Modeling the Revolving Revolution: Debt Collection Channel

Abstract

We investigate the role of information technology (IT) in the collection of delinquent consumer debt. We argue that the widespread adoption of IT by the debt collection industry in the 1990s contributed to the observed expansion of unsecured risky lending such as credit cards. Our model stresses the importance of delinquency and private information about borrower solvency. The prevalence of delinquency implies that the costs of debt collection must be borne by lenders to sustain incentives to repay debt. IT mitigates informational asymmetries, allowing lenders to concentrate collection efforts on delinquent borrowers who are more likely to repay.

Recent Developments in Consumer Credit and Default Literature

“…Dawsey and Ausubel () study the choice between formal and informal bankruptcy, arguing that the two should be thought of as substitutes from borrowers' perspective (they nicely utilize cross‐state variation in garnishment and exemption laws to make that point). Dawsey and Ausubel () think of informal bankruptcy as an absorbing state, and Drozd and Serrano‐Padial () find some support for that view in their analysis of data from Experian – the long‐term default state appears very persistent, with almost 80% of defaulters neither recovering nor filing for bankruptcy in a 2‐year window. By “long‐term defaulter” I am referring to those who have already been in default for 2 years, as opposed to newly delinquent borrowers.…”

“…One other common theme in this literature is the “democratization of credit” (including what Drozd and Serrano‐Padial () call “revolving revolution”) – the extension of credit to new (and seemingly riskier) borrowers in the recent decades. This phenomenon is clearly present in the data, and arises quite naturally in many different models, both in response to various improvements in information technologies (e.g., Sanchez, ; Athreya et al ., ; Narajabad, ; Drozd and Serrano‐Padial, ; Livshits et al ., ) and even in response to lower costs of advancing loans (Drozd and Nosal, ; Livshits et al ., ). The mechanism is usually quite intuitive – lending to the best (safest) borrowers generates the largest surplus, and thus, takes place even when (information) technology is underdeveloped.…”

“…Thus, one result of this quantitative research has been a call for more formal modeling of changes in the consumer debt markets, with a particular emphasis on the impact of the improvements in information technology (IT). And the very active research program that followed (Drozd and Nosal, ; Sanchez, ; Livshits et al ., ; Athreya et al ., ; Narajabad, ; Drozd and Serrano‐Padial, ) is the subject of the next section.…”

“…Another information‐based explanation has recently been advanced by Drozd and Serrano‐Padial () – they point to the IT advancements in the debt collection industry. Unlike the previous studies, which mostly focus on the improvement in the ex ante information available to lenders (based on which loans are advanced), this paper suggests that improvements in the ex post information regarding delinquent borrowers can have similar aggregate implications.…”

“…Second, at any point during delinquency, lenders can pursue collection efforts, which range from repeated phone calls to the borrower to obtaining court judgments allowing the lenders to garnishee the borrower's wages (the importance of debt collection is highlighted in Dawsey et al . (), Chatterjee and Gordon (), and Drozd and Serrano‐Padial ()). The collections can be pursued by the original lender or “outsourced” to one of specialized collection agencies (which typically purchase distressed debt from lenders) .…”