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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