Borrower Beware

Anya Kamenetz is the author of Generation Debt, now out with Riverhead Books. More of her work can be found at AnyaKamenetz.com.

Over the past few weeks, several different news reports referred to an alarming trend that puts the American way of life at risk. No, it's not global warming—although that is too. It's personal debt. The good news is federal agencies are finally stirring on behalf of consumers, but citizens need to get involved too. Nothing short of comprehensive reform and education will get us back in the black.

On May 15 the IRS announced that they had revoked the tax-exempt status of every single one of 41 consumer-credit counseling services selected for auditing. In revenue, the audited agencies comprised 40 percent of a $1 billion industry.

Credit counseling and credit repair agencies advertise on bus shelters or late-night commercials, offering peace of mind to those made desperate by overdue bills and creditors' phone calls. They promise to negotiate lower interest rates and simplified payment plans on behalf of the weary. Often they advertise non-profit status, implying that they are working in the public interest. Yet, despite their 501(c) 3 status, the IRS found the audited agencies operated as commercial businesses, paying their executives huge salaries and maintaining close relationships with banks. Actual counseling, including budgeting and debt education, was ignored in favor of enrolling people quickly in monthly payment plans, the better to profit creditors. These payments are often set so low as to lock people into years of repayment and multiplying interest charges; sometimes there are high fees. Twenty-two more of these companies are being audited and criminal investigations are underway.

This development is important for a couple of reasons. More and more Americans are getting into trouble with credit cards, using them to cushion against economic uncertainty and support increased levels of spending even as real income stagnates. The national savings rate for 2006 was negative 0.5 percent, at Great Depression levels.

Experian, the credit reporting agency, released a survey May 24 showing personal debt—not including mortgages—is up 12.5 percent since 2004, to an average of $11,669 per American. Late payments, in the same survey, are up almost a fifth. And the so-called Bankruptcy Abuse Prevention and Consumer Protection Act, which went into effect in October 2005, imposing obstacles and fees on filers, ironically led to a record year of bankruptcy filings—2.1 million, mostly before the law took effect.

Our debt is the credit industry's profit. In a generation, credit cards have gone from a loss leader to the most profitable sector in financial services. Those who pay off charges each month are known as "deadbeats" within the industry. The most profitable customers, by contrast, carry large revolving balances, remaining heavily leveraged without defaulting and writing off their debts. These up-to-their-ears, treading-water debtors were worth $24 billion in fees and penalties alone in 2004. Yet the banking industry has successfully framed debt as a problem of rampant personal irresponsibility, not their own predatory or deceptive practices.

The bankruptcy bill was the ultimate triumph in this regard. Among bankruptcy professionals, it has become known as BARF—the Bankruptcy Abuse Reform Fiasco. A means test makes it difficult for those who earn above their state's median income to file Chapter 7 bankruptcy and fully discharge debts. Creditors have expanded powers of collection under Chapter 13 bankruptcy. And would-be filers must first seek—you guessed it—credit counseling.

Credit counseling is supported by the banking industry through payments called "fair share," in addition to the fees charged consumers. It's kind of like having the liquor companies underwrite AA.  As a stigma spreads across the entire industry, even the "good guys" are now reporting that they don't have funding to do their jobs.
The National Foundation for Credit Counseling, whose 106 member agencies represent two-thirds of those approved by the Department of Justice to do pre-bankruptcy counseling, reported this week that they lose $13.25 per consultation, including those where fees are waived. Banks that pushed the new law have failed to pay up tens of millions of dollars they pledged to fund the mandated counseling.

When even those who seek help are prone to victimization, it's clear that the debt problem is not just about shopaholics but an industry out of control. Just as privacy rights are not just for those with "something to hide," credit rights belong to everyone. These IRS efforts are just the beginning. Comprehensive banking reform would start with a less punitive bankruptcy law in cases of illness, unemployment and divorce, which together account for a vast majority of bankruptcy filings, as Harvard professor Elizabeth Warren has documented. New national usury laws capping credit card interest rates would curb the spread of easy credit and high debt. An overhauled, truly independent credit counseling industry could be developed with a mixture of public and private support. Likewise, we need prevention, in the form of national financial education. Groups like the Jumpstart Coalition are developing curricula now.

Credit should be a tool in the hands of individuals, not vice versa.