Credit card debt collection

One interesting lens for understanding how industries work is looking at their waste streams. Every industry will by nature have both a stock and a flow of byproducts from their core processes. This waste has to be dealt with (or it will, figuratively or literally, clog the pipes of the industry) and frequently has substantial residual value.

Most industries develop ecosystems in miniature to collect, sift through, recycle, and dispose of their waste. These are often cobbled together from lower-scale businesses than the industry themselves, involve a lot of dirty work, and are considered low status. Few people grow up wanting to specialize in e.g. sales of used manufacturing equipment.

One core waste stream of the finance industry is charged-off consumer debt. Debt collection is a fascinating (and frequently depressing) underbelly of finance. It shines a bit of light on credit card issuance itself, and richly earns the wading-through-a-river-of-effluvia metaphor.

A disclaimer: I have had substantially more at-bats with debt collectors than most people, as a result of an old hobby of writing letters on behalf of debtors to their lenders and non-affiliated debt collectors. I did this over the Internet, on my own volition, because it seemed pro-social and I was extremely underused by my actual job at the time. This experience leaves me with strong opinions on the debt collection industry; a frequent archetypical person in need of a letter was a Kansan grandmother in diminished financial circumstances who had been harassed for months. I’m going to try to keep these views to a dull roar here, in the spirit of spending more mental energy on discussing why the system presents as so broken.

The lifecycle of a defaulted debt

The majority of debt which defaults in the United States is revolving credit card debt. (Without addressing the politics of it, the impression among many informed people that most defaulted debt is medically-related is the result of successful advocacy work rather than being substantially based in reality. Trustworthy numbers are not hard to come by, due to a combination of regulatory supervision and the U.S.’s almost unique degree of population-wide debt surveillance via credit reporting agencies. We’ll return to credit reporting some other day.) Assume I’m talking about credit card debt below, though the mechanics for medical debt bear overwhelming similarity. (I’d address it specifically except that healthcare economics is a fractally complex topic once you bring e.g. insurers, public programs, and the like into the mix.)

Credit card issues bucket users into various archetypes, personas, and predicted lifecycles, because behavior is extremely heterogeneous and this is important from both a marketing and risk management perspective. Most users of credit cards, probably including readers of this column, believe they are the typical user of credit cards; no bucket is typical. If I were to make some informed guesses, relative to the population-wide distribution, you, reader, use credit cards in preference to debit cards as a payment instrument, do not routinely revolve balances, and hold some combination of student loan, auto, and mortgage debt which dwarfs your credit card debt. And so it is critical to understand that most defaulting credit card debt is not held by people who act like you.

Most credit card debt which defaults non-fraudulently was incurred in the relatively distant past. Credit cards are revolving accounts; one’s balance can increase (even as one successfully makes payments) for years as one pays off a portion of prior balances but continues purchasing with the card. This is normal and expected use of the card, planned for thoroughly, much like never carrying a balance is also normal and expected use of the card, planned for thoroughly.

A small percentage of borrowers, carefully tracked and generally oscillating between 2.5% and 5% depending on the overall health of the economy, will go delinquent on credit card debt. (Some issuers specialize in certain parts of the credit spectrum and, as a result, will have sharply lower or sharply higher delinquency rates. American Express, for example, specializes at the high end and typically has delinquency close to 1%. Capital One made its name in so-called subprime credit cards, though it has diversified since, and typically tends towards the high end among banks whose names you know. There is a largely hidden ecosystem of banks you don’t know that issue very expensive products to poor people; you can accurately predict their default rates exceed anything mentioned above.)

Default typically begins by missing (or underpaying) a scheduled payment. That in itself is a theoretical breach of contract but not very outside the ordinary for a card issuer; they will generally automatically assess a fee but take very little action. Most borrowers will recover before they are 30 days late, which is the point at which most issuers start to treat an account as being a credit risk rather than a minor operational issue.

After 30 days, issuers will typically work the account internally, using a combination of communication methods to nudge the user into payment, until one of a few things happens. The happiest is the customer gets current on their account. An outright refusal to pay is substantially less likely, and can result in an issuer moving up timelines. But the most common is that the borrower ghosts the issuer for a few months.

