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The populist backlash in Chapter 11
From a bankruptcy perspective, the pandemic has unfolded differently than many expected. Prior economic crises have caused sharp upswings in bankruptcy filings. The 2007-2009 crisis was true to form, with business bankruptcy filings doubling during this time, to 60,837 in 2009 from 28,322 in 2007.1 Given that governments almost completely shut down the American economy in 2020, an even greater surge seemed likely. Many observers predicted a massive wave of bankruptcies.2 Bankruptcy scholars and bankruptcy organizations sprang into action, calling for Congress to increase the capacity of the bankruptcy system (primarily by increasing the number of bankruptcy judges) and to assure access to financing for companies that filed for bankruptcy.3
David Skeel
S. Samuel Arsht Professor Corporate Law – University of Pennsylvania Law School
The big surprise of the current pandemic is that the great bankruptcy wave of 2020 never materialized. The number of very large corporate bankruptcies increased,4 but overall business bankruptcies went down rather than up (from 22,780 in 2019 to 21,655 in 2020), and the decrease in consumer bankruptcy filings was even more dramatic (752,160 in 2019, 522,808 in 2020, a 28% drop).5 The most obvious reason for the surprising decline in bankruptcy filings was the enormous amount of stimulus money that buoyed the economy, including well over $1 trillion of business lending capacity in the CARES Act of March 2020 and subsequent boosters of the small business portion of the legislation. In addition, the buoyancy of the stock market provided access to equity capital for firms that might have found themselves in bankruptcy under other circumstances.
Although the pandemic confounded the typical pattern of rising bankruptcies during an economic crisis, in another respect the pandemic has proved true to form: It has provoked a populist backlash. During the 2007-2009 crisis, populist movements emerged on both ends of the political spectrum—the Tea Party on the right and Occupy Wall Street on the left—in each case, protesting bailouts of large financial institutions.
The current crisis has prompted another populist backlash, as can be seen in controversies that have arisen in the Purdue Pharma opioid bankruptcy and in the bankruptcy of USA Gymnastics after revelation of horrendous sexual abuse by former team doctor Larry Nassar. Unlike the Tea Party and Occupy Wall Street, the current outrage is directed at the bankruptcy process itself. There is a growing populist perception that Chapter 11—the bankruptcy provisions used to restructure financially distressed businesses—has become deeply unfair. It benefits insiders—the “haves”—at the expense of outsiders—the “have nots.”
The closest analogy to the current populist backlash comes not from the most recent pre-pandemic crisis but much earlier, during the Great Depression.6 After emerging in the second half of the nineteenth century, the American approach to corporate reorganization (originally known as “equity receivership”) came to be dominated by large Wall Street banks such as J.P. Morgan and large Wall Street law firms such as Cravath, Swaine & Moore. The banks that had underwritten a class of bonds would offer to represent the investors who bought the bonds in negotiations with a financially distressed railroad or other business. In the 1930s, New Deal reformers such as William Douglas—a Yale law professor who became chairman of the Securities & Exchange Commission and later a Supreme Court Justice—concluded that the Wall Street banks and lawyers were profiting (through the fees they charged and by assuming positions of control) at the expense of the investors they purposed to represent. The reformers ripped control from Wall Street by persuading Congress to enact, and President Roosevelt to sign, the Chandler Act of 1938. The Chandler Act prohibited bankers or lawyers that had represented a company before bankruptcy from representing it after the bankruptcy filing, which meant the company’s underwriters could no longer run the reorganization process. Within a few years, Wall Street had disappeared from bankruptcy.
The pandemic has spurred a remarkably similar populist backlash. Even before the pandemic, concerns were growing about current developments in the restructuring of large corporations. Critics complained about companies’ ability to file for bankruptcy almost anywhere they want to (“forum shopping”), insider control of the restructuring process, the payment of bonuses to managers before and during bankruptcy, and the use of bankruptcy in cases like Purdue Pharma to resolve not only the obligations of the company itself but also of individuals or entities like the Sacklers who have not filed for bankruptcy themselves. During the pandemic, discontent with current bankruptcy practice has grown considerably.7 Lawmakers have introduced a spate of bills, each of which has been prompted by populist dissatisfaction with current Chapter 11 practice.
