Consumer Law & Policy Blog

Second Circuit Upholds New York Fast-Food Menu Rule

by Deepak Gupta

I'm delighted that the Second Circuit has decided to uphold New York City’s landmark fast-food menu rule, which requires chain restaurants to disclose calorie information on their menus. (We previously blogged about the case here and here.) Today’s decision is a major victory in the fight against the obesity epidemic. It protects consumers’ right to know important nutritional facts and make informed and healthy choices when they eat out. The ruling is also significant because it clears the way for many similar state and local laws throughout the nation, such as those recently passed by the state of California and the city of Philadelphia.

The fast-food industry had asked the court to strike down New York’s rule, claiming that it was preempted by the Nutrition Labeling and Education Act of 1990 and that it violated the First Amendment under a compelled-speech theory. Public Citizen filed a brief opposing those arguments, representing a broad coalition that included Congressman Henry Waxman (the lead sponsor of the 1990 law), former FDA Commissioner David Kessler (who signed the first rules implementing the statute), the Center for Science in the Public Interest, the American Medical Association, the American Diabetes Association and many other leading public health groups and academic experts.

Today’s decision echoes many of our arguments and begins with a passage that comes right out of our brief: "In requiring chain restaurants to post calorie information on their menus," the court concluded, "New York City merely stepped into a sphere that Congress intentionally left open to state and local governments.”

In assessing the industry's First Amendment arguments under a rational basis standard, the court cited research showing that eating out is a major contributor to obesity and that consumers are typically unable to assess the caloric content of foods. They do not know, for example, that a smoked turkey sandwich at Chili’s (930 calories) contains more calories than a sirloin steak (540 calories), or that two jelly donuts from Dunkin Donuts have fewer calories than a sesame bagel with cream cheese.  Until I started working on this case, I had no idea either.

As a matter of political philosopy, New York's rule is perhaps a good illustration of the kind of "libertarian paternalism" advocated by certain scholars influenced by behavioral economics, such as Cass Sunstein and Richard Thaler (as described in their recent book, Nudge, which Jeff Sovern has thoughtfully blogged about in these pages.)  In theory, at least, this is the kind of law that people from all ends of the political spectrum should be able to support; it helps consumers make choices that will maximize their welfare, but the choice is ultimately left up to them. Even Richard Posner has offered a qualified defense of the regulation.

The Law and Economics of Subprime Lending

Todd Zywicki and Joseph Adamson of George Mason have a new article at SSRN offering a conservative law-and-economics take on the subprime mortgage lending crisis. After a lot of back and forth, the paper's basic point is that policymakers shouldn't do anything in response to the current crisis until we know much more about how to "balance the cost and benefits" of subprime lending. Here's their abstract:

The collapse of the subprime mortgage market has led to calls for greater regulation to protect homeowners from unwittingly trapping themselves in high-cost loans that lead to foreclosure, bankruptcy, or other financial problems. Weighed against this catastrophe are the benefits that have accrued to millions of American families who have been able to become homeowners who otherwise would not have access to mortgage credit. Although the bust of the subprime mortgage market has resulted in high levels of foreclosures and even problems on Wall Street, the boom generated unprecedented levels of homeownership, especially among young, low-income, and minority borrowers, putting them on a road to economic comfort and stability. Sensible regulation of subprime lending should seek to curb abusive practices while preserving these benefits.

This article reviews the theories and evidence regarding the causes of the turmoil in the subprime market. It then turns to the question of the rising foreclosures in that market in order to understand the causes of rising foreclosures. In particular, we examine the competing models of home foreclosures that have been developed in the economics literature - the "distress" model and the "option" model. Establishing a correct model of the causes of foreclosure in the subprime market is necessary for sensible and effective policy responses to the problem. Finally, we review some of the policy initiatives that have been suggested in response to the crisis in the subprime market. Because new regulatory interventions will have costs as well as benefits, until the causes of the market‘s problems are better understood it may be that the best policy in the short-term is to do little until well-tailored regulatory approaches are available.

