Mandating Information Disclosure vs. Banning Deceptive Contract Terms

post by David_J_Balan · 2009-12-20T20:55:58.088Z · score: 21 (28 votes) · LW · GW · Legacy · 77 comments

Economists are very into the idea of mutually beneficial exchange. 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.

One objection to this argument is that it's not always clear what is and what is not "voluntary." I once has a well-published economist friend argue that there are no gradations of voluntariness: either a deal was made under some kind of compulsion or it wasn't. 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. 

Another objection, one which economists tend to take more seriously, relates to information. Specifically, there is the idea that maybe one party to the contract is not fully informed about its terms. For this reason, many economists are willing to entertain policies by which firms are required to disclose certain information, and to do so in a way that is comprehensible to consumers. So for example we now have "Schumer boxes" that govern the ways in which credit card companies present certain information in promotional materials. This seems to many people to be a reasonable remedy: if the problem was that one side of the transaction was ignorant, then a regulation that eliminates that ignorance, while at the same time not interfering with their freedom to engage in mutually beneficial exchange, must be a good thing.

I think this reasonable-sounding position is largely wrong. The standard asymmetric information stories with rational agents are stories in which the uniformed party knows that it is uninformed, which influences the contract terms that it is willing to accept, which in turn either causes beneficial exchange not to happen (the "lemons" problem) or causes contract terms to be distorted away from the efficient ones. They are generally not stories about uninformed consumers not understanding that they are uninformed and blithely marching into traps as a result. But this is what we actually see all the time, one party tricks the other party into unfavorable terms. Indeed, very often this is the real-world problem to which providing better information is supposed to be the solution! But for trickery to be the problem, you usually need a model in which some agents suffer from some limitation on their rationality, such as myopia.** And if you have that, then you have a different problem from the problem of asymmetric information, and there is no particular reason for a different problem to have the same solution. If the problem is that people are getting tricked, then providing more information is only going to help if it is going to cause them not to be tricked, and it is not at all obvious whether and when this will be the case.

But there is a bigger problem with the standard way that economists usually think about these problems, which is that they completely ignore the fact that when people are being tricked, the virtues of voluntary exchange are absent and so there is no reason for a strong presumption against interfering with it in the first place. And sometimes the very existence of certain contract terms is an indication that the contract is a trick. 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. What should be inferred from the fact that these terms exist? Is it at all plausible that there is some subtle but very important reason why these terms must be present, and that if they were banned lots of mutually beneficial deals would not be made? Is it not much more likely that that these terms exist precisely because many consumers don't understand them and will be tricked by them? 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?

There is a very good paper by Gabaix & Laibson (2006) that provides a formal model in which firms "shroud" relevant information in order to trick myopic agents. The neat thing about their paper is that they show that this persists in equilibrium: competing firms turn out to have no incentive to march in and expose the shrouding and offer transparent pricing instead. But you don't need a fancy (and recent) paper to have known that the aforementioned terms in credit card contracts are only there to trick people. And if that's true, then what you really want is to get rid of contracts with those terms. Mandating information disclosure is only a good remedy insofar as it causes those terms to disappear. Gone is the economist's notion that the right solution is to make sure everyone knows the score and then to step out of the way. 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.

One could object to heavy-handed regulation on the basis of a slippery-slope argument. While there are some clear-cut cases like the credit card contracts, a government with lots of regulatory power, even a well-intentioned one, may end up getting overzealous and interfering in ways that will have unintended and negative consequences for efficiency. And Gabaix & Laibson take pains to point out that they are not advocating lots of regulation. Whatever the merits of this argument (I understand the fear of regulatory overreach but worry about it less than a lot of other people do), the main point of this post remains. There are important instances in the world we live in where the unaware simply get tricked and screwed. That is not, at root, a problem of asymmetric information among rational agents, and there is no reason to think that the appropriate remedy is the same as if it were. More importantly, in this world the virtues of voluntary exchange are absent, and so the economists' deference to it is misplaced.

There has been an important real-world development on this front. It seems that the Federal Reserve did a bunch of consumer testing to see how well people understood various terms in credit card contracts under different disclosure requirements, and concluded that they were simply too complicated for most people to understand. They therefore decided to go ahead and simply prohibit certain practices. Which I say is good news for the good guys.

