R.C. Lim, Attorney and Counselor at Law

Student Loan Reform in the Health Care Bill: A Lowdown Shame

The larger narrative of deregulation that has been largely accepted by large sections of Democrats and might have become the uncontested political force had there not been an intervening recession lives to fight another day.

Obama had promised a lot with respect to loan forgiveness, but he delivered very little. By funneling all government loans through the government Obama has raised the specter of creating another fat bureaucracy full of incompetent folks who cannot tie their own shoes. Yet Obama has also guaranteed, at least for a little while, that the students of the future wont need to pay the tax in the form of corporate profits to lenders that will evaporate into thin air the moment the economy slows down. (Here I am thinking of TERI, which was used as a sweetener to insure pooled student loan bonds, or the unfortunately named - MyRichUncle - a bank that focused exclusively on student loans.)

The Obama plan also creates a much needed modification of limiting repayments to 10% of income and to a term of 20 years on loans made after 2014. To fully grasp the significance of this last piece, you’d probably be best served sitting next to me in my office while I do client intake interviews and patiently explain the law as it relates to student debt and bankruptcy. The law’s super grim in this area. The number of people in financial trouble who cannot discharge their debt is large. Personally, I think that the Brunner test must be unconstitutional since bankruptcy is a right guaranteed by the Constitution. More significantly, folks who find themselves in this situation have done it all right. They stayed in school. Kept their noses in books.

The measures in the Health Care bill are certainly a start, but quite clearly: Obama has not done enough. Yet again, he has split the baby to no particularly good effect. Moreover, he has avoided the issue of resolving the real people who suffer under the yoke of burdensome student loans by simply postponing his remedy. By setting a time four years in the future, Obama has avoided certain challenges, but he has also failed a deserving constituency — the hard-working, educated class — even while he randomly distributes government largess to corporate undeserving and those - many who were quite irresponsible - who believed the real estate agent’s lies.

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.

Bank of America Announces Loan Mod Program

The program will specifically target many of the high-risk loans acquired by B of A from the Countrywide purchase and will include principal reduction of up to 30% of the value of the loans.

If you have a loan with B of A, however, you had better not get your hopes up too quickly. The bank’s program will affect only 45,000 loans, or just about 3.5% of the total number of loans with B of A.  More specifically, these are loans in which B of A is quite worried that the homeowners will walk away from a loan and leave the lender with a serious hole in its balance sheet. Further bear in mind that there are probably 45,000 loans on B of A’s books that are more than 50% undersecured.

But, it is certainly a step in the right direction.

A Surprise Win Again Student Lenders

To say that it is difficult to receive a discharge of student loan debt in a bankruptcy proceeding is an understatement. However, in a unanimous decision by the Supreme Court, it just got a little bit easier.

The requirement to discharge student loan debt, known as the Brunner test, is demanding and requires that the debtor show “undue hardship” if the loan were not modified. Although there has been some progress made. For instance, in the 9th Circuit it is possible to succeed in part, since the Circuit permits the debt to be split into dischargeable and nondischargeable portions.

The case decided yesterday, In re Espinosa, involved a debtor in Arizona who had either improperly scheduled the debt on his petition or improperly failed to set a motion to hear the issue of “undue hardship.” The Trustee and Judge in the case also failed to follow-up. In my opinion, there are two surprise in this case. The first is that the Court took the case at all since it only relates to a minor procedural matter. A second surprise here in this decision is that the Supreme Court voted unanimously in the case, given the great divide in belief among the Court’s Justices. The NY Times was right to point out that this case will affect few debtors. Perhaps this is some indication that the Court understands the truly awful human cost of the current state of the law with respect to student loans and suggests that we might expect some further progress for debtors with respect to student loans.

Prepay Your Mortgage? Probably Not.

The New York Times recently published an article investigating the question of whether to prepay mortgages. (That is, if you are so lucky!) Their assessment is that the question of whether to prepay centers on the two questions of how likely you are keep the money as savings and how good you will feel having prepaid the mortgage earlier than you might have.

Along the way the article points out a lot of other facts that might swing the pendulum against prepayment. For instance, it is observed that we are now at a historic low for mortgage rates and that the rate will likely soon start heading back up. Or that real estate are not the reliable and liquid investments that they were once thought to be.