Consumer debt issuance is generally, by law, an exclusive privilege of regulated financial institutions. (The other big one is taking deposits.) Society wants many things from regulated financial institutions; one of those things is having accurate books, because stealth losses cause financial institutions to fail and frequently leave society holding the bag. As a result, the Federal Reserve has a Uniform Retail Credit Classification and Account Management Policy.

This tail wags the dog. Many decisions about account servicing, which a naive conception of debt might assume are between borrower and lender, are done with the goal of aligning servicing to accounting standards. In this way, the books impose their will on reality, and where the books and reality differ, reality frequently adjusts itself to accommodate the books. (As my buddy Kevin frequently muses, states are gonna see. Organizations which are tightly tied to the state, like regulated financial institutions, will develop a vocabulary and processes for seeing like the state sees, and that edifice tends to capture non-state methods of seeing that they run in parallel.)

In particular, credit classification requires that financial institutions “charge off” delinquent debt. Mechanically, they have previously accumulated an allowance for delinquency on their books as a liability; they move a bit of that allowance to a bad debt expense. In principle, nothing has to happen to the actual debt. In practice, financial regulators encourage institutions to seek certainty and finality around this.

Financial institutions achieve certainty and finality by packaging portfolios of bad debt together and selling them to non-financial institutions. This durably moves them off of the books and realizes a very, very small residual value.

The debt collection industry

There are essentially two halves of the debt collection industry. A portion of it works on an agency model: a lender can have e.g. a law firm or similar work a debt on its behalf during the several month period where the delinquent debt lingers on their books, in return for a performance fee (often 15-30% of face value) should the borrower make good on the debt.

But debts, much like people, only age in one direction. Unlike people, debts universally decline in value as they age. We’ll return to that topic in a moment. Most debt which is not being serviced successfully by the first party lenders will not long be worked by their agents. It is instead sold to debt buyers, who will then attempt to collect the contracted amount (plus fees provided for in the contract, which are legally legitimate, and not infrequently fees which were not provided in the contract, which are frequently extremely questionable). Subtract the original cost of buying the portfolio and their substantial operational costs and the remainder is profit.

Most defaults are small. This fact drives everything about debt collection; it has to be done scalably, by the cheapest labor available, with a minimum of customization or thoughtful weighing of competing interests. The average defaulted credit card debt is on the order of $2,000, the median is between $500 and $1,000. These are processed like McDonalds burgers, not like grant proposals.

Debts are sold as part of a portfolio, where (typically) thousands of relatively similarly situated debts in a cohort are sold as a packet. The value of portfolios is a huge discount to the face value of the debts; at the point where a lender has only worked it themselves and the debt is a few months delinquent, portfolios generally fetch about 5 cents on the dollar. That value will continue to decay over time. There is an entire ecosystem of brokers supporting contractual infrastructure to convey these debts to buyers and insulate the issuing financial institutions from the actions of the debt buyers.

Partly, that is due to regulatory risk. (Particularly in recent years, regulators have begun using prudential regulation of financial institutions to strongly suggest that financial institutions adopt their social goals. There is a tortured argument by which a debt collector being unsavory in the process of debt collection would damage the reputation of the bank, which could damage an item on its balance sheet, which could damage its financial stability, which fact a regulator actually has jurisdiction over, and therefore regulators can discourage debt sales.)

Probably more surprisingly, financial institutions care acutely about brand damage, particularly to their own partners that can contractually obligate that. Many credit cards are co-branded; you, as an unsophisticated consumer, might think you have a credit card from Amazon, Best Buy, or Apple. You don’t, but those three firms are acutely aware of your miscomprehension, and they want to continue earning your business for the next 40 years. And so they might have hypothetically contractually bound Chase, Citibank, and Goldman Sachs (respectively) to never mention their co-branding partner in connection with debt collection and to bind subsequent debt buyers to the same.

This is a frequent cause of debtors mistakenly believing that debt collectors are confabulating debts against them. “But I haven’t ever done business with Citibank!” I’m slightly-more-than-unsympathetic to that, because of the relative sophistication of borrowers versus Best Buy’s marketing department. On the topic of true confabulation, oh yes, that happens minimally hundreds of thousands of times a year; debt collectors adopt business processes which simply make debts up because accuracy requires competence and costs money.