*A weaker version of this condition is that any third parties that are hurt are hurt less than the contracting parties are helped.

**I say "usually" because there are a few special models in which fully rational agents can nevertheless be tricked.

77 comments

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comment by CronoDAS · 2009-12-21T00:16:30.444Z · score: 8 (10 votes) · LW(p) · GW(p)

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. ;)

comment by [deleted] · 2009-12-20T21:16:09.376Z · score: 7 (7 votes) · LW(p) · GW(p)

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.

comment by cousin_it · 2009-12-20T22:05:31.124Z · score: 1 (1 votes) · LW(p) · GW(p)

The idea of a general divorce right for contracts sounds intriguing. Do you have any links to studies/discussions/advocacy? Google fails me, it seems.

comment by [deleted] · 2009-12-21T09:18:13.883Z · score: 0 (0 votes) · LW(p) · GW(p)

Sadly not. I came across different interpretations of contracts while I was browsing through libertarian and later objectivist sites, but no satisfactorily treatment of the topic. This is something that bothers me a great deal since as the article points out contracts are a fundamental part of economics.

comment by David_J_Balan · 2009-12-20T23:54:18.748Z · score: 0 (0 votes) · LW(p) · GW(p)

The possibility that well-intentioned regulations will be evaded is indeed a problem, and in some cases it limits what is possible. But other regulations are relatively clear and well-enforced, particularly when they have the necessary political support.

comment by nazgulnarsil · 2009-12-22T11:19:55.560Z · score: 6 (6 votes) · LW(p) · GW(p)

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?

comment by teageegeepea · 2009-12-23T01:34:23.411Z · score: 1 (1 votes) · LW(p) · GW(p)

100%? There has never been an underzealous government? Not that I'm saying I can name one.

comment by nazgulnarsil · 2009-12-24T10:29:14.175Z · score: 0 (0 votes) · LW(p) · GW(p)

well, this hints at much deeper subtleties than just naming governments. how are we to delineate what counts? if we say that a temporary decline in government tyranny doesn't count then the original assertion can be made true by choosing long enough time periods.

thus we are knee deep in the legitimacy problem: what successions can be counted as a continuation of the previous regime and which are not?

comment by Larks · 2009-12-23T11:43:51.204Z · score: 0 (0 votes) · LW(p) · GW(p)

He was rounding to 3 significant digits.

comment by RobinHanson · 2009-12-21T02:02:00.568Z · score: 5 (5 votes) · LW(p) · GW(p)

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?

comment by David_J_Balan · 2009-12-21T03:31:34.384Z · score: 3 (3 votes) · LW(p) · GW(p)

Robin, as you know from our paternalism debate, I do support a limited paternalistic agenda in what I would describe as "well functioning" societies. But as a practical matter, it is often simply not the case that the kinds of prohibitions that I'm talking about would have to be shoved down the throats of the people they are intended to protect. If you had to guess, would you think that the Fed's recent action referred to in the post would be popular or unpopular with the general public? Or with credit card customers?

comment by RobinHanson · 2009-12-21T17:25:26.353Z · score: 3 (3 votes) · LW(p) · GW(p)

I don't know if those policies were popular, but if they were popular, that might be because people didn't understand their consequences. Again the key point is how can an accountable government force people to protect themselves who don't want to be protected? My guess is that they would prefer private means of protection, but since those private means are not allowed, they must settle for the public means you offer. You argue that the reason we need public means is that private means will not work because they don't want to be protected. But if they don't want to be protected, why do they support laws protecting them?

comment by jimrandomh · 2009-12-22T13:08:13.841Z · score: 5 (5 votes) · LW(p) · GW(p)

Offering someone a bad contract harms them. (By 'bad contract' I mean one that gives negative utility to the party that didn't draft it.) Either they accept it without knowing it's bad, in which case the bad terms harm them, or else they find out and reject it, in which case they've spent resources analyzing it for which they get nothing in return. And checking a contract for bad terms isn't cheap; lawyers charge thousands of dollars for that service. Someone who goes around offering bad deals can still inflict massive damage even if none of his offers is accepted. No one has managed to come up with a "private means of protection" which is cheaper than a lawyer on retainer. I don't think the problem is that people don't want to be protected; rather, the problem is that most people can't possibly afford any private protection.

comment by David_J_Balan · 2009-12-21T18:38:28.940Z · score: 1 (1 votes) · LW(p) · GW(p)

As you know, there are limited instances in which I would support the government protecting people against their will. But I suspect that a lot of legal protections against predatory conduct are popular, even among the people whose conduct is restricted. One possible reason for this is that they don't understand that the policy restricts their freedom (but then they also don't understand that the lack of the policy will get them exploited, and I'd rather have them helped for reasons they don't understand than harmed for reasons they don't understand).

