Consumer Law & Policy Blog

Failed Gods of Behavioral Law & Economics

At this week’s International Association of Consumer Law conference, scholars from Europe and Brazil, among others, embraced the new orthodoxy of behavioral law and economics.  As I have argued elsewhere, the important insights of behavioral science have important normative implications (and law is about norms) that have been largely ignored.  Behavioralism undermines two key tenets supporting the edifice of neoclassical law and economics:  1) that unregulated markets promote consumer autonomy, i.e. freedom of choice, and 2) that this consumer autonomy happily and simultaneously advances the utilitarian value of maximizing consumer welfare. 

Thoughts on the International Association of Consumer Law conference

This week’s biennial meeting of the IACL was brilliantly organized by Professor Christine Riefa and her colleagues at Brunel University in Uxbridge, West London.  Gathered were consumer law experts from old and new Europe, Latin America, Australia, East and Southeast Asia and Africa, as well as a few of us from North America, to talk about consumer protection after the Global Financial Crisis (GFC).

In his excellent concluding presentation, incoming IACL president Dr. Sothi Rachagan highlighted the importance of consumer protection for emerging economies, especially in South and East Asia, where despite the GFC there has been a dramatic reduction of absolute poverty and continuing economic growth that will soon overtake the so-called advanced countries.  Consumer protection law has not only been a consequence but also a key ingredient in this dramatic growth and human development.

Robin Simpson of Consumers International reported on his organization’s vital work to influence the G20 project coordinating financial regulation, including consumer protection, among the major world governments.  The process so far seems to be taking place among national banks and bank regulators, with little or no participation from either consumer protection regulators or consumer advocates.  THe OECD is expected to release some sort of report on these activities within the next several weeks.  There is a real danger that the post-crisis legal world will be designed by the same bankers and bank regulators whose failings brought us the WFC.

Have Law Schools Violated Consumer Protection Laws?

Law professors have been buzzing about the graduate of Thomas Jefferson Law who brought a class action against the school under a UDAP statute for allegedly misrepresenting its placement statistics (a compendium of articles can be found here).  In addtion, 

Joel F. Murray

, a graduate of Cal-Davis, argues in Professional Dishonesty: Do U.S. Law Schools That Report False or Misleading Employment Statistics Violate Consumer Protection Laws? that law schools that report inaccurate figures are violating the FTC Act.  He urges the FTC to investigate.  Here's the abstract:

This paper examines the potential legal application of the Federal Trade Commission Act (FTC Act) to American Bar Association (ABA) accredited law schools. In recent years, evidence has emerged indicating that many law schools are misreporting or falsifying employment statistics in marketing materials and to the U.S. News Rankings and World Report law school rankings, the preeminent rankings for United States (U.S.) law schools. The reporting of false or misleading employment statistics to prospective students may violate provisions of the FTC Act that prohibit deceptive practices and false advertising. This paper reviews evidence that U.S. law schools are misreporting employment statistics, examines how the FTC Act applies to U.S. law schools, and argues that U.S. law schools that misreport or falsify employment statistics violate multiple provisions of the FTC Act.

 

Top Behaviorial Economist to Head CFPB's Office of Research

The Treasury Department today announced the hiring of behavioral economist Sendhil Mullainathan to serve as head of the CFPB's Office of Research.  The Wall Street Journal had this report on Mullainathan:

The leading behavioral economist of his generation, his research has focused on how people’s biases and weaknesses lead them to make bad economic decisions. He is also a founder, with Esther Duflo and Abhijit Banerjee, of MIT’s Jameel Poverty Action Lab.

His research has provided much of the intellectual foundation for the establishment of the CFPB, which is tasked with making “markets for consumer financial products and services work for Americans.”

“He’s more or less exactly what the CFPB should be: evidence based, appropriately suspicious of concentrated interests, and he understands that real people can make mistakes,” said Wharton School economist Justin Wolfers.

Mr. Mullainathan, 38, got an early lesson in how regulatory changes can affect people’s lives, and how fragile their livelihoods can be when a new rule in the 1980s disallowed foreign aerospace workers from doing defense-related projects. In practice, this meant that foreign workers couldn’t work on aerospace at all, since the delineation between defense and nondefense projects was fuzzy. His Indian father, an engineer at McDonnell Douglas, lost his job.

“There was this feeling of fragility, wow if my dad doesn’t get a job, then what?” Mr. Mullainathan recalled in a recent interview. “I still have that feeling very strongly, I understand it. It informs my thinking on this stuff and my motivation to work on it.”

A more extended WSJ piece is here.  According to a new blog post on the agency's website, the CFPB's Office of Research will not only publish findings under the agency's own name but will also encourage scholars to engage in independent research:

Frequently . . . researchers will choose their own topics, data, and methodology themselves, draw their own conclusions, and publish in their own names.  . . .  [W]e encourage this kind of “self-directed” research because it promotes evidence-based, rather than myopic or narrow, policymaking. Self-directed research will help us remain true to the core values that underpin our policymaking: honest investigation, independent thinking, and open discussion.

