Debt collection math

By Felix Salmon
January 24, 2011
Mark Gimein has an interesting analysis of the economics of Encore Capital Group, a company which buys up hundreds of thousands of busted credit cards and consumer loans for pennies on the dollar, then pushes them through assembly-line litigation to make a surprisingly small profit.

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Mark Gimein has an interesting analysis of the economics of Encore Capital Group, a company which buys up hundreds of thousands of busted credit cards and consumer loans for pennies on the dollar, then pushes them through assembly-line litigation to make a surprisingly small profit.

Gimein’s collections math looks like this:

$694 in collections per lawsuit
minus $283 in commissions to lawyers (40.8%)
minus $139 in court costs (20%)
$272 in collections after court and attorney costs

Gimein then looks at the very real downside of taking these debtors to court, and concludes that, societally speaking, it’s probably bigger than $272 per case. He concludes:

If indeed these social costs are excessive, one possible solution here—which I have not seen proposed—is simply to raise the costs of litigation. Just tripling filing fees and the like would cut into that $272 return enough to make most suits uneconomic for a company like Encore.

Some folks might worry that these costs are often assessed as part of the judgment against a debtor. In real life, though these kinds of lawsuits wind up recovering only a fraction of the judgement, so in practice for most suits it would be the plaintiffs—who’d have to budget for higher court expenses.

This would leave only those cases in which a substantial amount of money is at stake and the plaintiffs believe the debtor might realistically pay it—the cases, in other words, that the legal system is built for. Debt buyers have made mass litigation work by turning lawsuits into a low cost, high volume business. Those who worry about the social effects of this volume of litigation may want to think seriously about how to raise the costs.

Gimein’s point is well taken: very little societal good is served by companies which buy bad debt by the ton and push it through courts like so much meat through a grinder. But I’m not sure his proposed solution would work.

For one thing, Gimein’s figures show that after paying $139 in court costs, a creditor collects an average of $694. That’s actually a pretty high return on capital. The way that Encore works, it hires outside lawyers on a commission basis, and it still manages to make decent money, essentially just for providing the capital needed to pay the court costs and buy the debt in the first place. But even if Gimein managed to tweak things so that the Encore model wouldn’t work any more, there would always be lawyers willing to buy and litigate debt.

And raising filing fees and the like would certainly hit hard all of the debtors with relatively modest debts. People move house, they miss bills, their old cable company doesn’t have their new phone number, they think they’re contesting a charge, and then they don’t hear back and they think it’s settled — you know the score. For similar reasons they don’t find out about the court case — and then suddenly a contested $150 charge has become a $600 court judgment against them, once all those newly-inflated court costs are added in.

Maybe debt collectors would never litigate a sum so small, but I wouldn’t count on it, not when they’ve already set up their legal assembly line.

My feeling here is that the best course of action is to bring anybody litigating second-hand consumer debt under the remit of the Consumer Financial Protection Bureau. It’s a similar tactic; it just uses an increase in regulatory compliance costs instead of an increase in court costs. But it keeps the courts a place to go for justice, rather than somewhere with artificially high barriers to entry.


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Well this banker sees little sociatal benifit in allowing 2nd and 3rd parties buying up bad debts at 10 cents on the dollar so that they harass the irrisponsible into setteling for 20 cents. I don’t see much good comming from dozens of phone calls and clogging up the court system to get summary judgements that lead to wage garnishment and finally people being forced out of the banking system.

The goverment should set up a perminent bad bank responsible for buying up all legitimate unsecured debts that go beyond 90 days past due. The goverment would buy the bad debt at 0 and then share 50% of the recovery with the bank that made the bad loan. The goverment has every incentive to collect as much as possible… the treasury gets half the take… but they could also be much much more ethical in their collection practices. Unlike the commission based 3rd rate lawyers, the goverment workers would have no incentive to bend or break existing debt collection laws.

Recoveries would likely be higher than they are currently if you allowed the goverment to withold tax return funds. The cost of bad debt is built into the price of credit paid by those who pay as agreed. Lowering the cost of unsecured defaults should in theory reduce the cost of unsecured credit so if properly implemented such a system could be a huge benifit to working class borrowers rather than the bankers.

Banks would have even less incentive to originate questionable loans at >20% rates and sell off the 10% that defaults because it would be mandated that govermental bad bank be the only allowable buyer of non-performing consumer debt. This would allow bank regulators to immediatly identify bad lenders.

A larger issue than debt collection is the maximum allowed cost of credit. If you can’t make a loan work at %20 then I’m of the view that the borrower is better off without the loan. You can say that maximum interest rates just pushes the weakest borrowers out of the banking system towards even more predatory credit providers but if that’s your big fear then go after the loan sharks.

Posted by y2kurtus | Report as abusive

1. Well before the case goes to court, the credit card company is going to make some non-negligible effort to collect on its own. The fact that Encore is buying claims at 4 cents on the dollar makes that point pretty well.

2. There is a process, established in Article 1, Section 8 of the US Constitution, called ‘bankruptcy,’ which allows debtors to discharge debts. If Encore is suing you by definition you have not availed yourself of this longstanding legal remedy.

3. Notwithstanding the above, you and this dyslexic “y2kurtus” think that yet another remedy should be created for debtors, that of increasing filing/ regulatory fees such that these claims are worthless, and creditors thereby have no effective legal recourse against people who borrow relatively small amounts of money and then don’t pay them back.

