The CFPB Squeezes the 'Choke Points.'

The Consumer Financial Pro­tection Bureau just celebrated its fifth anniversary by releasing an outline for new debt collection rules that will encourage consumers to avoid paying their debts.

Nobody likes the stereotypical debt collectors who threaten and harass consumers, but neither the CFPB nor its new rules offer much protection against these shady characters. The bureau's reluctance to investigate sleazy, small-time debt collectors relegates tens of thousands of their victims to its Internet complaint database. Ironically, the CFPB uses the inflated complaint statistics it gathers there to justify new regulations aimed at big companies that buy delinquent debt portfolios.

In 2012, as a CFPB enforcement attorney, I was assigned to lead one of the bureau's first two debt-collection investigations. The targets were chosen only because they were the country's largest debt buyers and collectors. The CFPB's strategy was, and still is, to produce dramatic headlines by suing "choke points"—i.e., the leading firms in every consumer financial business.

The Dodd-Frank law that created the CFPB armed it with a Stalinesque administrative process that guaranteed these two unlucky firms would fork over tens of millions of dollars in fines. After three years of futile protests, both agreed to the same penalty the bureau charges almost all its investigation targets—the maximum they could afford to pay. CFPB enforcement attorneys demand detailed financial information from every target for the sole purpose of calculating that figure.

The investigations had an even more cynical objective. Both companies' settlements required them to adopt expensive procedures that the CFPB wanted to impose on the entire industry. Thus, the two debt collection giants could be counted on to support inefficient regulations so as to level the playing field with their competitors.

The other attorney assigned to my investigation had spent many years representing debtors in collection lawsuits. He told me he had no regrets about exploiting legal loopholes to help his clients escape valid debt obligations, because they needed the money more than their creditors. The CFPB's likeminded leaders later promoted him to a senior policy position.

My friend's progressive sentiments may be defensible, but not his economics. In competitive industries, companies don't earn above- or below-average profits, or suffer losses, for long. Lenders ultimately pass increased default and operating expenses on to borrowers by charging higher interest rates. When some consumers dodge lawful debts, all consumers pay the price.

There are two types of debt collection problems. The first is classic bad behavior—using harassment, intimidation, and deception to collect valid debts. These tactics may increase collection rates and reduce litigation, but any benefits are offset by societal harm. Congress struck a balance in the 1977 Fair Debt Collection Practices Act, which outlawed the most abusive practices.

The FDCPA, which predates cell phones, text messages, and email, needs to be updated. However, CFPB director Richard Cordray's promise to "put consumers in control of their communications with collectors" goes much further. For example, one proposal to let debtors end all future telephone communications by asking any collector to stop calling is comically naïve. While technology has changed dramatically since 1977, human beings have not. Debtors still try to avoid collectors; unreasonable communication restrictions inevitably lead to unnecessary lawsuits and damaged credit reports.

The second type of problem—attempted collection of invalid debts—is more serious. Many credit card issuers, medical providers, and other businesses sell their customers' unpaid account balances to collectors. But the account data may be inaccurate. Debtors may have provided false information, moved, or died. Sometimes they made payments that were not recorded. Debt buyers collect on some of the accounts, and in turn often resell the rest. With each resale, the accuracy and collectability of the portfolios decrease. The lowest quality debt collectors tend to buy the lowest quality debt.

Nobody should be charged, harassed, or sued for a debt they've already paid or for someone else's debt. However, the CFPB's proposed solution is a hopelessly complex system of debt validation requirements and procedures—with rounds of notices, statements, information requests, and document transfers between debtors, creditors, and debt collectors. The new rules will create so many loopholes that debtors with lawyers half as clever as my former colleague will never pay a dime, and may even get rich suing collectors.

The CFPB could prevent mistaken debt collection attempts far more effectively and efficiently by creating and maintaining a central debt registry, much like those that record deeds, mortgages, and other real property interests. Before any sale to collection agencies, the original creditors would have to sufficiently validate and register debts. Each debt would have only one owner, and owners would have to update the registry to reflect any payments or resale of the debt.

By enabling easy debt verification, a registry would eliminate most mistaken collection attempts, spare judges hours of document review, reduce litigation costs, and facilitate criminal prosecution of those who engage in abusive attempts to collect invalid debts.

The CFPB won't consider the debt registry solution for two reasons. First, like the bureau's Internet complaint database, it would be a big project. The agency might have to repurpose the tens of millions of advertising dollars it spends promoting itself each year. Second, the registry would eliminate uncertainty and make it harder for consumers to avoid paying legitimate debts. Heaven forbid.

By Ronald L. Rubin