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This report describes and comments on four practices that have prompted populist backlash. Several other controversial features of current practice that are not considered here are referenced in the footnote below.8
Bankruptcy venue
The first and most longstanding magnet for populist outcry is a company’s choice of where to file its bankruptcy case—known as bankruptcy “venue.” Under the current filing rule a company can file for bankruptcy in any of the following locations: where its headquarters are; its principal assets are; it is domiciled; or an “affiliate” of the company has already filed for bankruptcy.9 Although this sounds like a limited set of options, in practice a company can file its bankruptcy case almost anywhere in the country due to the “affiliate” option. If a Pennsylvania company wished to file for bankruptcy in South Dakota, it could simply create a new, wholly owned entity in South Dakota and have the new entity file for bankruptcy in South Dakota. The Pennsylvania company could then file for bankruptcy in South Dakota since an “affiliate” is in bankruptcy there.
During the decade after the current bankruptcy code was enacted in 1970s, many large corporate debtors filed for bankruptcy in the Southern District of New York. Starting in 1990, Delaware joined New York as another popular filing location for large corporate debtors. The late 1990s saw the first serious challenge to this “forum shopping.” Critics complained that New York and Delaware judges lured companies to their districts by, among other things, allowing bankruptcy lawyers to charge high fees, quickly approving all of the debtor’s initial (“first day order”) requests, and by authorizing rapid sales of the debtors’ assets.10 They also complained that New York and Delaware were too inconvenient for employees and small creditors of companies whose operations were in other states, which it made it impossible for small parties to participate.
Venue reform was never enacted, but it continued to percolate, with support from both Democrats and Republicans. In recent years, several other locations have joined New York and Delaware as popular venues, including Richmond, Virginia and most recently the Southern District of Texas (Houston). The new twist in the controversy is that debtors in several of these locations can pick not just the district where they file but the particular judge.11 The Southern District of Texas has made this easy by committing to assign all large Chapter 11 cases to two judges in the district. In Southern District of New York, a debtor that files its bankruptcy case in White Plains was, until late last year, certain to get Judge Robert Drain, the only Southern District of New York judge sitting in White Plains.12 Purdue Pharma appears to have filed its case there for this reason.
Congress is currently considering legislation sponsored by Senators Cornyn (R-TX) and Warren (D-MA) that would ban venue shopping.13 Under the proposed legislation, large corporate debtors would generally be required to file for bankruptcy in the state where their headquarters or principal assets are.14 The reform would remove domicile—the state where a debtor is incorporated—as a venue option, and the debtor could only file for bankruptcy where an affiliate has filed if the affiliate owns a majority of the debtor’s stock—that is, if the affiliate is the parent corporation.
As often is the case with populist measures, the proposed legislation has beneficial features but also deeply problematic ones. Some of the forum shopping concerns are well taken. Debtors should not be able to pick particular judges within a district and permitting a debtor to file anywhere an affiliate has filed is too easy to manipulate. But removing a debtor’s ability to file in its domicile would be seriously counterproductive. The loser here would be Delaware, where most large corporations are incorporated. Not only is the debtor’s state of domicile an obvious filing location for a large corporation, but substantial empirical evidence suggests that debtors that file for bankruptcy in Delaware file there because of the expertise of Delaware’s bankruptcy judges.15
Third party releases
Another contentious practice is so-called “third party releases.” When a corporation completes a Chapter 11 reorganization, its prebankruptcy obligations are extinguished. The bankruptcy laws only contemplate that the corporate debtor’s obligations will be extinguished, however, not the obligations of other parties such as the directors or officers of the debtor or outside parties that were involved in wrongdoing by the debtor. In many cases, a corporate debtor asks the court to extinguish the obligations of some of these other parties, often in return for a payment by the third parties. In the Purdue Pharma case, the Sacklers agreed to pay roughly $4.5 billion in return for a court order extinguishing their potential liability related to the opioid crisis. When companies owned by private equity funds file for bankruptcy, the private equity sponsor often seeks this protection. Such a release is known as a third-party release.
