Consumer Law & Policy Blog

The Honest Truth About Dishonesty and Consumer Protection

by Jeff Sovern

I have been listening to the audio version of Dan Areily's book, The Honest Truth About Dishonesty, and it may shed some light on consumer protection.  Ariely explores the causes and limits of dishonesty.  He reports on a series of experiments that suggest that many people cheat a little, but not so much as they could get away with, or, to put it another way, so much as economists presuming rational behavior would predict they would.  Ariely believes that the reason people don't cheat more is that they want to believe that they are good, and that if they cheated more, it would make it hard to believe that.  But he also reports that the internal limits to cheating are relaxed in some circumstances.

One such circumstance is if people are able to steal not money but something different.  For example, an employee might feel perfectly comfortable taking pens from an employer, but not money.  That may shed light on why mortgage originators were willing to submit false applications--perhaps they saw the false applications as being different from stealing money because they enabled people to obtain homes they were not able to pay for, which is a step away from stealing money.

Another circumstance is if conflicts are disclosed.  Ariely reports that when agents report a conflict of interest, they feel comfortable giving more self-interested advice than if the conflict is not disclosed.  Ariely also found that while principals discounted the advice somewhat when the conflict was disclosed, they did not do so enough to overcome the amount the agent's self-interested advice cost the principal.  Now think about how mortgage brokers got paid more when consumers took out subprime loans with higher payments than when the brokers put the consumers into lower-cost prime loans.  Many brokers steered consumers who could have qualified for prime loans to such subprime loans.  Under the TILA disclosure forms in use at the time, broker compensation, in the form of a yield-spread premium, was disclosed under a line captioned "POC."  That line was surely meaningless to most consumers, but perhaps it enabled mortgage brokers to feel that their conflict was disclosed, and so that they could steer consumers to higher-cost loans without feeling they were cheating the consumers.  All this raises an odd question: are consumers better off sometimes if conflicts are not disclosed?

Ariely also reports on experiments finding that reminding people to be honest seems to increase honesty on tests and in other contexts. The effect is more prounouced if the reminder comes at the outset.  We might do well to include at the top of forms--including mortgage broker contracts--certifications that the signer is being honest.  It's a nudge with minimal cost.

A Comment on Eric Grover's Essay on the CFPB in the Washington Times

by Jeff Sovern

A fellow named Eric Grover had a piece atacking the Consumer Financial Protection Bureau in the Washington Times this week titled "CFPB’s unchecked power."   A line at the end of the essay explains "Eric Grover is a principal at Intrepid Ventures."  I had never heard of Intrepid Ventures, but their web site states "Clients have included a broad range of payments, financial services . . . firms[, including] Fortune 10 global financial institutions." The web site reports that Grover's "prior experience includes Visa International, GE Consumer Finance, Bank of America, NationsBank and Transamerica. Mr. Grover currently serves on the board of Nordstrom's credit card subsidiary."  So Grover is part of the financial services industry, though readers unfamilar with Intrepid, as I was, may not have realized that.  It would have been appropriate to make clearer his interest in this matter.

What did Grover say about the CFPB? Here are some quotes, in italics, with my responses:

The abuse standard is new and gives bureau mandarins a blank check.

It is indeed new, but it doesn't give the Bureau a blank check.  The statute specifically identifies the circumstances in which conduct can be found abusive.

The bureau  took its first scalp with Capital One’s $210 million settlement for deceptively  marketing payment protection and credit monitoring. The $25 million in penalties  it collected will be used to reward administration allies.

Does anyone believe that Cap One would have settled the case for $210 million if it hadn't had a significant possibilty of being found liable for at least that sum?  Put another way, how plausible is it that Capital One did nothing wrong yet still agreed to pay that kind of money?  And what is the basis for the statement that the penalty funds willl be used to "reward administrative allies?"

Easy-to-vilify payday lenders may be next.

Could it be that they are easy to villify because they are doing something troublesome? 

Bureau architect Elizabeth Warren,  director Richard Cordray and Mr. Obama  think hapless consumers are victims of predatory financial institutions and,  even if all products’ material facts are disclosed fully, Joe  Six-Pack cannot be trusted to make the “right” choices.

Unfortunately, the evidence shows that many consumers make bad borrowing choices, especially when they are helped along by predatory lenders, and that that's why we had a financial crisis. What evidence is there to the contrary? 

