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How useful is debt counselling in bankruptcy?

Several countries (Canada, US, Scotland)  now include debt counselling as part of the  individual bankruptcy process but evidence is limited as to its beneficial impact.

Many official inquiries have supported the integration of counselling in the debt enforcement system.  In the 1960s and 70s  counselling was justified  by the  perception of a debtor as needing assistance in managing her financial affairs and possibly having wider problems in coping with life.  The English Payne Committee (1970)  proposed a social service office for debtors as part of a state enforcement office based on ‘abundant evidence that many debtors incur and fail to pay their debts because they are inadequate personalities or irresponsible in managing their affairs… They need to be assisted to financial health and stability.” (para 1210) Social workers would ‘perform for financially incompetent or inadequate or irresponsible debtors, the functions which are discharged for more successful members of the community by bank managers, accountants or solicitors’ (1216).   The influential Brookings Commission study (1971) in the US  proposed that financial counselling should be available to all debtors after finding  that 31 percent of debtors attributed their problems to poor debt management,  and  the US Bankruptcy Commission(1973) proposed that access to bankruptcy should be dependent on a debtor receiving counseling by the new administrative  agency which would administer the bankruptcy process. The Bankruptcy Reform Act 1978 contained no formal requirement for counselling. The US National Bankruptcy Commission in the late 1990s endorsed the introduction of counseling on a voluntary basis.

Canada pioneered in 1992 the legislative  introduction of two counseling sessions during bankruptcy for individual bankrupts (see here).  The objective was to prevent repeat bankruptcies and to further rehabilitative goals of behavior modification.  The Insolvency regulator (Office of Superintendent of Bankruptcy), debt counselling agencies and the Canadian Bankers Association supported its introduction.   In Canada the trustee (or their delegate) must now: (1) make a pre bankruptcy assessment outlining options including that of a consumer proposal (repayment of a portion of debt usually over three years), (2) provide an initial counseling session shortly after bankruptcy is declared entitled consumer and credit education and (3) a second session shortly before discharge which normally takes place nine months after the declaration of bankruptcy. Counselling is financed by a fee which comes out of the bankruptcy estate– $85 for each stage of counselling-usually made from income payments by bankrupt. Ninety percent of the sessions last under one hour. Counselling is  a condition for receiving a  discharge. The current Directive (OSB 1R3) defines it as ‘educating debtors on good financial management practices, including the prudent use of consumer credit and budgeting principles, developing successful strategies for achieving financial goals and overcoming financial setbacks and where appropriate making referrals to deal with non-budgetary causes of insolvency (ie gambling, addiction, marital and family problems)’.

Has the Canadian system of counselling achieved its objectives? It is difficult to measure this rigorously because one ideally  needs a  control group who go through  the process without counseling.  In early reviews  bankrupts generally were favourable in their assessments of counseling.  But does counselling change behavior or result in fewer repeat bankruptcies?  The only rigorous study of the Canadian system using a control group, conducted  by Saul Schwartz and published in the American Bankruptcy Law journal in 2003,  concluded that counseling did not lead to ‘any appreciable improvement in future creditworthiness’ and ‘has little effect on repeat bankruptcies in the first five years after an initial bankruptcy filing’. In Canada the overall repeat filing rate has increased from 10 percent in 2002 to 15 percent in 2011 and 16 percent in 2012.  Notwithstanding these data a recent evaluation  in 2013 by the Canadian Department of Industry argues that counselling has a positive impact because ‘debtors found the sessions useful’. The report  admits that ‘determining the effectiveness of mandatory counseling is challenging because it is difficult to disentangle the results of two counseling sessions from the broader changes that occur in a bankruptcy or insolvency’.  The study  suggests some short-term changes in understanding and behavior by debtors and notes that repeat bankrupts were slightly less likely to cite overuse of credit as a reason for bankruptcy. But the study is hardly a ringing endorsement for mandatory counselling for all bankrupts.