Courts have struggled with the question of whether third party releases should be permitted. Except with corporate debtors that have asbestos liability, which are subject to a special rule,16 bankruptcy law does not speak to the question of whether third party releases are permissible. There are plausible arguments that they are constitutional and plausible arguments that they are not.17 Some courts allow them, while others do not. As a result, corporate debtors sometimes seek to file their case in a location where third-party releases are permitted.
The Sacklers’ efforts to obtain third party releases has triggered populist ire at their use. The bankruptcy judge approved the releases, although he required the debtor to reduce the scope of the releases. The district court subsequently reversed, concluding that the bankruptcy laws do not authorize third party releases.18 This decision has been appealed to the federal court of appeals.
As with bankruptcy venue, Congress is currently considering a dramatic intervention—legislation that would almost completely ban third party releases.19 Unlike with venue, there is a plausible argument for simply disallowing third party releases, even if they are legally permissible. The argument is that parties who have not themselves filed for bankruptcy should not be entitled to benefits of bankruptcy such as the extinguishing of debts. If the Sacklers or other third parties want this benefit, they need to file for bankruptcy.
The argument that third party releases should be permitted, at least on some occasions, is more pragmatic. Some argue that the treatment of nondebtors such as the Sacklers is so closely related to the debtor’s reorganization that the company’s financial distress cannot be resolved without also addressing potential claims against the nondebtors.20 Defenders of third party releases also contend that everyone, including victims, may be better off when a release is given in return for compensation by the third parties. The Sacklers have argued that if they were not given relief they would defend themselves vigorously outside of bankruptcy and victims would likely receive much less than the $4.5 billion the Sacklers have agreed to pay in the bankruptcy.
Rather than simply banning third party releases, a more nuanced response would be to insist that third parties seeking a release provide more transparency about their assets and ability to contribute.21 In a sense, they would be required to submit to some same rules about disclosure that would apply if they had filed for bankruptcy. Releases might also be limited to third parties that did in fact make a substantial contribution to the payment of victims or other creditors.
The “Texas Two-Step”
A third controversial practice is moving assets from one entity to another—often creating a “good company” with plenty of assets and an asset poor “bad company”—and then subsequently putting one or both of the entities in bankruptcy. Private equity funds often conduct internal reorganizations that are alleged to have this effect after they acquire a company, as in the Chapter 11 cases of the Chicago Tribune and Caesar’s.22 More recently, financially distressed debtors have taken advantage of a Texas law that appears to bless these transactions.23 The most controversial current example is Johnson & Johnson. Johnson & Johnson created a separate entity for its talc line of business, which is subject to numerous lawsuits, and put the separate entity into bankruptcy. This strategy has become known as the “Texas Two-Step.”
These transactions also have spurred populist backlash, both because they seem to involve manipulation by insiders and because the manipulators often are private equity funds, a bête noire of many populists. The proposed legislation to ban third party releases mentioned earlier also would amend bankruptcy law to require dismissal of any case involving a divisional merger that “had the intent or foreseeable effect of … separating material assets from material liabilities … and … assigning all or a substantial portion of those liabilities to the debtor.”24
As with the other issues, courts already have a more nuanced response available to them. When a company transfers assets from a “bad company” to a “good company” within its corporate structure and one or both later end up in bankruptcy, the transfer can be challenged as a “fraudulent conveyance” if the bad company did not receive adequate compensation for the assets it transferred. Fraudulent conveyance challenges were central to the Chicago Tribune and Caesar’s cases.
