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In addition to supporting monetary policy and other analytical efforts, the Bank’s Research Department produces working papers and other publications, including the Business Review, which features articles written in a more generally accessible style by staff economists. The Payment Cards Center has had a strong partnership with the Bank’s Research Department and, as a matter of course, provides links to relevant Business Review articles on its website. One recent example is “Collecting Consumer Debt in America,” which appeared in the Second Quarter 2007 issue of the Business Review.*
In this article, Senior Economist Robert M. Hunt explores how creditors and their agents attempt to collect past-due consumer debt, how debt collection has evolved into a multibillion dollar business, and how various regulatory initiatives have influenced the industry. Hunt uncovers an evolution underway within the debt collection industry that is changing the ways in which creditors and their agents attempt to collect past-due consumer debt, particularly credit card and other unsecured debt.
Traditionally, firms have actively collected debts owed them by their own customers. This type of collection is known as first-party debt collection. However, more recently, other firms have begun to purchase debts that are (or were) owed to others. These firms are called third-party debt collectors, and, as Hunt notes, third-party debt collection is becoming a large and financially attractive business. In 2005, third-party debt collectors recovered $51 billion in delinquent debts, returning $39 billion to their clients, and employing more than 130,000 workers to do so. Moreover, these firms actively sought collection of more than $200 billion, contacting consumers over 1 billion times, and earning total revenues in excess of $11.4 billion.
Robert M. Hunt, Senior Economist, Research Department, Federal Reserve Bank of Philadelphia
What explains the rapid growth of this industry? Hunt provides several answers. First, he points to the volume of past-due consumer debt and the process by which creditors and their agents seek recovery of these debts. Hunt observes that, in 2006, total household indebtedness topped $13 trillion and that, if data gathered from 1992 through 2005 were reflective of 2006, approximately 4 million households were 120 or more days late on debt payments. Hunt notes that while many lenders must eventually write off much of these debts, many consumers who are behind on their payments do not seek bankruptcy protection immediately or at all. Hunt points out that no more than half of credit card debt written off by banks is triggered by the debtor’s filing for bankruptcy. As Hunt states, “There is a considerable period in which creditors and their agents seek to recover past-due debts using persuasion as well as the contractual and legal remedies available.”
Second, Hunt observes that creditors have changed their practices with regard to working with collection agencies. While creditors traditionally paid third-party debt collectors on a commission basis for debts collected on the creditors’ behalf, during the 1990s they began selling bad debt outright to these firms. It is estimated that in 2005 creditors sold $128 billion (face value) in nonperforming consumer debt, two-thirds of which (approximately $88 billion) was defaulted credit card debt. Moreover, two-thirds of all bad credit card debt sold (approximately $65 billion worth) was sold directly by card issuers. These issuers received, on average, 4.5 cents for each dollar of face value, totaling roughly $3 billion. Today, it is estimated that debt buyers hold approximately $170 billion in uncollected credit card debt that is less than five years old (typically the point at which legal remedies are no longer available).
Third, Hunt points to changes in technology. As an example, he cites advancements in computer dialing programs that have increased the ability of debt collection agencies to contact more debtors. These programs are capable of determining what time of day is best to call, of quickly matching collection agents with debtors who pick up their phones, and of measuring response rates in real time. Moreover, improvements in sorting programs have enabled the prioritization of consumers from whom collection is most likely and eased the arduous process of organizing collection records. Productivity growth enabled by technology is evidenced by the 250 percent increase in the number of people employed within the collection industry, versus inflation-adjusted revenue growth of 360 percent, between 1982 and 2002. Hunt also points out that innovation in information technology has made ancillary activities such as skip tracing (the process of locating the current address and phone number of a debtor) more efficient.
Fourth, Hunt observes that state laws typically reward unsecured creditors who are more prompt in their collection efforts by offering them more senior claims (priority) on the consumer’s assets or income not already pledged to repay secured debts. This creates an incentive for creditors and collection agencies to be vigilant in their collection efforts. In Hunt’s words, “Knowing that other creditors are [racing to claim a debtor’s limited assets or income], each creditor has an incentive to seek immediate repayment of his or her debt even if it comes at the expense of other creditors or induces a sale of the consumer’s assets at fire-sale-prices.”
Finally, Hunt turns his attention to federal laws, including the enactment of the Fair Credit Reporting Act of 1970 and the Fair Credit Billing Act of 1974. Hunt describes in detail the Fair Debt Collection Practices Act (FDCPA), the principal body of federal law regulating third-party debt collectors, which is primarily enforced by the Federal Trade Commission. Hunt notes that, unlike many other federal laws governing consumer credit, “the FDCPA acts as a floor for consumer protections rather than a ceiling,” and that in the 30 years since passage of the FDCPA, many states have enacted more stringent regulation of debt collection practices.
Hunt concludes his article by drawing on economic theory. He notes that it has long been understood that as the costs of ensuring loan repayment increase, less credit will generally be available or will be offered on less advantageous terms. Moreover, he observes that as punishments associated with default increase, demand may decrease, since some consumers will choose not to borrow in the first place. Hunt draws attention to several studies that have analyzed the effects of regulatory restrictions on both the variety of remedies available to unsecured creditors and the supply and demand for loans. Hunt points out that while those studies laid a foundation for understanding the effects of these regulations on the supply and demand for credit, there has been very little research of this sort in recent years. Given the many changes in industry structure and collection practices outlined in his article, Hunt argues that it is time for renewed attention and study by economists and other scholars.