Bankruptcy Credit Counseling Roundtable

by Jeff Sovern

      On June 1, I attended a terrific policy roundtable on the credit counseling required by the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, at Fordham Law School, put on by the Fordham Corporate Law Center and Susan Block-Lieb of Fordham.  Because I knew so little about the subject, not being a bankruptcy person, I remained silent, and have been feeling guilty ever since.  That's because there's an unstated expectation at these events that you'll pay back the other contributors from whom you learn by contributing yourself-and I learned quite a bit.  But one of the virtues of a blog is that you can expiate your guilt to some extent by commenting later (blogging as therapy).   Things stated at the roundtable were off the record, but I can report on materials in the public record and my own views, now that I've had some time to figure out what they are.

        The credit counseling industry has existed for some forty years and has had a checkered history.  While some studies have found credit counseling has had beneficial results, see Abdighani Hirad & Peter M. Zorn, A Little Knowledge is a Good Thing: Empirical Evidence of the Effectiveness of Pre-Purchase Homeownership Counseling 2 (2001) ("counseling can be effective in reducing mortgage delinquency . . . . borrowers receiving counseling through individual programs experience a 34 percent reduction in delinquency rates."); Gregory Elliehausen, E. Christopher Lundquist & Michael E. Staten, The Impact of Credit Counseling on Subsequent Borrower Credit Usage and Payment Behavior 31 ("one-on-one credit counseling has a positive impact on borrower behavior over an extended period."), counseling agencies have also been the subject of a many consumer complaints and FTC enforcement actions. 

Historically, part of the problem with the industry is structural.  One service offered by credit counselors is negotiating "debt management plans" (DMPs) between consumer-debtors and creditors under which creditors accept reduced payments (perhaps by waiving certain fees).  The creditors pay the credit counselors to work out these plans and those payments have been a major source of revenue for the counselors.  As a result, credit counselors have an incentive to encourage debtors to agree to DMPs even when that might not be in the best interests of the consumers.  At the same time, many counseling organizations are charitable organizations with tax-exempt status and to retain that status must provide a level of public benefit.  The IRS takes this obligation seriously; in 2003, it initiated a Credit Counseling Compliance Project which has resulted in revocation of tax-exempt status for many counseling organizations.  Trade organizations also provide some self-regulation for the industry.  Thus, credit counseling organizations have incentives to steer consumers to DMPs to generate income, and have conflicting incentives to act in the best interests of the consumers.  Another problem is that credit counselors may be limited in what they can advise clients because of the fear of engaging in the unauthorized practice of law.

Against this background, Congress enacted in the 2005 Bankruptcy Act a requirement that most debtors filing for bankruptcy obtain counseling from an approved provider in the six months preceding filing of the bankruptcy petition.  As a practical matter, that often means right before filing the bankruptcy petition.  The stated goal for the requirement was that the counseling might help consumers learn about alternatives to bankruptcy that they might prefer.  A more cynical explanation is that the requirement is one of a number of roadblocks designed to make it more difficult for consumers to discharge debts.  One interesting thing about the requirement is that it seems to assume that consumers with lawyers are being poorly advised by those lawyers-because the lawyers should recommend bankruptcy only when that is in the client's best interests, and if it is in the client's best interests to seek prefiling counseling, the lawyer should so advise even without the statutory requirement.

The U. S. Trustee's Office is charged with approving credit counselors and has established procedures for doing so.  As of October 2006, it had received 680 applications, approving 64%; an additional 32% had been rejected or withdrawn.

So how is this working out?  In April the GAO published a report titled "Bankruptcy Reform: Value of Credit Counseling is Not Clear" evaluating the results of the required counseling.  On the positive side, the GAO found that few formal complaints had been lodged against credit counselors. But the GAO also reported that anecdotal evidence "suggests that by the time most clients receive the counseling, their financial situations are dire, leaving them with no viable alternative to bankruptcy. As a result, the requirement may often serve more as an administrative obstacle than as a timely presentation of meaningful options."  The GAO noted that "available evidence indicates that only a very small number of clients receiving prefiling credit counseling have entered into any debt management plans. . . . fewer than 2 percent . . . ."  And it observed that "by the time individuals obtain prefiling credit counseling, they usually have already consulted with a bankruptcy attorney . . . ."  The GAO recommended that the Trustee develop a mechanism to track the outcomes of prefiling credit counseling.

