Let's Talk About Debt Buyers..

[kornellred]

I've heard it said that large banks are increasingly opting for selling bad debt to "debt buyers", typically after 6 months of unsuccessful in-house collection efforts.
People on this forum have complained about a firm named NCO - still the largest of the debt buying entities despite burgeoning competition but possibly in danger of being knocked out of the number 1 spot.

In doing research at the Wikipedia website, I have gathered the following (hopefully correct) information:

1. When the party of the first part (the lending bank) sells the "debt" to the debt buyer (third party), the debtor (party of the second part) no longer owes anything to the original lender. They could not accept any money from the debtor, even if the debtor wanted to pay. The debtor owes no money to the original creditor. It's over and done with, forever.

2. The debt buyer purchases the bad debt for between 3 and 16 cents on the dollar, typically. In a side note, it was stated that because of the economic downturn of 2008, the typical purchase price of the debt is 7 to 9 cents on the dollar.

OK. Let's say that a debtor owed (past tense) Big Bank A $20,000. A debt buyer buys the debt from Big Bank A for $1,500. This gives the debt buyer the right to try and collect the $20,000 debt that the debtor no longer owes to Big Bank A.

Debtor files for BK under Chapter 13. Debt buyer submits claim for $20,000 to BK court (plus expenses and fees). Debtor pays - let's say - $100 per month for 36 months. Trustee gets 10% - subtract $360 and over the length of the Chapter 13 plan the debt buyer gets $3240. (debtor paid the attorney up front).

Debt buyer gets $3240 on a $1500 investment. Try doing that in the stock market! And that's a guaranteed return on investment - practically no risk involved.

I say it's a win-win-win situation. Big Bank A wins because they collected a fast $1,500 on the bad debt, got the tax write-off, and besides, they were insured against loss to begin with. The debt buyer wins because the business is incredibly lucrative by default! (pun intended) And the debtor wins because Chapter 13 BK allows the debtor to escape the interminable burden of high-interest unsecured debt.

John Maynard Keynes and Milton Friedman are either turning over in their graves or clapping their bony hands in awe of my ostensible insight.

[ready2puke]

So what happens when the 13 is a 7?????? A big fat ZERO !! Unless the Junk buyer gets the creditor to pay them something..

[justbroke]

So what happens when the 13 is a 7?????? A big fat ZERO !! Unless the Junk buyer gets the creditor to pay them something..

Most of the "trafficking in Bankrtupcy claims" occur during Bankruptcy (post-petition). The original creditor knows they may get nothing... the junk buyer knows they could get it all. It's a gamble, and they actually look at your Plan to see what percentage you are paying...

Bankruptcy Junk Buyers will only buy Chapter 13 debt. It can be a windfall for them. Example, in a Chapter 13 you have to pay back a certain amount to creditors based on a.) your disposable monthly income, and b.) at least as much as they would have received in a Chapter 7 liquidation (this is what most people forget!!!). So for the junk buyer, who sees your plan at 80%... wow... they have an almost guaranteed 80% payment.

If your case gets dismissed, they just come for a judgment anyhow.

[keepmine]

they were insured against loss to begin with.

How do you figure they were insured?

[kornellred]

Note for keepmine - default by way of bankruptcies notwithstanding - banks buy insurance on their accounts receivable as a matter of common business practice. So there is no way that a bank can "lose" money in the event of non-payment. The bank can only "not realize" the profit they expected to make. And don't forget - when a bank loans you money, they are not taking money out of their on-hand reserves. They are literally creating the money they lend you out of thin air. The Federal Reserve Act allows banks to lend 10 times the amount of money that they have in reserve.

That's how I figure the banks were insured to begin with. Because they were.

[Never_Again]

That's how I figure the banks were insured to begin with. Because they were.

You are right on the 10% reserve matter, and that is how banks create money out of thin air. However, sooner or later the losses to have to be accounted for. That is per the Sarbanes Oxley act (which is part of what is causing all of the uproar in the market place... some securities (some of which are subprime loans) have to be accounted at a lower value than they actually are.

A JDB in a chapter 13... you have a point. However, it is not guaranteed money. The debtor could file for or convert to a chapter 7. They could die. And, if the case is dismissed, they could then try to collect.

