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Teaching bankruptcy avoidance.

A panel of bankruptcy experts discusses the merits of setting up a widespread program of debtor education to help put filers of bankruptcy back on track.

The long-awaited report issued by the National Bankruptcy Review Commission in October 1997 disappointed many involved in bankruptcy reform. Those feeling the report missed the mark included creditors, debtors, legislators, trustees and the legal community, which administers the current Bankruptcy Code. The issue of bankruptcy reform has been deeply divisive, and the debate heated. However, through this process, one area has been identified that may provide a solid platform on which to build a framework for constructive action: debtor education.

The sole topic on which virtually all parties with an interest in bankruptcy reform agree is that despite the growing number of consumers filing bankruptcy, the principal goal of the bankruptcy system - providing a fresh start - is not fully being realized. Furthermore, growing evidence suggests that consumers emerge from bankruptcy with little understanding of what led them into financial trouble in the first place, nor do they understand the rights and responsibilities they have in connection with bankruptcy relief. Last but not least, it is alarmingly clear from anecdotal evidence and analysis of repeat filings that consumer debtors emerge from bankruptcy with few, if any, of the financial management tools needed to avoid financial distress in the future.

Since 1995 - throughout the National Bankruptcy Review Commission's work on proposals for change to the bankruptcy system - this author has reported on qualitative and quantitative research conducted by Visa, U.S.A., on the causes and implications of consumer bankruptcy. This series of articles published in Mortgage Banking since February 1997 culminated in a report in the April issue on "debtor education" as it is currently being administered through several Chapter 13 Trustee offices (see "A Degree of Hope," April 1998).

This article builds upon that series by focusing on possible solutions through an interindustry dialogue among board members of the Coalition for Consumer Bankruptcy Debtor Education. The coalition, a not-for-profit corporation, is made up of individuals representing the various constituencies dedicated to the development of nationwide education programs for individuals who have filed for bankruptcy.

What follows are excerpts from their responses to six key questions about the role of education in bankruptcy. It is hoped their responses will enrich the ongoing public discussion of debtor education as a business strategy and as a public policy goal.

The five coalition participants who took part in this dialogue are Joe Guzinski, assistant director for research and planning in the Executive Office of United States Trustees; Karen Gross, professor of law, New York Law School; Joan Warrington, vice president, Citicorp Credit Services, Inc.; Ray Bell, servicing manager, Apex Mortgage Corp.; Andrea Stowers, director of risk management for Visa, U.S.A.; and Steve Holiga, vice president of risk management, Visa, U.S.A.

Why should a post-filing consumer debtor education program be instituted?

JOE GUZINSKI: The current bankruptcy system protects debtors from the claims of creditors that arose before the bankruptcy was filed. This relief is important, but it does not go far enough. Individual consumers not only need protection from their creditors; they also need the tools to avoid financial distress in the future. A well-constructed debtor-education program would provide these tools.

Perhaps there was a time in American history when relief from debt, by itself, was an adequate response to individual financial distress. If that time ever existed, it has certainly long since passed. Consumers today are confronted with complexities and choices that our parents and grandparents never faced.

Back [in our grandparent's day], personal financial planning for the future consisted of Social Security and a company pension; borrowing consisted of a home mortgage, car loan, a department store credit card, or installment credit from a local merchant, and was limited to a large extent by the value of the asset being purchased and carefully matched to an individual's disposable income.

All that has changed today. Planning for retirement is much more of an individual matter, as the future of Social Security has been called into question, individuals find themselves changing jobs more often, and responsibility for one's future depends largely on an individual's planning for himself or herself, and less on corporate retirement plans. Borrowing has become more a matter of individual choice and discipline. The credit industry, including mortgage lenders, looks less and less to the value of assets and more to the behavior of the individual borrower in evaluating whether to extend credit.

Mortgage lending used to largely consist of lending up to 80 percent of a home's value and confirmation that the borrower had income adequate to service the mortgage. Now, lenders advertise a willingness to loan up to 125 percent of a home's value, based on the borrower's income and past credit history. Individuals may have multiple credit cards all issued on the premise that the individual will act responsibly in using them.

Indeed, even the nature of money itself has changed from something viewed as having intrinsic value backed by commodities, such as gold or silver, to being essentially an abstraction (a series of ledger entries stored in a computer some place) whose value depends on nothing more than the belief of those who use it.