My own take on this it that while the GAO Report raises significant yellow flags about the value of the prefiling credit counseling, it's hard to tell whether the program is serving its purpose from the Report.  I don't take seriously the fact that few formal complaints have been received.  While I certainly can't claim to be a master of the extensive literature on consumer complaints (there's even a journal called the Journal of Consumer Satisfaction, Dissatisfaction, and Complaining Behavior), my understanding of that literature is that consumers rarely file formal complaints.  Consumers seem even less likely to file such complaints if they perceive the prefiling counseling as a procedural hoop they must jump through to file a bankruptcy petition rather than something they genuinely want.

But neither am I prepared to accept that the program is a failure just because of the anecdotal reports that few consumers decide against filing for bankruptcy after receiving the counseling (though my best
guess is that the program is not worth what it costs).  One thing I would like to know (and missed my chance to ask) is more about how the process works.   Suppose, for example, that it goes something like this:  a consumer meets with an attorney who recommends filing for bankruptcy and explains what is required.  On that list of requirements is obtaining a certificate from a credit counselor, and the attorney recommends one or more counselors.  The consumer then sees a recommended counselor.  The counselor understands that the consumer has been advised by the referring attorney to file for bankruptcy.  Under those circumstances, I wonder how many counselors will recommend against filing for bankruptcy, even when such advice is warranted.  The counselor knows that a lawyer-perhaps a bankruptcy specialist--has already advised the consumer to file for bankruptcy. In addition, the counselor would presumably want to retain the good will of the attorney, if only to obtain future referrals, and disagreeing with the attorney is not likely to accomplish that goal.  Similarly, attorneys who are compiling a list of credit counselors are not likely to be enthusiastic about including counselors who regularly disagree with the attorney's advice.  If it is true that consumers with attorneys end up with counselors recommended by the attorneys-and I don't know that it is true-then the program that seems designed to prevent attorneys from giving bad advice uses as a check someone recommended by the attorney.

I'm not saying that this happens.  I know very little about the process by which consumers end up at credit counseling agencies.  All I'm saying is that if the process looks like this, I would hesitate to conclude on the basis of the GAO Report that counseling provided by a genuinely independent counselor would not be useful.  My best guess, actually is that it is not useful at the point at which most consumers are about to file for bankruptcy, but I'm not sure we can tell that from this data.  And I should note that this comment is directed solely at prefiling counseling, and not at predischarge debtor education.

Comments

[Bankruptcy Lawyer]

Yes, the new bankruptcy law does help a lot. Lets face it, in a society where we spend above and beyond our means we will have people filing for bankruptcy. Btw, this is one of teh best bankruptcy blogs I've seen in ages. Keep up the good work.

[Craig Torey]

We need to let people know that even with the new bankruptcy law, there is still help available. Knowing our rights is our best defense.

[Free Credit Counseling]

I think its very important people are aware that there is free credit counseling, that it musn't be paid for. Excellent article.

[Mike Smith]

Great article

MIke
http://www.your-bankruptcy-information.com

[Jeff Sovern]

Thanks for pointing this out Lauren.

[Lauren E. Willis]

FYI: Staten et al. appear to no longer assert that their research demonstrates credit counseling to be particularly effective. Although their 2002 self-published monograph quoted by Jeff did, their peer-reviewed article reporting their results - Elliehausen, Lundquist & Staten, The Impact of Credit Counseling on Subsequent Borrower Behavior, 41 J. Consumer Aff. 1 (Summer 2007) - does not. Their results, once controls for self-selection are added, do not show any better credit scores 3 years out for consumers who receive credit counseling versus those who do not. Although they show that the counseled consumers have less debt 3 years out, the difference is apparently not enough to have an effect on credit scores. Further, although the authors do not discuss this, the two-stage least squares regression analysis they perform to control for self-selection can only partially correct for this bias.