Look under the hood of the new bankruptcy law that took effect this week, and you'll see an accident waiting to happen. Not only is the fox charged with guarding the hen house; an army of foxes has been put in charge of caring for sick hens.
There's plenty of ways to debate the merits of the bankruptcy changes, but here’s two incontrovertible facts: Bankruptcy candidates must now pay for private credit counseling before they are allowed to file; and the credit counseling industry has a deeply checkered past. By passing the new bankruptcy law, Congress has thrown debtors to the wolves, and has offered a blanket of legitimacy to an industry that has earned itself deep skepticism. Debtors, beware.
Hang out in bus stops around America's great cities, or watch late-night television, and you are bound to see aggressive pitches full of false hope aimed at Americans who are living close to the financial edge. The country is teeming with "credit repair" firms which lie about their ability to clear up bad credit. Some take money from consumers that’s supposed to pay bills and keep it for themselves. Others try illegal tactics to trick credit reporting agencies into dropping unpaid bills from credit reports. The Federal Trade Commission has brought 70 cases against such companies in recent years, according to the FTC's Steve Baker.
Credit counseling agencies, the cousins of credit repair firms, come in all flavors -- from decent to disreputable. Some offer real, helpful advice; others steer consumers toward unrealistic repayment plans when they should be filing for bankruptcy. Why would they do that? Because credit counseling firms are paid a bounty by the credit industry for every consumer they bring back from the brink of bankruptcy.
The conflict of interest is undeniable. So is this fact: These counselors have little incentive to act in the interest of consumers on the verge of bankruptcy. And now, Congress is sending every American who wants to file for bankruptcy right into the heart of this thicket.
'Just how non-profit are they?'
Most credit counseling firms are designated non-profits, but many are so tied into for-profit companies that it's hard to tell the difference. In fact, Nathalie Martin, resident scholar at the American Bankruptcy Institute, suggested consumers should ask this crazy question about a prospective credit counseling firm: "Just how non-profit are they?" Her tongue was barely in her cheeck.
There are some strategies designed to protect consumers from the worst of the lot. Starting this week, consumers who head to a lawyer to file for bankruptcy will be given a list of approved credit counseling firms. Approved by whom? A little-known division of the Department of Justice called the U.S. Trustee Program, which administers bankruptcies. So far, the U.S. Trustee Program has approved only about 50 counseling firms. If the expected 1 to 2 million people file for bankruptcy this year, those services will be deluged and likely unable to handle the workload.
Jane Limprecht, of the U.S. Trustee office, says more agencies are being approved every day by the two dozen or so government workers reviewing applications, and she feels confident there won't be a bottleneck -- particularly given the fact that counseling will be permitted over the Internet or the telephone.
But who will these counseling firms answer to? While the U.S. Trustee screening will hopefully keep out downright scam artists, that says nothing about the quality of advice counselors will get, says Travis Plunkett of the Consumer Federation of America. The real concern is that counselors will push people to repay bills they simply can't, at the behest of the credit industry. Who will evaluate the agencies for fairness as time goes by? That's the job of the U.S. Trustee Program -- which is already swamped just keeping up with applications. The agency is still developing its auditing procedures, Limprecht says.
Con artists love red tape
Meanwhile, unsavory credit repair and counseling firms will no doubt find a way to take advantage of the law. Already, regulators in Louisiana report seeing ads from credit repair firms telling consumers that a visit to their offices satisfies the new bankruptcy filing requirements. It's a lie; but scam artists know well how to take advantage of confusion over new red tape created by the federal government. We've already seen a number of alleged scams which take their oomph from Congress' confusing senior prescription drug discount program (read about PharmacyCard.com, Discount Card scams, and more recently MyFreeMedicine.com)
There have been abuses of bankruptcy filing; there are consumers who've used bankruptcy as a personal financial planning tool, to wipe away debts they perhaps could have paid. Those are the people the law is designed to trap.
But trapped with it will be hundreds of thousands of people suffering from one of these three things: overwhelming medical bills, divorce or downsizing. Most bankruptcies are the result of one of those three life events, according to the Consumer Federation of America. In fact, Harvard professor Elizabeth Warren in "The Two-Income Trap" argues that about half the time, a massive health care bill is the real cause of a bankruptcy filing. If you ask for debt relief because your wife just died after a long fight with cancer, does it make sense to force you to find a legitimate credit counseling firm?
In fact, the U.S. Trustee Program has already answered that question. It recently ruled that Hurricane Katrina victims who file are exempt from the counseling requirement. After all, being washed away by a hurricane doesn't mean you need to take a class in bill paying. If that's true, what about victims of a health care hurricane?
The mandatory counseling has all the flavor of driving classes that are forced on DWI convicts, or anger management classes mandated after domestic abuse. That is, they sound like punishment.
And actually, the new law says bankruptcy filers must enroll in two different education programs; credit counseling at the beginning of the process, and then "debtor education" at the end, before debts are discharged.
I'm all for personal finance education, something I believe our nation’s schools sorely lack. But if the credit industry really wanted to help, it would force consumers to take these debtor education classes before they receive their first credit cards, not as punishment for mishandling them.
Next week, I’ll talk about ways to avoid bad credit counseling and credit repair firms.