But another possible reason is that they correctly understand that right now credit cards without those exploitative terms are mostly unavailable (the primary exception that I know of are employee credit unions). They "voluntarily" choose them because there's no way to get a credit card otherwise. They might perfectly rationally support regulations that will improve the menu of options from which they will make their voluntary choice.

comment by RobinHanson · 2009-12-21T18:43:21.121Z · score: 0 (2 votes) · LW(p) · GW(p)

The point of your post was that analysis based on ignorance missed people who just didn't get that they might be tricked. Now you are saying they do realize they might be tricked, which is why they support the policy. So we are back to ignorance.

comment by Eliezer Yudkowsky (Eliezer_Yudkowsky) · 2009-12-21T18:49:01.920Z · score: 6 (8 votes) · LW(p) · GW(p)

People can realize in the abstract that they're probably being tricked by credit card companies without possessing the legal expertise (or the time!) to go through all the fine print and work out which companies are tricking them most or least. Mandating disclosure doesn't necessarily change this.

People can also underestimate the magnitude of the tricking, and still want to outlaw it.

They may even believe that mostly other people are being tricked (blind spot bias) and hence "altruistically" support a policy that would actually protect them just as much as anyone else.

And finally, the financially sophisticated may suffer from living in a world of financial products designed to be sold to the financially naive (being too small a market segment, or too hard to market to, or too local or too integrated a market, for specialized products for them to prove effective), and so the intelligentsia/nobility that produces all the visible talk on this subject, wants to outlaw financial trickery from being aware that they are probably being tricked, on behalf of the majority that are not aware they are being tricked (note this is not invalid as justification!)

comment by RobinHanson · 2009-12-21T20:33:19.679Z · score: 0 (2 votes) · LW(p) · GW(p)

Not knowing "which companies are tricking them most" is ignorance, and standard models of ignorance can apply.

comment by David_J_Balan · 2009-12-21T21:18:42.106Z · score: 2 (2 votes) · LW(p) · GW(p)

But ignorance in rational agent models of asymmetric information don't cause people to be tricked, so it's can't be ignorance of that sort.

It seems perfectly plausible to me that people understand that the deck is stacked against them, while at the same time not knowing exactly how to protect themselves and so falling for some of the tricks, and would be perfectly happy to have a government they trusted simply remove the bad stuff from the menu. I know that's how I see it.

comment by matt · 2009-12-22T09:09:52.636Z · score: 5 (5 votes) · LW(p) · GW(p)

Ooo - sign me up for that! A government I trust that will remove the bad stuff from the menu, and... ohh, hang on. What will the credit card companies, who are a concentrated, highly incentivesed interest group, do next? How will they act on our democratically elected representatives? When we present our carefully thought out policy recommendations to parliament, and the parliament passes the details through to committee... what will happen next? What's likely to come out the other end of the legislative sausage machine?

When we then try to organize the millions of self-identified likely victims of complexity, and the hundreds of thousands of wise altruists who want to help the likely victims, for all of whom this is a fairly unimportant matter... when we array them against the lobbiests... who's likely to stay the course and win the regulation that'll help their tribe?

comment by RobinHanson · 2009-12-22T20:00:25.270Z · score: 0 (2 votes) · LW(p) · GW(p)

David, that situation is well modeled as ignorance. So either there are models of ignorance supporting your case, or you need to describe a different situation.

comment by David_J_Balan · 2009-12-22T21:37:21.008Z · score: 1 (1 votes) · LW(p) · GW(p)

I think clarifying this disagreement is worth a seperate post, which I'll write up in the next few days.

comment by Psychohistorian · 2009-12-21T21:02:14.122Z · score: 2 (2 votes) · LW(p) · GW(p)

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... This brings us to an image of a powerful political elite forcing their protections on unwilling others, for the good of those others.