By offering our research staff the opportunity to pursue original ideas, the CFPB will also be in a better position to attract the best-trained researchers with the skills to strengthen our understanding of the benefits and costs of potential policies. Under the CFPB’s research policy:

• Researchers may elect to dedicate a substantial portion of their time to self-directed research. They may focus on household finance or behavior, consumer financial firms or markets, or other areas relevant to the mission of the consumer bureau. Other federal financial regulators also provide researchers time for independent research. For example, the portion of time provided at the CFPB will be comparable to that provided across the Federal Reserve System. Researchers who choose to conduct independent research will be evaluated based on research performance, such as their record of publications.
• Researchers are also encouraged to publish or present their work in peer-reviewed journals and other scholarly venues. The CFPB will not review or censor findings of self-directed research presented externally for policy content, so long as the researcher includes a disclaimer that the work does not necessarily represent the views of the CFPB.

Encouraging original inquiry and independent conclusions will help us act wisely on behalf of the American people. Allowing researchers to publish their findings will increase transparency – and that will help the public to hold us accountable

EFFICACY OF RESPA’S CLOSING COST DISCLOSURES

Guest Post by Elizabeth Renuart, Assistant Professor of Law, Albany Law School, based on the forthcoming paper in Housing Policy Debate she co-authored with Jen Douglas (who served as project coordinator of the NMDR during data collection and received her master’s degree in public policy from the University of Massachusetts Boston), titled The Limits of RESPA: An Empirical Analysis of the Effects of Mortgage Cost Disclosures:

As noted in an earlier blog post, the revised RESPA GFE and Settlement Statement became effective in January, 2010.  The new forms remain controversial and will get a second look over the next year.  In the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010, Congress instructed the Bureau of Consumer Financial Protection to review and combine both the Truth In Lending Act and RESPA cost disclosures into a single, integrated form for mortgage loan transactions by the summer of 2012. 

Congress passed the Real Estate Settlement Procedures Act in 1974 based upon documented instances of kickbacks between settlement service providers, unearned fees, and expensive and unnecessary closing fees paid by buyers and sellers of residential real estate.  It opted for a disclosure strategy accompanied by few substantive prohibitions.  Over the last thirty-five years, only a handful of studies attempted to measure the success of the mortgage loan disclosures by analyzing slices of the mortgage market. My co-author, Jen Douglas, and I used a uniquely rich database to examine this question in our working paper titled: The Limits of RESPA: An Empirical Analysis of the Effects of Mortgage Cost Disclosures. 

Due to the lack of detailed public data, the National Consumer Law Center collected loan data from attorneys, state agencies, and housing counselors.  In total, this dataset included 1,922 loans with either a GFE or HUD-1/1A, of which 779 loans had both a Good Faith Estimate (GFE) and a Settlement Statement (HUD-1/1A).  These 1,922 loans were made in 28 states by 318 lenders.

From these loans, we found evidence that borrower closing costs as a percentage of loan amount increased by 418% and by 182% for a subset of purchase loans since 1972.  Meanwhile, fee types doubled.  The early cost estimates underestimated the final closing costs and projected cash to borrowers in a majority of cases, lending credence to complaints of baiting and switching.  

We used our observations about the loans originated before the new forms became effective to opine upon whether the amended disclosure regime might improve or have no effect on specific problems we noted.   We expect that the new GFEs will more closely match the HUD-1/1As than those in our collection.  This should reduce the bait and switch concerns.  Further, HUD’s requirement that certain fee types be bundled into one number should increase the standard placement of fees.  Less clear is whether the changes will reduce the problem of fee proliferation, cryptic fee names, and similar concerns which we noted in our dataset.  Lack of transparency is the trade-off, however, since the bundled charges are no longer itemized.    Finally, we found important disclosure discrepancies occur when settlement agents chose to use the HUD-1, rather than the HUD-1A for refinance loans, a choice that HUD did not eliminate in 2010.   

While HUD vetted the new forms with focus groups, the agency has not investigated the worth of its forms in relation to the statutory goals in any consistent or routine way since 1974.  Our findings call into question the efficacy of the RESPA disclosure scheme.  Further, they point to the need for detailed data collection, routine monitoring of whether RESPA is meeting its legislative directive, and rigorous debate about whether RESPA’s goals can be achieved more effectively by another strategy.

Melissa Jacoby on the CFPB

Melissa B. Jacoby of North Carolina has written Dodd-Frank, Regulatory Innovation, and the Safety of Consumer Financial Products, 15 North Carolina Banking Institute Journal 99 (2011).  Here's the abstract:

Among the many parts of the Dodd-Frank Wall Street Reform and Consumer Protection Act, few have received as much mainstream attention as the creation of the Bureau of Consumer Financial Protection. As is often the case with legislation in recent years, though, some of the most vocalized critiques of the Bureau lack a foundation in Dodd-Frank as enacted or in the Bureau’s start-up efforts. This brief essay explores the nature of the Bureau and its promising possibilities for regulatory innovation that should transcend stale debates about regulatory overreach or command-and-control approaches. This commentary also reviews the unusual dialogue preceding Dodd-Frank about whether medical providers and other service businesses fall within the Bureau’s jurisdiction.