Shmuel Becher Papers on Consumer Contracts

Shmuel I. Becher has two papers on consumer contracts.  One is Behavioral Science and Consumer Standard Form Contracts, 68 Louisiana Law Review, available at http://ssrn.com/abstract=1016002. Here's the abstract:

Asymmetric information is a serious threat to the market of consumer standard form contracts. Yet, legislatures, courts, and market-forces do not provide an adequate solution to this threat. This Article argues that a considerable part of this failure is due to the fact that important and relevant social science insights regarding consumers' behavior is widely overlooked. This gap results in the prevalence of unfair or inefficient consumer form contract provisions. More profoundly, it entails that current approaches towards consumer contracts are fundamentally flawed and bound to reach erratic and sometimes unjust conclusions.

Cognitive biases and consumers' actual behavioral patterns should have an important role - descriptively and normatively - in the law of consumer contracts. This Article explains how psychological phenomena contribute (i) to consumers' tendency not to read form contracts even when by doing so they fail to maximize their utility; (ii) to consumers' inability to evaluate correctly contract terms once they do read them; and as a result (iii) to sellers' capability of manipulating consumers.

The end point of this discussion is twofold: First, it seeks to expand our understanding regarding the inadequacy of current approaches to consumer contracts and the harm that consumers are exposed to when actual behavioral patterns are ignored. Secondly, it provides policy makers with better insights as to the way in which contract law should design the alternative approach to consumer contracts.

Wright Paper on Behavioral Law and Economics and Consumer Contracts

Joshua D. Wright of George Mason has an article in 2 NYU Journal of Law & Liberty, Behavioral Law and Economics, Paternalism, and Consumer  Contracts: An Empirical Perspective, available at http://ssrn.com/abstract=1015899.  Here's the abstract:

Modern legal scholars frequently and increasingly base their analyses on the assumption, grounded largely in the extensive experimental literature, that individuals are subject to a number of systematic behavioral biases. Within the legal literature, behavioral economic analysis has been relied upon to generate a significant number of proposals for paternalistic regulation. These proposals are frequently accompanied by claims that neoclassical economics is insufficiently flexible to deal with these empirical observations, and that behavioral law and economics is as a superior guide for policy analysis. These claims must ultimately be resolved empirically and turn on whether incorporating insights from behavioral economics improves our ability to explain the law, understand the behavior of economic agents, or predict the consequences of legal change. This paper focuses on the shared interest of both neoclassical and behavioral economists in empiricism and explanatory power. It asks whether behavioral economic analysis of law has increased our knowledge in an area of “consumer contracts.” Specifically, the paper surveys the available empirical evidence to assess claims from the behavioral law and economics literature involving exploitation of consumer biases with credit cards, standard form contracts, and shelf space contracts. I find that the empirical studies of firm and consumer behavior in these examples do not support the claims that behavioral law and economics generates greater predictive power than conventional price theory.

Matt Edwards Paper on the FTC's Use of Behavioral Law and Economics

Matt Edwards's article, The FTC and the New Paternalism, can be found at http://ssrn.com/abstract=1014652.  Here's the abstract

During the past decade, we have witnessed a renaissance of paternalism in legal scholarship fueled by the rise of behavioral law and economics ("BLE"). This paper addresses the potential impact of BLE and the "new paternalism" on the Federal Trade Commission's consumer protection mission. After providing a survey of some of the basic teachings of BLE, the paper reviews the fascinating political and legal history of the FTC's unfairness authority to show how a major political battle helped to transform the legal concept of unfairness from a market morality norm into a law and economics concept grounded in the concept of consumer sovereignty.

The latter parts of the paper use three examples - mail-in consumer rebates, inducement of supermarket impulse purchases, and payday lending - to explore the challenges that the FTC faces if it decides to press unfairness claims based on alleged behavioral exploitation. These tasks include weighing uncertain costs and benefits of business practices, determining what harms are "reasonably avoidable" in cases of purported consumer irrationality, and elaborating a principle to mediate disputes between consumers' multiple selves. Given these empirical and normative challenges, and the FTC's unfairness history, one might expect the Commission to be cautious in its use of BLE and resistant to more radical strains of the new paternalism.

