Bankruptcy changes will overwhelm debt-counseling system
By Holden Lewis • Bankrate.com

Imagine that you manage a fast-food restaurant and that you are understaffed today. You're doing your best when, at the height of lunch hour, you watch helplessly as two school buses pull into the parking lot.

Debt counselors feel the same dread.

Thanks to bankruptcy reform, an estimated 1 million more debtors will seek counseling next year, and counseling agencies don't know how they'll handle the increased caseload.

On top of that, Household Credit Services, a major credit card issuer, just announced that it will cut funding in half to agencies that provide debt counseling by phone. Counseling agencies worry that other card issuers will follow suit, cutting the agencies' main source of revenue just as demand for their services soars.

Farewell to 'fair share'
At issue is something called the "fair-share contribution." When a debtor pays bills through a counseling agency via a debt-management plan, lenders send a percentage of that money back to the agency. That's the fair-share contribution. Household has cut its fair-share contribution for phone counseling from 6 percent to 3 percent.

Debt counselors expect other credit card issuers to do the same.

"The fair share has been taking a nosedive for a long time," says C. Philip Johnston, head of a debt-counseling agency in St. Louis. "Where it's going to bottom out, I don't know."

Says Steve Rhode, president of the debt-counseling agency MyVesta.org, "This recent cut from Household, I think, is just the first. I wouldn't be surprised if it goes to zero."

Credit counselors are not only resigned to the inevitability of reduced funding; they are angry, too. They point out that credit card companies pushed hard for changes in bankruptcy laws. They got almost everything they wanted from the House and Senate, including a requirement that people seek debt counseling before declaring bankruptcy. And after people file bankruptcy, the law will require them to take a personal-finance course.

The House and Senate passed similar bankruptcy bills that are expected to be reconciled and enacted this spring. Six months after the president signs it, the law will go into effect.

Congress didn't volunteer to pay for the required credit counseling, nor for mandated personal-finance courses that people will have to take before their debts are discharged in bankruptcy. Congress asked the nation's public schools to develop courses to teach children about debt and personal finance, but didn't put up any money for that, either.

Some counselors see opportunity
Not all debt counselors are chagrined about the expected influx of debtors next fall. The InCharge Institute of America, which runs nonprofit counseling agencies including Genus, Profina and Concord, sees it as an opportunity. Timothy Raftis, vice president of InCharge, says the question came up early about whether its agencies could handle the expected caseload.

"Our answer was, 'Absolutely,' " he says. "We handle over 120,000 individual conversations with consumers every month. Our scalability to work with this increase makes us very confident that we'll be able to provide part of the solution."

His tone is can-do, perky.

Johnston, of Consumer Credit Counseling Service of the Mississippi River Valley, delivers a similar message, but in a grim, determined manner.

"We are prepared to handle just anybody that comes to us, if we have to work nights and weekends to do it," he says.

Everyone expects a resumption of a trend that started in the late '90s, when credit card issuers became alarmed at the vast sums they were paying to counseling agencies in the form of fair-share contributions. Three years ago, the customary fair-share contribution was 15 percent. But suddenly, legions of debtors enrolled in debt-management plans, and the total amount in fair-share contributions skyrocketed.

"The money that the banks earned as interest was being diminished tremendously by these kinds of organizations, to the point that major credit card issuers found out that fair share was the second-biggest expense they had, after personnel," says Johnston, who was a credit-card executive for decades. "The crap hit the fan among these creditors. The senior people said, 'What the hell's going on down there? Cut those expenses.'"

So in 1998 and 1999 the card issuers reduced the percentage they sent back to counseling agencies. Johnston says Sears threatened to fire employees who failed to cut contributions to the nonprofits. Card issuers insisted that counseling agencies automate payments and deliver counseling by phone to reduce costs.

Now most credit card issuers contribute 8 to 10 percent. What will happen when the bankruptcy law forces debtors to flood into counseling agencies again, as they did in the mid-'90s?

"Now that a million people are going to be forced into credit counseling, that's two times greater than it was last year," says Rhode of MyVesta. "Do you think they're going to allow that line item to swell to twice what it was last year?"

The credit card companies aren't saying: Of 10 top issuers contacted for this story, three returned calls, and one of those, FleetBoston, declined to comment or to confirm that it contributes 9 percent to some agencies and 6 percent to others.

