2011 Boulder Summer Conference on Consumer Financial Decision Making June 27, 2011

1. Do Consumers Benefit From Credit Counseling or Counseling Repayment Plans? Michael Staten and Cathleen Johnson University of Arizona and John Barron Purdue University 2011 Boulder Summer Conference on Consumer Financial Decision Making June 27, 2011

2. Clearly, the Large Majority of Distressed Consumers Don’t File for Bankruptcy

3. Yet, the Credit Counseling Industry is in Turmoil • Counseling industry has a revenue crisis rooted in a faltering business model built on 501(c)3 agencies delivering educational services • Some industry practices and agencies have been justly criticized by regulators, consumer groups and the press • Bad publicity has created suspicion and doubt among consumers who need help

4. Credit Counseling Agencies Need to Document the Value of What They Do • With a significant stake in client outcomes, creditors can (and have) provide funding assistance, but need empirical evidence that investment in counseling (vs. other collection tools) reduces losses • Consumers need evidence to build awareness and trust - and be convinced to seek counseling help earlier • U.S. tax authority (IRS) needs evidence of education and rehabilitation value of counseling to continue tax-exemption of agencies • Lawmakers and regulators need empirical evidence to document that counseling activities serve the public interest

5. How Should We Measure the Impact of Counseling Agencies on Consumers? Sources of consumer benefits from counseling agencies: • Diagnosis and Education: Individualized budget/situation analysis, identification of options, recommendations for action • “Triage” to immediately relieve financial stress • Debt Management Plan product (DMP, a debt repayment plan) • Other specific products or referrals to programs that can resolve immediate problems • Follow-up contact and support, when desired Which can lead to: • Relief from immediate financial crisis (and associated benefits at HH level) • Rehabilitation and behavior change • Longer term financial well-being NOTE: Expectations for subsequent client performance may differ with respect to incoming problems • Situational crisis (external shocks such as job loss, divorce, etc) • Habitual spending/borrowing/money management woes

6. We Don’t Know As Much As We Should About the Longer-run Impact of Counseling But, there is a reason. Setting up valid studies is challenging. “Good” counseling bundles together diagnosis, education and triage In the vast majority of cases, budget/financial counseling is voluntary self selection by proactive consumers makes them fundamentally different from borrowers who don’t seek counseling need to handle/control selection effect need to identify observationally similar borrowers who don’t receive counseling and compare to counseled consumers

7. A Word on Need for and Limits of Randomized Control Trials in Credit Counseling Studies • Meier and Sprenger (2008) show that voluntary services attract the most motivated and future-oriented consumers => Higher motivation to seek assistance => counseled clients may outperform observationally similar others • And, we also know that foreclosure counseling and debt counseling attract borrowers who are aware they are in deeper trouble (often even before their credit report shows it) • Greater financial stress => counseled borrowers may underperform relative to observationally similar others But, RCTs are tough to sell to counseling agencies because most clients need help NOW (not with a time delay, or a less effective version of help). Thought: Even in health care, they don’t do many RCTs in the emergency room. So, the bundling of education and triage together in counseling delivery makes it tough to do large-scale RCTs.

8. Three Studies: Consumer Benefits from the Counseling Experience • Does the counseling experience alone (no subsequent DMP) positively impact a consumer’s credit profile over time? • Diagnosis, action plan, education (light bulb, “ah-ha!” moment?) 2007. Elliehausen, Lundquist and Staten, Journal of Consumer Affairs • Can technology-assisted counseling delivery (via the telephone; Internet) be as effective as traditional, face-to-face delivery? 2011. Barron and Staten, Working Paper 11-11, Federal Reserve Bank of Philadelphia • Does consumer experience with a counseling DMP repayment program lead to additional and longer-term improvements in consumer credit profiles, beyond those gained from the counseling session(s)? 2011. Barron, Staten and Johnson, Boulder Conference

9. Initial Step: Study #1 Impact of Counseling Alone (no DMP interaction) Issue: Does the counseling alone (no DMP product) have a positive impact on clients’ subsequent borrowing behavior and credit profile? Clients in sample: • Insufficient income to qualify for DMP product • Too much income, or appeared able to handle on own • Qualified for DMP but didn’t agree to start * CRC = Credit Research Center, Georgetown University