In this newer world of personal finance, many individuals will likely need more than breathing space from their creditors to get back on their feet. They need to understand how to manage complex choices to reduce the risk of financial distress in the future. Investments for the future, retirement planning and flexible credit arrangements give individuals an array of options never widely available before to plan their personal finances. At the same time, more opportunities are available for financial distress than ever before. Debtor education can teach people how to manage these choices.

KAREN GROSS: There are more than 1 million individuals debtors accessing the bankruptcy system annually. Indeed, if you count joint filings and nonfiling members of a debtor's family, the numbers grow significantly. Currently, we give debtors a legal fresh start (the opportunity to obtain a discharge of a sizable portion of their prebankruptcy indebtedness). However, we do not give debtors, especially those in Chapter 7, the tools to reenter the credit marketplace. Instead, whether or not they seek bankruptcy relief again, many debtors become marginalized economically. A debtor's bankruptcy filing gives us a window of opportunity, a chance to provide that debtor with the financial management tools and skills necessary to garner a true fresh start. I want to be very clear though. Debtor education should be neither punitive nor ad hoc. Instead, debtor education should be seen as educative and empowering; we are helping debtors not because they committed a wrong; we are helping debtors so they can become productive members of our market-based economy.

RAY BELL: First, it is the right thing to do. Consumer credit counseling and education should combine both pre- and post-bankruptcy initiatives. Several Chapter 13 rehabilitation programs in place for several years clearly show that consumers can benefit from education after discharge. Theories of blaming, theologizing and philosophizing should take a back seat to understanding that once a consumer receives a discharge, there is no real safe mechanism of controlling or resolving the consumer's financial future. The bankruptcy process itself continues to support money management at best through a trial-and-error method, emphasizing how much money one makes, instead of how one chooses to spend it. Further, the discharge of debts is a post-mortem event that allows, in most cases, the return to old habits again and again. The predictable result is refiling for bankruptcy.

How can we pay for a debtor education program, and is it cost-effective?

JOAN WARRINGTON: The Coalition for Consumer Bankruptcy Debtor Education [The "coalition"] is composed of a group of individuals representing diverse constituencies dedicated to developing nationwide debtor-education programs for individuals who have filed for bankruptcy relief. The coalition has established itself as a not-for-profit corporation in order to develop education materials and work with interested bankruptcy trustees to develop pilot programs to test the effectiveness of such educational materials. Initially, the pilots will be funded through money raised by the coalition. If such programs are effective, they could be funded on a larger scale through government appropriations, fees paid for filing bankruptcy or through creditor donations.

Proving the effectiveness of such programs is critical. We will need to establish a matrix to track the performance of people who elect education in comparison to those similarly situated who do not receive additional education. The cost of offering such programs should be compared with the amount of future loss averted, e.g., reduction of refilings and default rates by consumers who receive education. The qualitative impact of such programs, i.e., whether debtors feel that they are more in control of their finances, also should be studied.

JOE GUZINSKI: Before large-scale funding for a fully national program is justified, I believe it will be necessary for post-bankruptcy debtor education to prove itself. The program should be started as a pilot, supported with contributions from the private sector, with perhaps limited funding from the government. The curriculum should be tested, and results in the pilots tracked. At the end of a reasonable period of time, hard data will be available to evaluate the program, and the issue of how to fund a national program can be discussed in an informed manner.

That being said, I firmly believe that post-bankruptcy debtor education will be cost-effective. In the insurance industry, education and training programs are frequently used to assess exposure in high-risk groups. These programs have proven effective in reducing risk and insurance premiums. There is every reason to believe an education program made available to individuals who file bankruptcy will be similarly effective in dealing with the risk of personal financial distress.

STEVE HOLIGA: Measuring cost-effectiveness could take a very long time, even if it is possible. One could subsidize the cost with creditor funding. Perhaps the filing fee could be raised so that the debtor pays part of the cost of debtor education.

RAY BELL: This is a tough question to answer fully. There are some statistics that may be viewed as a development toward a true or reasonable answer. First, the American taxpayer is paying about $300 per year for the bankruptcy system to operate. Chapter 7, 12 and 13 trustees receive fee commissions on funds collected from the estate. Attorneys representing debtors in bankruptcy proceedings receive anywhere from $500 to $1,000,000 from either the debtor or the estate. The U.S. Trustee system receives a percentage of costs paid from the estate. While fees and costs are either approved by statute or the court, I believe it would be worthwhile to seek partial funding from the existing system. I do not believe that creditors should be tapped for payment of the program unless they are willing to contribute donations on a voluntary basis.