Recently I interviewed a financially responsible couple who are now on the brink of bankruptcy from prepaying their mortgage when they should not have. They used savings to prepay their mortgage before the housing crisis, whittled down their extra savings, and they are now still underwater on their house and without any savings.

Although the New York Time’s does not want to come right out and say it: right now, at this time, it’s really probably not such a good idea. One can never knows about job security or the strength of a family business. Unfortunately, sometimes the intervening forces are not good, and with times such as they are, it is much better to err on the side of caution.

Chinese Debt –> Chinese CRISIS –> US DEBT –> US CRISIS!!

The global economic recover that has happened to date has rested on various pieces:

1. The recovery of the Chinese economy, and

2. Altered FASB rules that alleviate banks from “marking to market” various assets that should be reported much lower.

Although the Chinese government has indicated that it may lower its purchases of the US debt, China has for the most part been the main consumer of US Treasuries since the economic collapse. By buying US debt, China has been a stand-up economic partner. China of course does not do purchase US debt for altruistic reasons. However, the effect is the same. The Chinese government continues to purchase our debt, even when the interest terms offered are not particularly good, thereby keeping our long term interest rates low, something that Federal Reserve Bank has absolutely no control over.

In studying Chinese companies on US exchanges, I have come to a conclusion. I am writing up this result up for posterity’s sake. My belief is that Chinese companies are all built on a house of cards of a different sort: trade credit. The extension of trade credit by Chinese companies to (presumably) other Chinese companies is a credit bubble that is built on hot air and not fundamentals and its unwinding might inevitably lead to a collapse that could destroy China’s economy. Such a collapse would prevent China from further purchases of US Treasuries and instead what we would see is that China will quickly turn to selling them instead.

This morning I was looking at the balance sheets, income statements, and statement of cash flows from a company named Yongye Biotechnology International (NASDAQ: YONG). This company manufactures the product fulvic acid, which is purported to aid plants in the absorption of nitrogen and other essential nutrients. This may or may not be the case, and I profess to know absolutely nothing about the scientific claims made by Yongye about the benefits of fulvic acid.  What I noticed on examining these statements is that what looks like a lot of growth may quickly turn into a mirage.

In two years, the company has grown revenues from $4 million to $13 million to $48 million. During that time, net income rose from $0.5 million to $4 million to $13 million as one would expect. Looks great! Peal back a layer, however, and you’ll see that in that time, the cash flow from operations gets worse and worse and worse, going from -$0.3 million to -$5 million to -$9 million. These deficiencies have all been financed by continuing sales of stock onto the US’s Nasdaq exchange.

The problem that China’s companies face is simple: counterparty risk. I know this only anecdotally because it seems like so many Chinese companies balance sheets and statements of cash flows look exactly like Yongye’s. And there may be a confounding variable here somewhere, but if there is, I don’t see it.

If you take a company like Yongye though that makes a new product and brings it to market. Other companies may want to purchase the product but are unsure about it. Yongye says to that company, “buy it on credit.” The purchasing company may like the risk that is taken out of the equation by the offer and further may think to itself that they will try to put the product back on Yongye later on if it does not sell. In the meantime, Yongye records a sale — an increase in net income — and also increases the accounts receivable side of the ledger rather than the cash portion.  Yongye is able to finance these generous terms by using some of the cash that it has accumulated by selling stock to Americans who are still looking for quickly rising assets and impressed by such rapid growth of the bottom line. (The company also fits an investment paradigm that has recently become trendy of investing in food nutrients.)

The cumulative effect of many, many different Yongyes is that Chinese companies have an inordinate amount of each others’ debt in the form of receivables. My conjecture here is that just like with our recent credit bubble, there has not been the underwriting discipline to only extend that credit to parties who are likely to pay. Moreover, the cash infusions and exotic locale have permitted many shaky companies to continue this essentially insolvent practice of not even paying for their own operations. If this is in fact such a credit bubble, and that credit bubble unwinds in a sudden way, like it did recently in the US housing market, Chinese companies and then the Chinese government will go from being savers to spenders. The problem for the US is that without the Chinese buying our debt our long term interest rates will skyrocket and US economic growth will really get seriously derailed.