Thursday, March 28, 2013
This is the eighth and final post in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. Below, Professor Bar-Gill (pictued) responds to the comments provided by Angela Littwin, Alan White and Nancy Kim.
I wish to open these comments by thanking Jeremy for organizing a great panel and for following up with this on-line symposium. I also wish to thank Angela, Alan and Nancy for their thoughtful comments and suggestions. I cannot, in this space, respond to all the valuable ideas and critiques that these experts presented in their posts. Rather, I will touch upon three sets of issues that I consider especially important or provocative.
1. The Role of Competition
Competition is often considered to be a solution to market failure. “Seduction by Contract” argues that competition is not necessarily a solution to the behavioral market failure, which is the focus of the book. In essence, if imperfectly rational consumers generate biased demand, sellers in a competitive market must respond to this biased demand by designing products, contracts and prices that exploit the consumer bias.
This does not mean, however, that competition cannot play a helpful role. It can, and it does. Consumer biases and misperceptions are dynamic and can be influenced by market forces. Specifically, sellers can educate or debias consumers through advertising. For example, until recently, imperfectly rational consumers paid little attention to late fees when shopping for a credit card. Now banks are competing over cardholders by advertising their late-fee policies. Another example, noted in Nancy’s post, concerns early termination fees (ETFs) in cellphone contracts. Until recently, ETFs were non-salient to consumers and a 2-year lock-in contract was the norm. Now many carriers are advertising No Contract options. Nancy argues that the rise of No Contract is an imperfect market solution, and I agree that it is imperfect. Nonetheless, it shows how markets can respond to changes in consumer perception (and misperception) and, in some cases, lead these changes.
2. Normative Framework
Alan asks about the appropriate normative framework. As an economist, I am a welfarist. But I should emphasize that welfarism is very different from utilitarianism. The welfarist cares about distributional effects; the utilitarian does not.
Since I focus my policy analysis on disclosure (see below), Alan infers that I care primarily about autonomy. But, as explained above, my normative framework is welfarist. My preference for disclosure regulation rests on the argument that optimally designed disclosures can enhance social welfare, by helping to overcome (or bypass) consumer biases and misperceptions.
This last point also responds to some of Alan’s critiques of my disclosure proposals. I agree with Alan that most existing disclosure mandates simply don’t work. But the fact that badly designed disclosures don’t work, doesn’t tell us very much about the potential benefits from well-designed disclosure mandates. My goal was to come up with disclosures that will be effective, given the imperfect rationality of consumers.
3. Legal Policy Response: The Role of Disclosure Regulation
The policy analysis in “Seduction by Contract” focuses on disclosure regulation. This is not because disclosure always works and it is not because disclosure, when it works, perfectly cures the behavioral market failure. I focus on disclosure, because I think it can help, when optimally designed; because often it is the most (and sometime the only) politically feasible mode of regulation; and because it avoids certain costs associated with more paternalistic modes of regulation. To be clear, I do not argue that more paternalistic intervention is never warranted. And if I had the tenacity to write a longer book, I would definitely explore other regulatory approaches beyond disclosure. Angela and Alan are disappointed by my focus on disclosure. I hope this response provides some (limited) reassurance.
The analysis of disclosure regulation in “Seduction by Contract” hopes to provide some guidance to lawmakers on how to optimally design disclosure mandates. I begin by emphasizing the importance of product use information, and product use disclosures. Second, I outline two disclosure strategies that can help imperfectly rational consumers. First, simple aggregate disclosures, like a “total cost of ownership” disclosure, can help consumers make better choices. Second, more comprehensive disclosures can be used, but these disclosures would be targeted at sophisticated intermediaries, and would not be for direct “consumption” by imperfectly rational consumers.
[Posted, on Oren Bar-Gill's behalf, by JT]
Wednesday, March 27, 2013
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IIIB: Nancy Kim on Cell Phone Contracts
This is the seventh in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. Today is the second of a two-part contribution from our own Nancy Kim of the California Western School of Law.
Bar-Gill argues that the three part design of cell phone contracts (summarized in yesterday's post) imposes welfare costs by preventing efficient switching of plans and discouraging comparison shopping and by regressively redistributing wealth from the consumers to carriers, and from lesser informed (and presumably poorer) consumers to better informed (and presumably richer) consumers. He also argues that market solutions are limited as providers must respond to the biased demands of consumers or else be driven out of the marketplace.
