98.8 Percent Overhead

Desperate debtors were supposed to be the key to riches for the North Seattle Community College Foundation, created to independently raise money for North Seattle Community College, a public school. Finding money for scholarships can be tough for a two-year school that alumni are prone to forget after they transfer to a four-year college. So seven years ago, the nonprofit foundation, which had relied on dinners and other traditional fund-raising events, settled on an unusual way to fill its coffers: credit counseling.

As the foundation began to morph into a credit-counseling agency in the ensuing years, organization officials predicted great things. Credit counseling would bring in as much as $1 million a year for scholarships, they said.

The foundation's credit-counseling business today is one of the biggest in the nation, generating yearly revenue in the tens of millions of dollars. But federal records show just a small fraction of that money—far less than $1 million in any given year—has gone to college scholarships or programs. Most of the money raised has gone to for-profit concerns contracted to do the foundation's credit-counseling work, not needy students.

In the fiscal year ending June 30, 2004, the North Seattle Community College Foundation took in $65.7 million and gave just $895,725 in scholarships and grants to college departments. Since setting up its credit-counseling business in late 1998, the foundation has taken in $233.6 million and contributed only 1.2 percent of that in scholarships and grants, according to tax returns. That would put overhead costs at 98.8 percent.

In April, the foundation found it was a poster child in a U.S. Senate report titled Profiteering in a Non-Profit Industry. Among many other negative findings, Senate investigators concluded that the foundation provided debtors with scant help to avoid financial trouble. With that notoriety and scrutiny by the Internal Revenue Service and other federal investigators, the foundation has changed its practices and says more changes might come. But former and current foundation officials insist that Senate investigators didn't find anything substantive.

The fact that this obscure nonprofit foundation is involved in a multimillion-dollar business at all is not widely known. The foundation's Web site (www.northseattle.edu/foundation) makes no mention of it, and how this came to be is a complicated story.

It begins with unfortunate folks who are drowning in credit-card debt. By engaging a credit-counseling agency, they get breaks on interest and late fees by consolidating their debt. The agency collects monthly payments and distributes the money to creditors. It's supposed to be charity work, with counselors talking with debtors to help them find their way to solvency. Roughly half the states and most credit-card companies require that credit-counseling agencies be nonprofit enterprises.

But there's big money involved. The nation's biggest credit-counseling agencies handle billions of dollars each year. With consumer debt increasing to record levels in the late 1990s and bankruptcies rising at a corresponding rate, a lot of folks saw a chance to get rich by going into the credit-counseling business. For-profit businesses in recent years have partnered with nonprofits, whose actual involvement in helping those in debt seems to be in name only.

Whether the North Seattle Community College Foundation has followed the law is up to the IRS, which won't comment on investigations or on whether any particular agency is in trouble. A foundation board member, though, confirms that the IRS is auditing the organization. And Joel Greenberg, president of New Jersey– based Garden State Consumer Credit Counseling, is blunt: "I don't think it's very ethical. This is not supposed to be this kind of business." Says David Lander, a St. Louis bankruptcy attorney who has served on the board of a nonprofit credit-counseling corporation for two decades and is considered one of the nation's leading experts on credit counseling: "This is a really screwy story. It smells."

Profitable NonProfits

Then–Gov. Gary Locke weakened state requirements for credit-counseling agencies. (Getty Images)

The credit-counseling agencies of the 21st century are a far cry from the first agencies that sprang up in the 1950s. At first, agencies didn't charge debtors for their services. Rather, credit companies paid the bills by contributing a portion, typically 15 percent, of money collected. Bona fide charitable organizations, such as the United Way, also helped keep agencies afloat. Besides consolidating debt and making monthly payments to agencies that, in turn, distributed the money to creditors, debtors visited counselors in person to pore over monthly budgets, be instilled with financial discipline, and make plans for solvency.

That's changed. More than 1,200 credit-counseling agencies have sprung up during the past decade, each a tax-exempt charity but many not resembling one. Supposedly nonprofit agencies flooded television with too-good-to-be-true commercials promising an easy way to end calls from bill collectors. Meanwhile, credit-card companies reduced their contributions for agencies' collection services by more than half, so debtors paid these nonprofits at least as much as creditors did.

Federal regulators have rooted out some of the worst agencies. Most notably, Maryland-based Ameridebt, once the country's biggest credit-counseling agency, was forced into bankruptcy as the Federal Trade Commission, the IRS, and attorneys general in Illinois and Missouri filed lawsuits charging violations of consumer-protection laws and unlawful enrichment of insiders, who established for-profit companies that held contracts with nonprofits to process paperwork and market services to consumers.