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The pre-bankruptcy debt trade

Today I learned about a robust industry trading in consumer debt that has been discharged by bankruptcy courts. Business Week explains how firms collect on debts that the debtors have no obligation to pay:

In the 1990s, businesses adept at tracking and trading consumer debt expanded their reach to dabble in accounts enmeshed in bankruptcy. That dabbling has grown into a robust market. Some of the trade in so-called bankruptcy paper involves debts that remain collectible. What’s troubling is that the market now also includes billions in discharged debts, which ought to have no dollar value. Owners of canceled liabilities can revive their value in two main ways: by directly pressuring consumers to cough up cash or by gaming the credit system, as allegedly happened in the Rathavongsa case.

How does this work? The creditors simply refuse to update the credit file of the consumers who filed for bankruptcy, so that it looks like a debt that has been legally discharged is still in collections. If the consumer wants to get a new loan, they have to pay up. In other words, it’s extortion.

You may not have much sympathy for people who wind up filing for bankruptcy, but I find it worrying that there are industries built around pushing people around by manipulating their credit reports. Right now, they’re using these tactics against people who’ve filed for bankruptcies but they’re no reason why they can’t employ those tactics against others as well.

4 Comments

  1. Currently Solvent

    November 1, 2007 at 9:56 pm

    While our culture encourages us to denigrate those who’ve filed for bankruptcy, most individuals who’ve done so have filed for very legitimate reasons and we’re lying to ourselves when we think we’d have done otherwise in their situation–the straits of the divorced guys whose wives left them and took the family credit on wild spending sprees; families struck by debilitating disease or injuries; young veterans returning from war with shattered bodies and psyches; the single parent doing all they can to give children a clean, healthy upbringing–these people file for bankruptcy as a last resort and an industry set up to screw them ranks with human traffickers and kiddie-porn dealers.

    If that doesn’t worry, or repulse you, investment banking based on such shady practice should. Business Week isn’t writing about back-alley hustlers and loansharks. From Neil Bush’s Silverado to today’s sub-prime fiasco, our banking system is showing itself to be built on an ever flimsier, and more corrupt, foundation. When America loses her economic hegemony, the new suer-powers that emerge will doubtless treat us in accordance with our behavior when we held power–are we prepared to face that?

    “Happens all the time, your honor,” the Chase lawyer, Thomas E. Stagg, responded.

    Indeed.

  2. I once worked for a small software company and data services that had a customer declare bankruptcy. A year or two later the customer came back and tried to open a new account, was told “sorry, your account is still in arrears”, and responded, in a huff, “but the judge discharged that debt!”

    I totally think it was within reason for said software company to say “tough”. The judge may have taken away legal recourse for collection, but when the law starts saying “you have to do business with these people” that gets kinda dangerous.

    Perhaps there’s a case to be made that credit bureaus be forced to pull such things off their books, but at some point it’s all a continuum across that same line.

  3. I’m pretty sure a bankruptcy stays on your credit report for 7 years, so anybody who gives you credit knows that you did that. And I don’t think you’re required to extend credit to anyone (beyond the laws pertaining to discriminatory lending), so if someone filed for bankruptcy and had debt that they owed you discharged, you don’t have to loan them money again.

  4. Even though the bankruptcy stays on your account for 7 years, isn’t that item separate from the individual accounts that have been discharged? I would think that a dispute with the credit agency (showing proof of the discharged debt on the account) would be enough to remove that bad account.

    But perhaps I misunderstand how the bankruptcy reporting works.

    Regardless, I think it’s totally acceptable for a company to refuse to do business with anyone they don’t want to (such as the software company Dan mentioned). If you defaulted on what you owed them (for whatever reason) previously, why would they want to trust doing business with you again?

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