Federal and state regulators are looking into how dozens of big U.S. lenders skirt the law to squeeze payments from bankrupt consumers, and investigators in at least one state have expanded their probes to include Ford Motor Co. and Chrysler Corp.
Sears, Roebuck and Co., General Electric Co., AT&T Corp. and others already have either said they broke U.S. bankruptcy laws or have been accused of improperly trying to force consumers to repay loans. Meanwhile, Ford and Chrysler’s finance units are being probed for using the same collection methods that landed Sears in its legal mess, said a person familiar with one state’s investigation.
Sears paid at least $178 million to settle claims that it broke the law. If investigators find widespread violations, the $1.2 trillion consumer and auto-lending industry could face billions of dollars in losses from forgone income they now wrongly collect, plus fines and restitution.
“Sears is a tiny tip of a very large iceberg,” said U.S. Bankruptcy Court Judge Keith Lundin in Nashville.
The Federal Trade Commission said it is investigating several unnamed lenders, while New York and Florida law-enforcement officials said they are investigating at least two auto-finance companies as part of a probe of as many as two dozen lenders. Connecticut officials said they, too, are investigating about a dozen lenders.
Heavy-handed tactics with bankrupt consumers also may lead to changes in laws that would make it harder for lenders to hound debtors.
Tough and sometimes illegal methods to collect from borrowers are a response to the record numbers of personal bankruptcies, which threaten lenders’ healthy profit margins.
Lenders have decided “to push the law as far as they could,” said U.S. Bankruptcy Court Judge Lee Jackwig, in Des Moines.
A record 712,000 people filed for Chapter 7–which normally wipes out unsecured debts–in 1996, a time when the U.S. economy was strong and unemployment fell to the lowest rate in more than 20 years.
“If people have the ability to make payments, creditors are entitled to be paid,” said Richard Campbell, executive vice president in charge of credit card operations for BankAmerica Corp., the nation’s 12th-biggest card issuer with 9 million customers.
Lenders, meanwhile, are trying to keep bankruptcies in check. Visa International Inc. in two weeks will hold a conference where it will give credit card issuers advice on preventing bankruptcies and describe the computer systems it’s developing to identify customers most likely to default.
Problems in loan collections came to light last April, when Sears said it used “flawed legal judgment” after persuading consumers to sign documents promising to keep paying off debts eligible for being wiped out by the bankruptcy courts. Sears failed to file the papers with the courts, a violation of federal law.
Lenders often press debtors to sign these so-called reaffirmation agreements by threatening to repossess purchased goods or by enticing them with offers of new credit, said debtors’ attorneys and regulators. The agreements are binding if filed and not rejected by the court.
The FTC has already said that Sears violated federal laws in bankruptcy cases involving an estimated 250,000 people. The agency now is looking into other lenders that failed to file reaffirmation agreements, said David Medine, an FTC official. He wouldn’t identify the companies.
As regulators broaden their investigations, they are looking into the consumer-lending operations of U.S. automakers, said state officials.
“It would include those companies that have financing arms (for cars), and without giving names, some of them are pretty large,” said Jack Norris, a Florida assistant attorney general.
New York also is looking into the automakers’ lending businesses, said Joseph Mahoney, a spokesman for the state’s attorney general, Dennis Vacco.
Ford denied wrongdoing and said it hasn’t been contacted by investigators.
“If we’re being investigated we haven’t been told about it,” said Kristen Kinley, a spokeswoman for Ford Motor Credit Co.
Chrysler said it didn’t believe it filed reaffirmations in Florida or New York, and a spokesman said, “We believe we are in full compliance with the law.”
The state investigations are in the early stages and they don’t mean that the companies broke the law.
The auto industry may be among the biggest offenders of the reaffirmation process, said bankruptcy Judge Lundin, who estimates that as many as one-third of all reaffirmation agreements on auto loans aren’t valid under federal law.
“We know there are an enormous number of cars passing through bankruptcy,” Lundin said. “Yet, only a small number of reaffirmations can be documented in court records.”
Car companies could repossess vehicles when a consumer files for bankruptcy, but they’d rather not. Instead, they use reaffirmation agreements. The consumer agrees to repay the entire balance on the loan, rather than the car’s depreciated value–which is what the bankruptcy court will order the consumer to repay, the FTC’s Medine said.
Debtors agree to pay off auto loans because they can’t get by without a car, judges and lawyers said. But a debtor’s willingness to pay doesn’t absolve the lender from filing the agreement with the courts, they say.
A study by Creighton University law professors Marianne Culhane and Michaela White of 1,000 personal bankruptcies found that debtors were willing to reaffirm almost two-thirds of their auto loans.
Yet reaffirmation agreements were found on just 21 percent of the loans, Culhane said, suggesting that auto lenders may not be filing the documents as required.
Bankruptcy experts said tougher enforcement and new laws are needed to keep lenders from overzealous collection practices.
“The credit industry is very firm in its pursuit of mechanisms to collect,” said New York Law School professor Karen Gross. “I don’t think this will scare them off at all.”
