When a debtor files for bankruptcy, the very first thing that happens is an automatic stay, which prevents creditors from attempting to collect from you while the bankruptcy process proceeds. Last year, an influential case, In re Meadows, came out of the Sixth Circuit Bankruptcy Appellate Panel saying that a payday lender can cash a post-dated check given to it by a debtor at the time of the loan, even after the debtor has filed bankruptcy. At Seattle Debt Law, we believe this decision is incorrect: cashing such a check should be considered a violation of the automatic stay. The court in that decision found that there was an exception to the automatic stay in a case where a creditor is “negotiating”—cashing—a check.

Our interest in the Meadows decision was piqued a few months ago when one of our Chapter 7 bankruptcy clients was the victim of a payday lender who took the money from her account over a month after we filed the bankruptcy case. We are currently fighting this in the bankruptcy court and hope that our judge will conclude that a post-dated check given in exchange for a payday loan is nothing more than collateral that cannot be seized during the automatic stay. Washington is not in the Sixth Circuit, so we’re hopeful that the judge will not be guided by the Meadows decision and will recognize that the action taken by the payday lender was unlawful. We will keep you up to date and informed on how the case turns out.

The bank with the stupidest name in America, Fifth Third Bank, has gone into the payday lending business. As the National Consumer Law Center reports (warning: PDF), the trend is picking up among the nation’s big banks. A bank loan with a 520% APR–sounds great!

Major news from Massachusetts this week, with the state’s Supreme Judicial Court upholding an injunction forbidding Fremont Investment & Loan from foreclosing on borrowers to whom it had issued what the court judged to be predatory loans. As Adam Levitin observes at Credit Slips (emphasis mine):

The Massachusetts Attorney General had argued that “a lender’s failure to reasonably assess a borrower’s ability to repay his loan and the use of loan features that predictably lead to foreclosure is unfair and deceptive and in violation of Massachusetts law.” More precisely, a consumer loan that is not intended to be repaid, but intended to be refinanced (a process that can only work if property values rise indefinitely) is inherently predatory. By upholding the preliminary injunction, the SJC endorsed this view and imposed a serious good faith workout effort on Fremont.

The decision by the court to recognize as inherently predatory a class of loans that are designed to be all but impossible for the borrower to pay off as structured can’t be emphasized enough. It’s beyond reasonable doubt at this point that the final years of the housing bubble were powered by increasing numbers of teaser-rate mortgages, especially in the option ARM or “pick-a-payment” space, that were never intended to be repayable by the borrower after the reset period. Even borrowers who aren’t currently upside down on such loans may encounter difficulty refinancing their way out if credit remains as tight as it has recently; those that can’t refinance often find their monthly payments doubling or worse. If the Massachusetts SJC’s interpretation of what constitutes an inherently predatory loan catches on in other states it could mean relief for thousands of distressed homeowners.

The Predatory Lending Association: “Helping payday lenders extract maximum profit from the working poor.”

This is the fourth in a series of weekly posts examining the positions of the major presidential candidates on bankruptcy, debt, and personal finance issues. This week, we’ll look at the candidates’ positions on predatory lending practices that trap unsuspecting borrowers into expensive and unnecessary debt. (Many of the other issues covered in this series include predatory lending aspects as well, so consider reviewing the candidates’ positions on bankruptcy, foreclosure, and credit card issues for the full story.)

Barack Obama (Issues Page)

Senator Obama supports a 36 percent APR interest cap on consumer debt. This is an interesting position in light of his response to Hillary Clinton at a January 2008 debate, which I wrote about last week, in which he explained a 2005 vote against a 30 percent cap on interest rates for credit cards and other consumer debt by saying he thought 30 percent was too high. However, it’s worth pointing out that Obama discusses this 36 percent cap specifically in the context of payday loans, which can achieve APRs as high as 5000 percent—amounting to just a few dollars over the course of a typical payday loan, but quickly becoming ruinous for someone who becomes trapped in the cycle of taking out new loans to pay off old ones. Obama would also require lenders to provide borrowers with clear and simplified information about fees, payments, and penalties during the application process, to make it harder for lenders to use “fine print” against borrowers.

During the primary season, Americans for Fairness in Lending (AFFIL) asked the candidates to endorse its statement of principles demanding reform in the credit industry. Obama endorsed the statement on September 25, 2007, saying “I am proud to support the important efforts of [AFFIL] to empower more Americans in the fight against consumer fraud and abusive lending practices.”

John McCain

Senator McCain hasn’t addressed predatory lending specifically, earning blasts from the Obama campaign over what they characterize as his inaction on the issue. His mortgage proposals do include provisions for homeowner relief from unmanageable loans in some circumstances, and a task force to investigate and punish criminal wrongdoing in the mortgage industry.

For insight into a potential McCain administration’s possible attitude toward predatory lending, we might turn to his chief economic advisor, former Senator Phil Gramm. McCain, who told the Boston Globe last year that “the issue of economics is not something I’ve understood as well as I should,” has all but ceded control of his campaign’s economic message to Gramm (who was forced to resign as McCain’s campaign co-chairman last month after his “nation of whiners” remark, but still advises the campaign on economic issues). Gramm was a staunch opponent of predatory lending protections when he was in the Senate, blocking several efforts to rein in some of the lending industry’s more outrageous abuses. “In Washington the buzzword today is predatory lending,” the always-quoteworthy Gramm said in 2001, “but there are predatory borrowers.”