Not-so-Standardized Insurance Form Contracts

Professor Dan Schwarcz of Minnesota Law has posted an excellent empirical study of homeowner's insurance contract forms, finding important variations in coverage, most of which reduce the level of protection from the presumed industry standard.  The paper offers a meticulous review of insurance policy contract forms from the top ten insurers in six different states, revealing a dizzying variety of provisions for events such as water damage, pollution damage, theft losses, and replacement cost standards. 

Even obtaining the actual contract terms in use proved to be a significant challenge.  In part III Professor Schwarcz recounts his exhaustive efforts to obtain copies of contract terms, from insurers themselves, from insurance agents, and from state regulators.  Shockingly, state insurance departments who all profess to require contract forms to be submitted and approved, and to be publicly available, are systematically unable to produce insurance policy forms on request.  The bottom line is that consumers cannot possibly shop for coverage terms because they cannot discover contract terms without purchasing a policy.

This is the sort of careful study of actual consumer financial markets and practices that the research division of the new CFPB ought to be doing, to inform consumer education and regulatory strategies going forward. 

Margaret Ryznar Paper on the Treatment of Household Income in Consumer Lending

Margaret Ryznar has written Underwriting Credit Cards, Overwriting Congress, and Rewriting Family Law: The Treatment of Household Income in Consumer Lending, St. John's Law Review (forthcoming).  Here's the abstract:

Remarkably, the Federal Reserve has proposed rules that would prevent stay-at-home mothers from opening credit cards in their own names. These rules would require credit card issuers to consider only a person’s independent income, and not the household’s income, when underwriting credit cards in an effort to protect young adults unable to repay debt. However, in addition to keeping credit cards away from young adults, the proposed rules would problematically do the same for a larger group of people: non-income earning spouses, constituted primarily of stay-at-home mothers. Given the possibility that the rules may have exceeded Congressional intent, and given the significantly negative effects of the Federal Reserve rules due to the importance of access to the credit card market - particularly in light of the historical exclusion of women’s participation in legal and economic affairs - the Federal Reserve’s proposed rules require immediate reconsideration. The final rules, or their amendments, should recognize the non-income earning spouse’s financial participation in the household.

 

Lind Paper on Nuisance Laws and Banks

Kermit J. Lind of Cleveland State has written Can Public Nuisance Law Protect Your Neighborhood from Big Banks? 44 Suffolk University Law Review 89 (2011).  Here's the abstract:

One manifestation of the mortgage crisis of the past decade is the destabilization of housing markets and neighborhoods where mortgage defaults were concentrated. As banks and their mortgage servicers employ business practices that result in banks or their agents controlling or owning vacant dwellings, the noncompliance with housing and other municipal codes by these institutional absentee owners presents neighborhoods and cities with a huge and costly public nuisance problem.

This article explores both the theory of public nuisance law and the experience of applying nuisance law in practice to mitigate the harmful consequences of bank debt collection and REO management. It looks at how and to what extent public nuisance law provides protection for those non-defaulting homeowners whose health, safety and welfare are threatened by the business practices of big banks. It compares litigation that applies public nuisance law in different ways to distinguish viable uses from unsuccessful uses of public nuisance law doctrine. The recent efforts to use public nuisance law against manufacturers and marketers of harmful products like guns and tobacco are distinguished from the application of public nuisance law against owners of real estate maintenance deficiencies are in violation of laws protecting the public health, safety and welfare.

Capuano and Ramsay on the Causes of Suboptimal Financial Behavior

Angelo Capuano and Ian Ramsay, both of Melbourne, have written What Causes Suboptimal Financial Behaviour? An Exploration of Financial Literacy, Social Influences and Behavioural Economics.  Here's the abstract:

This research report is part of a project, funded by the Australian Research Council, which will contribute to a broader understanding of the role of financial literacy and consumer behaviour in Australia. The research report explores the causes of financial behaviour and considers whether suboptimal financial behaviour has causes other than lack of financial literacy. Part A of the research report explains the importance of financial literacy. This part identifies the benefits of financial literacy to consumers, the community, the economy and the financial markets. Part B explains the meaning of financial literacy. This part reviews financial literacy surveys conducted worldwide and refers to academic literature to explain the key competencies and proficiencies of a financially literate consumer. Part C outlines the flaws in the decision making processes of consumers when choosing financial products. Part D identifies social, psychological and cognitive causes of suboptimal and irrational consumer behaviour. It considers social influences on financial behaviour such as wealth, income, social capital as well as psychological biases and heuristics studied in behavioural economics and neuroeconomics. It is shown that suboptimal consumer decisions have many causes, not just financial illiteracy. Part E reviews 23 financial literacy surveys to explain how financial literacy is measured. It also identifies common findings among the surveys. The Appendix to the research report provides a summary of 23 financial literacy surveys from the World Bank and a number of countries including Australia, the UK, US, Italy, the Netherlands, Singapore, Japan, Austria, Ireland and Russia.