Also, I would imagine that the debt of pro-se filers might be worth more, before discharge. Picture this... a person files pro-se and includes XYZ credit card. Right after the person files, XYZ sells their $1000 account to ABC Junk Debt buyer for $70.00. Two days before discharge, ABC files a motion to object to discharge on the $1000 debt. The Pro-Se filer, who may not be as well versed in the laws, contacts ABC to talk about this. ABC says that they are going to object to the discharge, and take it to court, but they will offer the Pro-Se filer a settlement in full for just $200.00. Pro-Se filer may be terrified of going to court, being relatively underinformed, and just pays the money. ABC has made a profit of $130.00.

In addition to pro-se filers, this may also work with any of the lawyers that I read about on this board. The lawyer tells them that they are going to want $1000 to argue this case, so the person settles on the $200, because it makes economic sense.

My lawyer has already told me that for someone to successfully object to any of our debts being discharged, they have to prove fraud. Normally, he said fraud is very difficult to prove, but bankruptcy court requires "clear and convincing evidence," and my lawyer says that this is the second highest standards of evidence, and is very difficult to prove. In addition, if they are not successful, they are liable the debtor's legal fees.

So, the debtor in our case files a response through his lawyer.

Now, ABC is looking at loosing and having to possibly pay $1000 to $2000 in legal fees. The risk is no longer acceptable to them, and they dismiss.

I hope that this has made sense, but it seems to be a very realistic way that a JDB might purchase bankrupt (but not discharged) debt.

And, even after discharge, they might list it with a CA again, and someone who is trying to "re-build their credit" might just settle and pay it to make it go away.

So, I guess bankrupt debt does have value to these guys... right or wrong.

[justbroke]

Correction: I was thinking about final discharge.

I think that Objections To Confirmation and Dischargeability in Chapter 13 are time barred. You only have 60 days after the 341 to do this. They can't ambush you in month 58 of a 60 month plan.

[justbroke]

... but they will offer the Pro-Se filer a settlement in full for just $200.00. Pro-Se filer may be terrified of going to court, being relatively underinformed, and just pays the money. ABC has made a profit of $130.00.

And let me add this.

This practice, mentioned, would be 110% illegal and a full and willful violation of the Automatic Stay. No company in their right mind would even think of threatening to sue or collect a debt that's scheduled in a Bankruptcy.

Even if the debt is disputed and being litigated in an Adversarial Proceeding, the Automatic Stay is in effect. As a point of fact, then an AP begins to determine dischargeability or a motion for Relief from Stay... the Stay is automatically continued and in full force for the duration of the proceedings.

I would absolutely LOVE some company like your ABC to try this on me.

[keepmine]

Note for keepmine - default by way of bankruptcies notwithstanding - banks buy insurance on their accounts receivable as a matter of common business practice

This isn't true at all. If banks were insured against losses from loans then, there would never be any need to establish a reserve for accounts that are chargedoff. No need to staff and run a collection dept. No need for a massive gov't bailout.

[kornellred]

Banks do not lose money on loans unless their reserves begin to dwindle. Banks insure each other. And yes, Virginia, there IS such a thing as accounts receivable insurance.

I thought that this thread would precipitate a bit of disagreement - in fact, I hoped it would. This is a good way to stimulate interest in how the banking system actually works at the "Joe The Plumber" level. Nobody - not even the bankers themselves, fully understand the situation anymore - that's why the overall situation has gotten out of hand. I think that so far they have figured out that finance is a game of musical chairs - when the music stops whoever is left standing is out.

Just don't believe for a minute that personal bankruptcies, either Chapter 7 or Chapter 13, have any significant bearing upon the banking industry overall.

[keepmine]

Banks do not insure each other.
A loss is a loss. If there was such a thing as insurance against bad loans, shareholders of Wamu and IndyMac wouldn't be wiped out.
If you think for a second that there is no risk to lenders because the loans are insured, why do banks spend millions every year staffing collection and legal depts? Why even have loss mitigation depts? Why spend millions every year tweaking credit scoring models to try and figure out how to minimize lending risk. Just file an insurance claim.
i've seen threads like this pop up from time to time on other sites and the purpose seems to be "lets not feel bad about defaulting because, the banks didn't reallly lose money". That just defies reality. In any lending proposition, their is risk to the lender and risk to the borrower and sometimes, those risks are realized for both parties.
As to losses from bk. I have no idea what the total affect is on lenders. But, it does not matter if someone files bk or, just defaults and walks away-the lender takes a loss and, that loss is real.

