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How does buying debt from creditors work? Would something like this actually cause buying debt more expensive and thus benefit creditors instead?

by pooyak 14y ago

Volpe 14y ago
Not really, because it could just set a metric on how cheap debt is before it purchases (i.e the 30:1 return they mentioned). In the end creditors want to get rid of risk, so if someone isn't paying the loan, getting 1/30th of that money is better than 0. I don't see how this could create a competitive (and thus drive prices up) situation.
- ISL 14y ago
  If I understand things correctly, it may drive borrowing costs down by lowering the lender's risk exposure. (If you loan money to someone, and they don't pay you back, with this program there's a tiny chance that OWS will, lowering your risk. Curious to see OWS bailing out bankers as well as debtors.)
scrumper 14y ago
Generally, any time there is more demand for something the will increase. OWS entering the market for certain kinds of distressed debt would be expected to increase the price of that debt - the group of buyers in the market has increased by one, so there is more competition for the asset. There is absolutely nothing wrong with this at all. The creditors are simply selling the debt to try and recover something from their original loan; getting more back than the would have a week ago is great. It doesn't matter to them whether the buyer is going to forgive the debt or collect it with men in leather jackets and hammers; they've sold, they've got back a few cents on the dollar and it's not their problem anymore. How does it work? The debt is an asset belonging to the original creditor. To use the $14,000 example in David Rees's post, creditor XYZ made a loan to debtor ABC for, say, $10,000 a few years ago. They made that loan expecting to receive $14,000 back over time - that's why they did it. Now, ABC looks unable to repay the debt. The obligation still exists, but it's no longer practical or profitable for XYZ to try and recover it. XYZ has no men with hammers, no provision for accounting for irregular payments or special arrangements and no real interest in hanging on to this now-useless asset. Luckily for them, there are other companies which do want that asset, but because of the difficulties in collecting on it they're not willing to pay a lot. $500, in this case. It's worth spending $500 with the hope of collecting $14,000; if you spend $500 enough times then you'll eventually get back a few $14,000s and now you have a business. The price reflects the probability of getting that money back. In this case, very, very unlikely indeed, and if something's that cheap on Wall Street then you can be sure nobody wants it. So that debt is bought and sold like anything else, according to the business needs of the various people involved. Your old neighbour's beaten old '68 Mustang might have been a piece of junk to him - it was too rusty to pass inspection - so he sold it for a few thousand, happy to get rid of a problem. To a specialist in vintage Fords, though, that car is worth a lot after they put the work in. In this case there is an opportunity for a body with a bit of spare cash to benefit individual debtors by forgiving their loans, while helping creditors stay in business - and their employees feed their families - by buying their crappy assets at market rates. They are adding both charity and liquidity to a gummed-up market with very real people suffering in it.
- malandrew 14y ago
  Question: If OWS does this often enough to the point it becomes expected by debtors (i.e. "I won't pay because maybe I'll win in the OWS debt lottery"), wouldn't that in effect reduce the number of people that would actually pay back the $14k? And assuming it does have a global effect that should depress the market value of distressed debts further, right? How can OWS depress the probability that creditors will get their money back enough so that the cost of buying debt becomes cheaper?
  - pmorici 14y ago
    At the point that OWS is buying the debt it has likely already effected the individuals credit record and score which would make it much more difficult for the person to get additional credit for some number of years.
  - scrumper 14y ago
    Moral hazard for private debtors, in effect? It's interesting, but OWS would need to be buying a LOT of debt for it to have an effect. It's also quite a bad trade from the point of view of the debtor: if OWS doesn't buy their particular obligation, they are in a world of trouble.
- washedup 14y ago
  True, nothing wrong with this, but a repercussion would be increasing interest rates, which would undoubtedly drive some debtors to default on their loans.
  - scrumper 14y ago
    How so? Making the creditor's loan pool more profitable (by increasing the resale price of defaulted debt) reduces their overall risk, which leads to either more loans being made or a reduction in rates.

