R.C. Lim, Attorney and Counselor at Law

Credit Reporting

When should you introduce the topic of your credit score to a new boyfriend or girlfriend?

In this video, a new couple describe their experience. The now hubby turns out to be the one with ideas about savings and personal finance. That’s probably a good thing since his stated career is “professional poker player.”

Difficult Times

Today’s report that second quarter GDP growth was revised down from 2.4% to 1.6% should not be a surprise to most working families actually struggling through these difficult times. Over the past several years, many consumers have grown to understand too well that the early figures that are announced do not reflect reality. As increased amounts of data arrive, downward revisions to the economic figures have become the norm.  This particular figure, 2010 second quarter GDP, will continue to be revised for the next three years to come.  Downward I expect. I personally will not be the slightest bit surprised to learn that growth was not only anemic but in fact stagnant or even falling during this period of time. If one backs out the one-time and temporary gains in employment through the addition of census workers, the jobs picture was then and still continues to be simply awful. It cuts across the economy among different economic segments, geographic regions, and types of employment. Unemployment figures that would include discourage workers and other categories commonly excluded from the headline figure is commonly believed to be as high as 20%.

On perhaps a somewhat different plane, it strikes me as quite significant that George Soros, the noted investor who rarely ever gets macroeconomic trends wrong, revealed in his most recent filings with the SEC a loss of faith of the US economic recovery and the fear of inflation. Another investing guru, Warren Buffett, has predicted the same. Again this simply recounts what struggling families already know: these are difficult times.

One issue that repeatedly recurs when families are having a difficult time meeting their monthly bills is that they must sometimes choose which bills to pay. One mistake families often make is trying to stay current on their credit card payments while giving up on their mortgage. While I do not want to suggest that there is a hard and fast rule here. That is, it may sometimes be the best decision to pay credit cards ahead of your mortgage. In most cases, it is not the right decision at all. One reason here is that if a family is struggling under a debt burden and is headed for a consumer bankruptcy filing, that bankruptcy would likely redress the unsecured credit card debt, but not other forms of secured debt, such as a mortgage. Another reason is that if there is equity in the home that equity may be exempt from your creditors from the state homestead exemption. The logic that many use of attempting to avoid stepped up interest payments is certainly sound. However, it is simply not necessarily a goal to be had at the expense of missing mortgage payments.

What is most important here is to be realistic. If you are in a home that you cannot afford, you are better off coming to the realization earlier rather than later. If you are grappling with credit card payments that you cannot afford, you are better off seeking to discharge them before you have run through all of your assets.

Student Loans Are A YOKE On the Backs Of Young Americans

At this point in my admittedly short career as a bankruptcy attorney, I have spoken to too many alums — many from very good schools — that have borrowed more than they can afford to pay off.

Unfortunately, there has been much too little about this story. Much like the case of mortgage lending that occurred before people actually began defaulting on their notes, there is hardly any coverage of the problem in the media. Today’s NY Times article is a wonderful exception. Unfortunately, it’s not news until people actually default. And with student loans, the loans can be deferred for a number of years before a default actually occurs.

The central problem is the same as that which happened with the mortgage crisis: deregulation! The reason that it is much much worse for consumers is that unlike other forms of debt, borrowers cannot discharge student loans except in exceptional circumstances. The Brunner test is so exacting that most bankruptcy attorneys don’t even bother.

Make yourself aware of this problem. And don’t let any college students you know take on too much debt. Even to go to Harvard, it’s simply not worth it.

Public Key Encryption Hacked

This post is perhaps a bit off-topic. But given that it’s potential connection to the possibility that millions will have their credit destroyed perhaps not.

Background:

This may be a little bit mathy. If so, my advance apologies. Encryption has long been one of my interests.