With a Texas Two-Step transaction, creditors also can challenge the bankruptcy case as having been filed in bad faith. If the transaction is abusive—if the bad company doesn’t have any real assets, for instance—the court can simply throw the case out.
Lender control of bankruptcy outcomes
Another controversial feature of current practice is lenders’ use of their financing agreement and related contracts to dictate the outcome of a Chapter 11 case. When Neiman Marcus filed for bankruptcy, it had signed a financing agreement with lenders to borrow $675 million, together with a so-called Restructuring Support Agreement that locked in a reorganization plan that required Neiman to transfer control to the lenders.25 Once the financing was approved, the case was over—no other outcome was possible.
If the market for providing financing to debtors in bankruptcy were competitive, lenders’ use of lending agreements to control the restructuring process might be less problematic. But the debtors’ current senior lenders have a monopoly, or nearly so, because other lenders fear that their loan will simply subsidize the senior lenders if the senior lenders have priority over the new lenders. Only if the court awards new lenders a “priming lien”—that is, priority over the current senior lenders—will new lenders offer to finance the debtor’s operations in bankruptcy. Bankruptcy courts have the power to provide priming liens if the senior lenders will be “adequately protected,” but they have been reluctant to do so.26
Although the monopoly of debtors’ current lenders has not yet gotten significant attention in policy circles, the issue is even more pervasive in practice. As with the issues discussed earlier, the problem does not require a legislative solution. Bankruptcy courts could facilitate competition by signaling a greater willingness to grant priming liens to new lenders and by declining to enforce contractual provisions that impede competition.27
A breaking point?
Complaints about insider control of Chapter 11 were rising even before the recent pandemic. The pressure has steadily increased during the pandemic, due both to the pandemic and to the confluence of highly controversial bankruptcy filings by Purdue Pharma, USA Gymnastics, the Boy Scouts, and others.
The long-term implications of the populist backlash triggered by these developments may depend on how bankruptcy professionals and bankruptcy judges respond to this unrest. If courts address the legitimate concerns raised by bankruptcy populists, the credibility and effectiveness of Chapter 11 may be restored. The Johnson & Johnson and Purdue Sackler cases offer hints of such a trend. With the talc entity of Johnson & Johnson, a bankruptcy judge transferred the case from North Carolina to New Jersey after allegations of forum shopping, and a motion to dismiss the case as having been filed in bad faith is pending. In Purdue Pharma, a district court struck down the controversial Sackler releases.
If these problems continue to fester, the populist backlash may lead to sweeping bankruptcy reform. Such reform is unlikely to be carefully tailored to the problems that prompted it. It could even destroy traditional Chapter 11 practice, much as the Chandler Act of 1938 brought an end to the reorganization framework that presaged current Chapter 11.
Although the pandemic did not overwhelm the bankruptcy system as many expected, it did bring a spate of preexisting conditions to light.28 The lesson for bankruptcy insiders, the “haves” of the bankruptcy process, seems to be “Physician, heal thyself,” before it’s too late.
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Who should regulate: Chairs or majorities of the board
2021 ended with a mini-crisis at the Federal Deposit Insurance Corporation (FDIC) resulting in the chair resigning after being outvoted by a majority of the board of directors. While this fight received substantial press attention, a similar fight occurred at the National Credit Union Administration (NCUA) where a majority of its board overruled its chair. These incidents highlight how financial regulators’ ability to function in the current politically polarized environment can depend on the agencies regulatory structure. A careful examination of recent trends shows trouble on the horizon for regulators of all shapes and sizes.