How does buying debt from creditors work? Would something like this actually cause buying debt more expensive and thus benefit creditors instead?

by pooyak 14y ago

How does buying debt from creditors work? Would something like this actually cause buying debt more expensive and thus benefit creditors instead?

Volpe 14y ago

Not really, because it could just set a metric on how cheap debt is before it purchases (i.e the 30:1 return they mentioned). In the end creditors want to get rid of risk, so if someone isn't paying the loan, getting 1/30th of that money is better than 0. I don't see how this could create a competitive (and thus drive prices up) situation.

ISL 14y ago
If I understand things correctly, it may drive borrowing costs down by lowering the lender's risk exposure. (If you loan money to someone, and they don't pay you back, with this program there's a tiny chance that OWS will, lowering your risk. Curious to see OWS bailing out bankers as well as debtors.)

scrumper 14y ago

Generally, any time there is more demand for something the will increase. OWS entering the market for certain kinds of distressed debt would be expected to increase the price of that debt - the group of buyers in the market has increased by one, so there is more competition for the asset. There is absolutely nothing wrong with this at all. The creditors are simply selling the debt to try and recover something from their original loan; getting more back than the would have a week ago is great. It doesn't matter to them whether the buyer is going to forgive the debt or collect it with men in leather jackets and hammers; they've sold, they've got back a few cents on the dollar and it's not their problem anymore. How does it work? The debt is an asset belonging to the original creditor. To use the $14,000 example in David Rees's post, creditor XYZ made a loan to debtor ABC for, say, $10,000 a few years ago. They made that loan expecting to receive $14,000 back over time - that's why they did it. Now, ABC looks unable to repay the debt. The obligation still exists, but it's no longer practical or profitable for XYZ to try and recover it. XYZ has no men with hammers, no provision for accounting for irregular payments or special arrangements and no real interest in hanging on to this now-useless asset. Luckily for them, there are other companies which do want that asset, but because of the difficulties in collecting on it they're not willing to pay a lot. $500, in this case. It's worth spending $500 with the hope of collecting $14,000; if you spend $500 enough times then you'll eventually get back a few $14,000s and now you have a business. The price reflects the probability of getting that money back. In this case, very, very unlikely indeed, and if something's that cheap on Wall Street then you can be sure nobody wants it. So that debt is bought and sold like anything else, according to the business needs of the various people involved. Your old neighbour's beaten old '68 Mustang might have been a piece of junk to him - it was too rusty to pass inspection - so he sold it for a few thousand, happy to get rid of a problem. To a specialist in vintage Fords, though, that car is worth a lot after they put the work in. In this case there is an opportunity for a body with a bit of spare cash to benefit individual debtors by forgiving their loans, while helping creditors stay in business - and their employees feed their families - by buying their crappy assets at market rates. They are adding both charity and liquidity to a gummed-up market with very real people suffering in it.

malandrew 14y ago
Question: If OWS does this often enough to the point it becomes expected by debtors (i.e. "I won't pay because maybe I'll win in the OWS debt lottery"), wouldn't that in effect reduce the number of people that would actually pay back the $14k? And assuming it does have a global effect that should depress the market value of distressed debts further, right? How can OWS depress the probability that creditors will get their money back enough so that the cost of buying debt becomes cheaper?
- pmorici 14y ago
  At the point that OWS is buying the debt it has likely already effected the individuals credit record and score which would make it much more difficult for the person to get additional credit for some number of years.
- scrumper 14y ago
  Moral hazard for private debtors, in effect? It's interesting, but OWS would need to be buying a LOT of debt for it to have an effect. It's also quite a bad trade from the point of view of the debtor: if OWS doesn't buy their particular obligation, they are in a world of trouble.
washedup 14y ago
True, nothing wrong with this, but a repercussion would be increasing interest rates, which would undoubtedly drive some debtors to default on their loans.
- scrumper 14y ago
  How so? Making the creditor's loan pool more profitable (by increasing the resale price of defaulted debt) reduces their overall risk, which leads to either more loans being made or a reduction in rates.