Public-key encryption, the one most commonly used in commerce is called RSA encryption, works by having two keys — one to encode and one to decode. Essentially, you have part of the cipher — the public key that you give to the public at large.  Then anyone can encode a message and send it to you. The neat thing is that no one can take your public key and then decrypt any of your messages. For that, they would need the private key, which you keep to yourself.  This kind of encryption is at work any time you look at your browser and see that little lock in the bottom right corner. It is used in nearly all Internet transactions.

The big idea behind this kind of encryption is that factoring, or breaking a number down into its prime divisors is difficult and time-consuming. While there are a few shortcuts, mostly the method to determine prime divisors is simply to try them one by one. Because its so time-consuming, to crack the encryption on your web browser would take modern computers longer than the life of the universe and certainly longer than any human life.

There has always been two big potential monkey wrenches here. One is the possibility that some crazy mathematicians figures a way around the supposedly hard problem of prime factorization. (There is no theorem that it’s got to stay a hard problem.) Two is that the computer power surges past the computations that would be necessary to crunch the numbers in a reasonable amount of time. Something of a hybrid of the two seems to have gotten it done.

Why You Might Not Want To Send Private Information Online For The Next Year Or More:

A couple of electrical engineers working on an entirely other problem have figured out that if you vary the voltage on the machine sending or receiving the encrypted message there will be errors, then if you examine the kind of errors that has occurred, you can figure out the private key in far less time. In this case, they were able to crack the RSA cypher in 10 days.

This should be huge news! Personally, I’d advise that you be cautious until the remedies can be implemented. The proposed remedies — that errors be purposefully included in all encrypted messages might work. (It’s still unclear if that doesn’t simply create a new much easier problem than the problem of factoring.) Until then, every rogue hacker has a blueprint of how to get into your private information over the Internet. There are a lot of people who have the skills to capitalize on this development before an effective remedy can be developed.

Derivatives, Bankruptcy, and Wall Street

Reading this op-ed in the WSJ today left me scratching my head.

Evidently, prior administrations — Dem and GOP — took the position that derivative contracts needed a special set of rules and considerations in bankruptcy. Their chief fear seems to be that not doing treating them as having special considerations might rattle derivatives markets. Strange!

Now President Obama does not want to sign any new financial reform legislation that does not include some regulation of the derivatives market. This is evidently so important that he has threatened to veto any legislation that does not include provisions accomplishing as much.

President Obama forever the seeker of compromise has now evidently found a cause that he believes in. And this time, he’s flat wrong! Presumably prior administrations were eager to go along with bad policy because they were worried that the derivatives market was sufficiently complex that there was much that they did not understand. Most people’s eyes glaze over when the Black-Scholes equation and all of that icky math enters the picture. Finally, President Obama shows a spine, but it’s on an issue where he gets it exactly wrong!

The missing fact that President Obama is ignoring is that the majority of the derivatives market is compromised of individualized contracts between two parties that are peculiar to the situation and so cannot regulated as if they were traded on an exchange. Moreover, he fails to recognize that trading risk in this fashion accomplishes a good. Namely, risk is spread throughout the system. The dispersion of risk throughout the economy, when it is not in the exceptional circumstance of placing the entire economic order at risk of collapse, is a public good and needs to be encouraged by the government and not discouraged.

Supreme Court Gossip: Elizabeth Warren To Replace Justice Stevens?

The latest gossip among the chattering lawyers is that Elizabeth Warren may be in line for the Supreme Court nomination to replace Justice Stevens. Professor Warren would likely be a more popular choice and face less Republic resistance than many potential nominees. Her nomination would also provide a strong example against the rule that law professors make lousy nominees because they have said and written too much.

In fact, Professor Warren’s populist message is exactly the sort that would give the Republican leadership pause because it’s so likely to be popular with their own constituents.  Given Professor Warren’s personal background as a consumer debtor attorney, it’s extremely likely also that during her term she would forever change the operation of finance in the United States.

The LA Times Picking Over Carrion: WaMu’s Role in the “Mortgage Time Bomb” Revealed!

Since the mortgage crisis has begun, I find that I often read newspapers and get the distinct impression that still no one gets what has happened here with our mortgage mess.

