IPIP Blog

By Jason Lange

WASHINGTON |
Tue Apr 3, 2012 9:25am EDT

In a developing story that SPEED.com has been monitoring this week, the future of Level 5 Motorsports could be in jeopardy following a recent motion set forth by the Federal Trade Commission on its team owner, Scott Tucker.

The FTC lodged a suit against the two-time American Le Mans Series champion and other associated parties, including the Level 5 Motorsports team, Monday in US District Court in Nevada.

The case alleges Tucker and his brother controlled a handful of internet-based payday lending companies that piled on undisclosed and inflated fees, and collected on loans illegally by threatening borrowers with arrest and lawsuits.

According to court documents, The FTC has asked a federal court to stop the allegedly illegal business tactics while the agency pursues its case against the defendants.

Level 5 Motorsports, LLC, along with a handful of other companies reportedly controlled by Tucker, are named as defendants of the case. According to documents filed with the court, Tucker and his brother, Blaine, are said to have transferred more than $40 million from the payday lending companies to Level 5 for sponsorship fees.

Over the last five years, the FTC said that its received more than 7,500 complaints about the operation, which is affiliated with a Native American tribe, which the defense has claimed makes Tuckers loan business immune from state-led investigations.

Tuckers operation is not the only payday loan company to have come under fire as of late, as the FTC is also investigating Payday Financial, LLC, another tribe-owned company based in South Dakota.

A statement from Jeff D. Morris, Council for Level 5 Motorsports and Scott Tucker reads: We are disappointed that the FTC has taken the action of filing a lawsuit, but we will defend the allegations through the legal process and begin the kind of dialogue appropriate for such a regulatory filing.

The governments interest in the online short term lending industry extends beyond those named in the lawsuit.Some of the parties named represent significant participants in the industry, so it is no surprise there is interest from regulators.

An FTC filing is not a finding or ruling that anyone has actually violated a statute or regulation. It is simply a lawsuit based on untested allegations. The FTC has sued the likes of Microsoft, Google, Apple, Citigroup, Coca Cola and Facebook and the reality is most actions resolve in settlements based on an agreed understanding of the facts. We will proceed accordingly and in good faith to address the recent filing.

Its unclear what effect, if any, the legal proceedings could have on the long-term future of Level 5s P2 program in the ALMS and its planned effort at the 24 Hours of Le Mans in June.

However, team manager David Stone told SPEED.com that there are no changes in the teams plans as they prepare for next weekends Grand Prix of Long Beach, where both of the HPD ARX-03bs are expected to race.

Level 5 is fresh off a class victory at last months Twelve Hours of Sebring, where Tucker, Christophe Bouchut and Joao Barbosa finished fourth overall, the highest among the ALMS entrants in the combined FIA World Endurance Championship race.

Tucker and Bouchut currently hold a four-point lead in the P2 drivers championship heading into the second round of the season.

John Dagys is SPEED.coms Sportscar Racing Reporter, focusing on all major domestic and international championships. You can follow him on Twitter @johndagys or email him at

The idea that banks are not constrained by reserve levels–because they can always borrow required reserves should they fall short–shouldn’t leave anyone with the impression that banks do not face serious constraints on their lending.

The biggest constraint on lending is the basic business model of banking.

When I was a banking lawyer, we usually referred to this as “cost plus lending.” The idea was that the bank’s source of profit was charging more for loans than it cost the bank to make the loan.

This sounds pretty simple until you start thinking about the source of the costs to make a loan. The first cost, of course, is what’s known as “the cost of funding”–the amount the bank must pay to borrow the reserves required to make loans.

But there are a host of non-funding costs as well. The bank must also somehow acquire the regulatory capital to back the loan, and capital can be expensive. The bank faces administrative costs in making the loan. Bankers must be paid. There may also be various taxes and government fees that apply.

Banks also face interest rate risk that they attempt to hedge by either borrowing funds at durations that match the term of the loan they are making–which raises the bank’s cost of funding–or making floating rate loans. But with very large loans, banks will often require floating rate borrowers to hedge against interest rate risk themselves–since you don’t want your borrower defaulting just because rates have increased. The price of interest rate hedging also has to be figured into the borrowers ability to pay the loan.

These aren’t trivial costs. The best estimate is that these add up to almost 300 basis points–the spread between the Fed Funds rate and the Prime Rate.

This means that even if banks can make loans out of thin air, there are plenty of loans that a bank cannot make. Or, to put it differently, if a bank makes too many of these loans it will lose money and eventually fail. A person or business whose free cash flow is too light to support the costs of the loan, for example, is not credit worthy–that is, not eligible to receive a loan under most circumstances.

