Alan Greenspan, the Ayn Rand acolyte (he was executor of her estate) who headed the Federal Reserve during the years when the bubble was inflating, insisted he never saw a housing bubble forming. Greenspan is famous for poring over financial and economic data, often in his bathtub, yet like Claude Rains’s Captain Renault in Casablanca, he claimed to be unaware there was gambling going on.
Many people saw the housing bubble forming, including me. And if I could see it, how could Greenspan not? Even though real estate was not my beat, I wrote two articles in the New York Times in 2004 to have a record I could cite when the collapse took place. Housing prices were growing faster than economic conditions could justify by 2002. Way back in 1993 George Akerloff, who won the Nobel Prize in Economics in 2001, and Paul Romer wrote a seminal paper after the savings and loan crisis titled “Looting: The Economic Underworld of Bankruptcy for Profit.” Anyone who read it could see the pattern that arose in the housing market starting in the late 1990s.
Criminologist Bill Black, who is now a professor of law and economics at the University of Missouri–Kansas City, testified widely about how the lessons of the savings and loan crisis should be applied to the housing bubble. Black gave speeches, promoted his book The Best Way to Rob a Bank Is to Own One and appeared on national television. He did everything he could except yell Thief! in a crowded bank. But hardly anyone listened. The White House, the Justice Department, and the banking regulators all failed to seek his counsel.
Instead of the thousands of prosecutions we saw after the savings and loan debacle, there have been less than a handful of prosecutions of bankers in the mortgage frauds. Angelo Mozilo, who made more than $600 million as head of Countrywide, escaped not only prosecution, but also civil liability. His $47 million in fines—modest compared to the costs Countrywide imposed on society—was paid mostly by insurance companies. Mozilo insists he did nothing wrong. So do the prosecutors and regulators who settled with him. Mozilo is another example of how thoroughly those at the top are insulated from accountability while those at the bottom are pursued in modern America.
14…
“Wells Fargo Will Take Your House”
I didn’t read, I just signed.
—Judge Richard Posner
14. Barbara Keeton’s old blue truck started leaking so much oil she knew she needed a new set of wheels, fast. Keeton lives in the nation’s capital with its modern subway and plentiful bus routes, but the system is designed to serve office workers, not people like Keeton, a former army cook who drives a school bus. She must get to the bus barn by six in the morning, just a half hour after the subway starts running, too little time for her to bundle up her little ones and get them to day care.
So one July day in 2005, the army veteran stuffed some pay stubs in her purse and drove across the Potomac River to one of seventeen used-car lots run by Easterns Automotive Group, which advertised heavily on television. Their commercials convinced Keeton she could count on a fair deal on an affordable car.
Keeton figured she could handle a $200 car payment. The Easterns salesman convinced her that she needed a better car than $200 a month would buy. Easterns put her into a four-year-old Mazda Tribute, a sport utility vehicle priced at $19,955 plus taxes and fees. Wells Fargo Bank financed the deal with a six-year loan at $389 a month for a total cost of more than $28,000.
Before long the Tribute stopped dead in traffic. The ignition system, one of those modern ones with electronic coding in the keys, had failed. Easterns fixed it, replacing the keys. Then the ignition failed again. Soon numerous other flaws became apparent. Between towing bills, repair bills and a car payment nearly twice what she had budgeted for, Keeton knew she was falling behind. Then she was placed on temporary disability, which meant her income dropped.
“My doctor put me out of work because I was forty-two and pregnant,” Keeton recalled. Knowing she could not make more payments, Keeton said she “asked them to take the car back, but they refused. So I went to my credit union because I knew you could refinance a car, and when the credit union said it was only worth $8,800 my heart sank.”
Wells Fargo repossessed the car and sold it—for $6,100, less than a third of what Easterns had charged Keeton for it. Then Wells Fargo called Keeton and demanded $13,368.95, the difference between what it got for the car and the loan balance.