[WhatMoney]

I don't know how "banks insure each other" for unsecured credit card debt. They usually set aside loss reserves for credit card losses. Only if the bank reserves drop below a required level is the bank taken over by FDIC or other more solvent banks. So far the bank CC losses have been minor compared to the subprime mortgage instrument losses.

But there is an type of insurance against bad loans used for large loans and securitized debt between major banks. This insurance was supposed to reduce risk against the subprime securitized packages (putting lipstick on a turd and calling it a rose) that were magically sliced and diced in to AAA-rated investments and sold to the world. This insurance is called CDS or Credit Default Swaps. Newsweek had a good article on these a few weeks ago:

The Monster That Ate Wall Street
How 'credit default swaps'—an insurance against bad loans—turned from a smart bet into a killer.

by Matthew Philips
NEWSWEEK Oct 6, 2008

They're called "Off-Site Weekends"—rituals of the high-finance world in which teams of bankers gather someplace sunny to blow off steam and celebrate their successes as Masters of the Universe. Think yacht parties, bikini models, $1,000 bottles of Cristal. One 1994 trip by a group of JPMorgan bankers to the tony Boca Raton Resort & Club in Florida has become the stuff of Wall Street legend—though not for the raucous partying (although there was plenty of that, too). Holed up for most of the weekend in a conference room at the pink, Spanish-style resort, the JPMorgan bankers were trying to get their heads around a question as old as banking itself: how do you mitigate your risk when you loan money to someone? By the mid-'90s, JPMorgan's books were loaded with tens of billions of dollars in loans to corporations and foreign governments, and by federal law it had to keep huge amounts of capital in reserve in case any of them went bad. But what if JPMorgan could create a device that would protect it if those loans defaulted, and free up that capital?

What the bankers hit on was a sort of insurance policy: a third party would assume the risk of the debt going sour, and in exchange would receive regular payments from the bank, similar to insurance premiums. JPMorgan would then get to remove the risk from its books and free up the reserves. The scheme was called a "credit default swap," and it was a twist on something bankers had been doing for a while to hedge against fluctuations in interest rates and commodity prices. While the concept had been floating around the markets for a couple of years, JPMorgan was the first bank to make a big bet on credit default swaps. It built up a "swaps" desk in the mid-'90s and hired young math and science grads from schools like MIT and Cambridge to create a market for the complex instruments. Within a few years, the credit default swap (CDS) became the hot financial instrument, the safest way to parse out risk while maintaining a steady return. "I've known people who worked on the Manhattan Project," says Mark Brickell, who at the time was a 40-year-old managing director at JPMorgan. "And for those of us on that trip, there was the same kind of feeling of being present at the creation of something incredibly important."

Like Robert Oppenheimer and his team of nuclear physicists in the 1940s, Brickell and his JPMorgan colleagues didn't realize they were creating a monster. Today, the economy is teetering and Wall Street is in ruins, thanks in no small part to the beast they unleashed 14 years ago. The country's biggest insurance company, AIG, had to be bailed out by American taxpayers after it defaulted on $14 billion worth of credit default swaps it had made to investment banks, insurance companies and scores of other entities. So much of what's gone wrong with the financial system in the past year can be traced back to credit default swaps, which ballooned into a $62 trillion market before ratcheting down to $55 trillion last week—nearly four times the value of all stocks traded on the New York Stock Exchange. There's a reason Warren Buffett called these instruments "financial weapons of mass destruction." Since credit default swaps are privately negotiated contracts between two parties and aren't regulated by the government, there's no central reporting mechanism to determine their value. That has clouded up the markets with billions of dollars' worth of opaque "dark matter," as some economists like to say. Like rogue nukes, they've proliferated around the world and now lie hiding, waiting to blow up the balance sheets of countless other financial institutions.

It didn't start out that way. One of the earliest CDS deals came out of JPMorgan in December 1997, when the firm put into place the idea hatched in Boca Raton. It essentially took 300 different loans, totaling $9.7 billion, that had been made to a variety of big companies like Ford, Wal-Mart and IBM, and cut them up into pieces known as "tranches" (that's French for "slices"). The bank then identified the riskiest 10 percent tranche and sold it to investors in what was called the Broad Index Securitized Trust Offering, or Bistro for short. The Bistro was put together by Terri Duhon, at the time a 25-year-old MIT graduate working on JPMorgan's credit swaps desk in New York—a division that would eventually earn the name the Morgan Mafia for the number of former members who went on to senior positions at global banks and hedge funds. "We made it possible for banks to get their credit risk off their books and into nonfinancial institutions like insurance companies and pension funds," says Duhon, who now heads her own derivatives consulting business in London.