The debt collection industry is, and I say this as someone who is capitalist as the day is long and attempts to be non-political in public, among the most odious hives of scum and villainy as exists in the United States. The business is sordid and virtually immune to reform, despite decades of trying. The Fair Debt Collection Practices Act was passed in 1978! It is older than me! I learned to cite it in 2004 against the same abuses it was designed to prevent! The situation did not markedly improve in the last 20 years!

This is not because of a lack of virtue or a lack of laws; the structure of the industry colliding with the socioeconomic reality of defaulting debtors basically ensures that it will be a miserable place populated by miserable people who will project leveraged amounts of misery into the outside world in the hopes of collecting a tiny sliver of defaulted debts.

Debts are conveyed to the debt buyers as large CSV files with minimal supporting documentation. The legal reality of a credit card debt begins with a contractualized promise to pay. You might assume that the owner of the debt necessarily has read that contract. Reader, if the debt has been sold, they have not merely not read that contract, they have likely not received a copy of that contract. They might have the contractual right to ask the seller of the portfolio to ask the entity it bought the portfolio from to follow a few more links in the chain to eventually ask the financial institution for a copy of the contract. In principle, financial institutions always have the contract… somewhere. In practice, they will frequently not organize themselves to actually locate it; this business is off their books and Operations has better things to do than hunting in the archives for a paper copy of a low-value contract signed several years ago.

Again, we’re talking about promises frequently denominated in the hundreds of dollars. It is a consensual social fiction that there is actually a legal process operating here. That consensual social fiction has real consequences, and sometimes bubbles up uncomfortably in actual courts of law, which we will return to in a moment.

The rights of debtors are observed by both primary lenders and eventual debt buyers mostly in the breach. One of those rights is to a written “debt verification”, with specified information in it, and (surprisingly, if you haven’t worked in this field) despite that being the law many debts are sold in such a fashion that the buyer couldn’t produce a responsive verification even if they wanted to. That isn’t even a political claim; it’s just the engineering reality of which columns are in their CSV file.

The former advocate in me will observe that the single most effective method for resolving debts is carefully sending a series of letters invoking one’s rights under the FDCPA (and other legislation) to a debt collector who is operationally incapable of respecting those rights, then threatening them with legal or regulatory action when they inevitably infringe upon them in writing, leading to them abandoning further attempts at collection.

This effectively makes paying consumer debts basically optional in the United States, contingent on one being sufficiently organized and informed. That is likely a surprising result to many people. Is the financial industry unaware of this? Oh no. Issuing consumer debt is an enormously profitable business. The vast majority of consumers, including those with the socioeconomic wherewithal to walk away from their debts, feel themselves morally bound and pay as agreed.

Why are debt collectors so bad at debt collection? Partially it is because credit card issuers are large national institutions with large, automated processes sitting atop a legacy of corporate acquisitions, IT migrations, and similar that makes availability of non-critical information extremely fragmentary. They then want to dump that complexity through a very small pipe (CSV files) onto the debt collection industry.

That industry is largely not characterized by large, nationally scaled, hypercompetent operators who happen to have decades of institutional inertia. Instead, it is heavily fragmented into strata of mid-market and smallest-of-small-business firms, governed by a patchwork of regulations on the national, state, and local levels, and runs (in large part) on faxes and post-it notes.

The operations of a debt collection firm

Roughly three quarters of debt is bought by ten large firms and one quarter is bought by so-called mom-and-pops, but this is complicated by the resale of portfolios which were worked by the majors. Mom-and-pops then buy them at a deep discount with the goal of getting the residual value which the majors did not successfully capture.

Suppose a debt collection firm has bought a portfolio. They will first "scrub" it, which means using automated or semi-automated processes to enhance the fragmentary data they have and prioritize the portfolio for collection efforts.

For example, one stage of the scrub will be associating a credit profile with as many debts as possible. Credit scores are extremely good predictors of who pays their debts; that is what they are designed to measure. You will get sharply better results on a per-call basis calling people with a 750 FICO versus a 450 FICO, accordingly, you should call all the 750s first and more frequently.

A second scrub will typically remove dead debtors, because they infrequently answer their phones. (Debts are not inherited in the United States, a fact which the debt collection industry frequently demonstrates strategic ignorance of.)