Keeton said that from the first call, the Wells Fargo collection agent was menacing. “She was very belligerent,” Keeton recalled. “She said ‘How much can you pay?’ and I said a hundred dollars a month, and she said, ‘We will come back for an increase in three months,’ and when I said I could not pay more, she said, ‘Fine, Wells Fargo will take your house.’”
Terrified that Wells Fargo, a Warren Buffett bank, would take her home, Keeton began a frantic search for help. She found her way to a legal clinic run by the law school at American University. The first students on her case took the car dealer and Wells Fargo to court. That was a mistake. The judge dismissed their case with prejudice, meaning no further action could be filed on Keeton’s behalf. The judge did so because Keeton’s purchase contract said she agreed she could not sue over any dispute, but must instead go to arbitration.
Unless you are one of the working poor, this may not seem like a case that matters much to you. Maybe you know how to negotiate the price of a car and you have a decent credit score. If you pay cash for your cars, this may seem like just another tale of a gullible single mother who didn’t stand up for her own best interests, but let a salesman sweet talk her into a clunker of a car at a premium price.
What happened to Keeton, however, shows how Congress and the Supreme Court are systematically destroying a crucial tenet of commercial law. The process encourages inflated prices and shoddy goods, and leaves consumers with little or no recourse. The lesson is broader than you may realize: bad law makes for bad conduct. And I’m not talking about Barbara Keeton’s.
ARE YOU AT RISK, TOO?
As the law now stands, you are at risk every time you buy a car, an appliance, furniture or many other goods. Open a bank account, deposit funds with a stockbroker or open a credit line and you could end up in the same jam that Keeton found herself in. The reason is that all of these transactions, and many others, are done using boilerplate contracts with a clause, often buried deep in the contract, requiring that any dispute regarding the contract be resolved through arbitration, not through the courts.
The beginnings date to a 1925 law, the Federal Arbitration Act. Congress enacted it so that disputes between corporations in different states, with their different laws, could be resolved quickly through binding arbitration. The record from 1925 shows no intention to apply the law to consumers and workers, only to corporations that negotiated mandatory arbitration clauses for their mutual benefit. Despite this limited purpose, the courts have now stretched the law into a parody of its original intent. In doing so they have encouraged misconduct by all businesses, but especially those with unscrupulous owners and managers.
This trend is encouraged by the refusal of Congress to increase the number of federal judges to keep pace with the demands of a larger, richer and more complex society. Not having enough judges makes those who sit on the bench eager to find ways to shed cases. Enforcing contracts that deny access to the courts and require private arbitration of disputes is an easy way for overworked judges to get rid of cases without considering their merits.
In arbitration a panel of private individuals, who may lack training, decide a case and their decisions, generally, cannot be appealed to the courts.
As reinvented by the Supreme Court in a series of decisions, the 1925 arbitration law now applies not just to disputes between corporations, but to consumers and workers. Worse, the courts have applied it in ways that eliminate consumer and employment rights in favor of business interests; impose costly barriers to obtaining redress; and ignore the Constitutional right to jury trial in civil disputes, all without any knowing consent by consumers and workers.
Margaret L. Moses, who teaches at Chicago’s Loyola University School of Law, has studied how courts have perverted this law. She wrote that if a bill that included today’s court interpretation had been placed before Congress in 1925, it probably would not have garnered a single vote.
Keeton’s path to the threat of the loss of her home began with the contract she signed for that overpriced Mazda.
Sales agents routinely present us with “standard form” contracts. “Initial here and sign there,” they say, and often we do as we are told without bothering to read the fine print. One of the greatest legal minds of our time, Judge Richard Posner of the federal appeals court in Chicago, told a 2010 legal conference that when he took out a home-equity loan, he was shown innumerable pages of documentation. “I didn’t read, I just signed,” Posner said.
Lawyers call these “contracts of adhesion.” The term means that the contracts are one-sided in favor of the company that presents the contract to you. Typically, the contract will require of the company few obligations beyond delivering the house or mortgage or whatever else you bought or rented. In law, the contract generally stands as valid unless its terms are found to be so unfairly one-sided that it shocks the conscience. But even the doctrine of the unconscionable is under judicial attack.