As Mr. Cordray declared, “We cannot  afford to tolerate practices, intentional or not, that unlawfully price out or cut off segments of the population from the credit markets.” This is exactly the  kind of thinking that brought down the housing market. The willful weakening and  politicizing of credit wreaked havoc in the financial sector. If the government  learned its lesson from that catastrophe, credit would be more expensive and  less available to risky borrowers.

This sounds like another claim that the Community Reinvestment Act caused the Great Recession.  Such attacks have been shown time and again to be utterly specious. 

Credit card issuers rely on race-blind scores to approve accounts. Paraphrasing King, credit scores judge men by  their character, not their skin color. But many liberals don’t believe in  colorblind credit. In a thinly veiled call for intervention, The Washington Post  reported “a persistent gap between the credit scores of white and black  Americans.” Logically, the next step is a call for credit-scoring apartheid,  which would be disastrous for financial markets.

How can we know how credit scores judge people?  Fair Isaac has provided only a bare bones description of what goes into credit scores.  The phrase "credit-scoring apartheid" sounds pretty bad, but what does it mean? 

I could go on, but you get the idea.  Another banking person wants banks to be able to do what they want.  So what if we have another Great Recession? 

Forgiven Mortgage Debt May Increase Homeowners' Income Tax Liability Starting Next Year

The cancellation of indebtedness generally produces income for federal and state income tax purposes. But as LA Times writer Jim Puzzanghera explains, "in 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act to give struggling homeowners a break. If the debt is forgiven because of a drop in a home's value or a decline in the owner's financial condition, up to $2 million of the relief for couples filing jointly is exempted from federal taxes." The tax break originally was set to expire at the end of 2010, but Congress extended it through the end of 2012. So, unless Congress acts again, homeowners who receive debt reduction from their banks in an effort to avoid foreclosure--for instance, as part of the multi-billion dollar government settlement with the nation's five largest mortgage debt servicers--could be handed a large, and unexpected, tax bill in 2013 and beyond. (Much of the relief under the government settlement will come in future years.)

Ninth Circuit Revises Opinion Rejecting Cereal Settlement

In July, we wrote about the Ninth Circuit's rejection of a settlement of claims that Kellogg's had misrepresented that kids could improve their attentiveness in school by nearly 20 percent by eating Frosted Mini Wheats for breakfast. The court held that the cy pres was not properly related to the claims and the class, and that the attorney fees were too high. This week, the Ninth Circuit issued a revised opinion. In addition to reorganizing parts of the earlier opinion, the court omitted the separate discussion of attorney fees. Instead, it says that its decision to strike down the settlement on its merits moots the fee issue. On the other hand, the court suggests that, if the $5.5 million cy pres is not of value to the class, then the valuation of the settlement's common fund ($10.64 million) is in fact half, making the attorney fee award excessive. The revised opinion also adds to the discussion of cy pres and its background and continues to emphasize that the cy pres in the settlement may not benefit a single member of the class.

In a case argued before the Ninth Circuit last October, our office represented an objector challenging the cy pres in a settlement of claims concerning Facebook's Beacon program. So look for another Ninth Circuit decision on cy pres sometime soon.

Cy pres can be very useful and appropriate. I have some concern, though, that cases in which cy pres is criticized or misused get more attention than cases in which it is used well. As a result, I worry that judges may be increasingly skeptical about cy pres, even where the proposed cy pres is appropriate and the best use of the award.

UPDATE: Read this detailed article by Amanda Bronstad regarding the Ninth Circuit's revised opinion.

Report on National Mortgage Fraud Settlement

We reported earlier on the national mortgage fraud settlement between the federal government, state attorneys general, and the five largest mortgage servicers. (Go here and here, for instance.) The settlement's official website has lots of information, including an executive summary, which sets out some of the settlement's key terms. The summary discusses the billions of dollars aimed at helping homeowners facing foreclosure to stay in their homes:

The settlement requires the five banks to allocate a total of $17 billion in assistance to borrowers
who have the intent and ability to stay in their homes while making reasonable payments on their
mortgage loans. At least 60 percent of the $17 billion must be allocated to reduce the principal
balance of home loans for borrowers who are in default or at risk of default on their loan payments.
Many homeowners, particularly in states like Florida, Arizona, Nevada and California, have
negative equity in their homes and have no realistic ability of refinancing or selling their homes, or
to build equity. Principal reductions will also yield lower payments and will give homeowners a
fair opportunity to preserve their homes.