Aaron Klein
Senior Fellow – Economic Studies
Twitter
AaronDKlein
The threat is not just messy politics regarding boards. The ability of single-headed agencies to remain independent of the electoral swings is in doubt. Two recent Supreme Court decisions—featuring the new conservative majority—struck down provisions of two major laws that emerged from the last financial crisis which aimed at creating stronger regulations to address consumer financial protection (CFPB case) and the government-sponsored housing finance agencies (FHFA case). The Court effectively turned the head of each agency into an at-will appointee easily removed by any sitting president, overturning Congress’ intent to create agency heads serving fixed terms meant to provide independence from easy removal by the president. The ironic result—a conservative court removing Trump-appointed regulators—may provide short-term comfort to pro-regulatory progressives. But the longer-term ramifications of the Court’s rulings effectively curtail political independence of single agency headed regulators, which should give pause to progressives. Given the long time periods required to implement financial regulation and the political difficulties inherent in regulation that gave rise to the desire for agency independence, the end result of the Court’s ruling will probably be deregulatory.
The ability of financial regulators to be independent of the president and to function effectively is at stake, and it is not clear when, how, or what the final outcome will be. An advantage of the board structure was supposed to be consensus-driven policy subject to majority rule. An advantage of a single agency head with a long term who is non-removable by the president was supposed to be the ability of an agency to achieve politically-difficult regulatory outcomes. Both objectives are threatened by recent changes.
Background
Some background for those not steeped in America’s byzantine and bifurcated financial regulatory system. Financial regulators come in all shapes and sizes: single agency heads to seven-member boards; no partisan affiliation to strict partisan splits; boards consisting of people chosen specifically for that purpose to boards that consist of officials from other agencies. The chart below shows the various structures of financial regulators with the footnote containing the full name of each of the alphabet soup of regulators.1
Financial Regulators by Agency Structure
Agency Structure
Single Head
3-Member Board
5-Member Board
7-Member Board
Agency
OCC, CFPB, FHFA, OFR
NCUA
FDIC
SEC
CFTC
Federal Reserve Board of Governors
Financial regulators are designed to have a greater level of independence from both the executive and legislative branches of government to avoid political interference and more effectively carry out their statutory missions. Each of the agencies mentioned has some independence, with details varying (for more details see this in-depth Congressional Research Service report). Part of this independence involves serving fixed terms ranging from five to 14 years that outlast any specific four-year presidential term. Single agency heads, however, find themselves in a different position. The comptroller is subject to removal by the president for “reasons to be communicated to the Senate,” and two recent Supreme Court decisions struck down provisions of the laws creating the CFPB and FHFA, making each agency head subject to removal at will.
Boards vs. single agency heads
Scholars debate how to balance regulatory independence with public accountability, including how much regulatory structure between boards and single agency heads matters. Congress and presidents of both parties have recently preferred single agency heads as opposed to boards. Financial regulatory agencies are usually created in response to financial crises, and the three most recently created financial regulators, FHFA, CFPB, and OFR, were all created in response to the 2008 crisis. Each was given a single agency head with terms that extend beyond the tenure of a presidential administration and limits placed on their removal by future presidents. The laws that created the three were signed by Presidents Bush 43 (FHFA) and Obama (CFPB and OFR) and had varying degrees of bipartisan support. While this structure was popular, it has been transmuted by these Supreme Court cases into agencies whose heads serve at the will of the president and can be quickly removed and replaced if they are at odds with the White House.
Boards were the more common structure for financial regulators created in the 20th century. Proponents of boards argue that by bringing multiple perspectives, often with bipartisan requirements, agreements can be worked out between different political and regulatory philosophies by non-elected but appointed individuals. Term appointments that cannot be rescinded at will provide board members the autonomy to form agreements not supported by elected political officials.
Different rules govern the role and designation process for the chair between the regulators. For the Federal Reserve, the position and term of chairmanship is separable from a position on the Board. This distinction between chair and Fed Board member came into play when President Trump publicly contemplated firing Fed Chairman Powell. The law was clear that Trump could not remove Powell from the Fed Board, but less clear as to whether Trump could remove Powell from the chairmanship. This was important as the Fed’s monetary policy arm, the Federal Open Market Committee (FOMC), elects its own chair and could in theory have kept Powell as chairman of the FOMC regardless of any attempt by Trump to demote his standing at the Board. Thus, the manner in which regulatory boards are structured can enhance independence.
