One of the least discussed changes in the new bankruptcy bill is the credit counseling provision. It may also be one of the most despicable. The new bill will require debtors to learn more about handling credit before they declare bankruptcy. Sounds great, right? Wrong.

What are credit counseling agencies?

Legitimate credit counseling agencies are (usually) non-profits providing valuable services to debtors. They offer education and financial guidance to help debtors get control of their debts. Some agencies also offer “debt repair plans.” Under these plans, the debtor pays the agency a fee, and the agency works to reduce the debtor’s monthly payments or overall debt (by negotiating reduced interest rates with creditors, consolidating debts, etc.).

Ideally, everyone wins: the debtor avoids bankruptcy; the creditor gets paid more than if the debts had been discharged in bankruptcy; and the creditor pays the agency enough of the debtor’s recovered payments to cover the agency’s costs.

The counseling industry boomed when bankruptcies skyrocketed. About nine million Americans contact these agencies each year; about 2 million people are in debt repair programs.

Big bad wolves

Here comes the bad news. Too often, credit counseling agencies are scams. According to a 2004 Senate subcommittee investigation, many pose as non-profits in order to fleece consumers:

Debtors seeking help receive little or no counseling. And millions of dollars that debtors pay in fees end up going toward executive salaries or are funneled to for-profit affiliates.

Several of the worst abusers were ultimately sued by the government. Just last month, they settled the suit for $6 million.

Meanwhile, the IRS is cracking down on other abuses:

The Internal Revenue Service has also been investigating nonprofit credit-counseling firms to see whether they are misusing their tax-exempt status. The tax agency is auditing 48 credit-counseling agencies -- accounting for about half of the industry's assets -- and has notified several firms that it intends to revoke their tax-exempt status.

Many credit counseling agencies are actually set up by the creditors. The credit card companies pay the fees, and that means they call the tune. Some agencies instruct their counselors to tell clients to pay the credit card companies, even if it means not paying the mortgage or the rent. Others forbid them from telling clients that bankruptcy might help them.

There are undoubtedly some very good credit counseling agencies out there. Unfortunately, they don’t carry any special sign to show that they are on the up and up. The bankruptcy bill will herd millions of families into the outstretched arms of companies that have no intention of helping them manage their money better.

All of which leads to some disturbing questions.

If the industry is so rife with abuse and bad faith, why are supporters of “reform” so eager to push more Americans into it?

Why does the bill require credit counseling for people who get sick, lose their jobs, or get called up to Iraq? Do reformers really think these unfortunate souls go broke for a lack of financial “education”?

And finally, is this new provision really about education? Or is it about giving creditors one last chance to pick debtors’ bones clean before they enter bankruptcy?