In the US the  2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)  introduced mandatory counselling  at the pre-bankruptcy stage as an eligibility condition for filing for bankruptcy and also  required bankrupts to undertake a financial education course during bankruptcy as a condition of receiving a discharge.   Pre-bankruptcy counselling is premised on the assumption that debtors turned too quickly to bankruptcy as a solution for their problems.  The Act is vague on the contents of the financial education course but the Federal US trustee has promulgated rules   which indicate that the course must include budget development, money management, wise use of credit (including distinguishing wants from needs), consumer protection, and coping with unexpected financial crisis. The financial education course must last a minimum of two hours  but may be completed in person, over the phone, or through the Internet.

Michael Sousa  in a recent article surveys existing  pre- and post- BAPCPA studies of voluntary counselling in bankruptcy.  He also  presents the results  of a qualitative study of  the effects of the BAPCPA counselling requirements.  Most debtors did not find the courses helpful. Pre-bankruptcy counseling was just ‘jumping through hoops’.  It did not have the consequences hoped for by Congress–where debtors rethought their decision and entered a debt management plan. Rather it either confirmed the correctness of  an individual’s decision  to file for bankruptcy  or helped to allay any fears about declaring bankruptcy.  Most debtors thought that a two-hour financial education course was not enough to provide long-term effects and in any event was  often inappropriate since many  individuals filed for bankruptcy because of  external economic changes unrelated to financial capability. Sousa concluded that the existing BAPCPA counselling requirements  are ‘by and large misguided and are in desperate need of overhaul and reform’.

Scotland  recently introduced counselling in the 2014  Bankruptcy and Debt Advice (Scotland) Act which Act will, according to the relevant Minister, Fergus Ewing,  deliver ‘the most significant change to the bankruptcy process in Scotland for a generation and take us closer to making the financial health service a reality’ (more on this claim in a subsequent blog).  Individuals must consult a money advisor before obtaining access to any  statutory debt relief. The policy objective is that of ensuring that individuals are aware of all debt relief options, although I suspect that it is partly motivated by the objective of ensuring that individuals do not enter too easily into writing down debt rather than the statutory Debt Arrangement Scheme which will generally require full repayment (again more about this on a further blog).   Financial education during bankruptcy is not mandatory for all debtors.  Only repeat bankrupts within the previous 5 years,  or debtors subject to  a bankruptcy restriction order made against them must undertake a course.  In other cases a trustee may refer a debtor to a financial education course where  ‘the trustee considers that the pattern of behavior is such that the debtor would benefit from a financial education course or the debtor agrees to undertake a financial education course.’  The Scottish legislation recognises that counselling is not necessary for all debtors. This suggests that legislators do learn something from comparative experience, since they seemed to be  aware of the criticisms of the US provisions.

England and Wales rejected  counselling in the 2002 reforms primarily because most groups consulted opposed its introduction. Debtors may therefore experience a variety of advice before and during insolvency,  depending on whether they seek advice in the public sector through Citizens Advice Bureaux,  non-profit debt counselling such as Step Change, or a private intermediary.

The UK is sometimes contrasted with continental Europe where it is assumed that a more ‘social’ approach exists to counselling debtors. But this is not the case. Counselling is not an integral part of the French process. Although debt counsellors play a central role in Germany, the large demand for their services means that they function more as processors rather than being able to provide substantial financial counselling. In Sweden, a recent official report was very critical of the standards of debt counselling which are operated by municipalities.

Debt counselling in bankruptcy is a programme which in the abstract can attract a broad support.  It is a policy around which a coalition of creditor, consumer and debt counselling interests can agree, and for regulators it gives a sense of purpose to the bankruptcy system–so the Scots view it as  part of a  ‘financial health system’. It is likely therefore to continue to be attractive but experience suggests an unwillingness by governments to invest significant resources in the project.

The credit counselling requirements are often  based on the assumption that bankruptcy is a consequence of imprudent or unwise use of credit or the need for individuals to adapt their credit behaviour to more desirable norms. But this is clearly not the case for many debtors who are subject to adverse changes of circumstances, unforeseen health costs or small business failures.