Bank regulatory boards: Majority rule?
The FDIC and NCUA currently have chairs who are in the political and policy minority. The FDIC has a majority of Democratic members converging to overrule the Republican chair. Their first action was a request for public comment regarding bank mergers and acquisitions. The FDIC chair disputed the ability of the majority of the agency to take action without her consent. The regulatory action taken, inviting comment for a review of bank merger regulation, is consistent with the priorities of the Biden administration as the White House encouraged the FDIC to update their merger guidelines in an executive order issued in July 2021.
The FDIC action is further complicated by the chair’s position that no action has been taken because she has not agreed to place the item on the agenda for a formal vote. The other FDIC board members take the position that they have voted on this topic with one board member placing the request for comment on his agency’s website. That these conflicting actions can occur is possible because, uniquely among financial regulators, the FDIC Board contains two heads of other agencies (CFPB and OCC) as members. These agency heads have access to post actions in the Federal Register and on their own websites in a manner that other agencies’ non-chair members do not necessarily have. The FDIC Chair announced her resignation on New Year’s Eve, defusing the current crisis. However, had she not chosen to resign, then either the situation would have ended up in the courts or the president would have had to try to remove her. Either would have been a messy situation, leading to a period where basic operation and control of the institution insuring American’s bank accounts was in fundamental doubt.
The ability of financial regulators to be independent of the president and to function effectively is at stake.
In contrast, the NCUA has seen the two non-chair Republican board members outvote the Democratic chairman to pursue a deregulatory agenda, approving rules deregulating lending requirements on so-called payday alternatives and activities of service organizations affiliated with the credit union. This deregulation is consistent with the conservative ideology of the Republican Trump appointees who have worked together to override the position of the Democratic appointee whom President Biden designated as chairman.
Two financial regulators are pursuing two opposite paths consistent with the standard political positions among the majority of their boards. The NCUA is deregulating while the FDIC is starting down the path to likely increase regulatory thresholds. The NCUA’s actions have earned the praise of credit union industry advocates while the FDIC’s actions have drawn rebukes by industry. Industry supporting deregulation and opposing regulation is not surprising, but it is important to note the role process plays in the debate. Praise of NCUA focuses on the actions of the majority of the board, while opposition to the FDIC focuses on the process. This is important because the method for a chair to avoid being overruled is to manipulate the process such that the board never has an opportunity to vote on an item. Control of the process can equate to control of the agency, regardless of the will of the majority.
Boards are expected to operate under majority rule, creating the potential for a board chair to be in the minority. This is what happened at the NCUA, which garnered little fanfare or media attention. It is not unique to the NCUA. While the Federal Reserve Board operated recently under substantial consensus, this was not always the case. The late Fed Chairman Paul Volcker was outvoted 4-3 on an issue before the Fed Board of Governors in the 1980s, as he detailed in his memoir. More recently, SEC Chairman Donaldson, a Bush appointee, joined with Democratic commissioners to pass a rule regarding mutual funds on a 3-2 vote. Regardless of the politics of the members involved, the principle of majority rule has held.
Should a chair be able to block a majority, the threshold for regulatory action becomes even greater. A five-member board needs both a majority (three members) and the chair. If FDIC Chair McWilliams had been able to set this precedent, it would raise another challenge for the FDIC to act going forward given that: two of the five members are heads of other agencies; that of the three FDIC full-time board members two are frequently of the minority party (in order to satisfy the no more than three members of the same party split required); and the natural hurdle of giving one member greater power to block action than to allow it.
Regulators run by a single agency head inherently escape the dilemma between the chair and the will of the majority of a board. Yet a single agency head that is not structurally independent of the sitting president is easily removed every time the White House flips. That is the situation the new financial regulators find themselves in after the Supreme Court’s two rulings mentioned earlier. The Supreme Court has checked the desire of Congress and presidents of both parties to structure new financial regulators as agencies headed by single individuals with this level of independence. This check had immediate ramifications. President Biden changed CFPB directors on day one of his presidency, a big contrast from his general lack of nominations to other bank regulatory boards (by December 20, 2021 Biden had not nominated a single new person to the Federal Reserve Board of Governors or the FDIC). Biden removed the FHFA director immediately after the Supreme Court issued its ruling on that case.