Becker and Posner on the Suprime Mortgage Meltdown

by Jeff Sovern

The Becker-Posner Blog, written by Law and Economics Guru Richard Posner and the Nobel Prize-winning economist Gary Becker, always offers interesting commentary.  In December they took on the suprime mortgage crisis (you can find their posts here, though you have to scroll down a bit).  The posts are worth reading in full, but here are some excerpts.  Becker offers this assessment about the Fed's proposal to prevent recurrences of the crisis:

Given the low interest rate lending atmosphere of the past few years, it is highly unlikely that borrowers would have turned down the mortgages they received if they had much better information about terms, or that lenders would have been more reluctant to originate or hold these mortgage assets if they had better information about the credit and other circumstances of borrowers. This is why I doubt that the rules proposed * * * by the Federal Reserve to require lenders to get more information about borrowers, and to provide more information to borrowers about the terms of mortgage loans, would have been effective in warding off this crisis, or will be effective in preventing future crises.

I'm not sure what the basis for his assumptions is, but it does make you think.  He also comments:

* * * it is ironic that only a few years ago, banks were being investigated for "redlining"; that is, for avoiding lending to blacks and other residents of poor neighborhoods. The Fair Housing Act of 1968 prohibits discrimination in lending, and The Community Reinvestment Act of 1977 requires banks to use the same lending criteria in all communities, regardless of the living standards of residents. As a result of the present crisis, however, banks and other lenders are being criticized for equal opportunity lenient lending to all, including black residents of depressed neighborhoods.

That isn't precisely how I interpret the CRA, and I would have mentioned ECOA's prohibition on discrimination in lending, and my own understanding of the criticism for lenders is not that they provided equal opportunity lending to all, but that they made some loans on terms unsuited to their borrowers, but perhaps he's seen some criticism that I haven't.  In any event, the perspective is interesting.  Here's an excerpt from Posner's post:

It has been argued that the people who took out subprime mortgages with adjustable interest rates did not understand the risks they were assuming, and that the banks that bought mortgage-backed securities did not understand the risks they were assuming. I am skeptical. Suppose you have a low income, you'd like to own a house, and a mortgage broker offers to arrange a mortgage that will cover 100 percent of the price of the house. What do you have to lose by accepting such a deal? Since you haven't put up any capital, you have no capital to lose if you lose the house because you cannot make your monthly mortgage payments. As for the banks, they rode the bubble for too long; but, to repeat, had they got out too early, they would have left a lot of money on the table.

If there's any evidence floating around that borrowers did understand the risks they were assuming, I'd love to hear it. 

How the Leegin Decision Will Hurt Consumers on the Internet

by Greg Beck

In Leegin Creative Leather Products v. PSKS, the Supreme Court last week overturned the nearly century-old rule in Dr. Miles Medical Co. v. John D. Park & Sons Co. that an agreement between a manufacturer and a distributor to set minimum prices is a per se violation of antitrust law. In doing so, the five-justice majority was persuaded by the amici curiae brief of twenty three economists, who argued that, at least in some cases, the availability of less expensive products on the Internet may be bad for consumers. The Supreme Court found persuasive the economists' argument that minimum-price agreements can help avoid the so-called "free-rider problem," which comes up when consumers shop at traditional retailers to make their decisions about what to buy but then use the Internet to find the cheapest available price. As the economists wrote:

Poverty in Business Week

Today's top story in Business Week:

The Poverty Business: Inside U.S. companies' audacious drive to extract more profits from the nation's working poor

Also:

Cutting the Cost of Poverty: Scholars are taking a fresh look at the financial problems of the working poor, and have some new suggestions on how to address them

Stop Fleecing Poor Americans (The Debate Room): The U.S. government should place greater restrictions on car sellers, pay-day lenders, and tax preparers who offer the working poor cash or credit with high fees and interest rates. Pro or con?