Providian confirmed that it gives a 10 percent fair-share contribution and Capital One, 9 percent. They had no comment about how much they plan to contribute in the future.

A spokesman for Household did not return a call asking about its fair-share reduction.

Joy Thormodsgard, chief operating officer of the National Foundation for Credit Counseling, a trade group for the industry, says the agencies will research ways to get additional funding. "Yes, funding is a valid concern," she says. "Yes, we're aware of it and we believe strongly that credit counseling will help these million consumers."

For counselors, a changing mission
Debt-counseling agencies see their mission as twofold: to educate consumers about personal finance, and to prevent bankruptcy whenever possible.

Now, the federal government is forcing these agencies to change their mission. Instead of preventing bankruptcy, credit counselors will be in charge of granting debtors permission to declare bankruptcy. A debtor can't file for bankruptcy without a certificate from a nonprofit counseling agency, attesting that bankruptcy is the debtor's best option.

"I can see a real problem of who's going to meet the requirements here," says Jean Braucher, a law professor at the University of Arizona who is researching education programs for people in bankruptcy. "Consumer credit counseling services are set up to avoid bankruptcy, and I have trouble seeing them issuing that paperwork."

Rhode, of MyVesta, says his agency will not participate. He says it's not his job to send people to bankruptcy court.

"We're not going to be part of doing budgetary or credit counseling for people who file bankruptcy," he says. The revised bankruptcy law grossly oversimplifies people's credit problems behind an unworkable get-tough veneer, he says. Rhode finds that credit problems usually are symptoms of deeper troubles.

"We can't be surprised that people use money in ways that mask problems in their lives," he says. "People are not numbers. People are people."

He describes a client who had such a traumatic childhood that, at age 45, he was spending in absurd ways to resolve those old issues. He owned a house and was making big payments on a 15-year mortgage (instead of the more common 30-year mortgage) because he didn't want to make house payments while in retirement. He was nervous about earthquakes, so he bought a travel trailer that he could live in, just in case a quake tumbled his house. He was overwithholding income taxes by $700 a month to force himself to save money. And a bankruptcy attorney had told the man that his best option was to declare bankruptcy.

Someone like that needs a psychologist, not a bankruptcy attorney or just a debt counselor, Rhode argues. But, under the new bankruptcy law, bankruptcy and debt counseling might be the only options offered. MyVesta employs psychologists, financial planners, tax specialists and others.

In St. Louis, Johnston worries about the attitudes of people who are forced to get credit counseling. "People who come to us today are here voluntarily," he says. "They've made a decision that they don't want to go bankrupt and they're eager to work with us to get on a good financial footing. The people who are denied immediate access to bankruptcy, they're not going to be so friendly to us. They're going to be upset. I have no way of judging what sort of cooperation we'll get from these people. It will present a challenge to turn their attitude around."

Johnston says his agency will send deserving debtors to bankruptcy court. He's just not sure how. He doesn't know how the agency will interact with bankruptcy courts and trustees, what criteria it will use to determine which clients deserve bankruptcy, how the agency will be evaluated by the feds.

"I guess this will all come out when the bureaucrats figure out their operations manual," he says.

That operations manual has to be written within six months of the law's enactment -- probably in November or December.

Tahira Hira, a professor of family finance at Iowa State University who advised Canada on bankruptcy reform, says with bemusement that a panel that could produce all the necessary bankruptcy guidelines in six months "would be the fastest-moving commission I've ever seen."

She says she thinks it's a good idea to make people get counseling before they declare bankruptcy. Debtors should know that they have other options. But she believes that it would be better if the bankruptcy court, and not a counseling agency, decided someone's eligibility to declare bankruptcy.

She predicts that another class of nonprofits will spring up to meet the need and that their money will not come from lenders. She notes that credit-counseling services exist to keep people out of bankruptcy, and that they are funded by creditors. She worries that the agencies will feel pressure to deny bankruptcy protection to people who deserve it.

"If I were sending 60 percent of my clients to bankruptcy, I would be afraid my funders would object and cut my funding," she says.

"The question is, who are these people who will be counseling them, and what are their qualifications?" Hira adds. "How do we recognize whether this is the right person to be advising people whether to file bankruptcy or not?"

Right now, there are no qualifications, and that worries Hira.

"We're diverting people from the courts and we don't know what that somewhere is," she says. "The people there, will we just pick them up off the street to do counseling? Don't you think that's frightening? I think it is."

-- Posted: March 26, 2001