I tend to agree but only to a point. I do think in many markets, and the cell phone service market is one, consumers eventually wise up (i.e. after “bill shock”) and competition heats up in response to consumer dissatisfaction. The problem is that it might take a while, and by the time consumers can muster up some momentum, the existing players have gotten bigger and more entrenched – and newer companies can’t compete in terms of marketing dollars. In the cell phone space, for example, Walt Mossberg of the Wall Street Journal, recently reviewed a new upstart called Republic Wireless. The company’s offering is the exception to the standard three part contract design – they offer no contract. Furthermore, users pay for the phone in exchange for which they pay a very low monthly fee – only $19. (Users also have the option of paying less for the phone and slightly more for the monthly service). The catch? The reception itself isn’t as good because the technology isn't quite there yet – but it’s coming. I think the bigger challenge for the company isn’t that calls sometimes get dropped – I use Sprint and my calls get dropped all the time! – it's getting their name out there (Republic who?) and overcoming consumer inertia.
Bar-Gill proposes disclosure regulation as a way to deal with problematic contract design. He’s right to a certain extent – while disclosure has been knocked as ineffective, the problem is really with the type of disclosure and not the notion of disclosure. In other words, we need the right kind of information. Bar-Gill proposes that carriers be required to disclose consumer use information (both specific to the consumer based upon past use as well as use by others similar to the consumer) and total cost of ownership information which would be the total amount paid by the consumer including overage charges on a yearly basis or over the duration of the plan. He also proposes that there be real time disclosures or warning so consumers know before they make that call that they are about to exceed their plan limit.
While I like his proposals, Bar-Gill omits one very important aspect of disclosure (which I have written about in other articles, most recently this one) – and that is visual design. In other words, effective disclosure should mean both the right information as well as the right presentation of that information. You can require all the relevant information you want but if consumers don’t notice it, then they won’t read it. How the information is disclosed is just as important, in my view, as what information is disclosed. Furthermore, in some markets, regulatory action of business practices (and not just disclosure regulation) may be required.
I could go on, but I’ve already taken up too much space. Hopefully this review has sparked your interest and made you want to run out and buy your own copy. Oren Bar-Gill has written a useful and thought provoking book and I think that it’s essential reading for contracts profs (as is Margaret Jane Radin’s book, BOILERPLATE, which was also discussed on a different panel).
[Editor's note: we expect to have an online symposium on Boilerplate in May)
[Posted, on Nancy's behalf, by JT]
Harvey Gilmore, Law School Grades: Flunked Out, But Did Not Really Fail. 7 Charleston L. Rev. 207 (2012-2013)
David L. Johnson, The Parameters of "Solicitation" in an Era of Non-Solicitation Covenants, 28 A.B.A. J. Lab. & Emp. L. 99 (2012)
Tuesday, March 26, 2013
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IIIA: Nancy Kim on Cell Phone Contracts
This is the sixth in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. Today is the first of a two-part contribution from our own Nancy Kim of the California Western School of Law. In this post, Nancy lays out Professor Bar-Gill's explanatory model. In tomorrow's post, Nancy will set out her differences with Oren's approach. Stay tuned:
Oren’s book adopts a behavioral economics approach to consumer contracts. His thesis is that companies are intentionally using contract design to exploit the imperfect rationality of consumers – what other contracts profs like Melvin Eisenberg and Russell Korobkin have referred to in their classic articles as “bounded rationality.” Prof. Bar-Gill’s book adopts this basic insight regarding contract design and applies them to three types of consumer contracts: mortgages, credit cards, and cell phones. The chapter I discussed was on cell phone contracts (Angela and Alan deftly tackled the other two).
Bar-Gill discusses some interesting facts about the cell phone market but the focus is on the three design features of cell phone contracts: three part tariffs, lock-in clauses and complexity.
The three part tariff consists of a monthly charge, a number of voice minutes that the monthly charge covers, and a per-minute price for minutes beyond the plan limit. Consumers choose calling plans based upon a forecast of future use, but consumers don’t forecast accurately. Many underestimate and end up paying much more by exceeding their plan limit whereas other (many more others, actually) overestimate their future usage and pay too much for their service by paying for minutes they never use.
The second feature, lock in contracts, are a market response to the imperfect rationality of consumers. The lock-in contract typically consists of a “free” fancy phone and a two or three year contract. The consumer is required to pay an early termination fee (although that is now greatly discounted or prorated– more on that later). Bar-Gill argues that these lock-in contracts take advantage of consumer myopia as subscribers are lured by the fancy free phone and underestimate the likelihood that switching will be beneficial down the road.
