Mandating Information Disclosure vs. Banning Deceptive Contract Terms

Software EULAs are also generally considered evil. On my part, I generally click "accept" with no intention of abiding by any restriction they mention unless I'm actually threatened with a lawsuit. And, because a clever lawyer can find a justification for anything, I can argue that "copyright misuse" renders EULAs unenforcable. ;)

sorry to put on my libertarian helm here but...

may end up getting overzealous and interfering in ways that will have unintended and negative consequences

may? MAY?!. read some history. how about 100% of governments throughout all of recorded history? how's that for may?

There seems to be a believe hidden there that government just needs to declare something illegal in order for it to disappear. However each law is just an invitation to find loopholes. There is ample evidence in Europe that regulations do not work.

In Germany we have so many laws that nobody can ever hope to know all that is or is not legal. So whenever any government starts to regulate the market in order to prevent deliberately confusing contracts, it will end only when the law is so complex that there are no more simple contracts because all of the law is implicitly part of any contract.

The only protective measure government must take is a divorce right. There must always be a way for any party in a contract to leave that contract with a jury deciding on just compensation for gained benefits or caused costs. Anything beyond that is a recipe for disaster.

The standard argument is that if two parties voluntarily agree to a deal, then they must be better off with the deal than without it, otherwise they wouldn't have agreed. And if the terms of that deal don't harm any third parties, then the deal must be welfare-improving, and any regulatory restrictions on making it must be bad.

[. . .] Think about the controversial terms often found in credit card contracts, such as provisions by which being one day late with a payment or being one dollar over your credit limit jumps your interest rate to 29.99% forever, or in which cards with multiple balances at different interest rates pay off the low rate balance first. [. . .] Have you ever heard of such terms being in contracts negotiated between sophisticated parties? Shouldn't this cause you to be much less worried about the consequences of simply banning them?

Another way to think about this might be to ask which is cheaper:

• For credit service consumers to spend time and money educating themselves about how to avoid being tricked, and for credit service companies to spend time and money educating themselves about how to trick consumers?
• Or, for a government to spend time and money deciding which contracts with credit service companies will not be enforceable, and for sophisticated parties (who would have educated themselves anyway) to not be able to use those contracts? (And for everyone to spend time and money educating themselves about how to trick citizens into getting the government to regulate contracts in their own favor?)
• (Or, for credit service consumers to spend time and money educating themselves about the need to proxy some of their powers of contract to private organizations which can veto their decisions to be tricked? (And for private organizations to spend time and money educating themselves about how to trick consumers into proxying too much power to them?))

At least in the short run, the government may be a natural monopolist here.

(In a longer run, the culture might change.

Advertising, and manipulations of symbols like the American flag, seem much less effective on today's Americans than on Americans of a hundred years ago. But are the differences a gain or a loss? Are our thoughts richer from improvement in collective epistemology, now that advertisers (and politicians) have exploited our irrationalities and removed some of them? Or are we experiencing extra overhead at the margin of bounded rationality, and it's just that the higher costs from more effort (and more learned jadedness) pass beneath our moral notice because they are part of the background, just like so many dust specks in the eye?

When I try to think about arguments about advertising regulation, it feels like a game of "accusation-of-rent-seeking tennis" between consumers and advertisers: "You think that any exploitation is okay, as long as it wouldn't take infinite computing power to avoid!" "You are making the insane demand to be freed from needing to think!")

I'm not an economist, but pages 32-33 of David D. Friedman's "Law's Order", about the social burden from pickpocket training and anti-pickpocket precautions, seem related.

A person who was aware that they might succumb to being tricked, might voluntarily agree to a legal regime which authorized judges to void contracts that seemed to be attempts to trick them. On the other hand, if they were not aware of this vulnerability, one might benefit them by forcibly preventing them from being tricked. But it is hard to see how a political regime which does this to them is accountable to such folks. If they had influence over the political system, they would want it to stop this sort of thing. It would have be that other people who had power over politics wanted for force this protection onto them. This brings us to an image of a powerful political elite forcing their protections on unwilling others, for the good of those others. Is this how you see politics?

This house would limit all contracts to 140 characters.

Interesting, but I'd like to see you expand on exactly the rationality mechanisms by which people get "tricked" by these contracts, and what kind of rules you might use to classify a contract as "trickery" versus "I wouldn't take it, but another reasonable person might."

I don't see a qualitative difference between a case like "Let's ban outrageous interest on credit card loans because rational people wouldn't accept this", "Let's ban certain drugs that we're not sure work because rational people wouldn't use them," and "Let's ban jobs without a certain minimum wage and safety regulations because rational people wouldn't take them". Right now, I judge these cases on a very intuitive "I'll know an irrational contract when I hear it" sort of basis, but the libertarian method of rejecting all of them alike attracts me with its elegance. Does research in this area give any pointers to what standards we would use to discriminate?

Credit Cards vs Payday Loans and Layaway.

I cannot pull out the reference but I have read that consumers are very responsive to credit cards; that those who do not carry balances know little about the rate that they would be charge while they know more about the perks they get from using the card, cash back etc.

It is shown that many of those who carry balances on the cards pick cards with lower rates and move balances when rates rise.

Some get trapped but is this trap worse than payday loans? If one over regulates unsecured lines of credit then the supply of unsecured credit will decrease and those in need of it will resort to black markets. The rate on a CC may be high but is far better than the options available 50 years ago. How can rates be low on a population with high default rates?