This is an absolutely enormous leap. There are very, very few people who do not admit to the possibility of being tricked. Just think of the broad cultural meaning of the phrase "didn't read the fine print." You take some hypothetical about humans that is so completely divorced from reality as to render us into fully alien beings, then you develop a model of politics based on this absurd assumption, then ask someone if that's the model he's using.

The hypothetical may be interesting, but I don't anyone, anywhere would argue that there exists a large voting block that believes it cannot be deceived and actively opposes government intervention to prevent deception.

comment by RobinHanson · 2009-12-21T21:06:08.516Z · score: 0 (0 votes) · LW(p) · GW(p)

David is saying standard ignorance models are flawed because they do not consider the possibility of people who do not realize they might be tricked. I am responding to David's assumption.

comment by Psychohistorian · 2009-12-21T22:32:09.381Z · score: 4 (4 votes) · LW(p) · GW(p)

That isn't his claim.

His claim is that people enter into contracts without contemplating that they might get tricked. They may be aware of the fact that people like them get tricked in contracts like the ones they are signing, but they simply trust the salesmen, or they just decide they need a credit card, sign next to the X, and don't think about it much further. They sign in near-mode, and analyze policy in far-mode. Your position requires that they are completely unaware of the possibility that they might be tricked in all contracts, not just specific ones they enter into; I think this would require both contracts and policy analysis to occur in near-mode. Your position would also require that they like the options that the law removes, and/or that they are aware of the costs imposed by such laws. In other words, they don't understand that a credit card contract could contain hidden fees, but they do understand that by blocking hidden fees in credit card transactions, the profitability of such transactions will fall and credit will contract as businesses can no longer exploit consumers. Such a combination of ignorance and sophistication seems rather unlikely.

Moreover, your inference that people who are unaware of being swindled should object to anti-swindling laws makes no sense. People may be unaware that there are rat guts in their sausage; this does not mean they would object to a law that bans putting rat guts in sausage.

comment by Psychohistorian · 2009-12-21T22:13:02.151Z · score: 0 (0 votes) · LW(p) · GW(p)

That just isn't what he is saying.

His point isn't about people who do not realize they might be tricked; it's about people who do not realize that a specific contract is (potentially) tricking them. They can still be aware, in the abstract, that there are businesses out there that will try to trick them, and even that the one they are currently dealing with might be trying to trick them. They need merely be unaware of the fact that they are actually being tricked, which is a requisite of being tricked in the first place.

When you buy sausage at the store, you don't make a significant effort to ensure that there are no rat guts in the particular brand you buy. However, if you've heard that sausage occasionally has rat guts in it, you may reasonably support laws that ensure sausage does not contain such ingredients, even if it costs you a few pennies.

Your position requires people believe themselves to be wholly immune to deception, which is absurd. David's actual position merely requires they be unaware of the deception in a specific contract, not that they be unaware of their ability to be deceived.

comment by magfrump · 2009-12-21T02:24:28.668Z · score: 0 (0 votes) · LW(p) · GW(p)

The unaware citizen may be a knowledge specialist (for example, a metro organization wonk) with a friend who is a different knowledge specialist (for example, a financial policy wonk). The two of them would then be able to enter into an agreement where each would attempt to hold their shared government accountable for injustice each could see, while trusting the other to prevent unseen injustice.

Sort of a technocratic turn of events but my heuristics are pretty heavily pro-technocracy.

comment by Steve_Rayhawk · 2009-12-21T02:54:41.100Z · score: 4 (4 votes) · LW(p) · GW(p)

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.

comment by saliency · 2009-12-20T21:47:29.851Z · score: 4 (4 votes) · LW(p) · GW(p)

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?

comment by Sebastian_Hagen · 2009-12-21T21:45:43.107Z · score: 3 (3 votes) · LW(p) · GW(p)

I don't know if that was your source, but the empirical results of people selecting CCs based on their usage pattern were mentioned on the Zywicki on Debt and Bankruptcy Econtalk episode starting at 17:40. Zywicki doesn't mention a specific source for those empirical results in the podcast, but he also included them in The Economics of Credit Cards (page 28ff. of the pdf), which does have sources.

comment by saliency · 2009-12-22T21:36:33.353Z · score: 1 (1 votes) · LW(p) · GW(p)

Indeed!