You, the weaker party, must adhere to the terms of such contracts. If all goes well, as it usually does, this is an efficient way to do business. For example, if you join a car-rental frequent driver plan, you can pick up a rental car by just showing your driver’s license. But if something goes awry, you will find yourself at a severe disadvantage because virtually all contracts of adhesion require you to give up your right to sue. Instead, they require that disputes go to binding arbitration. In arbitration you will not have the same rights you would in a court of law to make the other side reveal evidence, especially evidence that may show you were wronged.
In arbitration you will have to pay fees to file, and the arbitrator may require you to travel to another city or state for his convenience. The arbitrators may not even be lawyers, who understand legal principles, but former executives of the industry. Then you must pay half the cost of the arbitrator, who may charge $400 per hour. Then again, maybe you will pay more than half.
That is what happened to Ernestine Strobel, known as Mabel. She worked as a government secretary starting in 1944 and, after going to college at night, did drafting work for the navy. She never married. Having to support herself, Strobel lived frugally, saved and bought real estate. In 1998, when she was seventy-nine, she put more than $645,000 into the hands of a Morgan Stanley broker. Her broker then persuaded her to sell her real estate and entrust the half-million-dollar proceeds to Morgan Stanley, too.
Now you might think the firm would have bought some blue-chip stocks that paid dividends or a lot of bonds paying interest for the retired Strobel. Instead, Morgan Stanley put the old lady’s money into risky technology stocks and into Morgan Stanley mutual funds that charged a load (translation: commissions for the broker). Her accounts soon lost $281,000. In contrast, court records show, had the money been conservatively invested 15 percent in stocks and 85 percent in bonds her accounts would have grown by $11,000.
Strobel demanded recompense. After a five-day hearing before an arbitrator she was awarded just $5,000 in damages, with no explanation of how that figure was determined. But what was revealing about that award was how the three arbitrators, none of them lawyers, split the costs of the arbitration. Strobel was ordered to pay $10,350 in fees, more than twice the damage award, but Morgan Stanley paid only $6,900 in fees. This looks a lot like mitigating the damages award by shifting more of the arbitration fees onto Strobel. Morgan Stanley called the outcome a “fair and complete arbitration.”
Strobel did not agree and hired Jeff Lendrum, a San Diego lawyer who specializes in such cases, to get the arbitration award overturned as unconscionable.
The federal judge who heard the case, Roger T. Benitez, wrote that he was “troubled by the severe disparity” between the huge loss and the tiny damages the arbitrators awarded. The judge also dismissed Morgan Stanley’s claim that Strobel was rich and sophisticated and could ride out a ten-year slide in the markets. He also rejected as irrelevant Morgan Stanley’s suggestion that rather than being a frugal government employee who saved, Strobel had struck it rich in a rising real estate market.
Judge Benitez said he would award Strobel the entire $281,000, but the law did not allow him to do that. Indeed, he showed that he had only a very limited power even to review the case. He sent it back to the arbitrator. Eventually a settlement was reached, its terms confidential at Morgan Stanley’s insistence.
None of this would have happened had Strobel not had enough money to hire Lendrum. He believes brokers should have to put advice in writing and be held to a duty of loyalty to the customer, putting their interests ahead of their fees. Lendrum said he has seen many cases of elderly people who were put into speculative stocks and mutual funds that rewarded brokers with fat sales commissions instead of conservative portfolios appropriate to their age and need for income.
Strobel was disillusioned. “Before this happened, I thought that Morgan Stanley was a company that is fair and honest. And I don’t trust arbitration anymore, believe me.”
She was lucky in another sense. Lendrum has San Diego-area clients in their seventies and eighties who have had to go, at their brokerages’ insistence, to Las Vegas or Phoenix for arbitration hearings, adding travel costs as well as risks for those not in good health. He sees distant forums as just another way to discourage complaints and challenges for recompense.
