Major banks are cutting funding for the nation's 600 nonprofit credit counseling agencies, which are the major alternative to bankruptcy for most consumers.

The funding reductions come as bankruptcy rates hit record highs, and as the banking and credit card industry lobbies Congress to make it harder for individuals to wipe out debt through bankruptcy. Pending legislation backed by the credit industry would require consumers to seek credit counseling before being allowed to file for bankruptcy.

Banks defend the cuts as necessary belt tightening and as a way to force the counseling industry to become more efficient. But consumer groups and some bankruptcy experts say the drop in funding could force many nonprofits out of business and many others to reduce consumer education, which advocates on both sides of the issue agree is the best way to shrink the number of financially troubled consumers.

"This is the height of hypocrisy by the banks to cut back support of consumer credit counselors at the same time that they are pushing Congress to require debtors to go to these counselors," said Elizabeth Warren, a professor at Harvard Law School who specializes in bankruptcy and commercial law. "What they are trying to do is squeeze every American family that's in trouble even harder."

Consumer credit counseling agencies, which help consumers set up debt workout plans, were created by lenders 50 years ago. They are funded largely by credit card issuers and other creditors, who pay an agency a percentage of the debt the agency recovers from a borrower. For more than a decade, that rate typically was 15 percent, giving an agency 15 cents for every $1 of debt it collected.

But in the past 18 months, most major credit card lenders -- including MBNA, Citigroup, First Union Corp., Bank One, Bank of America and Household International -- have cut rates by a third or more so that they typically now range from 6 percent to 10 percent, according to bank and credit agency executives.

In addition, many large lenders have become less willing to reduce interest rates and late fees for consumers in a workout plan, said bankers and credit agency executives. Bankruptcy experts say that without significant reductions in interest rates -- which often run from 15 percent to over 20 percent -- people in financial trouble can't repay their debt within a reasonable time, which is generally considered to be 5 or 6 years. Instead they are forced into bankruptcy, where creditors recover little or nothing of what they're owed, bankruptcy experts say.

"People who want to pay their debts -- who we help determine what they can realistically pay each month -- could not even cover the interest alone if the majority of the debt is being charged a double-digit interest rate," said Durant Abernethy, president of the National Foundation for Consumer Credit, the trade association for 190 agencies representing about 55 percent of the debt handled by the counseling industry.

Counseling agencies review a consumer's situation and then work with creditors to reach a repayment plan based on what the agency estimates a person can pay each month. The consumer agrees to tear up his or her credit cards and to submit one payment each month to the agency, which then disburses it to creditors.

Consumer credit agencies have about 900,000 consumers in workout programs, representing debt of about $15 billion, industry executives say. The average debtor owes about $22,000, including car payments, and has a pretax income of $30,000 a year.

Lenders say they like counseling because it increases the chance creditors will receive a portion of the money they are owned -- ideally, all of the principal and some of the interest.

Banks have slashed funding largely to reduce their own expenses, according to industry executives and to recent letters from banks to agencies. Bankers also are trying to install a performance-based pay system, rather than one fee across the board, to reward agencies they think are more efficient and effective, said Beth Climo of the American Bankers Association.

Another factor is that a rise in troubled debt has brought more counseling agencies into the business in recent years, making it more competitive, said Sam Giordano of the American Bankruptcy Institute, a nonprofit, nonpartisan education group. Lenders also are scrutinizing troubled borrowers more closely in the belief they can extract more repayment from this group than they have in the past, he said.

Last year 1.4 million personal bankruptcies were filed, an increase of nearly 4 percent over 1997 and almost double the number at the start of the decade. About 70 percent of those bankruptcies were filed under Chapter 7, which permits most debts to completely erased, rather than under Chapter 13, which requires a partial repayment over time.

The ABI estimates that about 3 percent of people who file under Chapter 7 could repay a portion of their debt under Chapter 13. The credit industry estimates the number to be 10 percent to 15 percent, and that's why they are pushing the legislation now before Congress, said Jeffrey A. Tassey of the American Financial Services Association.

Consumer groups attribute the rise in debt problems in large part to the aggressive marketing tactics of credit issuers, which they say are increasingly targeting poorer, riskier clients.

The House passed the bankruptcy legislation in May, and the Senate plans to vote on it this fall.

"The credit card industry has spent millions of dollars to scapegoat many working Americans for the increase in bankruptcy," said Travis Plunkett, spokesman for the Consumer Federation of America. "But how can we take their claims seriously when they are moving so aggressively to undermine the most effective alternative to bankruptcy?"

But banks say the drop in funding doesn't undermine their support of the industry.

Bank of America sent letters yesterday saying that on Aug. 1 it will reduce its 10 percent contribution rate to 9 percent for agencies that use computers and are otherwise automated and to 6 percent for those that are unautomated, said spokesman Dennis Wyss. But, he said, the company is also going to cut interest charges to zero -- from 12 percent -- for troubled debtors using credit counseling agencies.

First Union told 1,000 consumer credit agencies June 1: "As part of an ongoing effort to reduce expenses in a demanding budget environment, First Union will reduce its contribution from 12 to 9 percent effective July 1, 1999."

MBNA, which did not return telephone calls, announced in May that it would cut some payments to 6 percent from 10 percent.

Household International sent a letter May 11 to counseling agencies that offer telephone counseling only, rather than face-to-face service, to announce rates would be cut to 6 percent June 1, down from 9.5 percent, "in an effort to be consistent with our competitors."

"Face-to-face counseling is a more expensive service to provide and, we believe, more effective," said Household spokesman Craig Streem. "I haven't done an audit to verify that, but intuitively it makes sense."

Citibank reduced its payment rate to 10 percent from 12 percent, saying the industry is more automated and can operate on less money.

"Rates below 10 percent can really hurt the education programs of well-run agencies," Abernethy said, who said that while some recent cuts have been aimed at rewarding better run agencies -- and punishing others -- that trend is only beginning and doesn't explain most of the cuts up to now.

David Jones, chief executive of Genus Credit Management of Columbia, the largest nonprofit credit counseling service in the country, serving 200,000 consumers, attributes the cuts to "a push for economy on their part, but I think it's shortsighted." He says that if the economy turns down, many more consumers would face financial stress.

He and others, including Cindy Stark, spokesman for Debt Counselors of Silver Spring, the first online nonprofit credit counseling agency, say they have been told that these cuts are across the board and so far haven't been based on performance.

Abernethy says credit companies are pouring money into creating much more sophisticated internal systems to track how well credit agencies perform. Among the criteria creditors will use is how well an agency gauges a consumer's ability to pay, how long a counseling session lasts, how long a debtor stays on the plan and how much education the agency provides.

A Smaller Cut

Most major credit card lenders have cut the rates that they offer credit counseling agencies for recovering debt from a borrower. Here are previous and current rates for these "fair share" payments:

PREVIOUS CURRENT

Citibank 12% 10%

First USA / Banks 12% 10%*

MBNA 10% 6%

Chase Manhattan 12% 10%

Bank of America 12% 10%

Capital One 10% 10%

Household Credit

Services 9.5% 6%**

Fleet 12% 10%

Providian 10% 10%

Wells Fargo 10% 10%

*Rate for those who don't pay electronically; for those who pay electronically, rate is 10 percent.

SOURCE: Consumer Federation of America