Fire Your Student

The “fire your customer” idea has made its way to academia, in the sensational story this weekend of the University of Southern California driving out an entire class of graduate fine arts students along with faculty after the fine arts program became an obstacle to the university’s plans to make its name in commercial art. Such changes are rare in higher education because a customer will stay only a few years at most, so even when a program is being discontinued it is so easy to let the students complete their degrees. A transition period of two or three years is a short time by the standards of academia. It was just a matter of time, though, before an impatient university would not be willing to wait even this long, and here you have it: a university essentially firing its students, along with faculty, less than a year after the decision to kill off one of its programs to make room for something new.

At LA Weekly:

An Entire Class of USC Art Students Leaves School After Dean Pisses Them Off

At LA Times:

Behind the impasse that led USC's 2016 MFA students to withdraw in protest

This Week in Bank Failures

Banks might have invented the funny accounting that can make a moldy loan portfolio look fresh and healthy, but that doesn’t mean other lenders can’t do the same thing. The SEC charged for-profit college holding company ITT Educational Services Inc. with accounting fraud for hiding the deteriorating quality of its student loan portfolio and loan guarantees. ITT’s loan guarantees and related obligations look worryingly large, large enough to force it to restate its 2013 earnings, then large enough to eat up three fourths of its cash on hand in 2014. But more than that, loans are the lifeblood of a for-profit college. Without loans, there would be few new customers, but a college can find itself squeezed. The high tuition and low educational quality of for-profit colleges mean that many former students owe large amounts compared to their potential incomes, so that the loans are often beyond a former student’s ability to pay. At the same time, a college must show success with its old loans in order to write new loans. This squeeze can turn a for-profit college into something resembling a Ponzi scheme, in which a college spends huge sums to disguise the poor quality of its older loans, covering the costs with money that comes from new loans issued to new students. Like any top-heavy scheme, eventually it can all come crashing down, as in the case of Corinthian College, which ran out of cash and abruptly shut down last week after it got caught exaggerating its job placement results.

The SEC says there is reason to worry about ITT in a civil fraud case filed this week against the college and two executives. If you believe the SEC, ITT owes far more in loan guarantees than what it is telling investors. ITT failed to record the loans on the balance sheet it showed investors and failed to disclose money it set aside to cover loan defaults. Separately, ITT may have to pay up in a predatory bait-and-switch lending practice, in which it offered zero-interest loans to new customers. It canceled the loans after one year and steered customers toward high-interest replacement loans. New student enrollment at ITT is already down 16 percent from last year, a decline that analysts have said is rapid enough to put the college’s future in doubt, and that, of course, is a further deterrent to new customers.

Starbucks gift cards have become the new focus of organized transaction fraud. While not all the details are clear, criminal groups are obtaining the codes from existing cards and using this information to encode fake cards. It may also be that criminals are altering the value of legitimate Starbucks cards by generating false transactions in transaction networks. After creating fake card balances, the criminal groups then sell the cards at a steep discount online. Purchasers rush to take the fraudulent cards to a Starbucks location to transfer the balance to yet another new card before either Starbucks or the legitimate card owner figures out what’s going on. This scheme is spelled out almost openly in online forums that are easy to find in an Internet search.

In a related problem, more widely reported, criminal groups are guessing passwords for Starbucks card accounts and entering transactions on the Starbucks web site to transfer balances. For accounts with the auto-reload option, popular with Starbucks’ most frequent customers, this can result in draining the cardholders’ checking accounts. On the other hand, these are also the customers who are quickest to notice the problems with their accounts. Starbucks doesn’t seem to be aware of the scale of activity surrounding its gift cards, in part because many gift card holders have no idea what their card balances are on any given day. Based on the buzz surrounding online markets for hacked and forged Starbucks gift cards, though, the electronic thefts could easily exceed $1 million per day.

The U.K. government is taking longer than planned to liquidate its stake in bailed-out Lloyds Banking Group. It will not meet a self-imposed deadline of June 30. Instead, the stock sales may take until next year to complete, according to government sources cited by Reuters.