This is one way that monetary policy works to encourage more lending. When monetary policy brings down the price of banks borrowing reserves–that is, reduces the Feds Funds rate–it brings down the cost of making loans. This means some borrowers will be credit worthy at lower rates that wouldn’t make the cut at higher rates.

The flip side of this is that potential borrowers must also see opportunities to put bank loans to work. If they view potential for future profit as weak, the demand for new loans shrinks. Of course, monetary policy plays a role here too. Low rates can make otherwise uneconomic projects work and, as the Austrians put it, may send a signal that there is more saving in the economy available for future spending. (Although, I would add, that under our current system of Fed manipulated interest rates and endogenous money creation by banks, this is almost certain to be a false signal.)

Banks also must price in the “credit risk” of making a loan–the risk that the borrowers may default, either because the collateral for the loan becomes so undervalued that the borrower “walks away” or because cash flow fall short of what is needed to make the loan.

Credit risk depends both on the individual character of each borrower and the general economic prospects. Rising unemployment, fall in consumer demand, the plausibility of management’s business plans all feed into credit risk.

Evidence indicates that credit risk, interest rate risk and other costs of lending exercise very strong influences over lending. The stuff the Fed tends to influence most directly–the cost of funding–can be overwhelmed by the credit risk and cost of capital.

As Christina and David Romer showed in this 1994 paper, banks have shown that they can maintain high lending levels even when policy is tightening. And, as we’ve seen recently, banks can maintain low lending levels (relative to reserves) even when policy is loosening.

To put it differently, banks are not free to create money willy-nilly. They are subject to restraints imposed by both the markets and regulators. But under current procedures, these restraints do not arise from a hard limit on the amount of reserves in the system. They arise from the costs of lending, which is conditioned by (a) the interest rate targeted by the Fed, (b) regulatory and market capital requirements and the market price for bank capital, (c) by back-office administrative and hedging costs of lending, and (d) the credit-worthiness and credit-hungriness of borrowers.

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Chinas largest banks lent some 300 billion yuan last month, the countrys official securities journal reports.

The Security Times says that figure, which represents $47.5 billion, would mean that total loans in March could hit 900 billion yuan, a strong jump from Februarys disappointing 710.7 billion pace.

The four largest banks in China write between 30 and 40 percent of the countrys new debt.

Bank lending has fallen from the surge seen at the end of 2011, with January new debt increasing by738.1 billion yuan. Economists had expected the figure to top 1 trillion yuan after a strong December, and expected the government to implement some form of easing.

Even if lending increases during the month to its fastest rate in three months, a recent report out of Deloitte Touche Tohmatsu could temper expectations.

Data from Deloitte shows that a rise in non-performing loans in China is on the horizon, with the total ratio likely hitting the high single-digits.

However, Deloitte analysts do not believe the bad debt will substantively impact the country.

WASHINGTON (AP) — Americans took out more loans to buy cars and attend school in February but used their credit cards less frequently for the second consecutive month, the Federal Reserve said Friday.

The New York Times

Consumers increased borrowing by $8.7 billion, the sixth straight monthly increase, the Federal Reserve said in its monthly report.

The increase in borrowing was driven by an $11 billion increase in the category that includes mostly auto and student loans. Borrowing on credit cards fell by $2 billion, after a $3 billion decline in January.

Total consumer borrowing rose to a seasonally adjusted $2.52 trillion. The figure was nearly at prerecession levels and was up from a postrecession low point of $2.39 trillion reached in September 2010. Borrowing had tumbled for more than two years during and immediately after the recession.

Consumer borrowing rose by $18.6 billion in January, after similar gains in December and November. The gains for those three months were the largest in a decade.

A rise in borrowing could suggest that consumers are feeling more confident about the economy. However, few are comfortable enough to step up credit card use. Consumers carried $799 billion in credit card debt in February — 15 percent less than they held in December 2007, the first month of the recession.

Steven Wood, chief economist at Insight Economics, said February’s borrowing increase was strong. But he said it was the smallest increase since October.

“Consumers still appear to be reluctant to use their credit cards,” Mr. Wood said in a note to clients.

Consumers are taking on more debt at a time when their wages have not kept pace with inflation. And they are paying more for gasoline. The average price per gallon nationally was $3.94 on Friday.

Households began borrowing less and saving more when the recession began and unemployment surged. While the expectation is that consumers are ready to resume borrowing, they are not expected to load up on debt the way they did during the housing boom of the last decade.

