Debt Collection Agencies and the Supply of Consumer Credit:
When the Market Takes Care of Itself
Viktar Fedaseyeu∗
January 14, 2010
Abstract
This is the first paper that studies the role of third-party debt collectors in consumer
credit markets. Using law enforcement as an instrument, I find that effective collections are
associated with an increase in the supply of unsecured credit and have no effect on the supply
of secured credit. I also find that creditors are willing to lend to a larger pool of borrowers
when debt collection capacity increases. Consistent with these findings, they charge higher
interest rates since these new borrowers are likely to be higher risk lower income applicants.
My results contrast and complement the findings from the personal bankruptcy literature and
help explain why creditors may be willing to provide entrance into retail credit markets for
consumers with limited or non-existent credit histories.
∗Email: fedaseye@bc.edu. I am deeply grateful to Phil Strahan for his unwavering support and encouragement
and for the extensive feedback he has provided. I also thank seminar participants at Boston College for their valuable
comments. All errors are my sole responsibility.
1
1 Introduction and review of related literature
What are the mechanisms that ensure creditor protection in retail credit markets?
Debt collection agencies, the focus of this paper, provide one of them. It seems
that we know a lot more about the mechanisms that protect consumers than about
the mechanisms that enable creditors to ensure the repayment of debts. Arguably,
however, the latter are just as important as the former in determining the structure
of retail credit markets and the pricing of consumer credit since credit would not
exist without creditors.
Consumers are the driving force of the U.S. economy. The sheer size of consumer
credit markets makes them difficult to ignore. At the time of this writing, the latest
data available from the Federal Reserve’s Flow of Funds were from the second quarter
of 2009. Ac