Argentina is considering punitive action against Citibank which could include withdrawing the bank’s license to operate in that country. Argentina has already barred one executive and revoked the bank’s authority to operate in capital markets. The moves do not come as a surprise and Citibank is presumably prepared to sell off or wind down its operations in Argentina. Separately, a national strike against all banks in Argentina is set for June, with bank workers asking for a 30 percent pay increase.

There were two actions on credit unions on April 30. The NCUA placed New Bethel Federal Credit Union into conservatorship. The church-related credit union in Portsmouth, Virginia has fewer than 200 members. The NCUA liquidated TLC Federal Credit Union of Tillamook, Oregon, which had 13,375 members, after finding that the credit union was insolvent. Member accounts were transferred to Washington-based Fibre Federal Credit Union. TLC Federal Credit Union was originally formed as a teacher’s credit union.

In the Shadow of Disasters

I have disasters on my mind today after two events that occurred late yesterday. In my town a shopping center fire burned for five hours and destroyed about six businesses. Two major streets had to be closed and in the traffic backups I was delayed 20 minutes in getting home. Obviously, others were far more inconvenienced than this, but fortunately, there were no major injuries.

Not long after and not far away, a train derailed injuring between 100 and 200 passengers. Some died. The busiest passenger rail line in the country remains closed 12 hours later, stranding thousands of travelers and forcing a much greater number to change their travel schedules or find alternate commuting routes. Authorities are so worried about the fragile condition of the broken train that news accounts are withholding the precise location of the crash. This was not even a high-speed train, but a train carries so many passengers that the human impact of this crash begins to compare to that of a plane crash.

I wasn’t directly affected by either disaster, unless a detour from roads closed as a safety precaution counts as a “direct” impact. They nevertheless affected my state of mind. The news of the fire kept me up an hour later than planned. Fortunately, I didn’t get the news of the train derailment until the morning, though that news then cast a shadow over my day today.

It seems to me that it is easy to underestimate the extent to which disasters can have a minor impact on a vast number of people, especially those nearby or for whom there is a personal connection. New York City was the destination of the train that crashed, and today anyone in New York can tell you about someone who had to change their plans because of the closed rail line. Rail travel between New York and Boston is running but the schedule has had to be reshuffled with no trains arriving from the south, and of course, it is the same story at Washington. Very few of us have the advanced Zen skills to allow us to return quickly to what we were doing after a disaster strikes close enough to affect the people around us.

The change in mood and schedule might be small but the number of people affected is enormous, making it a large effect in the aggregate. It is all the more reason to do what we can to prevent disasters like these. The secondary impact of the fire I mentioned did not reach so far as that of the train derailment, but in economic terms, it was nevertheless larger than the total value of the building involved. The comparison suggests that we could go farther to ensure that things go smoothly, so that we have more ordinary days in which disasters don’t happen.

A High Bar for Lumber Liquidators

CNBC reports that Lumber Liquidators’ insurance companies are refusing to cover its liability for the sale of toxic flooring materials:

Lumber Liquidators’ latest woe: Insurers denying coverage

Lumber Liquidators has filed suit, claiming that the insurance companies should pay the legal bills and liability claims for the laminate flooring it sold. It stopped selling the flooring in question last week because of concerns that the product has unreasonably high levels of formaldehyde, a potentially harmful poison. The specific legal questions about insurance coverage are difficult and technical and must be left for lawyers and judges to work out; however, I am skeptical of Lumber Liquidators’ legal position on this issue.

First, there is the question of coverage in general. Lumber Liquidators admits it never had a product liability policy, the insurance policy that would normally cover claims of harm from defective products. Instead, it had commercial general liability policies with several insurance companies. A general liability policy might or might not cover product liability, and if so, it is a limited form of coverage. It isn’t meant to cover a business acting in the capacity of a manufacturer or importer. That’s what the product liability policies are for. Lumber Liquidators is said to be the exclusive U.S. source of the Chinese-made flooring in question, and if that is so, it will be very difficult for it to establish that it wasn’t effectively involved in either manufacturing or importing the flooring. If it turns out that Lumber Liquidators was the importer in any practical sense, or if it had any say in the way the product was made, the insurance companies are correct in denying coverage, and they will be able to have the cases thrown out.