The Federal Reserve’s borrowing report covers auto loans, student loans and credit cards. It excludes mortgages, home equity loans and other loans tied to real estate.

China may be the worlds second-largest economy, but its financial system still answers to strict state controls that critics say hold back the countrys development.

The free market plays little role in determining how Chinas currency is valued, how banks set interest rates or how much capital is allowed to flow in and out of the country.

But in the last two weeks, a series of moves has raised hopes that financial freedoms could be expanding in the so-called birdcage economy.

Chief among them was Chinese Premier Wen Jiabao telling a national radio audience Tuesday that the nations four biggest state banks were a monopoly that profited too easily.

The criticism took aim at the countrys across-the-board interest rates that prevent lending institutions from having to compete.

With one-year deposit rates set at 3.5% and lending rates nearly double that, Chinas banks need only sit back and rack up heavy loan volumes to reap their rewards.

The big four banks — Agricultural Bank of China, Bank of China, China Construction Bank and Industrial amp; Commercial Bank of China — saw earnings rise 26% last year to about $100 billion despite a slowing economy and souring real estate market.

The banks dont want to loosen their grip because its very easy for them to profit, said Yi Xianrong, an economist at the Chinese Academy of Social Sciences, a government think tank.

The restrictions prevent Chinas banks from pricing risk into their lending portfolios. As a result, state-owned companies receive the lions share of loans rather than riskier small- and medium-sized private enterprises.

On the day of Wens radio address, the China Securities Regulatory Commission more than doubled the amount of money foreign institutions could invest in Chinese equities from $30 billion to $80 billion.

Though that was a small increase in the grand scheme of things, a boost in foreign investment could help reduce the volatility of the Shanghai and Shenzhen stock markets, whose roller coaster swings are often driven by speculators.

The announcement sends a clear and positive message to international investors that the central government is encouraging further opening up of Chinas capital markets, wrote Jing Ulrich, JP Morgans head of Global Markets, in a research note.

A week earlier, the Wen-led State Council unveiled a pilot program in the entrepreneurial city of Wenzhou to legalize and regulate underground lending as well as broaden access to investments overseas.

Economists say theres growing recognition in Beijing that reforming the nations financial system is crucial if leaders want to internationalize the countrys currency. That would allow China to free itself of its dollar reliance.

Whether Wen, who will step down later this year, has the political capital to force interest rate or capital account reform remains to be seen. To do so would mean breaking powerful interest groups.

The longer you wait, the larger the economic stake becomes for those who like the status quo, said Louis Kuijs, an economist formerly at the World Bank and now at the Fung Global Institute in Hong Kong. Maybe Premier Wen feels like we should really get it going.

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Dan Mitchell has borrowed $3 million in the last year and a half to buy real estate and equipment to expand his brewery, Ithaca Beer Co. It wasn?t easy. Mitchell went to at least four banks in his city of Ithaca, NY, looking for a loan. His sales were growing 25 percent a year and the company had become profitable. His distributors wanted to buy more beer from him.

But most of the loan officers just handed him applications, told him to fill them out and to send the papers in. Even a bank that had already loaned Mitchell money wasn?t interested. He says he still doesn?t know why his own bank turned him down.

?The craft (beer) industry is really strong and our sales were strong because of it,? he says, still mystified by the cold reception he kept getting.

Mitchell?s experience isn?t uncommon. Banks remain hesitant to lend, and when they do, they?re asking for more information and toughening requirements. It?s a trend that is stalling the pace of lending to smaller companies.

PayNet, a company that analyzes commercial loans has an index that tracks loan applications by small businesses. The index peaked in the fourth quarter of 2008 at 115 as the financial crisis hit and then dropped to 75 by the first quarter of 2010. Since then, it has fluctuated between 70 and 75.

But Mitchell?s experience proves that there is some lending going on. He finally got the loans he wanted from MT Bank. He met with several bank officials including the regional manager. ?They wanted to get the deal done,? he says.

Tough Requirements

Before the recession, companies of all sizes were able to get loans like lines of credit, says Jeff Stibel, CEO of Dun Bradstreet Credibility Corp., a service that evaluates the creditworthiness of businesses. These days, the most successful borrowers are ones that are almost medium-sized, he says. Generally, according to the Small Business Administration, a small business has fewer than 500 employees.

When banks do grant loans, the requirements are tougher. Often the company has to meet higher revenue and profit levels to get loans ? and to avoid paying them back early. Surviving the recession isn?t going to score extra points with bankers, he says.