The final feature, complexity, allows carriers to hide the true cost of the contract, Complexity refers to all the confusing features and pricing variables offered by companies – in addition to the 3 part tariff, lock in clauses and early termination fees, there are different prices for different times of day, rollover minutes, family plans, etc. Boundedly or imperfectly rational consumers do not effectively aggregate costs associated with these different plans and will focus on a subset of salient features and prices and ignore or underestimate other features and prices. In response, providers will increase prices or reduce the quality of non-salient features.
Bar-Gill explains how carriers design their contracts using these three design features to exacerbate the misperceptions of consumers. In doing so, they reduce the net benefit that consumers derive from their service. He also addresses a typical rational choice explanation for the three part design of cell phone contracts, namely that consumers have heterogeneous preferences; complexity and multidimensionality cater to those differences. Yet, Bar-Gill concludes that this rational choice explanation fails simply because it is too costly for even perfectly rational consumers to ferret out this information. The cost of sorting out the information exceeds the benefit of finding the perfect plan, thus deterring any shopping for terms.
[Posted, on Nancy Kim's behalf, by JT]
Monday, March 25, 2013
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IID: Alan White, The New Law and Economics and the Subprime Mortgage Crisis
This is the fifth in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. This post is the fourth (and last) of a series within the series contributed by Professor Alan White of the CUNY School of Law (pictured at right).
Part III: Prescriptions for Future Mortgage Regulation When Information Is Not Enough
In my prior posts, I discussed two aspects of Oren Bar-Gill’s book chapter on subprime mortgages: the behavioral economics insights that describe how these disastrous contracts came to be, and the norms and values that the law should promote in regulating the mortgage market in light of the subprime fiasco. I now turn to the conclusion of the chapter, and its policy recommendations. In brief, Oren proposes two steps, an all-in loan price disclosure by means of an improved annual percentage rate (APR) formula, and requiring disclosures earlier in the mortgage shopping process. “Disclosure regulation is the right place to start . . . A disclosure mandate seems to provide . . . an effective response to the behavioral market failure in the subprime and Alt-A mortgage markets.”
Given the range of regulatory tools already adopted by Congress, the Federal Reserve and the CFPB, and the extensive damage done by the subprime mortgage market, this prescription is surprisingly timid. Oren acknowledges that Dodd-Frank includes substantive regulation of contract terms, but nevertheless adheres to a very traditional economist’s solution – fix information problems and the market will maximize welfare.
But the whole point of behavioral economics, in the context of mortgage loans, is that information isn’t enough. Even borrowers who understand risky and expensive loan terms will still choose them, and suffer welfare harms as a result. Subprime brokers were also very adept at using mandatory disclosures to mislead consumers and reframe choices. Moreover, Oren nicely summarizes the evidence that literacy and math skills of most adults are not up to the task of assessing mortgage risk and making complex price trade-offs, for example with adjustable rates and prepayment penalties, even with perfect disclosures.
Although the recommendations are not presented as exclusive, Oren implicitly comes out favoring consumer autonomy as the primary norm for mortgage regulation. To my mind this evades some more difficult choices for the law of mortgage contracts, where serious attention to welfare maximization and economic equity would call for stronger legal intervention, but where we can recognize that autonomy is a value as well.
On the question of foreclosure risk, for example, the Dodd-Frank act is paternalistic. It requires lenders to make a reasonable determination of the borrower’s repayment ability, i.e. it prohibits excessive foreclosure risk. The new law’s regulatory approach is an interesting balance between consumer autonomy and welfare maximization. The CFPB is charged with prescribing contract terms that are deemed safe, and loans with those terms are immune from legal attack. Loans outside the safe harbor contract design are legal, but may be attacked under the broad affordability standard in the statute. This is a form of nudging or choice architecture advocated by other behavioral economists.
There are also important value trade-offs in current debates around fair lending laws, such as how to apply the disparate impact test to mortgage lending, that directly confront the normative conflicts between autonomy, welfare maximization and racial justice. A prescription to begin with disclosure seems ill-suited to addressing the huge impact subprime mortgage lending had on racial wealth distribution in our country, and ill-suited to preventing future systemic mortgage contract failures and their disastrous consequences for homeowners and the economy generally.