The second issue has to do with intentionality. Insurance does not cover damages resulting from the intentional sale of a bad product. If Lumber Liquidators was cutting costs by intentionally sourcing a product with bizarrely high levels of formaldehyde, that would be a criminal act, and insurance legally cannot cover criminal acts of any kind. Lumber Liquidators disclosed a week ago that federal agents searched two of its facilities in September as part of a criminal investigation, and more recently, it was notified that the company will face criminal charges. Unless the criminal charges turn out to be unrelated, courts might very well order insurance companies to withhold any payments to Lumber Liquidators until the criminal case is resolved.

The mere fact that Lumber Liquidators is filing suits against nine insurance companies is cause for skepticism. Why would it have nine liability insurance companies and not just one or two? When a business is piling up as much liability coverage as it can find, it may be a sign that it knows it has done something wrong.

It is the retailer that filed the suits against the insurance companies, so it is the retailer that has to prove its case. It will have to answer questions and turn over its internal documents, and they will have to demonstrate that the company reasonably believed that the flooring products in question were reasonably safe. That argument won’t stand up if documents show the kind of corporate thinking that tries to wish problems away. All in all, Lumber Liquidators has a difficult case to try to make.

This Week in Bank Failures

Officials in Moldova believe they know what happened to $1 billion in banking assets that went missing during a three-day period last November. The money was paid out in loans to shadowy limited partnerships that seemed to disappear almost as soon as they took the payments. There was no collateral, computer records were erased, and many of the paper documents were loaded into a van that was set on fire. Eventually much of the money was traced to bank accounts in Latvia. The owners listed for these accounts are foreign businesses that don’t have any other record of existing. The sudden loss of $1 billion left three of the largest banks in the country insolvent, leading to a government rescue. The amount of money suddenly swept out of the country was the equivalent of more than six weeks of GDP, so it was a difficult blow to the government and has been the subject of political unrest ever since the scale of the problem was discovered.

Who could have perpetrated such an intricate plan to steal so much money so quickly? A government report released this week says that several people must have been involved, but it specifically points to the CEO of one of the three banks, billionaire Ilan Shor. Shor has been indicted and placed under house arrest while the investigation continues. It could take another year of forensic accounting to work out all the details of the transactions, which span at least five countries.

The scale of the theft is so vast and the method so daring the story is sure to be turned into a Hollywood movie sooner or later. Most of all, it is the motive that captures the imagination. What would make a billionaire, already rich beyond the point of material wealth, decide to steal a billion more? The logistics are equally dizzying. Even if you are the CEO, how do you hire someone to erase the records of illicit transactions from the bank’s computers, including the offline backups and paper trail? How do you maintain the coverup after the bank is financially crippled from its massive losses?

As for the financial transactions themselves, they are startlingly mundane. It takes only two bank officers to approve a loan. A scheme like this can minimize scrutiny by issuing a large number of routine-looking “loans” of various sizes to hundreds of seemingly unrelated borrowers. Once the money is out of the bank’s hands, anything can happen to it. Making money disappear then is not much more than a shell game: move it around enough times, and the hope is that the forensic accountants won’t be able to follow. The techniques are obvious enough to anyone who has ever worked with an audit team: make the payments look routine, and they may not raise any red flags. Generally similar approaches were involved in Enron, CorpBank, AIG, Petrobras, the Espírito Santo empire, the “rogue trader” schemes we keep hearing about (which never really involve just a single trader), and the failures of several banks (smaller ones, of course) in the United States over the last few years.

What makes the Moldova case so singular, though, is the way it moved so much money in such a short time, apparently a period of just three business days — well, that and the burning van. Bank robbers who take a more subtle approach must get away with the money far more often than the cases we hear about.

There was a bank failure in Chicago tonight, the first U.S. bank failure in two months. State regulators in Illinois closed Edgebrook Bank, which had $90 million in deposits and about the same amount in assets. Republic Bank of Chicago is assuming the deposits and purchasing most of the assets. The failed bank was having such trouble with its loans that in March, the FDIC ordered it not to make any further loans without regulatory approval.