New analysis from the Mercatus Center at George Mason University reviewed the law and economics of consumer debt collection and its regulation. The expert who compiled the report insisted that the Consumer Financial Protection Bureau should consider all the potential consequences of new regulation — both intended and unintended — to ensure that it will benefit consumers.
Mercatus senior research fellow Todd Zywicki emphasized how it is important for policymakers to understand the six potential consequences in light of an announcement by the CFPB that it is considering new regulation for consumer debt collection.
“Effective legal rules governing debt collection are essential to the efficient operation of the consumer credit economy,” Zywicki said in the paper titled, “The Law and Economics of Consumer Debt Collection and Its Regulation.”
Zywicki continued with, “If creditors are unable to effectively collect debts, they will be reluctant to lend. If borrowers feel oppressed by unfair debt collection practices, they will be reluctant to borrow.
“Maintaining a modern, flexible system of rules for debt collection is essential in order for both borrowers and lenders to have confidence that contracts will be enforced and that the terms of those contracts will be fair and transparent,” he went to say.
Before imposing new regulations, Zywicki pinpointed six factors that can adversely affect consumers of credit that he believes the CFPB should consider, including:
1. Consumer debt collection is already subject to extensive regulation
Since the 1970s, Zywicki noted consumer debt collection has been subject to extensive regulation at both the federal and state levels.
“Most questionable debt collection practices have previously been outlawed or restricted. Concerning existing practices, it is challenging to discern whether further restrictions would create any new benefits for borrowers that would exceed their additional costs,” he said.
2. While good regulation can improve economic welfare, bad regulation can injure consumers and the economy
Zywicki pointed out that restricting creditor remedies raises the risk of loss and the loss rate for lenders, leading to higher prices for loans and a reduction in supply.
On the other hand, he acknowledged restricting creditor remedies reduces the total cost of borrowing for consumers, producing an increase in the demand for loans.
“As a result, restrictions on collections simultaneously reduce supply and increase demand,” he said. “It is unclear whether restrictions would actually increase or decrease quantity.”
3. Riskier consumers tend to be injured the most by restrictions on debt collection practices
The George Mason expert explained restrictions on debt collection may benefit consumers who are actually subject to the collection process, but this will come at the expense of other consumers who have to pay more for credit and gain less access to credit.
“Because riskier borrowers are predicted to be the most likely to default, they will also bear a greater proportion of the cost of regulation than other borrowers, even though in most cases they repay their debts,” Zywicki said.
Zywicki pointed out that restrictions on collections tend to adversely affect credit card lending relative to other types of lending. He added higher-income consumers will be able to avoid some of these negative effects by making greater use of secured debt (such as home equity lines of credit), whereas lower-income users will be forced to turn to products such as payday lending and auto title loans.
4. Third-party debt collectors and debt buyers play a unique role in the consumer collections system
Zywicki insisted third-party collection agencies provide liquidity and expertise in collection practices that reduce losses and increase efficiency for consumer lenders.
“This reduction in losses may be particularly valuable to some types of creditors compared to others and may be useful for creditors that otherwise might be overly lenient in their collection efforts and pass on the costs to their other customers,” he said.
5. Regulation of particular collection practices can have unintended consequences
Zywicki explained debt-collection practices tend to follow a sliding scale of intensity, beginning with low-expense practices such as letters and phone calls and escalating to higher-intensity practices such as lawsuits.
“Restricting the use of less-intense practices can interrupt this important economic calculation, leading to swifter invocation of more-intensive practices, such as lawsuits,” he said.
6. Regulation should not disproportionately burden small debt collection firms and stifle competition
Zywicki went on to mention compliance with Dodd-Frank and other regulations enacted since the financial crisis is disproportionately costly for smaller firms in the financial services industry, including the debt collection and debt buying industries.
“Smaller firms, however, have traditionally played an important role in the debt collection industry by providing knowledge of local economic conditions and promoting competition that can benefit consumers,” Zywicki said.
“Regulation that disproportionately burdens small businesses with unnecessary regulatory compliance costs will promote unnecessary consolidation of the debt collection industry,” he went on to say.
2 more suggestions for CFPB
Zywicki closed his analysis by making a pair of other recommendations for the CFPB to consider.
He reiterated that many restrictions on collections do not benefit consumers
“Even if restrictions on collection practices raise prices, consumers will still benefit if they value the ability to avoid those practices more than the creditor values the ability to exercise them,” Zywicki said.
“In practice, however, many restrictions fail cost-benefit analysis, because consumers place less value on avoiding particular remedies in the case of default than the increase in price they would have to pay the lender to offset the loss of the remedy,” he continued.
Zywicki also suggested that regulations should be based on careful cost-benefit analysis and consideration of changing consumer lifestyles and communications technology
“Given the likelihood of unintended consequences arising from new collections regulations, the CFPB should conduct careful cost-benefit analysis before it imposes new regulations on debt collection,” Zywicki said.
“The CFPB should consider consumers’ growing reliance on technologies such as cell phones, email, and text messaging, and modernize its rules to allow more flexible contact using those technologies while at the same time protecting consumers from intrusions on their privacy,” he went on to say.
Zywicki closed by making one final point about the bureau’s potential moves regarding debt collection.
“From its inception, the CFPB has described itself as a ‘data-driven agency’ that applies sound economic and empirical analysis to craft consumer protection policies,” he said.
“The CFPB should seek to follow this goal for consumer debt collection rules and consider rules that can be shown to protect consumers from overreaching creditor behavior, ensure access to credit at competitive prices, and avoid burdening consumers with unnecessary restrictions and compliance costs,” Zywicki concluded in the document that can be downloaded here.