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The long-term result of the Court’s actions will be regulators that are less independent and more politically controlled by the White House. Chief Justice Roberts’ ruling distinguishes between multi-member boards and single agency heads in finding differences as to the constitutionality of non-at-will appointments. Absent a change in the Supreme Court’s view of these issues, the creation of single agency head regulators will be confined to those easily replaced by presidents. One may disagree with this logic, but until reversed, it stands. The result will be a greater incentive for Congress to structure financial regulators as boards for greater independence from the executive branch.
2021 featured a credit union regulator with a board overriding the chair and a bank regulator in a battle with a chair who views the majority as attempting to “wrest control from an independent agency’s chairman with a change in the administration.” The FDIC chair’s resignation sets 2022 off in a new direction, defusing the immediate crisis, but the structural problems of both models of financial regulation—boards and single agency heads—still need to be addressed.
The Brookings Institution is financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment. A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this report are solely those of its author(s) and are not influenced by any donation.
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Opening statement of Aaron Klein at roundtable on America’s unbanked and underbanked
Chairman Himes, Ranking Member Steil, members of the Committee, thank you for inviting me to participate at this roundtable on America’s unbanked and underbanked. I laud the Committee’s attention to these substantial problems that impact approximately one out of four American families. Rectifying these problems is essential to achieving this Committee’s goal of addressing the growing prosperity gap.
Aaron Klein
Senior Fellow – Economic Studies
Twitter
AaronDKlein
Basic financial services have become a reverse Robin Hood system whereby lower income Americans pay tens of billions for services that middle- and upper-income Americans receive for free.1 This is particularly the case for the underbanked. The Federal Deposit Insurance Corporation(FDIC) estimates that about one in six American households are underbanked, which they define as using a bank account but also using a payday lender, check casher, or wire transmitter service.2 In addition, one in twelve American families with bank accounts pay $350 a year or more in overdraft fees, according to the Consumer Financial Protection Bureau.3
Why are so many Americans paying so much for financial services when they have a bank account? The answer: our financial system is not well structured to provide the services people living paycheck-to-paycheck need at low costs. This forces many people into high cost workarounds. The result is that the less money you have the more money you spend to access your own money. Basic banking is one reason why it is expensive to be poor in America.
An example elucidates this problem. Consider depositing a check. Despite rapid improvements in the technology involved in clearing checks and legislative changes to enable this new technology (the Check 21 Act of 2004, which I worked on) it still takes sometimes as long as six days for the money from a check to be available in a consumer’s account. For those who always have money in the bank, this delay is relatively meaningless. But for those who are living paycheck to paycheck the results are devastating.
Consumers who run out of money while waiting for the payment to clear are left with bleak options: continue to pay bills and use your debit card, you face overdraft fees that average $35 per transaction; go to a payday lender and pay $50 for a few hundred dollars to make it through the weekend; or avoid the bank altogether and take your check to a check casher, paying on average $20 and get cash immediately.
Estimates for the total amount of overdraft fees paid range from $15 to $35 billion a year.4 5 Payday lending fees have been estimated at nearly $10 billion.6 These are fees only paid by people with bank accounts—by definition every overdraft fee is paid to a bank or credit union and every payday loan requires an account in order to give the lender a post-dated check as collateral. My research using FDIC data shows that 70 percent of check-cashing customers have bank accounts and that the majority of checks cashed are from these customers.7
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Other elements of our slow payment system drive up these costs, including banks and credit unions’ ability to post debits before credits and the inability for consumers to even know when exactly their check or direct deposit will be available. Millions of Americans got paid on Friday, December 10. For most with so-called ‘direct deposit,’ the money was actually withdrawn from their employer several days earlier. This money has been sitting for days while people living paycheck-to-paycheck are spending potentially $50 billion a year in just these three fees alone as they wait for their own money to arrive.
