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Potential Conflict of Interest Seen In New Credit Counseling Mandate

By Eric Dash 
and Jennifer Bayot

A requirement of the new bankruptcy law that sends Americans into credit counseling before they can erase their debts is drawing criticism from consumer advocates, bankruptcy lawyers and financial educators, who are concerned that the lenders are subsidizing the advice.

Critics say that the new counseling requirement, part of the law that takes effect on Monday, increases the risk that people will be improperly steered away from the courts and into debt management plans, for which the counseling agency often receives part of the creditor’s fees.

“Lots of people see the opportunity to make lots of money off the backs of consumer debtors, and that should make people extremely cautious about this,” said Karen Gross, a New York Law School professor and president of the Coalition for Consumer Bankruptcy Debtor Education advocacy group.

The counseling agencies, which will receive no additional government aid under the new law, are increasingly reliant on funds from the credit industry. And the industry has already pledged $10 million to the agencies for this year, and possibly more.

Although the agencies maintain that they balance the competing interests of debtors and creditors, the aggressive practices of some counseling providers have been questioned by Congress and scrutinized by the Federal Trade Commission and the Internal Revenue Service. Indeed, IRS officials say that they will propose revoking the nonprofit status of at least 20 agencies by the end of the year.

Credit counseling industry officials say their services can help consumers make informed decisions about their finances.

William P. Binzel, chief counsel of the National Foundation for Credit Counseling, an industry group, compared a counseling session to a medical briefing before surgery. The agencies must present a range of alternatives, he said, just as a doctor must explain the procedure and its potential outcomes.

Right now a credit counselor’s office may be harder to find than a health care provider. While more than 2 million people are expected to seek counseling next year as a prerequisite to filing for bankruptcy, there are only 50 or so agencies approved so far — and there may be fewer if the IRS carries out its proposal. In many parts of the country, from entire states like Ohio and to major cities like Nashville, Tenn., counseling will be available only by phone or over the Internet — at least until the government approves more agencies.

“On the surface, the notion that people should consider their alternatives is not a bad theory,” Gross said. But “the way the system is structured suggests that will not happen.”

The credit counseling requirement is part of the amended bankruptcy act that changes the balance of power between debtors and creditors. Intended to make it more difficult for Americans to wipe out their debts, the new law requires a thorough review of whether they can pay off at least some of their credit card bills and other debts. It will also ask debtors to pull together more paperwork, increasing the time and legal costs of filing.