[Posted, on Alan White's behalf, by JT]
Friday, March 22, 2013
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IIC: Alan White, The New Law and Economics and the Subprime Mortgage Crisis
This is the fourth in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. This post is the third of a series within the series contributed by Professor Alan White of the CUNY School of Law (pictured at right).
Part II: Plural Norms for a New Law and Economics After the Subprime Mortgage Crisis
Although Oren is not explicit about his normative framework, the frequent references to consumer welfare, maximization, and efficiency hint at a standard utilitarian framework based on revealed preferences. He does mention distributional concerns at certain points, including a reference to the race discrimination evidence. In the end, I was left wondering what role either welfare maximization or distributional equity were supposed to play; his prescriptions for future legal intervention (better disclosure) ultimately seem motivated mostly by autonomy concerns.
One of the great insights of behavioral economics is that consumer autonomy and wealth-maximizing efficiency are not so neatly aligned as law and economics previously assumed. The removal in the 1980s of restrictions on mortgage loan terms and prices increased consumer autonomy; it did not maximize consumer (or lender) welfare. Some behavioralists (for example, Michael Barr) advocate choice architecture or “nudging”, for example by creating favored mortgage products to be offered as the default option. They implicitly favor welfare maximization over autonomy, but obviously give some weight to autonomy as well in preferring “nudges” to legal mandates for contract terms. Oren, on the other hand, recommends disclosure as the legal response to subprime mortgages, and so seems to come out on the autonomy side of the autonomy-welfare dilemma.
These competing values are embedded in present-day policy choices being made for the law of mortgages. One example can be found in the debate about the “qualified residential mortgage” (QRM) under the Dodd-Frank financial reform law. Federal regulators have proposed that mortgage borrowers must make a 20% down payment for a loan to be a QRM. Mortgages that do not qualify as QRM’s are not banned, but lenders cannot package and sell non-QRM loans as securities without retaining some of the risk on their balance sheets. This nudge favoring high down payments might further the utilitarian goals of limiting risk and hence external costs of default, and might be thought to promote borrower and lender welfare as well, albeit paternalistically. On the other hand, lower down payments may promote equity for disadvantaged groups, and may also have positive welfare effects, with careful underwriting. A rule allowing a broader range of product choices would also promote borrower autonomy, perhaps traded off against these competing values. There is no clear answer, and revealed preferences, i.e. whatever unregulated lenders and borrowers would agree to, are not especially helpful in weighing the value choices.
The new law and economics recognizes that not all markets simultaneously advance consumer autonomy and welfare, to say nothing of equity. As Nathan Oman points out, markets sometimes are very good at increasing wealth and decentralizing political power, but they can also be pathological, advancing none of our values. The law in law and economics can benefit from economists’ insights about utilitarian welfare effects, while the economics in L&E can be explicit about its value choices, and seek to measure welfare, equity and autonomy effects of different legal rules for markets. In my final post, I will turn to the specific proposal Oren makes for an improved APR disclosure as the preferred legal response to the subprime mortgage problem.
[Posted, on Alan White's behalf, by JT]
Thursday, March 21, 2013
Shu-Cheng Steve Chi, Raymond A. Friedman and Huei-Lin Shih, Beyond Offers and Counteroffers: The Impact of Interaction Time and Negotiator Job Satisfaction on Subjective Outcomes in Negotiation, 29
Negotiation J. 39 (2013)
Ann E. Conaway & Peter I. Tsoflias, Challenging Traditional Thought: No Default Fiduciary Duties in Delaware Limited Liability Companies after Auriga, 13 J. Bus. & Sec. L. 1 (2012)
Michael Keegan, Bargaining for Power: Resolving Open Questions from NRG Power Marketing, LLC v. Maine Public Utilities Commission, 65 Me. L. Rev. 99 (2012)
Donald J. Kochan, The Property Platform in Anglo-American Law and the Primacy of the Property Concept, 29 Georgia State University Law Review 453 (2013) (available on SSRN here)
Monica P. Navarro, Materiality: A Needed Return to Basics in False Claims Act Liability, 43 U. Mem. L. Rev. 105 (2012)
Alexander Volokh, Privatization and the Elusive Employee-Contractor Distinction. 46 UC Davis L. Rev. 133 (2012)
My article "Party Sophistication and Value Pluralism in Contract" has been "published" to the Touro Law Review website. I am told that it will be published in a print version in my lifetime - whatever, print is dead (or maybe not and here's the reason why). In all seriousness, even if you don't check out my article, check out the Law Review's fancy new website.
