Supporters of bankruptcy-reform legislation must feel as though they are on top of the world. First proposed in 1997, the concept has gone through dozens of versions and countless hearings. It also has been reviled by consumer advocates and has been defeated because of a variety of political machinations, including a presidential veto.
The legislation was passed by Congress this spring, and President George Bush signed the bill into law April 20. After eight years, proponents finally can breath a sigh of relief.
But now the tough part: implementing the reforms. Some of the biggest questions involve the counseling that consumers will be required to undergo before filing for bankruptcy.
Credit grantors contend the bankruptcy system is antiquated and gamed by some individuals to avoid paying their debts. More than 1.5 million consumers have filed for bankruptcy in each of the last three years.
About 70% file for Chapter 7 bankruptcy, where consumers can write off most of their debts. The legislation aims to send more debtors into Chapter 13 bankruptcy, where they would agree to pay off a portion of their bills in a three-to five-year period.
Consumers seeking to file must go through a complicated means test. Those earning more than their state's median income, or who are able to pay at least $6,000 over five years, will be sent to Chapter 13.
"If you have minimum of $100 a month that can go into paying off creditors, you will go to Chapter 13," says Catherine M. Williams, vice president of financial literacy with Houston-based Money Management International, a credit-counseling agency with 110 offices in 18 states.
Credit counselors will play a key part in the reform process. The legislation requires consumers considering filing for bankruptcy to visit an approved, not-for-profit credit counselor six months prior to any filing. The counselor must provide a budget analysis for the consumer, discuss alternatives to filing and lay out the consequences of stepping into bankruptcy. The counseling session must be provided for free if the consumer cannot afford it.
In addition, consumers who have filed and weathered the process of paying off their debts must visit a counseling agency before exiting bankruptcy. This session is designed to help debtors to return as full-fledged consumers, prepared to go cold turkey and trash the dozen card-acquisition letters they might receive every week.
Fees for counseling sessions still are being determined, says Williams. MMI will charge a $55 to $60 set-up fee along with a monthly fee if the consumer enters a repayment plan, she says. Charges will be on a sliding scale depending on where the debtor lives, she says.
The changes wrought by the reform bill have the industry asking several questions: How many consumers will seek help? Are the agencies prepared? What agencies are approved to conduct these sessions? How will the sessions be conducted? How will the agencies be compensated?
Congress has left many of these questions unanswered, and industry experts admit that much is uncertain. These responsibilities arise as the industry modernizes its approach to counseling and federal regulators investigate a number of bad apples in the business. Additionally, several major card issuers are radically changing the way they compensate agencies.
There are a number of statistics that pressed Congress to move on the bankruptcy bill. The Federal Reserve has reported that Americans are deeper in hock than ever, with debt rising 110% in the last decade to $2.12 trillion (not including mortgage debt). And record-setting numbers of consumers have filed for bankruptcy, reaching 1.62 million in 2003 from about 800,0000 a decade ago, until falling last year.
Research house Global Insight Inc. projects that consumer bankruptcy filings will grow 14% in the next few years, to 1.8 million in 2007 from 1.57 million in 2004 (chart, page 24). Rising inflation and interest rates and a slowdown in income growth will drive the increase, according to Global Insight's April study "Predicting Personal Bankruptcies."
The bankruptcy-reform law also could cause an increase in filings because creditors will feel confident they can step up their loans to riskier consumers that offer greater returns, says Mark Lauritano, Global Insight managing director. And many consumers will continue to take on too much debt and fail to pay it off in a timely fashion, he says.
"Bankruptcy laws may make it more difficult to file, but they will not fundamentally change (consumer) behavior," says Lauritano.
Global Insight also foresees little change in the number of consumers filing Chapter 13 instead of Chapter 7. In 2004, about 28% of total consumer filings were under Chapter 13, but the rate will rise to only 30.3% by 2008, the Waltham, Mass.-based research company says.
The National Foundation for Credit Counselors anticipates that more consumers will seek help once the law is enacted, but it has not made a projection on the increase, says William P. Binzel, the foundation's chief counsel. About 1 million consumers annually seek assistance from members of the foundation, the industry's largest and oldest trade group.
The foundation generally represents old-line counselors. For a time, members only provided face-to-face counseling, but the organization has since added Web and phone services, says Binzel.
Both the Consumer Federation of America and MMI's Williams project that 50% more consumers will seek help. "There will be a 'herding affect.' About 1.5 million could seek help," Williams says.
The counseling industry has changed in the last decade as it has adapted to consumers foregoing face-to-face counseling for assistance over the phone and through the Web. There is also a trend toward consolidation.
MMI has merged with 14 regional agencies since 2000 to become the largest member of the NFCC. As recently as three years ago, the Foundation had 175 affiliates running 1,400 offices ("Turmoil Among the Debt Counselors," January 2002). Today the Foundation has 120 member agencies with about 1,000 offices nationwide, says Binzel.
Many of the newer agencies that pioneered electronic counseling have joined a second trade group, the Association of Independent Consumer Credit Counseling Agencies. Some have opted to go it alone.
The bankruptcy law states that consumers must receive counseling at an agency that has been approved by the U.S. Trustee Program, a division of the U.S. Department of Justice that operates 21 regional offices overseeing bankruptcy casework. Several experts have suggested that the regional offices will determine the qualified agencies for their area.
However, a spokesperson for the Trustee Program declined to answer questions about its plans, saying that no announcement would be made until after the law is enacted. It takes effect in October, six months after the president has signed it.
Travis Plunkett, legislative director with the Consumer Federation, says the Trustee Program may not have the resources or time to exclude questionable agencies. And if a sleazy "agency is on the list, then Congress is forcing consumers to go to an unscrupulous agency."