10. Study Methodology • 5 NFCC-member counseling agencies provided data on 14,000 clients counseled during 1997 (large majority was face-to-face delivery). All clients, minus those who signed up for DMPs. • Trans Union provided credit report and credit score data for each client at 2 points in time: • March 1997 (at time of counseling) • March 2000 (3 years after counseling) • TU also provided data on a matched-sample comparison group of 100,000 borrowers who did not receive counseling • Same 1997 risk score range as counseled group • Same geographic location as counseled group

11. Outcome Variables (3 years after counseling) Primary metric: • Client credit score (i.e., FICO score equivalent as a measure of overall creditworthiness and credit opportunities in the market) Supplemental metrics (from the credit report) directly related to counseling session discussions: • Number of accounts with positive balances • Total debt • Non-mortgage debt • # bank cards with positive balance • Bank card % utilization (across all accounts) • Revolving debt • Number of delinquencies

12. A Self Selection Correction Procedure • Estimate a “selection” model to determine the likelihood that a borrower will be in the counseled group. Key instruments: • Willingness to take action • Degree of financial distress • Skill (or lack thereof) in handling credit • Use the estimated probability values in place of the counseling dummy in the “evaluation” equation that identifies whether counseling influences subsequent credit performance

13. Results of Evaluation Model(after correcting for self-selection) • Counseling had a significant positive impact on an overall measure of a counseled borrower’s creditworthiness—the borrower’s risk score – compared to the risk scores of clients who were not counseled • Impact was greatest on borrowers with the lowest risk scores at the start (those with the least success at handling credit in the past) • Illustration of economic significance: For borrowers in the lowest 10th percentile of initial risk scores, the average score improvement over the subsequent three years was equivalent to a 38 percent reduction in predicted likelihood of a 90+ day delinquency, charge-off, or bankruptcy

14. Study #2: Efficacy of Technology-Assisted Delivery:Telephone, Internet • Through the 1990s, in-person, face-to-face counseling was considered the “gold standard,” BUT, is much more resource intensive than phone or Internet counseling • Many consumers strongly prefer the convenience of telephone or Internet delivery; they won’t seek counseling assistance otherwise • In times of severe financial distress (e.g., mortgage foreclosure crisis of 2007-2008), in-person counseling can’t possibly keep up with demand • Technology-assisted counseling (via telephone, internet) has heightened the skepticism of the IRS and other regulators regarding the educational value of a core counseling product: the DMP. Tax-exemption status for some agencies hangs in the balance.

15. Project Objective • Determine whether technology-assisted counseling (telephone; Internet) is associated with larger or smaller improvements in client financial circumstances, relative to traditional, face-to-face delivery Sponsorship: • Launched in 2004 as a partnership between Consumer Federation of America and American Express for a multiyear study of the effectiveness of credit counseling models

16. Agencies and Samples • Participating agencies selected through a competitive RFP process • Agencies offered a mix in terms of size and delivery channels • Telephone counseling specialists (some large, national) • Regional agencies with both telephone and brick-and-mortar delivery channels (and Internet) • Smaller, local agencies offering primarily traditional, face-to-face counseling

17. Primary Sample • 60,000 clients received initial counseling in March and April 2003 • For each client, we have • Intake interview data from the counseling session • Up to 40 variables on client demographics, debts, assets, expenses, primary cause of financial problem • Session outcome and counselor recommendation • DMP details (when a plan was started) • Credit report variables (150+) and credit bureau risk scores at four points in time (2002, 2003, 2005, 2007)

18. Impact of Delivery Channel, part 1 • Primary Sample: 26,000 clients from the 5 agencies that offer clients a choice between telephone and in-person counseling and have sizeable volumes in each (excludes Internet clients) • Constructed and estimated models to explain 3 outcomes, measured four years after counseling: • Probit model: Incidence of a bankruptcy filing anytime between March 2003 and March 2007 • OLS model: Bankruptcy risk score measured in March 2007 • OLS model: Delinquency risk score (FICO equivalent) measured in March 2007