[Meredith R. Miller]
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IIB: Alan White, The New Law and Economics and the Subprime Mortgage Crisis
This is the third in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. This post is the second of a series within the series contributed by Professor Alan White of the CUNY School of Law (pictured at right).
At least three important points should be added to Oren’s account of the subprime market failure. First, the range of consumer and lender biases, abbreviated reasoning, and situational influences that cause mortgage products to depart systematically from rational welfare maximizing is considerably wider than the territory he surveys. Second, his account focuses on pricing, but much of the harm done by subprime mortgages was due to product features that needlessly increased the risk of default, quite apart from whether prices were excessive or misunderstood. Third, subprime mortgage originators and their funders did more than simply respond to consumer behavior. They deliberately framed the choices and exploited consumer behaviors to maximize yield spread. In other words, lenders had agency, and the product offerings were not merely a response to consumer demand.
Lauren Willis’ 2006 paper, for example, described subprime mortgage borrowers’ “assent” to harmful contracts as a result not only of the cognitive limitations mentioned by Oren, but also to the ego threat presented by the possibility a loan application will be denied, and the emotional distress attendant to the home purchase and financing context. She points out as well that abbreviated reasoning brought on by both cognitive limitations and emotional factors led subprime mortgage borrowers to focus almost exclusively on the initial monthly payment as a proxy for the loan price. Indeed, minority mortgage applicants may not attend to price terms at all, if their focus is primarily on finding a lender willing to approve a loan in the first place. These emotional factors are not readily addressed by better information disclosure.
Sellers, of course, are not perfectly rational either. Apart from the exploitation issue, any account of the subprime mortgage market that does not acknowledge overt and implicit racial bias is necessarily incomplete. The empirical evidence is clear that price discrimination, i.e. charging higher rates and fees to equally qualified borrowers, was rampant and had a disparate effect on minority borrowers. While price discrimination can be seen as rational rent seeking, it is difficult to explain the systematic practice of steering minority mortgage borrowers to unnecessarily expensive loan products when market share might have been gained by competing on price for these borrowers. It bears emphasizing that minority homeowners did not just face more expensive and risky loans because of lower credit scores and home values. The credible research tells us that homeowners of color paid higher rates and were more likely to get subprime mortgages than comparably qualified white homeowners. Homeowners lost homes, and much of their accumulated wealth, not just because they were financially weaker, but also because they were black or brown. The role of race in the descriptive story of the subprime mortgage market distinguishes it from the market failures in credit card, cell phone, and other consumer markets, and has important implications for regulation of mortgage contracts.
Even when loan prices reasonably reflect lender costs, subprime loans imposed welfare losses via excess risk of default and foreclosure. By increasing the loan amount, dispensing with income verification, adding prepayment penalties and deferring payment of interest and principal, lenders dramatically increased the risks of default, in ways that borrowers either misunderstood or predictably ignored. Often the same borrowers would have qualified for safer mortgages at similar cost, or in the case of income documentation, at lower cost. Consumers’ inability to judge loan risk or avoid needlessly risky mortgages is the topic of another paper by Professor Willis. While rational choice adherents would say borrowers who knowingly took on a 25% risk of default might have reasonably weighed the benefits of the loan and the risk, and therefore they were not harmed by taking such a risky loan, that account of welfare and utility is thin indeed. The excessive default risk of subprime mortgages is not easily fixed with disclosure-based solutions.
Behavioral economists tend to minimize the agency of sellers in framing and manipulating consumer biases and mental short cuts. The emphasis on consumer errors is significant. Oren repeatedly refers to lenders “responding” to consumer misperception and bias. A different characterization ascribes more responsibility to lenders: faced with consumer biases and heuristics, some mortgage originators deliberately manipulate consumer behavior. As he points out, lenders could respond to consumer optimism bias by marketing fixed payment loans and selling their safety compared to teaser-rate or teaser-payment loans. Instead, they chose to push payment deferral and to obfuscate prices, electing the profit-maximizing strategy of exploiting rather than correcting consumer bias. Whether we describe mortgage lenders as responding to consumer errors, on the one hand, or exploiting behaviors, emotional states and cognitive limitations of consumers on the other, will matter considerably when we turn to the normative and prescriptive conclusions to be reached from our better understanding of how the subprime market worked (or didn’t).