Not So Cute Anymore

by Christopher Peterson

Gary Coleman endeared himself to Americans as a child actor staring in the 80's sitcom "Different Strokes". His cherubic face and affably excitable character reliably delivered punch lines, including especially his signature catchphrase "Whatchoo talkin' 'bout, Willis?"  When his television show ended, Coleman found that his parents and manager had mismanaged his multi-million dollar trust fund, eventually leaving him penniless.

I always felt sympathy for the actor, who suffers from a congenital kidney disease, as he tried to break out of his childhood typecasting and find a satisfying path in life. Still, it raised my eyebrows when I learned that Mr. Coleman had accepted a job as a spokesperson for Cash Call, Inc., a California based finance company that makes high-interest, unsecured loans to consumers in California, Idaho, Nevada, New Mexico, and Utah. In most other states Cash Call also acts as a solicitation agent for First Bank & Trust, Milbank, South Dakota.

This three-way relationship brought a couple of thoughts to mind:

First, lenders have a tendency to focus on economics when they talk about public policy. Discussions of usury law, disclosure law, and bankruptcy seem to inexorably turn to concepts like opportunity costs, Pareto optimal outcomes, and regulatory distortion. The intellectual contributions of behavioral economists are generally scorned or minimized. But lenders do seem to rely on psychology when they talk to their customers. Mr. Coleman is valuable to Cash Call and First Bank & Trust because of his notoriety. It is not as though loans from by a firm endorsed by Gary Coleman are better or cheaper loans. Rather they employ him because he is salient in the minds of millions of people who watched him on television back in the good-ole’ days. Mr. Coleman reminds us that things don’t always work out, and that even former TV super-stars do not need to feel bad about borrowing money from a shady company like Cash Call now and then. (Go to ripoffreport.com and search under "Cash Call" for a long list of upset customers, including this one or this one.) Mr. Coleman is an ideal spokesman for a company that wishes its customers to lower their guard. After all, who wouldn’t trust cuddly, little "Arnold" from TV?

A second point. In an essay forthcoming in the American Law Review, I question the wisdom of granting federal preemption to agents of chartered depository institutions. According to the Office of the Comptroller of the Currency and the Office of Thrift Supervision, independent agents of national banks and thrifts should be regarded as beyond the regulatory and legislative oversight of state governments. The FDIC is considering an attempt to grant similar powers to state banks, such as First Bank & Trust, Milbank, South Dakota. Federal regulators have explained that state governments should not be allowed to regulate national banks and thrifts simply because the financial institutions chose to deliver services through an agent. But as Cash Call’s relationship with First Bank & Trust demonstrates, non-depository agents will always tend to have less incentive to forego predatory behavior than a depository institution with closer oversight, greater capital requirements, and relatively greater investment in reputational capital. If First Bank & Trust wants to use Gary Coleman to peddle their high-interest loans, shouldn’t they be required to hire him directly, rather than hiding behind an agent?

In the end perhaps Mr. Coleman still deserves our empathy. I suspect he is being used yet again.

Race, Price, and the Mortgage Market

by Deepak Gupta

Professor Lauren Willis of Loyola-Los Angeles (whose new article on price disclosures was discussed by Jeff Sovern here last week), had an op-ed in yesterday's Washington Post entitled "The Fleecing of Black Borrowers."   Willis cites new Federal Reserve Board data showing that less than one-fifth of non-Hispanic whites took out high-priced loans last year, as opposed to more than half of African-Americans.  "Black borrowers paid--and will continue to pay for the life of these loans--high prices at more than triple the rates that whites did."   

Neither racial discrimination nor the relative risk of lower-income minorities as borrowers, she says, fully explain these disparities:

The home loan market is what economists call "inefficient" and what the rest of us might call plain unfair: Minorities -- and many whites -- receive high-priced loans when they are financially qualified for lower-priced loans.

Why? As an official of the American Bankers Association, quoted in The Post, put it: "People shop more for a loaf of bread than they do for a mortgage."