A great Econtalk episode. I highly suggest people interested in the topic listen.

comment by CannibalSmith · 2009-12-21T07:24:09.552Z · score: 3 (3 votes) · LW(p) · GW(p)

This house would limit all contracts to 140 characters.

comment by Larks · 2009-12-23T11:44:43.327Z · score: 1 (1 votes) · LW(p) · GW(p)

This house would limit all laws and treaties to 140 characters.

comment by Scott Alexander (Yvain) · 2009-12-20T23:10:44.847Z · score: 3 (3 votes) · LW(p) · GW(p)

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?

comment by David_J_Balan · 2009-12-20T23:51:55.860Z · score: 2 (2 votes) · LW(p) · GW(p)

I'm not aware of any general standards for distinguishing between abusive contracts and beneficial ones and I'm not sure there could be any. But the question "would anyone who really understood what was going on ever want this contract?" must be a relevant one. You could argue about how much humility should be applied: after all, just because I can't see any reason why a rational person would sign this contract doesn't mean there isn't one. So as is often the case, the optimal policy is not obvious. But make no mistake. The libertarian policy will result on a whole bunch of vulnerable people (almost none of whom will be libertarians by the way) getting screwed over and over and over again. You could (barely) argue that the libertarian policy has benefits that overbalances these costs, but there is no denying that the costs are real and big.

comment by matt · 2009-12-22T09:30:50.272Z · score: 1 (1 votes) · LW(p) · GW(p)

screwed over and over and over again

How many of these people have you met? Not just screwed over and over again, but over and over and over again!? What are the chances that you're thinking of a fairly small number of real people who are stupid enough to need institutionalization (from where they don't need these regs) and very few other real people?

comment by loqi · 2009-12-21T23:23:36.871Z · score: 1 (1 votes) · LW(p) · GW(p)

But the question "would anyone who really understood what was going on ever want this contract?" must be a relevant one.

Indeed, and this only seems like the "first-order" version of the question. For example, a credit card with extreme late payment penalties might be of reasonable appeal to someone sufficiently confident in their ability to pay on time. But it would need to derive its appeal from some other benefit, which presumably exists only because enough people fall into the late payment trap. In this way the credit card company becomes more like a "trickery broker", passing along the spoils to some rational subset of customers while taking a cut.

So a variant of your question might be, "if this contract were only entered into by people who really understood the terms, would it still exist?"

comment by mattnewport · 2009-12-21T00:01:48.426Z · score: 1 (1 votes) · LW(p) · GW(p)

You could (barely) argue that the libertarian policy has benefits that overbalances these costs, but there is no denying that the costs are real and big.

Accepting for the sake of argument that the costs are 'real and big' you seem to be leaping to the conclusion that therefore something must be done. The costs are not generally imposed on me though and not everyone is a utilitarian. I don't see any reason why I should be concerned about costs that others impose on themselves through their own bad decisions.

comment by magfrump · 2009-12-21T02:21:21.362Z · score: 1 (1 votes) · LW(p) · GW(p)

Because helping other people with their problems will help you gain status?

comment by mattnewport · 2009-12-21T03:12:08.754Z · score: 0 (0 votes) · LW(p) · GW(p)

I don't think this particular example is a very cost effective way to raise my own status. This kind of thing is obviously a cost effective way for politicians to raise their status since they generally receive a disproportionate share of the credit and the costs are shared widely so they pay a relatively small proportion of the cost. That is why we see so much of this kind of proposed regulation (of course proposing it and then not following through is arguably even more cost effective than actually passing legislation on the issue).

I can think of much more cost effective (and more fun) ways to raise my own status in those contexts where I care about it.

comment by CronoDAS · 2009-12-20T21:23:22.497Z · score: 3 (3 votes) · LW(p) · GW(p)

See also: confusopoly.

comment by pdf23ds · 2009-12-27T22:45:53.679Z · score: 2 (2 votes) · LW(p) · GW(p)

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.

comment by Larks · 2009-12-23T11:51:52.963Z · score: 2 (2 votes) · LW(p) · GW(p)

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.

comment by CronoDAS · 2009-12-21T22:22:58.409Z · score: 2 (2 votes) · LW(p) · GW(p)

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

comment by teageegeepea · 2009-12-22T08:08:38.740Z · score: 0 (0 votes) · LW(p) · GW(p)

Could you elaborate on what's a "bad bargaining position"? Can anyone be shown not to have one?

comment by wedrifid · 2009-12-22T08:10:53.216Z · score: 5 (5 votes) · LW(p) · GW(p)

Could you elaborate on what's a "bad bargaining position"? Can anyone be shown not to have one?

