Monday, May 6, 2013

Our State Senate at Work: Personal Loans for Hedge Funds

Our State Senate at Work:  Personal Loans for Hedge Funds

In recent days, I’ve been writing about the North Carolina pension plan’s desire to increase its allocation to alternative investments.  While the Senate Pension and Retirement Committee was giving favorable consideration to the Treasurer’s proposal, the Senate Commerce Committee and the full State Senate were making sure that they’ll be a good supply of risky consumer credits for alternative managers to devour.

To Dos (1999)

State Senator Rick Gunn is from Burlington, North Carolina, but his legislative stewardship would make you think he works in Greenwich, Connecticut for a hedge fund.  Senator Gunn is the chief sponsor of a bill to amend the Consumer Finance Act in North Carolina.[1]  The legislation would increase the size of high interest consumer finance loans and contains any number of nasty provisions designed to trap the working poor in mountains of debt.  I won’t bore you with all the details; however, you need to get a bit of flavor.  The bill requires lenders to first apply any payment to late fees and accrued interest before paying down principal.  This little nugget will help ensure that folks who get behind on their loans will stay behind on their loans.  The bill also repeals the term limits on these loans, so these loans can now extend well beyond the old maximum of 60 months on a $2,500 loan.

The pernicious business of making these consumer loans isn’t conducted by obscure finance companies.  No, two of the biggest players are Citigroup and BB&T, although they won’t let their brands be tarnished by this tawdry practice.  Citi’s efforts are cleverly disguised as OneMain Financial and BB&T hides behind Lendmark Financial.  Clearly, I could make the easy connection between Senator Gunn and the finance industry in North Carolina, because the Senator and his colleagues have been lavished with campaign cash.  However, there’s a bigger story.

The Senator is actually doing much more important work for the hedge fund industry.  This bill is going to create a lot more high interest consumer loans.   As these loans pile up, BB&T, Citigroup and other providers will package up the loans (know as a “securitization”) and sell them to hedge funds.  In an environment where interest rates are very low for ordinary borrowers, these loans can carry annual interest rates above 20%.  So even if the default rate is relatively high, credit hedge funds are likely to devour these securities as fast as the banks can securitize them.  Suppose the portfolio of consumer loans starts to really go bad.  No worries; there’s an ample supply of hedge fund managers who live off distressed debt ready to profit on the financial woes of the working poor.   Where are the hedge fund managers going to raise the capital to acquire these loans?  Undoubtedly from public pension plans.  The hedge funds are fortunate to have agents like Senator Gunn all over the United States who are helping to create an ample supply of high yield product from which they can profit handsomely. 

Nonetheless, Senator Gunn knows  that these consumer loans are toxic.  In order to broaden support for the bill, he put in a set of consumer protection provisions for military personnel.  Soldiers must be permitted to back out of a loan within 30 days, and finance companies cannot force the soldier to submit to binding arbitration in a dispute.  Moreover, the loan documents and fair lending disclosures must also be sent to the soldier’s commanding officer. 

Here’s how Senator Gunn’s law will work.  A couple of financially strapped twenty-three year olds will apply for a consumer finance loan in Fayetteville, North Carolina.  They are both automobile mechanics, except that one fixes his commanding officer’s vehicles at Fort Bragg, and the other one repairs the COs car at a gasoline station down the street.  The civilian is going to borrow the money and his loan is destined to be a tiny piece of a  hedge fund portfolio.   As for the soldier; there’s some hope that he’ll realize (or his CO will tell him) just how onerous the loan would be before he becomes indebted.

With or without the bit of consumer protection contained in Senator Gunn’s bill, it is likely to become law.  The working poor will have the pleasure of knowing that their interest payments are going to so many useful purposes.  Senator’s Gunn’s campaign’s can be financed.  Kelly King, the CEO, of BB&T can earn his bonus.  Hedge fund managers can enjoy their 2 and 20.  And, pension plans can try to get closer to their return assumptions and hedge their risks.  Everyone wins, except the folks who are so strapped that they’ll accept the terms laid out in Senator Gunn’s bill.


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