19. Explanatory Variables Included in Models • Variables from counseling session: • Delivery channel (phone vs. in-person) • Counselor experience (in months) • From interview: # unsecured creditors • From interview: Total unsecured debt • Counselor evaluation/recommendation • Indicator of whether a DMP was started Credit bureau variables (values as of 2003): • Bankruptcy risk score • Delinquency risk score (FICO equivalent) • # accounts with balance > 0 • Total balance on all non-mortgage accounts • Total balance on mortgage accounts • # of bank card accounts • Proportion of bank card accounts with balance > 50% of limit • # of non-installment accounts over 50% of limit • # accounts 30+ days past due during last 18 months • # of accounts currently past due • # of inquiries in last 6 months • Highest retail credit limit

20. Findings, part 1 • Clients differ in their choice of delivery channels: face-to-face clients have: • Lower credit scores • More accounts with positive balances • Less credit card debt, but more unsecured creditors • Face-to-face clients have a higher incidence of bankruptcy in the four years after counseling • But, controlling for initial credit bureau info, initial credit scores, counselor experience, and counselor recommended action: Delivery channel has no statistically significant influence on the client’s delinquency risk score for clients, measured four years after counseling

21. Findings Part 2: Internet Delivery 6,000 clients of CCCS-Atlanta received initial counseling in March-April 2006 Sample includes clients distributed across three delivery channels: Face-to-face (19.4%) Telephone (55.8%) Internet, including Live Chat with a counselor (24.7%) Agency claims several advantages of Internet counseling over other delivery channels: Convenience: available 24/7 and session can start/stop on demand Organization: Clients can take all the time they need to gather records, answer questions Anonymity: Greater degree than other channels Learning Style: Appeals to visual learners who want to move at their own pace

22. Findings Part 2: Internet Delivery, cont’d Sample data contain credit reports and credit scores at three points in time: March 2005, 2006, and one year after counseling, in 2007 Internet clients are different from other clients Younger Much higher monthly income More unsecured debt Larger reduction in credit score during year leading up to counseling In the year following counseling, scores increased, on average, but scores for the telephone and Internet clients did not perform differently from scores of clients counseled face-to-face (controlling for other factors)

23. Study Three: Does DMP Participation Benefit Consumers? Data Sources: • Five agencies again provided client and session outcome data on 29,000 clients counseled in Oct-Nov 2007, including nearly 3 years of DMP performance data • Trans Union appended credit report and VantageScore data and returned the depersonalized file to the research team Outcomes (dependent variables): • Credit Score Improvement • Incidence of Bankruptcy • Debt Reduction Observation Period: • November 2007 to August 2010 (33 months, post counseling)

24. Summary of Key Results Among clients for whom the counselor recommends a DMP: • DMP starters look better after three years: • Those who actually start a repayment program have significantly higher credit scores and lower incidence of bankruptcy after 33 months, compared to those who do not start. • Selection correction procedure => the positive effect of DMP participation on credit scores and bankruptcy incidence is not due solely to sample selection. • Longer time on plan generates greater debt pay-down. Importantly, this leads to large score improvement and lower incidence of bankruptcy • The size of creditor reductions of interest rates and fees positively impacts time on plan and debt pay-down.

25. Predicted Change in Credit Score Based on Initial Credit Score and DMP Participation

26. Summary of Project Attributes Study attributes: • Large samples (75,000 clients across 4 distinct samples, 15 agencies) • Multiple time periods for counseling (spanning 1997 – 2010) • Extended observation periods (one to four years, post counseling) • Administrative data (no self reported data) • Client demographics • Matched sample comparison group or instrumental variables to deal with self selection • Quasi-standardized treatment of clients

27. Key Project Findings, part 1 • Education value of counseling? (Study 1) Diagnostic experience apparently helps. The treated clients got better, relative to observationally similar untreated clients. • Triage component of counseling appears to work (Studies 2 and 3): counseled clients “cure” (improve their credit-related profiles) faster than those who don’t experience the treatment • Technology-assisted counseling (telephone; Internet) can be just as effective as face-to-face counseling for improving client credit profiles several years after counseling. • The size of creditor concessions is directly related to both client debt repayment and longer-term improvement in credit bureau profile

28. Key Project Findings, part 2 • The many months of discipline resulting from continued DMP participation, reinforced by agency follow-up contacts and educational messaging, appears to help clients improve their credit profile. • There are differences across agencies, but we don’t know enough about differences in procedures by client to link to differential outcomes • But, in this area there is great promise for future research • Utilize RCTs to determine how to design • Better products (e.g., less than full balance DMP) • Better programs (e.g., borrow less tomorrow) • Better treatments (coaching; messaging; followups)