaac published by American Banker on May 13, 2016

The CFPB’s Overly Simplistic Approach to Loan Underwriting By William M. Isaac published by American Banker on May 13, 2016

The May issue of The Atlantic contains an insightful story titled “The Secret Shame of Middle-Class Americans,” by Neal Gabler. Gabler puts a face to one of the biggest economic issues facing this country: the erosion of household savings in America and the resulting traumatic impact on the middle class. He cites a Federal Reserve survey — released about a year ago — finding that nearly 50% of Americans have trouble finding $400 to pay for an emergency and confesses that he finds himself in this same predicament.

By candidly discussing the financial challenges he faces despite being a successful writer, Gabler highlights the fact that bad credit is pervasive. Numerous studies support this. Last year, the Corporation for Enterprise Development reported that a majority of Americans, 56%, had nonprime credit scores, or scores below 700. The Consumer Financial Protection Bureau, meanwhile, recently found that about 11% of the U.S. adult population was “credit invisible,” or lacking credit scores.

For most people this isn’t due to a lack of education or irresponsible behavior; it’s a result of the economic reality that millions of Americans face today. Fluctuations in income and increasing costs of living, especially in health care and education, are causing more and more Americans to live on the edge.

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Where Is OCC in Court Battle Over State Usury Limits? By William M. Isaac and Alex J. Pollock published by American Banker on April 27, 2016

Where Is OCC in Court Battle Over State Usury Limits? By William M. Isaac and Alex J. Pollock published by American Banker on April 27, 2016

A surprising decision of the Second Circuit Court of Appeals in the case of Midland Funding v. Madden threatens the functioning of the national markets in loans and loan-backed securities. The ruling, if it stands, would overturn the more than 150-year-old guiding principle of “valid when made.”

The effects of the decision could be wide-ranging, affecting loans beyond the type at issue in the case. It is in the banking industry’s interest for the Supreme Court, at the very least, to limit its applicability. And since the Madden case could deal a blow to preemption under the National Bank Act, it is time for the Office of the Comptroller of the Currency to voice an opinion.

Under the valid-when-made principle, if the interest rate on a loan is legal and valid when the loan is originated, it remains so for any party to which the loan is sold or assigned. In other words, the question of who subsequently owns the financial instrument does not change its legal standing. But the appeals court found that a debt buyer does not have the same legal authority as the originating bank to collect the stated interest.

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CFPB Should Tread Cautiously on Payday Loans by William M. Isaac published by American Banker on March 23, 2016

CFPB Should Tread Cautiously on Payday Loans by William M. Isaac published by American Banker on March 23, 2016

Readers of the American Banker know that I am very concerned that regulators at the Consumer Financial Protection Bureau might inadvertently strangle the small-dollar, payday loan market, destroying a lifeline of credit for millions of responsible, low- and middle-income Americans. CFPB Director Richard Cordray, whom I respect and believe wants sincerely to keep small-dollar credit available, would do well to have his staff talk with researchers at the Urban Institute.

The institute’s recent study, “Small-Dollar Credit: Protecting Consumers and Fostering Innovation” (December 2015), is the latest in an intelligent series of published roundtable discussions about what researchers and regulators know — and do not know — about small-dollar credit. The authors of the study (Signe-Mary McKernan, Caroline Ratcliffe, and Caleb Quakenbush) point out that most research on small-dollar loans focuses on consumers’ needs and behaviors, but is quite light, at best, on the needs and behaviors of lenders.

Yet, without a better understanding of providers’ business models, profitability, loss rates, volume and overhead costs, regulators cannot possibly create a product that ensures consumers get the credit they need and deserve. The first protection a consumer needs is the assurance that any new reforms will not inadvertently drive all regulated credit from the market. No lenders, no credit. Or worse, as the authors note, consumers will be forced to find other, far more harmful products.

The authors note that most research suggests the overwhelming majority of borrowers need credit because of a family emergency; a temporary, unexpected cash shortfall; or an occasional manageable gap between paychecks. Right now most of these consumers are getting credit when they need it. Regulators must be careful that they do not destroy this supply of credit while trying to help the much smaller percentage of borrowers who probably should not be getting credit at all.

To this end, the authors offer some suggestions.
Here is the link to the full article

Isaac: Chapter 9 offers Puerto Rico a path to solvency By William M. Isaac published by The Washington Post on February 25, 2016

Isaac: Chapter 9 offers Puerto Rico a path to solvency By William M. Isaac published by The Washington Post on February 25, 2016

This week, Puerto Rico faces another critical juncture in its debt crisis, as the House will devote simultaneous hearings to the island’s fiscal situation on Thursday. I will appear alongside a panel of other witnesses at the hearing before the House Financial Services’ Oversight and Investigations subcommittee, while Treasury Counselor Antonio Weiss will be the lone witness to testify before the House Natural Resources Committee.

Puerto Rico’s complex and increasingly severe debt crisis demands federal intervention and, ultimately, a significant debt restructuring. The urgency of this need is not lost on Washington, where there is rare bipartisan consensus in Congress and within the administration that lawmakers must act to offer the island debt relief and put in place policies to foster long-term economic growth.

As noted by Puerto Rico’s government and other observers, this is a task that presents significant challenges. The commonwealth has amassed a spiders’ web of debts from various issuers, each with their own legal guarantees and ranking, which amount to just under $70 billion in total obligations. For an island with an ever-shrinking population of only 3.5 million and an economy mired in a decade-long recession, this is an unsustainable debt load which inevitably must be subject to restructuring.

Here is the link to the full article