Debt-collection tactics under scrutiny

At issue: Coercing debtors into waiving rights they don't know they have.

Debt collector Antangela Pauldo had heard every excuse for why people couldn't pay their auto loans. And like most in her line of work, she instinctively had a skeptical view of every sob story.

Today, however, Ms. Pauldo has a new appreciation for the depths to which some in her profession will go to collect debts, especially ones that are no longer legally owed – or were never owed in the first place.

A nearly 10-year-old credit-card account she claims wasn't hers popped up out of nowhere and led to verbal harassment and voice-mail runarounds. Finally, $900 was garnished from her bank account by a Georgia law firm. The firm is now being investigated by the state Office for Consumer Affairs.

"It's made me look at my job differently," says Pauldo, who complained to the Georgia Better Business Bureau. "There are [debt] issues that people bring up that are legitimate, and it's my job to help them – not criticize them."

The story of the debt collector who got burned by her own industry is part of a widening debate about "zombie debt," or debt that never dies. At issue: the tactics used by third-party debt collectors to coerce Americans into waiving a US common-law right: debt forgiveness.

On the heels of a credit-card reform movement in Washington, the Federal Trade Commission (FTC) is now joining a growing number of states to strengthen consumer protections and shed more light on the shadowy tactics of junk debt collectors.

The question, experts say, is whether Congress and regulators have the fortitude to stand up to a $100 billion industry that represents the underbelly of America's recent addiction to easy credit.

"Nobody thought there'd ever be such a thing as a debt industry," says Robert Manning, director of the Center for Consumer Financial Services in Rochester, N.Y. "Now we're seeing a set of issues emerge about American insolvency laws, entrepreneurship, and the whole social and moral underpinnings of who gets loans, and why.

"This is the bottom of the food chain," he adds. "They have power to freeze accounts, create collateral damage, and see who responds."

Hundreds of such "junk debt" firms – ranging from mom-and-pop operations to multinational companies with 100 employees or more – buy millions of discharged accounts from lenders each year. (These are bad loans that a bank has written off as a loss for tax purposes.)

They then run computerized "skip traces" that use Social Security numbers to locate debtors, then cajole them into waiving the statute of limitations on old debts and paying up.

Junk debt companies can legally try to collect. Thirty-year-old consumer protection laws give consumers certain rights, but they don't guarantee that debt collectors must inform people of those rights – creating what the FTC's Julie Bush calls a "gray area" that can be exploited by collectors.

"There's no requirement that [debt collectors] indicate that the debt is older than the statute of limitations," says Ms. Bush.

What happened to Atlanta mom Stephanie Maple shows how the junk debt industry makes money, as well as the kinds of tactics it uses.

In Ms. Maple's case, a $5,000 debt may have been bought by a collection agency for as little as $100. She paid $200, then had another $700 taken out of her bank account without her permission before she finally stopped getting calls. The company realized as much as an 800 percent profit, but may have broken laws in the process, including those that prohibit collectors from verbally threatening or abusing consumers.

"We have never been in trouble like this before. We're hardworking poor people, so when they threaten us like, 'We're going to issue a warrant and lock your husband up and take your home,' naturally I panicked," says Maple, an airline employee.

Such complaints are skyrocketing, reports the FTC. In 2008, 34 percent of complaints against debt collectors were for harassment, up from 19 percent in 2007. Another 13 percent of those who complained say collectors used obscene, profane, or otherwise abusive language – also an increase from the previous year.

Why all the phone yelling? The short answer: Debt collectors, who often work on commission, are trying to adjust tactics to a recession, when fewer consumers have extra money and often can't get fresh credit to pay off old debts.

Still, the industry as a whole welcomes reform, says Patrick Lunsford, editor of Inside ARM, an industry newsletter.

Governed by both the FTC and Federal Communications Commission (the FCC has a role because telephones are used), debt collectors often work under contradictory rules, Mr. Lunsford says. One example: Leaving voice-mail messages about debts is not allowed because of privacy concerns, but that necessitates repeated phone calls, which consumers often complain are abusive.

"The majority of [debt collectors] are good actors, and they want [more] guidance," says Lunsford.

But the industry is likely to fight one proposed reform: forcing phone collectors to let consumers know upfront that theirs is a time-barred debt that they don't have to pay. That would undermine the entire zombie debt business model, says Mr. Manning.

"This system is not designed to have people knowing their rights, but to dupe people into waiving their rights," says attorney Dick Rubin of Santa Fe, N.M., an expert on zombie debt. "Most people are so well-meaning and trusting that they don't know how to tell these people to get off."

Under the Fair Credit Act, consumers have the right to request that collection agencies validate the debt in writing. But acknowledging an old debt by making a partial payment essentially refreshes the debt, affecting a consumer's credit report.

Charles Walker says he was sued by a debt collector over an old government college loan, but never received notification about the court date, possibly because he had recently moved. The judge found for the debt collector, a process that reawakened the debt on Mr. Walker's credit report, putting his homeownership at risk.

"I don't have anything against them for attempting to collect debt," says Walker, a computer networking technician in Richmond, Va. "But the tactics they use are just so underhanded, so aggressive and downright bullying."

For a long time, Georgia regulators thought they had no jurisdiction over debt-collection practices. A recent Georgia Supreme Court ruling found otherwise. So the state is now investigating two major national collection firms in Atlanta, the home of several national debt collectors. A Superior Court in Cobb County, Ga., will decide whether the state has a right to subpoena records from those firms to investigate complaints. •