Beyond the active and passive debtor: New study by Bank of France

Policy making in bankruptcy is driven by assumptions about debtors and their reasons for over-indebtedness. If debtors are assumed to be imprudent or unable to manage their finances then financial education might be a solution. If the primary reason is unemployment or a change of circumstances then budgeting advice may be of little assistance and a better safety net could be developed. During the 1990s and noughties the Bank of  France regularly published statistics on the reasons for overindebtedness. They divided the reasons into two categories; active and passive overindebtedness. The former included over-spending and bad budget management, the latter unemployment, divorce/separation and illness. By the mid 1990s  it appeared that passive over-indebtedness dominated the reasons for overindebtedness. This finding had several policy implications. First, it meant that neither creditors nor debtors could be blamed for overindebtedness. It provided common ground between creditors and consumer groups.  Consumer groups argued that the growth in those using the over-indebtedness commissions reflected the fraying French social safety net. The dominance of passive over-indebtedness also justified greater liberality in discharge of debts.    Debtors were not attempting to take advantage of the system but rather were victims of circumstances beyond their control. Financial institutions could argue that it was not necessary to introduce positive credit reporting (see discussion here) because problem debt arose as a consequence of events which occurred after credit was granted

The active/passive distinction depended on both the validity and reliability of the Bank of France statistics and the coherence of the distinction.  In 2010 the Cour Des Comptes (National Audit Office) published a searing criticism of the validity and reliability of the Bank statistics. For example, if a person was divorced the Bank seemed to always classify them  as passively indebted even if the divorce occurred many years before the debt problems! More fundamentally the Audit Office questioned the coherence of the simple active/passive distinction since there might often be a combination of events which leads to an inability to repay. As a consequence of this critique the Bank stopped publishing statistics in its surveys of debtors on the reasons for the over-indebtedness.

The Bank has now published a new study on the paths leading to over-indebtedness, conducted by a consultancy firm. This provides a more complex typology of reasons for individuals using the over-indebtedness commissions. Unemployment or reduced employment (23%); budget constraints (17%), and  inappropriate use  of credit (14%) are significant reasons.  But the  largest percentage (41 percent) represent a conjuncture of events including  a change of circumstances with some individuals not adjusting effectively their budgets to these changes. Some of the budget constrained group also seemed to make impulsive purchases.  A comparison group of similar individuals who had not accessed the Commission seemed to manage their budgets slightly more effectively.  An underlying theme in the report is that behavioural limitations of debtors are a significant driver of a spiral of over-indebtedness. The Bank uses these findings  to justify greater financial literacy education, which of course has become a worldwide crusade.

The findings deserve more extended scrutiny than is possible in this blog.  What is most interesting however is  how the French policy making community managed to sustain for so long the defective active/passive distinction and its implications for policy making.   A characteristic of  the development of French policy making on overindebtedness is its management by the French technocracy through the Bank of France and Consultative Committees. Dialogue takes place within these groups, with critiques coming from within the technocracy (such as the Cour des Comptes). The absence of non-state initiated studies of bankrupts  in France, and the limited role of interdisciplinary studies in the French legal academy reinforce this approach.  This means that the overt ‘war of ideas’, which characterised  US bankruptcy policy making in the period before the Bankruptcy Abuse and Consumer Prevention Act of 2005, does not occur in France.  In my forthcoming book (here) I compare these different policy styles, and the role of social science knowledge within them, as part of understanding the paths of bankruptcy law development in these countries.