Beggars. Apparently they can't be choosers.

comment by teageegeepea · 2009-12-23T01:33:18.468Z · score: 1 (1 votes) · LW(p) · GW(p)

Sometimes.

comment by 110phil · 2009-12-21T00:31:07.438Z · score: 2 (2 votes) · LW(p) · GW(p)

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. )

comment by David_J_Balan · 2009-12-21T01:10:20.616Z · score: 2 (2 votes) · LW(p) · GW(p)

You're right that not every case is equally severe. But even in your relatively mild case, it's still a "gotcha." The term is there because the credit card company knows that people will sometimes not understand or will forget. It's got nothing to do with efficiently matching people who want to lend money with people who want to borrow money (which is one of the primary legitimate function of credit markets), it's got to do with figuring out how best to screw people over. Since there is no reason to believe that that contract got to be that way for any efficient purpose, there's no reason for any great reluctance to interfere with it through policy.

comment by 110phil · 2009-12-21T01:42:00.388Z · score: 1 (1 votes) · LW(p) · GW(p)

Ah, but now you're changing the argument! In the post, you argued that it's OK to interfere because people are being tricked (an argument for which I have some sympathy). Now, you're arguing that it's OK to interfere because the only purpose of the cards is to match borrowers with lenders. That, I dont agree with at all.

People choose a card for many different reasons. I can imagine people choosing to (perhaps falsely) signal their high wealth by choosing a high-rate card (their friends will assume they pay it off every month). They might choose the "trick" card to give themselves an incentive to pay on time. They may enjoy trying to "outwit" others by paying the card off on time and letting others cover the issuer's expenses.

In a competitive market, the money the company makes by "tricks" is competed down: other cards will find it profitable to enter the market and charge less (even if they use the same "tricks"). So a larger cost is borne by those who fall for the "tricks". Still, those people might not be happier with the tricks removed.

For instance, suppose I forget to pay on time every five years (which is probably about right). And suppose my forgetting costs $60. Now, the government comes along and decrees that, instead of charging me $60 when I forget, they'll charge me $1 a month regardless.

I wouldn't like that. It might be irrational, but that's still my preference. Haven't you, the government, done me wrong by eliminating the "trick" that I understood but chose anyway? Does my being less happy than before rank at zero on your scale of costs and benefits?

comment by magfrump · 2009-12-21T02:18:48.041Z · score: 1 (1 votes) · LW(p) · GW(p)

The impression I got was that:

(a) the universe OP is working in has the premise that creating efficient deals is why you should not regulate things

(b) people are being tricked by dealmakers

(c) regulating to stop people from being tricked does not deter efficient deals

you are saying "I'm not being tricked"--that's a denial of assumption (b).

It may be true that there exist people who are not being tricked and who benefit from the existence of tricks.

On the other hand, that's not the point. The point is that enough people ARE being tricked, to their detriment, that regulating the tricks will increase total welfare.

This is true regardless of whether or not you personally are being tricked.

OP also cited a paper discussing how tricks aren't effected regularly by competition, so there is anecdotal evidence at least indicating that the government wouldn't actually charge you $1 a month regardless.

A large part of your statement was addressing the factuality of (b) which is good, and I'm overall sympathetic to this objection, but you don't seem fully aware of that being your point, and I disagree with the point in general.

comment by David_J_Balan · 2009-12-21T03:39:47.364Z · score: 0 (0 votes) · LW(p) · GW(p)

Either those terms represent an efficient contract or they don't. The most obvious way that they wouldn't would be if they tricked you, and as a practical matter that is where most of the action is. Originally it sounded like you agreed that you were being tricked also, but in a milder sense. If you positively prefer those terms, then in your case they are efficient. But I rather doubt that these are really terms that you would have chosen.

