Even with the fear and loathing, debt collectors actually ease the stream of credit

At the end of the first quarter, the household debt in America topped a record $12.7 TRN and not many people are cheering these rising debt levels. About $615 B or 5% of that total is in delinquency. This is great news for third-party debt-collection companies, who are hired to recover the majority of consumer loan for creditors who don’t have the resources to pursue the debtors on their own.

Remex’s boss, Keith Kettelkamp, states that business is increasing “at a robust rate”. They are based in New Jersey and serve clients like utilities, banks, sellers of musical instruments, etc. Nationwide, over 6,000 collections companies contact debtors over 1 billion times annually. One of every eight Americans is in third-party collections with an average outstanding amount of slightly over $1,300.

There is no doubt that third-party collectors have developed a dubious reputation. They receive a high number of complaints from customers, more than any other kind of financial-services provider as per the watchdog the Consumer Financial Protection Bureau.

Their business model is probably the root of their reported aggressive approach. Some work based on a contingency fee where they only get paid when they recover any part of the outstanding debt. Some just buy the debt and they keep whatever they recover. However, with this approach, they lose their entire investment if they don’t recover the outstanding amount. Either model is based on over-persistence.

Mr. Kettelkamp, however, feels there are too many regulations in the debt-collection industry. The regulations include when the debtors can be contacted legally all the way up to the way and the content of the communication with the debtor. There are licensing requirements and huge financial penalties are imposed if they break the rules.

The perspective is very different for the consumer-rights advocates, but Kettelkamp might not be too far off. Julia Fonseca from Princeton University along with Basit Zafar and Katherine Strair of the Federal Reserve Bank of New York wrote a provocative report that shows limitations on the practices in debt-collection could, perversely, cause more damage to the consumers than actually helping them. The “restrictiveness” of state-level debt-collection legislation was the focus of the authors. They discovered, once controls were in place for extreme factors, like income levels and unemployment, in states where there is a stricter regulation of debt-collection procedures, borrowers found it more difficult to get access to credit, due to the cut back by lenders. In states where debt-collections procedures were not as intense (due to stricter regulations), borrowers got $213 less for car loans and $136 less for personal and retail loans on average compared to borrowers in states that had fewer restrictions on debt collectors.

This is due to the fact that aggressive third-party debt-collection companies act as an insurance against huge losses for lenders, and is very similar to how consumers are protected from personal bankruptcy. Third-party collectors act as a deterrent and without out them, consumers are more likely to take on more financial risks and over-borrow. The borrower see default as a lower cost, which could result in increased default rates and this forces lenders to limit the supply of credit as a way to limit losses. People who have low credit scores will pay a bigger price as they won’t qualify for most loans. Therefore, the debt collector is actually offering a service to both lenders and borrowers. Even with this well-argued academic publication, the industry’s image of the lenders or the borrowers won’t change anytime soon.

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