See also: confusopoly.

I would entirely agree with you, but if we started mandating certain contracts and banning others, we'd be in great danger of regularatory capture: the banks have a huge incentive to influence the regulators, are staffed by the same people, etc., which would mean we'd end up mandating the exploitative contracts and banning the fairest.

One reason to accept a bad contract is a bad bargaining position...

Suppose the terms "if you are even one day late with a payment, your interest rate jumps to 29.99% forever" are in very large print on the contract, and the cardholder has to read it and initial it (or, perhaps, copy it out in full!) before the card is approved.

And suppose that consumers accept those terms even after understanding them.

Would that weaken your argument?

(The reason I ask: I am fully capable of paying off my balance every month. Sometimes I forget. When I forget, it costs me $80 in interest. I am capable of borrowing money at a rate that would cost me only $10 in interest for that kind of debt.

Therefore, I see the interest I paid as a bit of a "gotcha". But I am willing to accept it. I figure it's part of the cost of the card, that it's going to cost me $80 or so every few years on the rare occasions I forget.

I entered the agreement knowing that was there, and I would do so again. I figure there are indeed people out there who would voluntarily accept the "one late payment and your interest rate is 29.99%" condition too.

Maybe they think they would just apply for a low-interest card and transfer the balance, but, when push comes to shove, they're just too lazy to do that. Or maybe they might figure that other people might forget to pay, but not them. Or maybe a host of other reasons. )

I think it would be an improvement if we could simply get companies to not include already illegal (i.e. unenforceable) clauses. For instance, apartments charging "concession payback" on broken leases, which is really just obfuscatory language for "a fee several times larger than our actual damages on top of the fee for damages". See this, for instance.

If you mandated disclosure and then saw those contracts continuing to exist, the conclusion you should draw was that the disclosure was ineffective, not that the terms were efficient.

Interestingly, this seems to be the logic of the FTC of late; its new guidelines for the use of testimonials take the position that if somebody is convinced by an atypical testimonial that they will get the same results, it doesn't matter that the advertiser never claimed they would or even explicitly said the results were atypical.

(I have mixed feelings about this, since on the one hand I think deception is bad. On the other hand, they seem to be making advertisers responsible for how illogical or self-deluding their customers might be.)

I think there's also a sort of commons problem with disclosure relating to time/attention: for any given 5000-word EULA or warranty or credit card disclosure supplement, it's plausible that someone could have read and understood it. But it's impossible for anyone to function in the modern world and thoroughly review all the information that's "disclosed" to them.

In a perfect theoretical world, this wouldn't be necessary: you would just need a few people to read each standard piece of paperwork and raise hell about particularly unfair or non-market terms, and the rest of us could rely on those signals. For some products, this seems to work well and disclosure is effective at leading to fully-informed transactions. But for many products it doesn't, and credit cards are a great example. Is there a way to better distinguish the products/services where disclosure is effective from the ones where it isn't?

My general theory of credit card contracts is that credit card companies can raise your interest rate to whatever they want simply because they feel like it. (Which is one reason why credit cards really suck.)

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Slow down on the "economists this, economists that" talk. You have highlighted an information asymmetry that economics has been aware of for years. When an unsophisticated party enters negotiations with a sophisticated party they will always come out below, entirely because they do not have the education and background understanding of the product the sophisticated party has. Information is not just the physical terms of the contract, it is the individual's ability to understand these terms.

Whilst government policy economists spit out a regulation and move on with (usually) poor follow up, hundreds of academics will be able to point the obvious flaws in these policies instantly.

You raised a great point that does need to be addressed by policy makers, but I feel you were a little heavy-handed on the dismal science.

-A

Great article. One can even make an analogy between the corporation and a uFAI ( many have argued that the closest thing we have to >human intelligence is a corporation) - the AI/corporation will maximize its profits/utility within the letter - not the spirit - of the rules we create to constrain it.

"""being one day late with a payment or being one dollar over your credit limit jumps your interest rate to 29.99% forever"""

I hear this all the time as an example of wicked behaviour, but I wonder if people have data to back it up. Is there no signal in missing a payment by a few days? I know that if I were to miss a payment, it would be due to some minor issue such as I having been out of town when the bill arrived or such. The credit card company only knows that the payment didn't arrive. Add in a bit of modelling stupidity (having an input boolean variable PAYMENT_LATE into the model) and you might get a jacking up of prices as the rational response.

All my credit cards jacked up their interest rates pre-emptively after the new regulations were announced (not that I have ever carried a balance on any of them). This indicates that it was not only about bait-n-switch (some of those cards, I have had for years).

I am honestly asking for data, not being knee-jerk pro-credit-card-companies.

I asked him if he would be OK letting his then pre-adolescent son make any schoolyard deal he wanted as long as it was not made under any overt threat, and I think (but am not totally sure) that he has since backed off this position. So there is an argument for purely paternalistic restrictions on freedom of contract.

There may be an argument for purely paternalistic restrictions on freedom of contract but you haven't made it here. You've simply cited an example of getting a friend to accept paternalistic restrictions in a rather literal way (over his actual son), you haven't presented a justification for paternalistic restrictions.

Most legal systems consider that certain categories of people are not capable of entering into legally binding contracts due to not being competent to judge their own interests. Children and the mentally ill are commonly treated this way. Extending the concept of capacity) to the merely unintelligent leads in some troubling directions.

How does the theory of voluntary transactions account for, say, Bernie Madoff?