As for the issue of competition, that's not how it works. When Laibson presented the paper I referred to in the main post, my recollection is that he said that, while the credit card industry is quite competitive, the way that competition happens is that the companies use expensive promotions to identify myopic consumers. So competition doesn't benefit consumers, and in the end it doesn't even benefit the credit card companies! It's pure social waste.

comment by pete22 · 2009-12-21T19:30:45.435Z · score: 1 (1 votes) · LW(p) · GW(p)

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?

comment by pjeby · 2009-12-20T23:17:34.335Z · score: 1 (1 votes) · LW(p) · GW(p)

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.)

comment by CronoDAS · 2009-12-21T00:20:47.843Z · score: 2 (4 votes) · LW(p) · GW(p)

"Results not typical" really doesn't give enough information. I think that a "results not typical" disclaimer really ought to be required to include what the typical results actually were.

comment by magfrump · 2009-12-21T02:27:32.571Z · score: 1 (1 votes) · LW(p) · GW(p)

my P(advertisers are aware they are exploiting people) is very high, and my Expected Value of people not being exploited is similarly high.

My Expected Value of not being paternalistic is relatively low, especially since the FTC has some knowledge specialty, so their being founded could be taken as a mutually beneficial contract with average people to help the average people avoid exploitation.

comment by Vladimir_Nesov · 2009-12-21T02:44:21.404Z · score: 0 (0 votes) · LW(p) · GW(p)

my P(advertisers are aware they are exploiting people) is very high, and my Expected Value of people not being exploited is similarly high.

My P(obfuscatory terminology helps) begs to differ.

comment by CronoDAS · 2009-12-20T21:16:00.980Z · score: 1 (1 votes) · LW(p) · GW(p)

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.)

comment by mattnewport · 2009-12-20T22:54:52.577Z · score: 2 (2 votes) · LW(p) · GW(p)

Credit cards suck if you're dumb enough to carry a balance on them. They're pretty damn great if you pay off in full every month.

comment by CronoDAS · 2009-12-21T00:01:33.053Z · score: 1 (1 votes) · LW(p) · GW(p)

Until they start mailing you bills that arrive on the day they're due. (Which, I admit, is exaggerated, but "giving you as little time as possible before a bill is late" is another one of those revenue maximizing strategies.)

comment by mattnewport · 2009-12-21T00:04:47.564Z · score: 1 (3 votes) · LW(p) · GW(p)

I don't remember the last time I relied on a paper bill for anything. There's really no reason why anyone should ever make a late payment with Internet banking and the practically universal ability to set up automated transfers to cover at least your minimum payment.

comment by CronoDAS · 2009-12-21T00:21:45.822Z · score: 0 (0 votes) · LW(p) · GW(p)

If something goes wrong, it helps to have a paper record. And, if you set up direct debiting from a checking account instead of mailing checks, it's harder to refuse payment in the event that you get billed for too much. (For example, when you have a Paypal account linked to a bank account, Paypal tells the bank how much to debit, and they go ahead and debit it without you having to confirm - or allowing you to object to - each individual debit.) Getting your money back is harder than refusing to send it in the first place.

comment by mattnewport · 2009-12-21T02:08:30.194Z · score: 1 (1 votes) · LW(p) · GW(p)

I get mailed a paper statement for my credit card as well but I never have to look at it as I handle everything online. I've had the occasional problem with my credit card but nothing that I've needed a paper statement to resolve.

Having an automated payment to your credit card doesn't generally carry the risk of other automated payments since in a worst case scenario of them taking too much from your bank account you just end up with a positive balance on your credit card so you can use that to pay for things until the situation is resolved. In fact, one of the benefits of having a credit card is that you can set up most of your automated payments to come off the credit card (where you have much better protection against incorrect or unauthorized payments) and only have a single monthly automated payment from your chequing account to your credit card.

Anyway, I don't really want to get into an extended discussion of the best way to use a credit card. My main point is that if you understand them and use them sensibly (paying them off in full every month, not carrying a balance, not using them for cash advances) then they are a very useful tool. They can be a problem if you're stupid but lots of things can be a problem if you're stupid. I'd say that reflects the negative utility of stupidity rather than the particular evils of credit cards.

comment by Alicorn · 2009-12-21T00:09:10.079Z · score: 0 (2 votes) · LW(p) · GW(p)

There's really no reason why anyone should ever make a late payment with Internet banking and the practically universal ability to set up automated transfers to cover at least your minimum payment.