Now, the second part of it is cost-effectiveness. Once again, we face difficult questions without quantifiable, historical data. However, I would look at the following for tracking purposes:

* Reductions of consumers who refile.

* Reduction of newly filed bankruptcies.

* Default rates on consumers who receive debtor education.

KAREN GROSS: I believe there are lots of ways to fund such a program; indeed, funding could and should come from several sources. However, before I proffer six possible funding sources, let me eliminate one possible funding source (the federal government). I do not envision a new federal bureaucracy with major funding from the federal till; bankruptcy has more than enough administrative layers as it is. New possible funding sources include:

* A small contribution (say $10 to $20) from debtors participating in the program (with a waiver for those who cannot pay).

* Contributions from creditors (banks, finance companies, credit card issuers, credit unions).

* Foundations, particularly those interested in increasing financial literacy.

* Settlement awards in bankruptcy class-action suits (such as the fund envisioned in the Sears settlement of its reaffirmation situation);

* Cy Pres awards in litigation involving debtors where the actual debtors affected cannot be identified.

* The escheated funds that derive from monies allocated for distribution to creditors in bankruptcy cases that are never actually distributed because the creditors cannot be located.

As to cost-effectiveness, let me begin by saying that not all effectiveness is easily measured. Improvement in one's sense of well-being and self-worth are valuable and not always easily (if ever) quantifiable. But there should be no question about this: Enabling debtors to reenter the credit marketplace benefits everyone - the debtors and their families, future creditors and the community. A well-educated debtor will, instead of continuing as a possible drain on the economy, be a positive contributor to it.

Will it be cost-effective in a traditional sense? Let's try debtor education on a pilot basis and see what a study of it shows. I speculate (and hope) that the success of the program will demonstrate cost-efficiency.

Isn't such a program too little, too late?

STEVE HOLIGA: It's never too late for education. The number of filings is still increasing. There is no shortage of potential students. How we implement such a program is not easy though. The effort has to be a nationwide implementation by a national organization like the NACTT {National Association of Chapter Thirteen Trustees) or the NFCC {National Foundation for Consumer Credit).

ANDREA STOWERS: Chapter 13 trustees who have offered these programs to debtors during the past 20 years consider these programs to be self-funding to the extent that the administrative and teaching costs are paid through their budgets. Each trustee's budget is funded by a portion (up to 10 percent) of the monies repaid by debtors through their Chapter 13 repayment plans to creditors. While expanding the Chapter 13 programs throughout the country will allow access by more Chapter 13 debtors to the benefits of education and training, Chapter 7 debtors will have to be funded through a different structure, such as those suggested herein.

As to the cost-effectiveness, many trustees and creditors who support Chapter 13 programs in progress boast a less than i percent default rate on new debt undertaken by those "educated" debtors. They also claim significantly higher repayment and completion rates for their debt repayment plans. If this success can be replicated and expanded nationwide to more Chapter 13 and to Chapter 7 debtors, I believe that the credit community will likely provide at least supplemental funding for debtor education.

JOAN WARRINGTON: As the old adage goes: better late than never. Moreover, our hope is that the development of solid debtor-education materials and the learning derived from the pilot programs will be extended eventually to prebankruptcy courses, either through the courts or through independent not-for-profit creditor counseling organizations. Such materials could even be the basis for courses geared to high school and college students just beginning to need to learn how to manage their finances.

RAY BELL: If we believe that consumers are going to stop filing bankruptcy, then 'no,' we don't need debtor education. But that doesn't appear to be the case, now does it?

Should debtor education be voluntary or mandatory?

JOAN WARRINGTON: Members of the coalition discussed this issue at length. Those favoring mandatory education thought that such a requirement would ensure that educators would have the opportunity to reach all debtors and expose them to financial concepts. As one educator told the group, her most grateful students were often those who had been forced to take her course by the local Chapter 13 trustee. Other members of the coalition were concerned about the logistics of requiring debtor education, citing language barriers and scheduling problems involving work and family obligations. For purposes of the pilot, it would be interesting to offer courses on both a voluntary and a required basis and compare the results.