Continuing rise in overindebtedness files in France—but significant regional variation

The Bank of France issued  recently its Barometer of Overindebtedness for the third trimester of 2014.  Filings with the Commissions reached over  230000, a  rise from 217000 in  2009.  In an earlier post  I outlined the findings of the Bank’s  Enquête Typologique  of debtors in 2012.  The Bank issued in November 2014 a further report  for 2013. This indicates similar demographic characteristics of debtors–overrepresentation of renters, single individuals, and women in the rétablissement personnel  procedure, those between 25-54, the unemployed and blue and white-collar employees.  Debtors are atypical of the French population. In 2004 31 percent of debtors had no repayment capacity, in 2013 54 percent had no repayment capacity and 71 percent less than €250. Applications to the commission  represent 4.35 persons per 1000 of the national population  (15 years or older).

The report breaks down over-indebtedness by region, comparing  the  filing rates with the regional levels of unemployment, RSA (social welfare), separation and divorce rates, and disposable income of the population. Filings corresponded generally with these factors; the old industrial regions  exhibited higher levels of filing.  However there were some anomalies with for example southern regions such as  Midi-Pyrenées (3.74) having significantly lower levels than Haute-Normandie (6.24) notwithstanding similar indicators on unemployment, social welfare, divorce and disposable income.  The report speculates that these differences might be explained by other factors such as social norms.

The issue of subnational variations in insolvency filings within Europe has not been studied systematically.  In England and Wales recent data from the Insolvency Service also indicate significant differences between regions with the North East and South West having higher than national levels of bankruptcies and DROs, and London  a significantly lower level. Paul Bishop has analysed these data over the period 2000-2007  using a variety of techniques.  He finds a persistently high level of bankruptcies in the South West which may be associated with low incomes and the large presence of ex-military personnel. He also found  a low-level of filings in London  which may be associated with higher incomes and the “Capital city effect”.  US  studies of persistent regional variations have often focused on state variations in laws and local legal culture but also recognise other demographic characteristics. The European studies suggest that greater attention might be paid to regional variations in bankruptcy filings. Since these filings may often be the ‘canary in the mine’ signifying economic or social problems, regional studies may be more helpful in identifying problems and  targeting potential policy solutions.




No positive credit reporting in France?




France differs from the UK in its approach to credit bureaux. The Bank of France administers  ‘negative’ credit reporting systems which contain information on whether individuals have made applications to the Over-Indebtedness commissions or  are  in substantial arrears on repayment. They do not include ‘positive’ information on loans taken out  and payment record, a characteristic of UK credit reference systems.  Private credit bureaux do not operate in the  French consumer credit market and in 2007 the Conseil d’État upheld a refusal by the French privacy regulator (CNIL) to permit Experian to establish a central database.

The French system was introduced in 1989 as part of the loi Neiertz to address 0ver-indebtedness.  However,  the continued rise in over-indebtedness in France since then has resulted in pressure to introduce positive credit reporting on the assumption that this will enhance  credit decision-making and prevent  subsequent over-indebtedness.

The introduction of positive credit reporting in  France is controversial. First, a strong conception of privacy–understood as the ability to shield one’s financial affairs from market and commercial intrusion–is argued to be influential in France. This is best developed by James Whitman in his study of Western cultures of privacy. Undoubtedly this is a factor but political interest groups have also been influential in the debate. Although one might expect financial institutions to be in favour of having more information available on potential debtors, French banks through their lobbying group have opposed the creation of  a positive reporting system. Why?  The answer is probably a fear of greater foreign competition and new entrants to the consumer credit market. The ability of a financial institution to access a neutral third-party information source on debtors would reduce the advantage of existing incumbents who already have built up sophisticated scoring systems on their clients. Consumer groups are also divided in their support. Some groups are opposed, although those involved with over-indebted individuals (such as Crésus) support the introduction of a positive system. The opposition here is partly a concern that because the primary cause of over-indebtedness relates to events which occur after the credit has been granted then more information will not necessarily reduce the risk to an extent that the economic and social costs of introducing a system outweigh the benefits.

It seemed  as if a positive credit reporting system operated by the Bank of France  would be introduced when an expert body appointed as a consequence of the 2010 Loi Lagarde implementing the EU 2008 Credit Directive, recommended this option. It was included within the recent loi Hamon which introduced a variety of consumer protections. However, the relevant sections were referred to the Constitutional Council (Conseil Constitutionel) which on March 13 2014 struck down the sections as a disproportionate intrusion on the constitutional right of privacy which was not outweighed by benefits related to credit decision-making.

