Bill to correct Madden ruling would benefit consumers

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Scott Astrada’s recent BankThink column reflects a misunderstanding of the bipartisan “Madden fix bill” that recently passed the House.

Rather than fostering predatory lending against helpless borrowers, as Mr. Astrada claims, the bill would restore the governing law that existed for hundreds of years prior to the Madden v. Midland decision and increase access to credit to low-income individuals and small businesses.

Contrary to Mr. Astrada’s implication that the House bill would “facilitate rent-a-bank schemes,” the underlying transaction in Madden v. Midland was a credit card loan by a national bank to Saliha Madden. There is no dispute that the loan was valid when made, consistent with the usury laws of the state (Delaware) where the national bank resided and whose law applied under federal law. Several years later, Madden defaulted on a $5,000 balance, and the loan was sold to a collection service. At that point, Madden argued that the interest rate, although originally valid under Delaware law, violated the law of her home state, New York, and that the governing state law should switch from Delaware to New York because the national bank no longer held the loan. A panel of the U.S. Court of Appeals for the Second Circuit agreed.

The Madden decision has significant consequences for the secondary market for loans and conflicts with longstanding and carefully considered precedent. Banks depend on the ability to sell or assign the loans they originate when they determine whether to make the loan and how to price it. Banks have been selling debt in this country for centuries, relying on the so-called “cardinal rule of usury,” which provides that the non-usurious character of a loan does not change based on a subsequent sale or other transaction involving the loan. Importantly, this doctrine was explicitly endorsed by the U.S. Supreme Court in 1833 (though numerous other courts had previously adopted it) and has not been disavowed in the intervening years until Madden. Indeed, the Obama Justice Department opined that the Second Circuit had gotten the Madden decision wrong on this point.

The stakes are even higher now than when the doctrine was first adopted, as regulatory requirements have made it cost ineffective for banks to originate and hold some loans that they extend — particularly higher-risk loans to low- and moderate-income consumers. Of course, those loans tend to carry higher interest rates and are thus the most likely to see their secondary market value undermined by Madden.

Mr. Astrada’s op-ed does not include this history, and instead mischaracterizes the case in two important ways. First, Mr. Astrada states that the “Madden fix bill” would foster “rent-a-bank schemes whereby non-banks, such as payday, installment loan or credit card companies, form a superficial partnership with a bank in order to piggyback off bank preemption of state usury laws and charge triple-digit interest rates well in excess of state rate caps.” This reference to “rent-a-bank schemes” conflates the valid-when-made issue present in Madden with separate “true lender” issues that are being pursued and examined by regulatory authorities across the country and not at issue in Madden. Madden involved the sale of a charged-off credit card account to a third-party debt collector, not an arrangement where a “partnership” was formed between a bank and another entity with the express purpose of extending credit from the outset.

Second, Mr. Astrada states that the Madden decision “reaffirmed the illegality” of such lending arrangements. As noted, Madden did not involve “such lending arrangements” — the “rent-a-bank” schemes to which Mr. Astrada refers. Nor did the decision “reaffirm” the illegality of those arrangements or banks’ sale of loans, which was actually involved in Madden. And rather than being illegal, the origination and subsequent sale of loans by banks is squarely within the powers granted to national banks by statute. The National Bank Act provides that national banks may exercise “all such incidental powers as shall be necessary to carry on the business of banking,” which includes the origination and sale of loans and participation in the secondary markets for loans, as well as the power to pursue collection of delinquent accounts by selling the debt to debt buyers for a fee.

As a result, Mr. Astrada alleges that the proposed remedial legislation would “dramatically broaden the scope of federal preemption of state law.” In fact, the legislation would not do anything other than affirm a core principle that has allowed the loan markets to function efficiently and consumers and businesses to access credit. Indeed, this would return the loan markets to the status quo that existed for centuries prior to the Madden decision — during which time, notably, “predatory triple-digit loans” were far from the norm.

"As interest rates rise, higher-risk loans will necessarily be made at interest rates that exceed caps set in numerous states."

Under Madden, potential purchasers of loans and interests in loan securitizations will face the significant risk that a loan that was valid at origination may have been rendered usurious through assignment. This increased risk is likely to make purchasers less willing, if not entirely unwilling, to buy loans or interests in certain securitizations of loans that may turn out to be subject to additional state usury limits (including criminal penalties), or even a change in the usury law of the state in which the loan was originated. Credit market participants are likely to respond by reducing the origination of loans, increasing the original rate of interest, or simply refusing to purchase or securitize certain loans.

Thus, while the Madden decision might end up decreasing the interest rates charged on some loans, it almost certainly will decrease the availability and increase the cost of credit, particularly for small businesses and lower-income families. Because loans to such borrowers carry greater credit risk, such loans require higher interest rates, thus creating greater exposure to usury limits. If a bank originates such a loan, bank capital regulation has already dramatically increased its cost of holding it, and Madden will significantly limit the ability to securitize it.

The impact of the Second Circuit’s decision is already being felt in the marketplace. Some financial institutions have reportedly imposed restrictions on credit facilities used to finance consumer lending, prohibiting loans to borrowers in the Second Circuit if those loans bear interest at rates higher than the state-enacted usury rates. Similar effects have been felt in the securitization market, as firms have removed loans made to borrowers in the Second Circuit from asset-backed securitizations due to usury concerns.

And the impact will almost certainly be even greater in the future. In the current low interest rate environment, state usury laws have generally been non-binding. But, as interest rates rise, higher-risk loans will necessarily be made at interest rates that exceed caps set in numerous states that have fixed usury rates. In turn, banks and other lenders will likely have to impose even tighter restrictions on lending to ensure that the loans they make will not be subject to usury if sold, further limiting access to and increasing the cost of credit for small businesses and lower-income consumers.

So the Madden fix bill wouldn’t “spread” predatory loans like a virus — unless one views loans that are legally valid when made by national banks as predatory. Rather, it would rightfully return certainty to the loan markets, thereby once again allowing consumers and small businesses to access credit that they may not otherwise have access to if the Madden decision is not fixed.

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