While reading government reports, I chanced across a mention that a novel form of scrub uses third party databases of so-called litigious debtors. This was surprising to me (as far as I know, it was Not A Thing when I was doing advocacy), but makes a lot of operational sense. You can trivially Google providers with [litigious debtor scrub] as a keyword.

The FDCPA and state legislation provides for automatic damages for illegal behavior from collectors, the incidence of illegal behavior is extremely high, and a debt collector with a high school education and three months of experience will frequently commit three federal torts in a few minutes of talking to a debtor then follow up with a confirmation of the same in writing. (You think I am exaggerating. Reader, I am not. “If you don’t pay me I will sue you and then Immigration will take notice of that and yank your green card” contains three separate causes of action: (frequently) a false threat to file a suit where that is not actually a business practice of the firm, a false alleged affiliation with a government agency, and a false alleged consequence for debt nonpayment not provided for in law.)

As a result, private companies compiled databases of (public in the U.S.) court filings and organized them by Social Security number, address, and similar to allow debt collectors to identify which debtors are aware of their legal rights. In principle, a debt collector could do anything they wanted with that fact, like being extra careful to follow the law in contacting them. But the economics of debt collection do not counsel careful, individualized consideration of credit card debt.

I will bet you that, in practice, they simply avoid collecting against anyone who demonstrates ability and financial resources to enforce their rights. This is one for the history books of borked equilibriums. We devoted substantial efforts to pro-consumer legislation to address abuse of (mostly) poor people. We gated redress behind labor that is abundantly available in the professional managerial class and scarce outside of it, like writing letters and counting to 30 days. (People telling me they were incapable of doing these two things is why I started ghostwriting letters for debtors.) We now have literal computer programs exempting heuristically identified professional managerial class members from debt collection, inclusive of their legitimate debts, so that debt collectors can more profitably conserve their time to do abusive and frequently illegal shakedowns of the people the legislation was meant to benefit.

After scrubbing their lists, debt collectors will attempt to locate contact information for the debtors. You would think this would be fairly straightforward, given that they were given that information in the CSV file they purchased. But information is fragmentary and outdated, and people likely to default on debts also have complicated and frequently changing relationships with their addresses and phone numbers. So there exists an ecosystem of “skip tracing” providers, delightfully (ugh) borrowing the jargon from the business of bounty hunters, to match up fragmentary information with current contact information.

Operational and IT issues at this stage create a lot of the harm in the debt collection industry. For example, to use an example ripped from my own experience (which was part of over $100,000 of confabulated debt that caused me to fall down the credit advocacy rabbit hole), consider a fragmentary piece of information identifies a P.J. MacKenzie at an unspecified town in Illinois as owning a debt in the few hundred dollar range. That name is a fuzzy match to one Patrick Johnathan McKenzie of Chicago, Illinois. Here you are welcome to your moral intuitions as to whether simply asserting that I owe you a few hundred dollars is legitimate. The debt collection industry frequently assumes, as a matter of business practice, “I mean, probably you do factually owe me, and if you don’t, oh well, then you won’t be one of the ~8% of people who we successfully collect from.” No individualized application of human labor is required to reach this conclusion. No one is accountable for the mistake; no one made it, not in the usual sense of people making mistakes. People architected a system which generates this outcome by default.

And then begin the calls. To you, if the above processes have successfully found you. To your friends and relatives, if they have not. (The FDCPA provides that debt collectors are only allowed to contact a debtor’s family to find current contact information. They do this with gusto, including when they have current contact information. It is used coercively, because many debtors will make sacrifices to find $250 so their mother stops getting calls.)

Debt collectors typically work in call center environments, assisted by technological improvements to greatly increase the number of calls per hour each collector can do. These include so-called predictive dialers, which (as a sketch) dial several debtors in parallel for each collector, since most calls will not be answered or will go to voicemail, then connect only those that pick up to a debt collector waiting in the queue. Maximizing the efficiency of callers is key to the economics of debt collection; labor frequently costs more than than underlying debt does, even when one is paying four cents on the dollar and hiring collectors straight out of high school. An unhappy consequence of this is that debt collection firms build extremely scaled systems to project externalities into the phone network and the people attached to it, including very many people who never owed them a dime. But for the (dubious) cover of law, this is what technologists would call a volumetric denial of service attack: a relatively small expenditure of resources allows a collector to disable a relatively large number of phones.

