For the past year or so, Dechert has been keeping a close eye on the marketplace lending industry and the tension between innovation, which portends the development of an entirely new non-banking financial space, and the instinctual reaction of the regulatory state to resist and restrict innovation. Earlier this summer, we published an OnPoint providing a comprehensive review of recent hurdles and developments affecting the marketplace lending industry, including the potentially far-reaching Madden v. Midland Funding case from the Second Circuit. The Supreme Court has now denied cert in the case and so the Second Circuit’s decision will stand.
The Madden case was all about consumer protection. The Second Circuit in Madden held that the purchaser of a loan from a national bank is not entitled to federal preemption of New York’s usury laws. This result surprised the industry because it was contrary to the long-standing view that it was settled law that a purchaser or assignee of a loan is protected by the “valid-at-inception” doctrine. See FDIC v. Lattimore Land Corp., 656 F.2d 139, 148-49 (“The non-usurious character of a note should not change when the note changes hands.”). The Madden case greatly complicates a bank’s ability to transfer debt. If the borrower is located in a jurisdiction with strict usury laws, such as New York, the purchaser could be vulnerable to challenges against enforcement of that debt. There are many such jurisdictions.
This case has been seen as a marketplace lending decision. A somewhat Luddite inspired slap at the new and rapidly growing marketplace lending industry. To our political class and its regulatory apparatus, it is often viewed with enormous skepticism and innovation is just a fancy word for bad behavior. Maybe this is more about consumer protection and bad debt trading. The court curiously failed to even address the long-standing notion of “valid when made,” but nonetheless, and particularly after the Supreme Court declined the opportunity to take it up, this is law and law in our most important circuit.
The Madden case has largely been seen as a problem for the marketplace lending industry and indeed it is, but it is also a problem for our securitization industry. In either case, we are looking at non-prudentially regulated entities acquiring loans from the prudentially regulated.
Look, it’s not the end of the world. First, usury is largely a problem only in the consumer sector and the usury limits are usually pretty generous. Can a marketplace lender or securitization vehicle diligence loans to make sure it meets the lowest common denominator of the usury statutes from the jurisdiction from which it acquires loans? Certainly, moreover, it’s only a Second Circuit case and so far at least the thinking of the case has not infected the other circuits, although I guess we should stand by for that. What’s troubling here is that it has more than a whiff of judicial activism in service to the regulatory state about it. Here we have one of our most prestigious courts overruling years of precedential certainty, maybe because it was an appealing plaintiff, maybe because the court simply didn’t like the unregulated jungle of the marketplace lenders. But regardless of motive, it’s a retrograde step in the march of progress. An expression of the Know Nothing movement. It feels a bit of a cloth with efforts to roll back Glass-Steagall to restore the world of “It’s A Wonderful Life” banking; almost a nostalgia for a past, for which we should feel absolutely no nostalgia. This decision negatively impacts the efficient management of financial assets. It impacts liquidity. As we have said in this commentary many times before, liquidity is critical to the efficient operation of the capital markets. These types of actions, whether judicial or regulatory designed in a jejune passion to protect the “folks” ultimately hurts the users of capital and hurt our economy.
In any event, it’s just a data point, but stand by and keep your eyes open for this continuous drumbeat of events, rulings, regulations and jawboning officials who conflate modern financial innovation with market failures. This has the causality arrows backwards, or at least sideways and will achieve very little good yet impose a very real cost, a cost the system really doesn’t need right now.