This helps explain the main reason why people without a bank account report not having one: Bank accounts are too expensive and do not provide the service they need. Roughly half of the unbanked cite costs and fees as the main reason why they do not have a bank account.8 In comparison, less than one in twenty cite location or hours as the main reason. Far too many solutions to the ‘unbanked problem’ focus on questions of physical access when the main problems are cost and speed.
The problems in our banking and payment system impact federal government programs, reducing the effectiveness of policies meant to help. For example, Congress acted with incredible alacrity in providing emergency assistance to millions of American families who were suddenly without income at the beginning of the COVID-19 pandemic, enacting emergency payments to families just weeks after the shutdown hit on March 27, 2020. However, the U.S. Treasury did not start sending out money until April 10, and then it took another five days until April 15 before the funds were actually available to those who were lucky enough to receive the first batch. What were families supposed to do for those days while they waited for their money?
Less than half of all eligible Americans received their COVID-19 stimulus in that first round. More than one-third had to wait until May or later to receive their emergency funds.9 And when they did receive their money, for one in four it was by paper check or plastic card. How can it be that 95 percent of families in this country have a bank account, but Uncle Sam could not find 25 percent of Americans bank accounts to give them money in the midst of a national pandemic? Part of the reason is that the Treasury Department simply does not have the information, and another part is that they are unwilling and unable to work with those private sector companies that do.10 This problem still has not been solved, as one in seven families eligible for the child tax credit did not receive their money through direct deposit.11
The result is meaningful for those impacted. One estimate is that $66 million of the first round of CARES Act stimulus payments went to check cashers, as people couldn’t afford to continue waiting. There is still not an easy system for families who are receiving the child tax credit to use it as the regular direct deposit that is required by many banks and credit unions to be eligible for ‘free checking’ accounts.
There are several simple and hopefully bipartisan solutions to these problems. The single most impactful thing the federal government could do is to give people access to their own money immediately. This can be done by simply amending the Expedited Funds Availability Act to require immediate access for the first several thousand dollars of a deposit, instead of permitting the lengthy, costly delays that harm people living paycheck to paycheck. Empowering people to have access to their own money immediately ought to be the small ‘c’ conservative idea that crosses ideologies and forms sensible policy.
Access to digital money is a requirement to participate in the new digital economy. Accessing digital money is easy and free for those with money while for those without a lot of money, digital money is expensive. Requiring all banks to offer a low-cost, basic bank account is one solution to many aspects of this problem.12 The FDIC designed a Safe Account product, which has been picked up by the BankOn movement. Many banks and credit unions offer these types of accounts already. The American Bankers Association urges banks to offer such an account as part of its best practices.13 This best practice should be universal so that any American in any bank can open a basic low-cost, full-service account. Every bank and credit union has a charter from the government. That charter provides great benefits and also responsibilities. A basic, low-cost account is such a responsibility.
In conclusion, there are no magical, single-bullet solutions to fix the entire system. But there are a series of simple policy levers that can be pulled, each of which helps to fix a portion of the problem. Thank you very much for the opportunity to participate, and I look forward to engaging in a lively conversation.
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Interoperability between payment systems across borders
by Codruta Boar, Stijn Claessens, Anneke Kosse, Ross Leckow and Tara Rice Interoperability among payment systems – as the foundation for enhancing cross-border payments – requires technical, semantic and business system compatibility so that end users can seamlessly transact with each other across systems. Public and private sector options in pursuing cross-border payment system interoperability can be illustrated using four stylised models, ordered in increasing complexity and cost but also greater efficiency – a single access point, bilateral link, hub and spoke or a common platform. The BIS Innovation Hub is putting theory into practice with several innovative projects to foster interoperability across the four stylised models. An ambitious, multi-year G20 programme to enhance cross-border payments is under way.