If there is one thing that unites debtors, it is the cacophony. The phones ring and ring and ring. They ring at all times legally permissible and many times not. They ring from the same collector calling you twice a day. They ring from the same debt being collected by multiple different agencies, several of which sold the debt on but neglected to update their internal systems to stop collecting on the debt they no longer own. They ring from dozens of different firms, because the circumstances which caused you to go delinquent on one debt caused you to go delinquent on several debts. Each of those is collected in parallel by a process which considers every other debt collector a competitor for your scarce dollars and must outcompete them by ringing you harder, faster, and more persistently.

What does a debt collector hope to get from a call?

The goal of calls is to get a verbal promise to pay and payment credentials. The most useful payment credential, from the perspective of a debt collector, is a checking account number, but in a pinch they will also usually take debit cards or credit cards. (Many people who have defaulted on debts still have access to credit, because in deteriorating financial circumstances one could default on some but not all credit lines. There is also an extremely efficient financial industry capable of extending credit profitably at a wide variety of predicted repayment likelihoods.)

Many promises to pay are not promises to pay in full, but rather “a plan” to pay the face value of the debt plus accumulated (and accumulating) interest over time. Most debtors who agree to payment plans will not successfully complete those plans. This is, from the perspective of a debt collector, not a problem. If they paid five cents on the dollar for your loan, and successfully convince you to pay twenty cents today and the balance over monthly payments over a year, you know what they’re left with in month three when you default? Ability to collect from you again, or to sell your debt for more than they paid for it, because you are a better credit risk than most people in the portfolio. You proved that, by paying.

Many less sophisticated customers assume that they have substantial control over sending payments via check. All checks have the account number, printed on the face of them, and collectors will push aggressively to get that number over the phone versus waiting for a check to arrive. The goal of having the number is to present the bank holding the checking account with an electronic ACH debit or a “demand draft”, in both cases representing that the account holder has pre-authorized the debit. How many debits did a debtor agreeing to the above sketched plan pre-authorize? Not less than thirteen.

They will frequently be very surprised to learn that, and they will be frequently surprised when their financial institution backs the debt collector, who often has a sudden fit of competence and manages to record this part of the conversation.

The amount of gamesmanship that debt collectors get up to regarding payments could use its own column. The verbal authorization to debit your account (“payment plan”) was probably silent on timing, so they will use their substantial experience in dealing with people in poor economic circumstances to target the dates and times of day when benefits payments or paychecks have posted to your account. They’ll surge collection attempts at 3 AM on the 1st of the month, learn the differences between various banks as to when Social Security payments post, etc. They’ll also do things like e.g. splitting the agreed upon payment into smaller payments, with the goal of getting at least one rather than having the payment declined for insufficient funds (NSF, in financial industry parlance). This has frequently magnified fees assessed by banks to debtors, because NSF fees are frequently assessed per-occurrence.

Why does this continue being so broken?

Incentives rule everything around us. The structure of the industry, technical issues, and similar alluded to above cause most of this, and they have continued causing it despite decades of effort to correct.

There are also human capital issues at play. Discussing them is a bit difficult, because the people who physically make phone calls for debt collectors share many of the life challenges of debtors as a class. They are poorly educated, poorly paid, poorly managed, and churned through viciously. The work is soul crushing; turnover at the large firms is 75-100% annually. Call centers are already generally a high-stress, terrible working environment even when one is doing routine customer service or order entry work; a debt collector is the type of call center worker that no one wants to talk to. Successful debt collectors need to both harden their hearts against tales of woe (and personal abuse) from debtors and also successfully execute on some combination of moral suasion and threats to eke out a few percentage points at the margin in collections. Success in the field is the difference between e.g. 7% and 8% collection.

Few competent people remain in this field over an extended period of time; an effective, morally upright debt collector would be a better telephone sales rep at a tenth the stress and two to five times the total compensation. As a result, most calls being made today are not by effective, morally upright debt collectors. Illegal threats may be more effective than diligent suasion and management frequently, through incompetence or careful refusal to watch the sausage being made, ignores that collectors are making threats but tracks per-collector productivity very carefully. Solve for the equilibrium.

