Bankrupt Profits: The Credit Industry's Business Model for Postbankruptcy Lending
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Abstract:
Consumer credit and consumer bankruptcy filings have grown rapidly over the last two decades, and several researchers have attempted to understand the relationship between these two intertwined features of the modern American economy. Teasing out causation is almost impossible, as consumer advocates lay blame on the industry and the industry responds by citing the same data to show consumer misbehavior. Using a novel vantage point, this analysis examines what the credit industry's behavior toward recently bankrupt families reveals about its internal profit models and the likely causes of consumer bankruptcy. The empirical evidence on postbankruptcy credit solicitation suggests that the industry sees bankrupt debtors as lucrative targets for high-yield lending. Such findings have important implications for developing optimal consumer credit policy and bankruptcy law.
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Associated Press Business News: Study: Card Offers Flood Ex-Bankrupt: JPM - MSN Money
WASHINGTON (AP) - Credit-card companies target people fresh out of bankruptcy with credit offers, a finding that raises questions about the industry's efforts to paint bankruptcy filers as "untrustworthy deadbeats," according to a recent study.
The study by Katherine Porter, an associate professor of law at the University of Iowa, found that nearly 100 percent of more than 300 families surveyed had been offered new credit cards within a year after completing Chapter 7 bankruptcy proceedings.
Of 341 families who were solicited, 87.7 percent received credit-card offers that mentioned their recent bankruptcy filings. More than 20 percent were solicited by creditors whose debt had been discharged through the bankruptcy.
"Debtors report being overwhelmed after bankruptcy with a variety of credit solicitations from many sources," the study says.
Porter's research, based on interviews with the families at the one- and three-year mark after their bankruptcies ended, found that consumers who've erased their debt through Chapter 7 bankruptcy received more credit offers than those who repaid their debts over time after filing for Chapter 13 protection.
The findings of the study show "how the credit industry seeks to profit from financial distress," Porter wrote.
Porter said the findings in her study, "Bankrupt Profits: The Credit Industry's Business Model for Postbankruptcy Lending," cast doubt on the industry's own arguments to justify sweeping changes to the Bankruptcy Code that have made it more difficult for individuals to wipe out their debt. The industry lobbied for the 2005 legislation -- saying lenders were losing money as bankruptcies skyrocketed and debtors abused the system.
"The strong overall pattern of credit offers to bankruptcy debtors suggests that creditors themselves reject a view of bankruptcy filers as either immoral individuals who chronically fail to honor their obligations or as strategic actors who are apt to abuse legal protection to avoid debts," the study says.
In an interview, Porter said she hopes her study can help reshape the debate over financial responsibility, bankruptcy reform and the duty lenders have to make sure Americans aren't taking on too much debt.
"Financial distress is a dynamic between the debtor and the creditors," she said. Lenders are "constantly putting temptation in front of (debtors) that they don't want."
Porter said most of the individuals interviewed for the study didn't accept the offers. Many, she said, expressed shock and frustration over the number of solicitations they received -- an average of more than 14 per month compared with the six offers industry researchers say the average American gets.
"You'd think I was Donald Trump, the way they would send me credit cards," a woman from California told the interviewers.
Advocates for the consumer-credit industry say people just out of bankruptcy need new opportunities to obtain credit so they can rent cars, reserve hotels rooms and begin the process of rebuilding damaged credit.
"There's nothing necessarily wrong with making credit available to people who've just gotten out of bankruptcy," said Philip Corwin, a lawyer at Butera & Andrews in Washington. He is a consultant for the American Bankers Association, which lobbied for the 2005 bankruptcy-law changes. "The ability to re-establish credit is part of the whole fresh start you get."
Corwin said although credit offers to consumers just out of bankruptcy are likely to carry higher interest and tighter lending conditions, he "wouldn't want somebody taking advantage of someone just out of bankruptcy."
If consumers aren't interested in the offers, they can "just toss them in the trash," he said.
Sen. Charles Grassley, a sponsor of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, said it's up to bank regulators to determine whether these credit offers are abusive or improper.
"However, the credit counseling and financial education provisions in the new bankruptcy law were intended to help people understand that there are choices when they receive solicitations like those outlined in the report," Grassley, an Iowa Republican, said in an e-mailed statement. "I expect those provisions will help prepare individuals going through Chapter 7 and 13 bankruptcy to make smart borrowing choices." {yeah right
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Porter argues that the credit-card industry actually profits from financially distressed customers. "There's no doubt that the way the industry profits in the consumer market is changing and has changed," she said. "Profitability doesn't necessarily require full repayment."
Robert Lawless, a professor at the University of Illinois, said credit-card companies count on high interest, late fees and missed payment penalties as a source of revenue.
"Someone who's filed bankruptcy has sent a signal to the credit-card industry that they're more likely to be one of those profitable customers," he said. Lawless is participant in the Consumer Bankruptcy Project, which collected the data for Porter's research, but he didn't work on her study.
Capital One Financial Corp., Bank of America Corp., JPMorgan Chase & Co.'s Chase consumer banking unit and Discover Financial Services, among the largest credit-card providers in the U.S., didn't respond to requests for comment.