Unfortunately, the public has had many opportunities in the last few years to read about or be ripped off by crooked agencies. In March, the Federal Trade Commission charged three firms acting as agencies with bilking consumers out of $100 million. Charges ranged from making false promises of free debt counseling to operating as a for-profit under a non-profit cover.
Committees in both the U.S. House and Senate have held hearings on the industry in the last two years, focusing on agencies that provide little service to consumers while charging them myriad fees. In March 2004, Senate investigators found three major agencies were creating a blend of not-for-profit and for-profit subsidiaries, using the not-for-profit side to bring in revenue-generating consumers. The umbrella organization might charge the consumer for help in organizing a debt-management plan, then route his payments, for a fee, through a transaction processing sister company.
DebtWorks in Germantown, Md., garnered almost $109 million in gross revenues from its not-for-profit affiliates from 1999 through 2002, according to Senate investigators. That caught the eye of the Internal Revue Service because firms registered as not-for-profits receive certain tax benefits because of the education and assistance they provide. Last summer, the IRS released an internal memo stating that many newer agencies did not provide any education or benefit for the poor, and instead operated for private benefit.
The IRS soon began auditing about 50 credit counselors that represented half the industry in terms of asset size. This April, IRS Commissioner Mark W. Everson told the Senate Finance Committee that the agency had revoked or proposed the revocation of not-for-profit status for firms that represent over 20% of the counseling industry's gross assets. The IRS does not release the name of a firm either undergoing or appealing an audit.
Counselors are so beset with bad news that some believe it is time for fundamental change. "The industry is in chaos and carnage right now," says Andrew Gill Smith, a director with Consumers for Responsible Credit Solutions, an organization that operates a Web site that monitors the industry. "The IRS is auditing, (regulators) are looking at it, ... and there's massive incompetence." Gill testified to the Senate that for-profit agencies would be a better advocate for debtors in their dealings with credit grantors.
Gill declines to share names of the leadership of his group, and observers have claimed it is funded by several of the agencies that have been put under the legislators' spotlight. Whatever the group's pedigree, some states are listening to Gill's argument.
The Virginia legislature voted in March to eliminate a requirement that counseling agencies be not for profit. Maryland is considering a similar proposal.
Binzel of the credit counselor's foundation argues that a for-profit firm is more interested in the bottom line than in helping the debtor. In addition, a for-profit firm will spend its resources on marketing, while not-for-profits will spend on education, he says.
Counseling agencies traditionally have been not-for-profits because they arose from religious and civic organizations providing help to those down on their luck. These agencies receive funding from credit grantors in return for helping debtors pay off some or all of their debt. Credit grantors return a percentage of the consumer's payment to the agency under a system dubbed fair share.
In the last decade, creditors have sliced the fair share from 15% of repaid debt to about 6%, driving many agencies to seek funding elsewhere. MMI, for example, charges for some educational materials and services, says Williams.
Any shift to a for-profit model could throw the counseling business in a flux. Many major credit grantors by policy only will pay fair share to a not-for-profit agency. Additionally, most states require agencies to be not for profits.
Still, some creditors are rethinking the entire concept of fair share. Citigroup Inc. instituted in 2004 a quarterly charitable contribution to agencies instead of a fair share payment. Citi based its payment on a performance review of the previous quarter, looking at such quantifiable statistics as consumers served and the number that enter and complete a repayment plan.
MMI believes credit grantors are watching the Citi experiment closely. "Others haven't joined Citi, but we suspect Citi's approach will become the trend," says Williams. "It's not money oriented but results oriented."
A Citi spokesperson declined to discuss credit counseling, saying it was proprietary information. Citi wrote off nearly $5 billion in credit card charges that its cardholders failed to pay off last year. Citi's North American card group reported $139.6 billion in card receivables in 2004.
Some credit grantors are becoming more proactive in the way they treat consumers sliding into problems. HSBC-North America works to customize its approach to the cardholder that has become delinquent on his account, says Steve Basilotto, managing director of risk control.
"We began a sales model approach four years ago. We give the staff the authority to work with the consumer as an individual," says Basilotto. "We communicate by phone and mail (that) 'We will work with you. You have options. Bankruptcy is not the only option.'" This outreach is essential because bankruptcy attorneys aggressively advertise their services and send letters to consumers, says Basilotto.
American Express Co. is funding a multiyear study of the counseling industry to determine the best counseling approach for any given consumer. Plans called for an evaluation of face-to-face, phone and Web counseling with agencies providing data on clients and outcomes of each method.
In March, AmEx awarded a total of $250,000 to 10 agencies participating in the research, scheduled to begin this summer, according to a spokesperson. The Consumer Federation will administer the program, and the Credit Research Foundation at Georgetown University will conduct research.
MMI's Williams says some of the changes resulting from bankruptcy reform probably are good for an industry that was becoming complacent. "Our biggest problem is going to creditors and saying, 'You should give us fair share because it feels good.' The industry needs to mature," says Williams.
Most observers believe the bankruptcy-reform law will alter the counseling industry dramatically in the next few years. Some predict lawsuits from the law's proponents and opponents as its ramifications become clear. For now, the industry will wait and see.
"The potential impact of the bill is significant," says Basilotto. "But we won't know it until it unwinds."
BANKRUPTCY TO KEEP RISING
2004 2005 2006 2007 2008
Chapter 7 1,122,529 1,156,321 1,110,926 1,190,599 1,248,253
Chapter 13 445,547 429,750 489,641 521,322 543,196
Total 1,568,076 1,586,071 1,600,570 1,711,921 1,791,449
Source: Global Insight Inc.
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