As a former advocate, I’d report that it is never in a debtor’s interest to verbally speak to a debt collector under any circumstances. One’s likelihood of being abused or lied to, including in financially consequential fashions, is high, and one’s ability to counter that is minimal. Instead, force them to do all correspondence on paper, where lies are self-documenting, illegal threats are immediately admissible to regulatory processes or court, etc.

The incentives and hiring pool available to debt collection firms cause them to put most of their limited competence into scaling phone teams and very little competence into individualized written correspondence. That would require them to successfully keep a folder about a debtor for a month and route communications to the desk with that folder; this is an edge case for them and uneconomical to do at the hundreds of dollar range. This means they will, through a combination of incompetence and strategic decisions by management, frequently simply abandon collection activity where that would require them to read and write.

Suing people with robots

Most debts are not litigated, but various debt collection firms have various strategies here. Almost no consumer debts are worth serious amounts of professional attention, but above about $1,000 or so (depending heavily on jurisdiction), they can be worth doing high-frequency lawyering on.

Basically, the debt collector will either itself or, through use of a law firm, file hundreds or thousands of lawsuits in a single court against its roster of uncollected debtors. Those lawsuits will be entirely templated. A frequent detail that emerges in news reporting is that they’ll often be physically robosigned, so that the relevant lawyers don’t give themselves repetitive stress injuries by needing to affix their name to all of the things they are swearing to under penalty of perjury.

You might have a view of the judicial system where two highly educated advocates joust in front of a neutral finder of fact like a judge or jury. This ain’t that.

The goal of this business process is generating so-called default judgements. They’re both judgment that a default happened and also the judgment that happens by default; the overwhelming case for issuance is when one party is summoned to court and does not show up. Many debtors will ignore correspondence about court cases believing that ignoring them will make the problem go away; this is the opposite of the truth. Many will lack transportation, not be able to take off work, etc. In any event, filling 100 court cases means that, in expectation, your lawyer will collect 60-95 default judgements or more. Not a bad day’s work.

Default judgements turn a debt that hasn’t been collected voluntarily into a financial asset with value. They can be used to garnish the contents of bank accounts or wages paid to debtors, in many jurisdictions. For debtors who own property, which is a fact pattern that occurs much more commonly than you probably would guess, a default judgment can frequently be turned into a lien against the property. This swaps an unsecured consumer debt for a senior claim against the debtor’s home equity. That claim is itself salable into an ecosystem of lien investors, and the debt collector will frequently sell it for (say) 80 cents on the dollar, realizing a profit over their low basis in the debt and collection costs.

Should a debtor actually show up to the courthouse, the lawyer will almost invariably offer an on-the-spot settlement. Fifty cents on the dollar seems to be popular, anecdotally. Avoid the expense and stress of a legal proceeding, etc etc, this is obviously incentive compatible.

When debtors actually contest their debts, or have competent legal representation, the debt collectors frequently get beaten like drums. Many judges take an unsurprisingly dim view of lawyers who profess to have personal knowledge of the facts of the case then can’t locate the contract they are suing over. (Again: they do not and never did possess a copy of the contract. The lawyer does not actually know any facts of the debt other than that the firm purchased a name, address, and perhaps a Social Security number in a CSV file. They don’t have the contents of any previous correspondence about the debt, owing to some combination of incompetence and unwillingness to present evidence of crimes in court.) Then comes some gamesmanship, where the debt collector will attempt to ask for an extension to get their paperwork in order and the debtor’s attorney will push for dismissal, claims under the FDCPA and similar, and costs.

This makes for good human interest pieces occasionally, but the economics make the lawsuit machine very profitable to run even accounting for losses, and accordingly it continues robosigning cases by the tens and hundreds of thousands.

What can be done about this?

Many people have suggestions for obvious improvements here, which might rhyme with the Federal Trade Commission’s suggestions from 2010 or the Consumer Financial Protection Bureau’s spate of rulemaking from 2021 through 2023 or the FDCPA from 1978.

I’ll leave rulemaking to the rulemakers, as this essay has gone on long enough. The state of reality is very bad, not because any single person woke up this morning attempting to maximize evil, but because a complex interaction of structural factors over multiple different parts of society got us to where we are.

Untangling that Gordian knot is hard and has empirically eluded us.