This French decision is interesting internationally in terms of the role of credit bureaux and the balance of positive and negative information.  International agencies such as the World Bank promote strongly the introduction of credit bureaux with wide information sharing. They argue that it promotes better screening and risk assessment, reduces bad debts, increases competition by reducing the advantages of local incumbents, makes it easier for consumers to switch, and widens availability of credit. But although these institutions may be useful in kick-starting a credit system, there are concerns that in mature credit economies comprehensive credit information on individuals becomes part of a lender strategy to maximise profits rather than minimise risk, with the expansion of the market to include higher risks and targeting of individuals who are highly profitable because they will yield high late payment and other fees. This is the so-called ‘sweat box’ model of credit card lending.

These concerns combined with privacy issues and accuracy of information have prevented the EU from developing an EU wide credit reference system or set of norms. The EU established an expert group on credit histories in 2009.  It could not agree on whether positive reporting should be a norm concluding that the ‘economic literature offers contradictory (and often not definitive) views and that the European experience shows that both approaches can work effectively’. Thus although the EU may require  lenders to consult credit databases in mortgage lending and to have cross-border access to databases where necessary, no agreement on the form of the credit database exists.

Two further points. The existence of extensive credit reporting in the US and the UK did little to prevent the sub-prime lending crisis, or in the UK the large run-up in credit card debt prior to the Great Recession. The credit reference industry and multinational credit firms have an interest in expanding the role of credit bureaux, so that they become central sources of information for purposes such as checking tenants or employees.  The example of France where they are unable to operate in the consumer credit market represents a challenge to their growth and to influential thinking about credit bureaux, suggesting that the overall economic and social value of these systems needs further analysis and debate.



Bank of France Report on Debtor Characteristics

The Bank of France published recently its 2014  report  on the demographic characteristics of  individuals using the OverIndebtedness Commissions during 2012 (Enquête Typologique; for a discussion of the development of the French system see my  2012 article).  Those using the system are primarily renters or living in subsidised accommodation (90 per cent) in a country with a home ownership rate of approximately 60 percent.  Single individuals (including separated, divorced and widowed) are overrepresented. Women comprise 54 percent of debtors. Compared to the general French population, higher grade employees and managers are underrepresented and blue and white-collar employees over-represented.  Those in the age group 25-54 are overrepresented.  A high level of unemployment exists with 26 percent unemployed at the time of application.  Over 75 percent have less than €2000 in monthly resources and 49 percent less than the SMIC (the minimum full time wage of €1425 in 2012). Over 50 percent have no repayment capacity. Those using the rétablissement personnel procedure which permits an immediate discharge of debts for individuals who have no possibility of making repayments over the next eight years are more likely to be women (60 percent), renters or in subsidised accommodation (only 1 percent owners), earning less than the minimum wage (69 percent).

The use of the immediate discharge procedure has grown significantly in recent years, from 33,378 cases in 2008 to 68,235 in 2013, partly because of changes in the law which facilitated the use of this procedure by the Commission.  Although the Bank of France no longer publishes the reasons for  filing with the Over-indebtedness Commissions, earlier studies suggest that unemployment and other changes of circumstances are the primary reasons. Although  French debtors may not fit the ‘middle class’ image of the US bankrupt, further research going behind the headline data would be necessary to confirm this hypothesis. The Overindebtedness Commissions were introduced in 1989 as part of a programme of measures (see the Loi Neiertz), one of which was the introduction of a Fichier which records the names of those filing with the Commission. A controversial issue has been whether France should introduce a general credit reference system with positive as well as negative data which creditors could consult  before granting credit. The government recently proposed a Fichier Positif  operated by the Bank of France but it was struck down as disproportionate to the right of privacy by the  Conseil Constitutionel.I  will discuss this in a separate post.