Paul and Pamela Casarotto got a costly taste of this after they bought a Subway sandwich shop franchise in Montana. They opened their Missoula eatery in 1988 at a location that was not the best, but one they agreed to when Subway’s franchising agent promised that when a better location became available, they could move. But when they tried to move, Subway said no. The Casarottos then sued Doctor’s Associates, the Connecticut firm that owns the Subway name.
Montana law required that any mandatory arbitration requirement be “typed in underlined capital letters on the first page of the contract.” Subway disclosed the requirement for arbitration on the ninth page of fine print.
The Casarottos also complained that they should not be required to go to Connecticut to have an arbitrator hear their case under Connecticut law because the travel posed an unreasonable and costly burden on their small business. They said Montana law should prevail and the case should be heard in Montana. The case worked its way through the courts until it came before the Montana Supreme Court in 1994. Subway’s lawyer, Alan G. Schwartz, opened his argument with a casual remark that unwittingly helped make the Casarottos’ case.
“It is a pleasure to be here in Montana after my trip from Connecticut,” Schwartz said, introducing himself to the court.
“Was it a long trip, counselor?” Justice Terry N. Trieweiler asked.
“A very long trip,” Schwartz said.
“Well, counselor,” Trieweiler responded, “that’s how far these plaintiffs would have to travel to have their case heard by an arbitrator.”
The Montana Supreme Court ruled against Subway because it did not disclose the arbitration requirement prominently on the front page of the contract, as state law required. When Subway appealed to the United States Supreme Court, which takes only a tiny minority of the cases presented to it each year, the court took the case. Its ruling? Eight to one in Subway’s favor.
Justice Ruth Bader Ginsburg held that the Montana law requiring the front-page disclosure was invalid. Why? Because the disclosure requirement applied only to arbitration and not to all types of disputes, making it discriminatory and thus invalid. The decision invalidated similar notice laws in Georgia, Iowa, Missouri, Rhode Island, South Carolina, Tennessee, Texas and Vermont.
Business lawyers hailed the decision—it obviously enhanced corporate power in such disputes—but not s
o consumer advocates. Deborah Zuckerman, a lawyer for the American Association of Retired Persons, which filed a brief in support of the Casarottos, described the decision as an “unfortunate ruling for consumers” because “the Montana statute at issue in this case is merely an attempt to ensure that parties are aware that a contract contains an arbitration clause.”
This decision illustrates how the Supreme Court focuses on legal formalism without context and often without recognizing how the law operates in the real world. It is part of a long line of decisions that skew economic power toward corporations that use contracts of adhesion. It also erodes the ancient legal concept that courts must look out for the interests of less sophisticated, less informed and weaker parties if the law is to be merciful and thus widely respected. Ginsburg, a liberal long known for taking a sharp look at discrimination, in this case hurt many buyers not as sophisticated as she is about discrimination.
Justice Trieweiler got another chance to express his views when the case came back to the Montana Supreme Court. He went right to the heart of the issue—unequal power between a big corporation and its customer.
“What I would like the people in the federal judiciary, especially at the appellate level, to understand,” Trieweiler wrote, is that they make a “naïve assumption that arbitration provisions and choice of law provisions are knowingly bargained for” when in fact “these procedural safeguards and substantive laws are easily avoided.”
He added that “any party with enough power over the other” can “stick…an arbitration provision in its preprinted contract and require the party with inferior bargaining power to sign it.”
Justice Trieweiler wrote that the idea that “people like the Casarottos have knowingly and voluntarily bargained and agreed to resolve their contractual disputes or tort claims by arbitration, is naïve at best, and self-serving and cynical at worst. To me,” Trieweiler continued, “the idea of a contract or agreement suggests mutuality. There is no mutuality in a franchise agreement, a securities brokerage agreement, or in any other of the agreements that typically impose arbitration as the means for resolving disputes…. These provisions, which are not only approved of, but encouraged” by federal judges and others, “subvert our system of justice as we have come to know it. If any foreign government tried to do the same, we would surely consider it a serious act of aggression.”
The Fine Print: How Big Companies Use Plain English to Rob You Blind Page 20