Before long, credit default swaps were being used to encourage investors to buy into risky emerging markets such as Latin America and Russia by insuring the debt of developing countries. Later, after corporate blowouts like Enron and WorldCom, it became clear there was a big need for protection against company implosions, and credit default swaps proved just the tool. By then, the CDS market was more than doubling every year, surpassing $100 billion in 2000 and totaling $6.4 trillion by 2004.

And then came the housing boom. As the Federal Reserve cut interest rates and Americans started buying homes in record numbers, mortgage-backed securities became the hot new investment. Mortgages were pooled together, and sliced and diced into bonds that were bought by just about every financial institution imaginable: investment banks, commercial banks, hedge funds, pension funds. For many of those mortgage-backed securities, credit default swaps were taken out to protect against default. "These structures were such a great deal, everyone and their dog decided to jump in, which led to massive growth in the CDS market," says Rohan Douglas, who ran Salomon Brothers and Citigroup's global credit swaps research division through the 1990s.

Soon, companies like AIG weren't just insuring houses. They were also insuring the mortgages on those houses by issuing credit default swaps. By the time AIG was bailed out, it held $440 billion of credit default swaps. AIG's fatal flaw appears to have been applying traditional insurance methods to the CDS market. There is no correlation between traditional insurance events; if your neighbor gets into a car wreck, it doesn't necessarily increase your risk of getting into one. But with bonds, it's a different story: when one defaults, it starts a chain reaction that increases the risk of others going bust. Investors get skittish, worrying that the issues plaguing one big player will affect another. So they start to bail, the markets freak out and lenders pull back credit.

The problem was exacerbated by the fact that so many institutions were tethered to one another through these deals. For example, Lehman Brothers had itself made more than $700 billion worth of swaps, and many of them were backed by AIG. And when mortgage-backed securities started going bad, AIG had to make good on billions of dollars of credit default swaps. Soon it became clear it wasn't going to be able to cover its losses. And since AIG's stock was one of the components of the Dow Jones industrial average, the plunge in its share price pulled down the entire average, contributing to the panic.

The reason the federal government stepped in and bailed out AIG was that the insurer was something of a last backstop in the CDS market. While banks and hedge funds were playing both sides of the CDS business—buying and trading them and thus offsetting whatever losses they took—AIG was simply providing the swaps and holding onto them. Had it been allowed to default, everyone who'd bought a CDS contract from the company would have suffered huge losses in the value of the insurance contracts they hadpurchased, causing them their own credit problems.

Given the CDSs' role in this mess, it's likely that the federal government will start regulating them; New York state has already said it will begin doing so in January. "Sadly, they've been vilified," says Duhon, who helped get the whole thing started with that Bistro deal a decade ago. "It's like saying it's the gun's fault when someone gets shot." But just as one might want to regulate street sales of AK-47s, there's an argument to be made that credit default swaps can be dangerous in the wrong hands. "It made it a lot easier for some people to get into trouble," says Darrell Duffie, an economist at Stanford. Although he believes credit default swaps have been "dramatically misused," Duffie says he still believes they're a very effective tool and shouldn't be done away with entirely. Besides, he says, "if you outlaw them, then the financial engineers will just come up with something else that gets around the regulation." As Wall Street and Washington wring their hands over how to prevent future financial crises, we can only hope they re-read Mary Shelley's "Frankenstein."

http://www.newsweek.com/id/161199

[domaingamer]

"Soon, companies like AIG weren't just insuring houses. They were also insuring the mortgages on those houses by issuing credit default swaps. By the time AIG was bailed out, it held $440 billion of credit default swaps. AIG's fatal flaw appears to have been applying traditional insurance methods to the CDS market. There is no correlation between traditional insurance events; if your neighbor gets into a car wreck, it doesn't necessarily increase your risk of getting into one. But with bonds, it's a different story: when one defaults, it starts a chain reaction that increases the risk of others going bust. Investors get skittish, worrying that the issues plaguing one big player will affect another. So they start to bail, the markets freak out and lenders pull back credit."

Very well written paragraph. Because these credit default swaps tied all these companies together, once you started unraveling one company and allowing it to fail (see Lehman Bros) then you started a huge avalanche of problems for all the companies that had related debt. I don't think our government fully grasped the enormity of the problem initially and how intertwined everyone was, now they seem to be getting the picture quite clearly.