You mean except for people who don't have computers, or maybe enough money to pay the bill?

comment by mattnewport · 2009-12-21T01:56:19.681Z · score: 2 (4 votes) · LW(p) · GW(p)

I think it's fairly safe to assume that CronoDAS has access to the Internet.

I wasn't arguing that credit cards are a good idea for everyone, I was disagreeing with CronoDAS's original implication that credit cards suck in general. As I said originally, they are great for people who pay them off in full every month. Having access to the Internet makes it easier to avoid accidental charges due to late payments. I would say the kind of person who doesn't have access to the Internet is probably not the kind of person for whom having a credit card is a good idea.

People who do not have enough money to pay the bill are also not generally people who benefit from having a credit card. They would fall into the category of people 'dumb enough to carry a balance on them', a category that I agreed credit cards suck for.

comment by Bo102010 · 2009-12-21T03:03:47.057Z · score: 1 (1 votes) · LW(p) · GW(p)

I agree that credit cards suck in general, which is why I never got one.

That people seem so unwilling to opt out of what is so widely panned as a terrible deal leads me to believe that they don't mind being exploited as much as they say they do.

People always act like you can't get along in the modern world without a credit card, and that somehow that justifies intrusive regulations. I submit that you can get along just fine without one.

comment by CronoDAS · 2009-12-21T21:57:52.232Z · score: 1 (1 votes) · LW(p) · GW(p)

I use debit cards when I spend my own money.

comment by orthonormal · 2009-12-22T05:37:16.864Z · score: 3 (3 votes) · LW(p) · GW(p)

So did I, until I was informed that having a credit history is a very useful thing, and that one doesn't need to ever incur interest or fees in order to obtain a good credit rating with a credit card.

comment by byrnema · 2009-12-21T03:20:32.638Z · score: 0 (0 votes) · LW(p) · GW(p)

I submit that you can get along just fine without one.

That's the way it ought to be. However, it's difficult to rent equipment at some places without one. I'm outraged when this happens..

(I'm also outraged when my social security number is used as 'secure identification' to procure a credit card.)

comment by TraderJoe · 2012-04-27T13:43:46.492Z · score: 0 (0 votes) · LW(p) · GW(p)

[comment deleted]

comment by Apaniyam · 2010-01-05T07:23:58.800Z · score: 0 (0 votes) · LW(p) · GW(p)

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

comment by Roko · 2009-12-23T18:24:20.777Z · score: 0 (0 votes) · LW(p) · GW(p)

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.

comment by luispedro · 2009-12-21T07:31:51.270Z · score: 0 (0 votes) · LW(p) · GW(p)

"""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.

comment by David_J_Balan · 2009-12-21T18:43:34.522Z · score: 0 (0 votes) · LW(p) · GW(p)

If credit markets worked the way they were supposed to, the terms on which you could get credit would indeed depend on objective measures of your credit-worthiness. Any adverse event would appropriately cause the credit markets to downgrade their opinion of you, and worsen the terms on which you get credit. But I have never heard anyone seriously suggest that the data bear out a conclusion that being a day late with a payment indicates that you are a credit risk so massive that a 29.99% interest rate is appropriate.

comment by mattnewport · 2009-12-20T23:12:15.541Z · score: 0 (0 votes) · LW(p) · GW(p)

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.

comment by David_J_Balan · 2009-12-20T23:41:41.293Z · score: 4 (4 votes) · LW(p) · GW(p)

This story wasn't the main point of the post, but its purpose was to illustrate that it's pretty easy to imagine something in between purely voluntary and coerced at gunpoint. People can be manipulated into "voluntarily" doing things that hurt them, even if they are not tricked or lied to. This merely raises the possibility of beneficial paternalistic intervention; it certainly doesn't establish that the benefits of such intervention outweigh the costs. Here are some old posts on that subject, for whatever interest it may have.

http://www.overcomingbias.com/2007/03/heres_my_openin.html http://www.overcomingbias.com/2007/03/disagreement_ca_2.html

comment by CronoDAS · 2009-12-20T21:21:19.986Z · score: 0 (0 votes) · LW(p) · GW(p)

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

comment by saliency · 2009-12-20T22:03:46.754Z · score: 2 (2 votes) · LW(p) · GW(p)

Madoff committed fraud.

If you give me $1,000 for a ring that I tell you is platinum and it ends up being silver I have violated our contract.

Maldoff did not simply manage peoples money ineptly he stole it.