November 18, 2015

The Unintended Consequences of CFPB Debt Reform

Todd Zywicki

George Mason University Foundation Professor of Law, Antonin Scalia Law School, George Mason University
Summary

While we can be confident that new regulations for the debt collection industry are on the way, it's not yet clear whether those regulations will help or harm consumers. The result is largely dependent upon the Consumer Financial Protection Bureau (CFPB), which has the opportunity to either help facilitate open, constructive communication between consumers and debt collection firms, or to saddle the industry and consumers with hasty regulations that result in unintended consequences.

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While we can be confident that new regulations for the debt collection industry are on the way, it's not yet clear whether those regulations will help or harm consumers. The result is largely dependent upon the Consumer Financial Protection Bureau (CFPB), which has the opportunity to either help facilitate open, constructive communication between consumers and debt collection firms, or to saddle the industry and consumers with hasty regulations that result in unintended consequences.

The CFPB so far appears to be pursuing debt collection regulatory reform through the normal regulatory process, receiving more than 20,000 public comments in the wake of their proposal last year, and is surveying consumers about their experiences with debt collection. In addition to those laudable efforts, policymakers would do well to consider the lessons that can be learned from studying the historical legal and economic framework of consumer debt collection regulation.

As the CFPB contemplates new rules, it should remember that that consumer debt collection has been heavily regulated for decades at both the state and federal level. While the debt collection process is certainly not a pleasant experience, the worst practices of the industry's past have generally been outlawed. Because of that, the CFPB should prioritize comprehensive regulatory impact analysis to determine whether the costs of additional regulatory burdens imposed on the industry will outweigh the limited marginal benefits.

Fair and effective protections against fraudulent and abusive practices by debt collectors can help consumers by making them more willing to borrow without fear of harsh collection practices. To be willing to make a loan, however, lenders must be able to price the risk of the loan accurately (through the interest rate on the loan and other terms) or reduce their risk of loss (such as by lending less to riskier borrowers). Poorly designed or overzealous regulation of collection practices can result in higher interest rates or a reduction of access to credit for consumers. Those consumers who are deemed to be the riskiest borrowers (often lower-income consumers) will be the first to be denied credit, or will be priced out of their first-choice credit options. Since those consumers will still have a need for credit, that means forcing them to use less-preferred and more expensive options like payday lending or auto-title loans.

Moreover, even those in the collection process can be harmed by poorly designed regulation, particularly those that limit communications between creditors and debtors, by leading to more lawsuits against consumers. Changing technology has created a number of ways in which consumer debt collectors might communicate more efficiently and proactively with those facing unpaid debts, which can lead to voluntary dispute resolutions.

Lawsuits are expensive and unpleasant, for both consumers and firms, but if the less costly methods of achieving a debt resolution are removed or further limited via new regulations, we should expect firms to turn to courts more quickly in the debt collection process. Consumers may not even know that it would have been possible to achieve a resolution out of court if firms are barred from communicating with them.

This is certainly not to say that the CFPB can or should do nothing.

Today's debt collection rules were designed in an era when most communications were through landline phones and snail mail. Modernizing the rules governing consumer debt collection to enable firms to work constructively with consumers, such as allowing more flexibility to contact consumers by email and cell phone, while still protecting consumers' privacy could substantially improve the circumstances of consumers currently going through a debt collection process and those in need of access to reliable credit in the future.

The CFPB should go about doing so carefully, however. There are decades of empirical research on the economic trade-offs involved in these regulatory decisions, and what initially looks like a well-meaning rule to protect consumers can quickly turn into a host of unintended consequences that hurt the most vulnerable.