AFFIL has asked McCain to endorse its statement of principles, but he has not done so.

Coming next week: The Candidates on Student Loan Issues

A few more highlights from the package of articles and features on the debt crisis from Sunday’s New York Times, which I first wrote about on Monday.

“Borrowers and Bankers: A Great Divide” is an analysis of the differences in how the federal government has responded to the financial woes of lenders and investors like Bear Stearns, Fannie Mae, and Freddie Mac (bailouts) vs. those of ordinary borrowers (you’re on your own), and explains some of the reasons behind the discrepancy.

“Work Out Problems with Lenders? Try to Find Them” talks about something I’ve written about in the past: mortgages are sliced and diced into securities and traded among big investors so much that people who want to work out payment terms with their lender are having difficulty even figuring out who they should be contacting. (I would be remiss if I did not point out that a good bankruptcy attorney can help you with this!)

In fact, as Sunday’s front-pager notes, it’s not just mortgage lenders who have been securitizing and trading consumer debt in recent years: credit card issuers have gotten into the act as well. The result has been the creation of a system in which lenders increasingly don’t even care if borrowers will ever be able to pay their debts in full. Securitization allows lenders to see an immediate return on investment (ROI) for issued debt instead of waiting years for the borrowers to pay it off, but it also means that they’re far less concerned with ensuring that borrowers can pay their debts off in full over the long run—as long as borrowers remain current until the lender unloads their promissory note onto someone else, the theory goes, all is well.

The lending industry has become a huge, nationwide game of Hot Potato, which worked well enough in good economic times, but as the economy has faltered we’ve started to see some of the huge problems that exist with a lot of these loans, and the so-called subprime mortgage crisis is looking more and more like it’s just the tip of the proverbial iceberg.

[T]he lucrative lending practices of America’s merchants of debt have led millions of Americans — young and old, native and immigrant, affluent and poor — to the brink. More and more, Americans can identify with miners of old: in debt to the company store with little chance of paying up.

It is not just individuals but the entire economy that is now suffering. Practices that produced record profits for many banks have shaken the nation’s financial system to its foundation. As a growing number of Americans default, banks are recording hundreds of billions in losses, devastating their shareholders.

A must-read article in Sunday’s New York Times evokes Merle Travis’ “Sixteen Tons” to shine a light on the practices that credit-card issuers, mortgage banks, and other issuers have used in recent years to more than triple  the amount of debt carried by the average household (in today’s dollars) over the past 25 years, even as the national household savings rate has dwindled to nothing. I deal with these issues every day in my practice, and yet it still takes me by surprise sometimes to realize how successful the lending industry has been at tilting the playing field in their favor, even at the cost of the economy as a whole.

Gretchen Morgenson’s front-page article is part of a package of stories and interactive features called “The Debt Trap,” about which I hope to write more later.

File this one under “things you wouldn’t think you’d have to tell someone”: The Federal Reserve moved today to outlaw a number of shady practices among mortgage lenders. My personal favorite: “a restriction on the use of the word ‘fixed’ to describe the terms of a loan whose rate will change over time.” Other welcome new restrictions:

— Prohibit lenders from loaning to borrowers who cannot repay the loan from income and assets other than a home’s value.

— Require lenders to verify a borrower’s income and assets.

— Ban prepayment penalties for the first four years of any adjustable-rate subprime mortgage; other subprime mortgages could have no prepayment penalties for two years.

[...]

— Prohibit advertising in which different loans are compared unless all payments and rates are also disclosed.

— Prohibit foreign-language mortgage ads in which required disclosures are presented in English.

— Prohibit a lender from encouraging or coercing an appraiser to misrepresent a home’s assessed value. [!]

— Require lenders to credit borrowers’ payments on the day of receipt.

There are many more new regs that I can’t quote without running afoul of the fair-use standard, so go and read the whole thing.

This is big. Following the announcement of lawsuits against Countrywide Financial this morning by the states of California and Illinois, Governor Gregoire said the state is going to attempt to revoke Countrywide’s license to operate in the state of Washington after an investigation found that the company had engaged in predatory lending practices:

“The allegation that Countrywide preyed on minority borrowers is extremely troubling to me,” Gregoire said. “And I hope to learn eventually just how much this may have contributed to foreclosures in our state. The allegation offers evidence that Countrywide engaged in a pattern to target minority groups and engage in predatory practices.”

“That’s why we intend to bring the full weight of the state on Countrywide to rewrite home loans for minority borrowers who may have been misled into signing predatory mortgages,” the governor noted. “My job is to protect hard-working Washingtonians, and protect them we will.”

Countrywide is also being fined $1 million for discriminatory lending and will be required to pay $5 million in back assessments. You can read the charging document here . More on this as it develops.

Sad news today that legendary Seattle jazz musician Ernestine Anderson, 79, is facing foreclosure on the Central District home that she and her family have owned and lived in since 1946. The Associated Press reports that Anderson, who has largely retired from performing and lives on Social Security benefits of about $1,000 a month, has a loan on her home that asks for a payment of $5,000 every month. Counselors are trying to find out more about how Anderson got into the loan, but given the size of the monthly payment it certainly sounds predatory. (Elderly people with lots of home equity but low incomes are prime targets for predatory lenders and scammers.)

Anderson has to come up with $44,000 in back payments and taxes by Monday, June 30, or her home will be put up for auction. Donations can be made at any Bank of America branch.