KAREN GROSS: I don't know the answer to this question, and I waiver in my response to it depending on when I am asked. I can certainly see the arguments both ways. So, my preference is not to decide now. First, I want to probe the Canadian experience more fully. Canada is the only nation in the world with mandatory debtor education, and preliminary results of its program demonstrate success (although the population is vastly different from our own). A more detailed study in Canada is currently under way. Second, let's try a voluntary pilot debtor-education program here and see what happens. For example, how many people will enroll? How do they differ from those who did not participate? After two years, we can compare debtors who did and did not participate. Are there vast differences in terms of life choices, finances, creditworthiness and emotive state?

How do you define the success of a debtor-education program?

JOE GUZINSKI: A successful debtor-education program would enable individuals to avoid financial distress after they emerge from bankruptcy. As an objective measurement, I would propose defining a successful student of a debtor-education program as one who keeps his/her debt load within some reasonable range; and who is viewed as a good credit risk by a credit rating agency within 18 months of receiving the bankruptcy discharge.

STEVE HOLIGA: Success could be a measurable decrease in the refiling rate of those who attended classes vs. those who did not. Success could also be an increase in the completion rate of plans in a given jurisdiction. Finally, success could be the measure of decrease in the number of conversions to Chapter 7.

JOAN WARRINGTON: Success should be defined both qualitatively and quantitatively. Our goal is to help people feel more in control of their finances by teaching them how to budget and use credit wisely. Better understanding of financial concepts should translate into better credit records and fewer bankruptcy filings.

RAY BELL: Success can be measured through consumers who complete their bankruptcy cases; emerge with greater money-management skills; and do not refile for bankruptcy.

ANDREA STOWERS: Success can and should be measured in all of these ways through a longitudinal study over, say, five years. Not only would the data derived from such a study validate these measurements, it would quantify the monetary value of education. Assigning monetary value will, assuming success, ensure access to money-management training for all consumers over the long term.

If there were one category of data that would help this process, what data would you want?

KAREN GROSS: The paucity of data about the bankruptcy system is startling; indeed, we know more about mating habits of fruit flies than we do about debtors. If the National Bankruptcy Review Commission process demonstrated nothing else, it did shine a bright light on the lack of. data about the bankruptcy process.

The data I would most like to see involves demographics. I would like to know the age, gender, race and ethnicity of debtors. That would help us in designing education programs; it would enrich our understanding of who seeks bankruptcy relief in the first instance, and why, and it would give us a clue as to what happens to debtors post-filing. It is awfully hard to design a system when you know precious little about the system's users.

RAY BELL: We need refiling and conversion statistics.

STEVE HOLIGA: I strongly believe that some sort of audit is needed to verify assets and liabilities as well as current income and expenses. The biggest problem with available data is that it is not accurate.

JOAN WARRINGTON: Currently, the court system does not track "true" repeat bankruptcy filings; only aggregate refiling numbers are available. Many refilings are not reflective of new financial difficulty, but relate to the same situation. Those refilings often are used procedurally to delay foreclosures. We need to know how many people receive a discharge in bankruptcy, only to find themselves back in bankruptcy court again. Our guess is that recidivism is becoming more common.

JOE GUZINSKI: We should have an accurate statement of nonpriority unsecured debt of each individual debtor, categorized by the type of debt (credit cards, loans, judgments, health care costs and so forth).

ANDREA STOWERS: One of my former bosses was fond of saying, "The data tells all." Only over time did I fully comprehend that this statement extends beyond the mere collection and analysis of statistics to play a fundamental role in the formation of policy. I believe that the current system can only be improved when the rhetoric becomes informed by fact. The importance of this national pilot is that it will not only improve the quality of life for debtors who have access to it. It will also provide the data that will ensure continued access to these skills and tools, which will ensure more informed and responsible use of credit, which in turn will strengthen the stability of this credit-based economy.

An emerging consensus

What the answers of each of these participants best illustrate is that despite their diverse perspectives, there are a number of shared goals. Debtor education should not be divisive; it can and should result in positive change. This discussion reveals that we, as an industry of credit providers, can be optimistic about the prospects for reaching consensus on the issue of debtor education and rehabilitation. If we can implement a nationwide debtor-education program, then whatever else happens in the field of bankruptcy, we will have made a significant contribution to the lives of debtors in a market-based economy and enhanced the stability of the credit system.

Andrea Stowers, CMB, is director of risk management at Visa, U.S.A., in San Francisco.
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Author:Stowers, Andrea
Publication:Mortgage Banking
Article Type:Panel Discussion
Date:Jun 1, 1998
Words:3590
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