Today’s Los Angeles Times leads with a story uncovering Washington Mutual’s role in the housing crisis. Here the main piece of news is that the bank continued to accept loans in which it had uncovered fraudulent activity because the bank knew it would simply package the debt and sell it off to some other party.

The issue here is that this was commonplace among all of the banks in all of the various lending markets and had been so for years! Moreover, this is not a very well kept secret. Talk to any honest real estate appraiser, and he or she will tell you about the mountains of business that didn’t come his or her way because of scruples. Talk to anyone who packaged the debt, and he or she will tell you about the bag of tricks that were then used to gain higher ratings from the credit agencies.

Washington Mutual makes a convenient scapegoat because it no longer exists as an independent bank. Washington Mutual collapsed and was seized by regulators and then in turn sold to Chase. When the LA Times runs a story about how nearly all of the still existing banks were basically in the same line of work, that’ll be news! Basically, the inference that I draw from WaMu’s collapse is that the bank was less involved in the “mortgage time bomb” than the banks that are still around since it means that they did a worse job at getting the toxic stuff off of the books.

Our Fair City - Los Angeles Heads Closer to Bankruptcy

At first it looked like Detroit would be the first large US city to need bankruptcy protection.  Detroit has what looks to be an unfixable $450 million hole in a $1.6 billion budget.

But Los Angeles may beat Detroit to the punch. Currently there is a showdown between the L.A. City Council and L.A.’s Department of Water and Power and Mayor Villaraigosa on the other side. At stake are rate hikes to implement clean energy that the City Council won’t agree to and $74 million in “surplus revenue” that the D.W.P. in turn refuses to hand over to the City. Mayor Villaraigosa has already called for the temporary shutdown of certain city services. However, his efforts do not seem to be working. Regardless of who is it at fault, the sudden loss of an expected $74 million could turn L.A. upside down and into Chapter 9 quickly.

2010 Estate Tax 101

Okay, the really quite odd thing happened and Congress did not get around to changing the estate tax last year. Hence, there is no estate tax for those who die this year regardless of the size of the estate: millions, hundreds of millions, or even billions….

The complication comes in that the basis step-up that most receive on death is no longer available. This means that beneficiaries will usually inherit the tax basis of any asset they receive from a decedent. This further means that when and if they go to sell that asset, they will owe capital gains tax on any increase in value. Since the assets in questions — homes, IRA accounts, etcetera — that beneficiaries receive have usually appreciated over the decadent’s life, this means that taxes will be owed by most estates.

The net effect will be to increase the tax on the smaller to mid-size estate, while almost entirely removing the tax for large and exceptionally large estates, a truly perverse outcome. Worse still, it’s worth remembering that most brokerages do not keep or report records to the IRS on purchase prices of securities. In the absence of knowing a precise number, the IRS typically assumes the value to be zero and capital gains taxes are presumed to be owed on the entire amount from the sale of any securities. The problem here is that it is often the case that the executors and administrators who are rummaging through the old records cannot reconstruct the purchase prices either. This leaves those in charge with the difficult task of making up a number based on the surrounding or circumstances or simply paying the tax on the entire amount. Congress has certainly created a real mess by allowing the Bush’s repeal of the estate tax to go into effect.

New Federal Loan Mod Program Aimed at Principal Reductions

Now that the housing crisis is bad and getting worse, the Feds have announced a new $75 billion program that will aim at principal reduction for borrowers who are underwater on their first and second mortgages but current on payments. The program will provide incentives for lenders to work with borrowers to avoid strategic defaults by borrowers who are struggling.

Like many of the programs that have come before, like the Making Home Affordable program, this program will exclude most borrowers. The requirement that borrowers be current would exclude nearly all of my clients since even among the ones that could have been current have gotten behind in some (misguided) attempt to force a loan modification from their lender. In fact, I have heard several clients actually report that they have been indirectly given the advice to fall behind to improve their chances at working out a loan modification.