On August 29, 2012, the settlement monitor, Joseph A. Smith, issued his first progress report on the settlement. At Credit Slips, Adam Levitin offers a preliminary (and skeptical) assessment of the report, pointing out, among other things, that only a tiny percentage of underwater borrowers have been helped by the settlement so far.

More on a Constitutional Amendment to Overrule Citizens United

Yesterday, we posted on President Obama's statement that if other means of curbing corporate election spending fail, he would consider a constitutional amendment to overrule the Supreme Court's Citizens United decision. The President thought it possible that the Court would itself overrule Citizens United, but that seems unlikely in the near term in light of the Supreme Court's (very) summary reversal this past June of a Montana Supreme Court decision upholding Montana's statutory ban on corporate electoral spending.

Ruth Marcus has written this opinion piece providing a more detailed analysis of the President's views. Among other things, she says she has no problem with the President criticizing the Supreme Court's decisions, but she's "uncomfortable" with a President using the threat of a constitutional amendment to coax the Court into rethinking one of its decisions.

Researchers Question Health Value of Organic Food

Read this AP story. Here's an excerpt:

Patient after patient asked: Is eating organic food, which costs more, really better for me? Unsure, Stanford University doctors dug through reams of research to find out — and concluded there’s little evidence that going organic is much healthier, citing only a few differences involving pesticides and antibiotics. Eating organic fruits and vegetables can lower exposure to pesticides, including for children — but the amount measured from conventionally grown produce was within safety limits, the researchers reported Monday. Nor did the organic foods prove more nutritious. “I was absolutely surprised,” said Dr. Dena Bravata, a senior research affiliate at Stanford and long-time internist who began the analysis because so many of her patients asked if they should switch.

The study was published in the Annals of Internal Medicine and can be found here.

President Obama Says He Could Support a Constitutional Amendment to Overrule Citizens United

As explained here, President Obama recently posted to the on-line community reddit that he could support a constitutional amendment to overrule the Supreme Court's controversial 2010 Citizens United ruling that unleased corporate campaign spending as never before. Here's what the President said:

Money has always been a factor in politics, but we are seeing something new in the no-holds barred flow of seven and eight figure checks, most undisclosed, into super-PACs; they fundamentally threaten to overwhelm the political process over the long run and drown out the voices of ordinary citizens. We need to start with passing the Disclose Act that is already written and been sponsored in Congress – to at least force disclosure of who is giving to who. We should also pass legislation prohibiting the bundling of campaign contributions from lobbyists. Over the longer term, I think we need to seriously consider mobilizing a constitutional amendment process to overturn Citizens United (assuming the Supreme Court doesn’t revisit it). Even if the amendment process falls short, it can shine a spotlight of the super-PAC phenomenon and help apply pressure for change.

Eminent Domain and the Fight to Save Underwater Homeowners

We have previously posted about the use of eminent domain as a tool for saving the homes of people whose mortages remain underwater as a result of the mortgage meltdown and the effects of the economic depression (go, for instance, here and here).

Now, read this article by Ben Hallman about the political (and possibly legal) battle brewing on that subject in San Bernadino, California. A couple excerpts give you a flavor:

Governments usually use this power, known as eminent domain, to acquire private land for public purposes, such as roads or utility lines. But th[e San Bernadino] plan, proposed by a San Francisco-based venture fund Mortgage Resolution Partners, calls for government authorities to seize the mortgages of underwater borrowers, paying the investors that own them a fraction of what they are owed, using money borrowed from the fund. Homeowners could then refinance with a federal loan at a much lower rate, based on what their home is actually worth instead of what they owe.  *  * *  "It is a disaster of epic proportions," said John Vlahoplus, chief strategy officer at Mortgage Resolution Partners, of the dramatic decline in home prices that in many areas has left homes worth less than half what the borrowers paid. "The crash has devastated the family wealth of these communities." [A] group from the East Coast, representatives of the mortgage finance industry, don't like this idea much at all. They have worn a path to Devereaux's office in recent months to tell him, and anyone else who would listen, that the proposal amounts to nothing less than a threat to the entire mortgage finance system, and an assault on free enterprise and the U.S. Constitution.

Hat tip to Bradley Girard.

Corporate Profits Up; Compensation Stagnant

As this article by Jared Bernstein explains, corporate profits as a percentage of gross domestic product has passed where it was prior to the economic recession, but compensation as a percentage of gross domestic product is far lower that pre-recession levels. See the graph below.