I disagree.

Posted by johnhhaskell | Report as abusive

These numbers are misleading at best. They take into account only the accounts Encore chooses to litigate. They say nothing about the debt they buy and decide not to litigate, and say absolutely nothing about the overall profitability of Encore as a debt buyer. You cannot leave out the price paid for the debt and the overhead necessary to process it in determining the company’s agressiveness.

Every single person Encore sues signed a legal contract to pay back what they owed. If Encore is doing its due diligence properly, it does not sue people for whom there is little likelihood of recovery. I’m sorry to tell you this, but the courts still expect people to live up to their legal obligations.

Posted by Jeff.Baldwin | Report as abusive

The notion that a company should not be encouraged to get into the business of buying legal claims is hardly new. At common law, the doctrine of champerty made it a crime for a “stranger” to buy a claim in consideration of the proceeds from a judgment. The practice probably would have prohibited the practice of buying debts if it only intended to sue on them.

It seems the present day concern is the sense that the people being sued in this context are being railroaded.
My sense is that most claims that make it to court are against people who actually can’t afford to pay. People who stopped paying because of a dispute can probably settle for far less than the face value of the account.

By all means, increase the filing fees for these claims (Felix’s concern that court still be a “place to go for justice” made me cackle). But use the increased filing fees to fix the problem underlying the concern. Provide court-appointed lawyers.

As a practical matter, using the higher filing fees to appoint counsel for debt buyer defendants would increase the costs of filing suit exponentially. Debtor’s counsel would increase the time and effort necessary to obtain a judgment by seeking proof in the discovery process, contesting robosigned affidavits, and taking undocumented claims to trial. Doing so would greatly increase the debt buyer’s staff and legal costs – rending many, if not most, of its claims uneconomical.

Posted by dudeman69 | Report as abusive

With all due respect, dudeman, this is what I’m trying to say. Your sense of what is happening is bereft of many, many factors. If Encore wants to be a profitable debt buyer, which they are, they cannot afford to litigate cases that have very low likelihood of paying. So, a sense that most claims that make it to court are against people who actually can’t afford to pay is very likely just that, a sense, not a fact.

The math referenced in the original post is per account that is litigated, it says nothing about the percentage of accounts purchased that are actually lititgated, there are an awful lot of assumptions you cannot draw from the data.

Posted by Jeff.Baldwin | Report as abusive

I wish the government would finally establish a ListOfPeopleFelixThinksTheLawShouldApply To and of course a ListOfPeopleFelixThinksTheLawShouldNotAp plyTo so Felix can stop writing these regular features on another class of aggrieved citizens he feels shouldn’t pay their debts.

Posted by JohnOmeara | Report as abusive

Those commenters who have judged that the collection firms are only attempting to enforce their legitimate rights are presuming quite a lot. These firms buy debt in bulk, with only the most minimal of detail on each one.

Having been on the receiving end of a collection attempt for an erroneous bill (for the grand sum of $12) from a medical lab, I can attest that the collectors have zero incentive to actually check and validate the particulars of any individual claim. Theirs is a business built on automation and volume. They are completely indifferent to the consequences for anyone they are trying to collect from of posting erroneous credit information to the three reporting firms, as I discovered to my dismay when I tried to refinance a mortgage.

But I don’t think making the cost of litigation higher will address that. I strongly suspect that most of these firms’ revenues come from non-litigated cases when, on occasion, a debtor finally responds to a form letter. Not too many have to pay off when they’re buying them for pennies on the dollar.

Posted by FosterBoondog | Report as abusive

Jeff, my point was that debtors in these cases often make the strategic decision to stop paying a given creditor in order to continue paying other, higher priority debts. I don’t really see how that matters.

It still seems fair to ask whether we think this type of business is beneficial to society. Perhaps society is actually worse off forcing loads of debtors to pay a charged off credit card buyer when, for example, the debtor would prefer to continue paying on the car he drives to the job where taxes are taken out of his check and used to fund public services.

Debt buyers often say that they provide utility by making consumer credit cheaper and more widely available. But by providing inexpensive yet powerful collection tools to those that make credit cheaper, our courts simply encourage more irresponsible lending on the front end and more lawsuits against already strapped debtors on the back end.

Posted by dudeman69 | Report as abusive

Again, if Encore, or any debt buyer, is operating efficiently, they are only litigating accounts that have a reasonable assurance that the consumer has an ability to pay. Perhaps society also suffers when the message is only pay those debts you find it convenient to pay, do not worry about the legal agreement you signed. Go ahead and enjoy that big screen HDTV even though you have not prioritized paying for it.

I understand the defense of debt buyers is difficult, given some of their tactics. To simply state that they buy debt with minimal information is patently irresponsible. There is a rigorous due diligence process for any portfolio of debt, and if there are doubts about the validity or chain of title to a portfolio, the debt buyers will walk. Like any business, there are good and bad players.

Having run two collection agencies, I can tell you my companies were meticulous about credit bureau reporting and complied with all laws pertaining thereto.

Dudeman, you have a very good point about the availability of credit, the lenders must always be held complicit in a certain percentage of the bad debt.

Posted by Jeff.Baldwin | Report as abusive