[Posted, on Alan White's behalf, by JT]
Wednesday, March 20, 2013
Online Symposium on Oren Bar-Gill's Seduction By Contract, Part IIA: Alan White, The New Law and Economics and the Subprime Mortgage Crisis
This is the second in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. This post is the first of a series within the series contributed by Professor Alan White of the CUNY School of Law (pictured at right).
Oren Bar-Gill’s work on contracts in various consumer markets has contributed importantly to the deconstruction of the dominant law and economics paradigm. That paradigm has centered around rational choice theory as a description of markets generally and consumer contracts in particular, on norms that are utilitarian, equating aggregate welfare with revealed preferences, and legal prescriptions that begin with deregulation and noninterference by the state. The law and economics paradigm found expression in the broad deregulation of consumer credit contract terms generally, and mortgage loans particularly, from 1980 until 2008, by Congress, the banking agencies and the courts. Oren’s application of behavioral economics to consumer credit markets helped pave the way not only for important academic debates but for the change in course for federal regulatory policy that followed the global financial crisis.
In Seduction by Contract, Oren lays out a general behavioral law and economics framework and then applies it in three consumer markets: credit cards, mortgage loans, and cell phone contracts. I will address the chapter on mortgages, and will consider three aspects, the descriptive, the normative, and the prescriptive, in separate posts. In this first part, I focus on Oren's descriptive model. In tomorrow's post, I will suggest three additional points that supplement Oren's account of the subprime market failure.
The mortgage chapter begins by describing the contract design features of subprime mortgages that came to dominate the market just before the 2007 foreclosure crisis. Oren then presents the rational choice model, that would explain whatever mortgage products and pricing that emerged during the run-up to the crisis as an expression of homeowner preferences. The proliferation of home loans with rapidly escalating payments, negative amortization, and hefty prepayment penalties, would have been a response to consumer choices, so that homeowners and buyers rationally shifted away from fixed-rate amortizing loans in the face of higher home prices and reduced affordability. Some mortgage borrowers, especially investors, might rationally have speculated on rising prices by taking out loans with below-interest payments gambling that they could resell homes at a profit.
As Oren points out, the rational choice account is difficult to square with the empirical evidence. There were investors, but rarely more than 10% to 20% of mortgage borrowers. Prepayment penalties were contracted for by many borrowers who ended up paying the penalties to refinance or sell, and would have been better off paying a slightly higher rate without the penalty. Most importantly, the massive default rates, as high as 25% or more for some types of mortgages even before home prices collapsed, reflected the fact that the “affordability” of initial low payments was illusory, and unlikely the result of rational borrowing decisions.
Oren identifies the two essential characteristics of subprime mortgage design as cost deferral and pricing complexity. He then argues that these features were not the product of rational consumer choice. Instead, they responded to consumer behavioral biases, especially myopia, optimism, limited financial literacy and the tendency to focus on salient price elements while ignoring non-salient costs.
This behavioralist description, while it improves on the rational choice model, to my mind leaves out other lender and borrower behaviors that contributed critically to the widespread contract failure. The departure from rational choice and welfare maximization was far worse in the subprime mortgage market than in credit card and cell phone contracts. Welfare losses were not limited, as in the case of credit card customers, to paying 3% or 4% more than necessary on balances and a few hundred dollars in excess fees. Subprime mortgages wiped out families’ entire net worth, evicted them from their homes, and had global external effects that we all know. A deeper critique of rational choice theory in this context is essential to getting the prescriptive part right, i.e. to evaluating the welfare effects of various regulatory interventions in this market.
[Posted, on Alan White's behalf, by JT]
With the help of our former intern, Christina Phillips, we stumbled upon this cover story from Santa Cruz's Good Times magazine. It is a profile of Racquel Cool, who makes a living as an egg donor. The article gives background on why Cool decided to become an egg donor and the process through which one registers with various services and gets matched up with couples in the market for viable eggs.
The article also provides the following interesting information about contractual aspects of egg donation:
- The contracts specify that the payment to the donor is not for the eggs but for her time, effort and discomfort;
- The payment, appropriately enough, since it is not a payment for the ova themselves, is the same regardless of the number of eggs harvested;
- The amount one is paid per donation increases if a donation results in a pregnancy;
- If the donor has a partner, s/he must also consent to the donation;
- While the practice is frowned upon by the American Society for Reproductive Medicine, donors with especially prized qualities (athletes, Ivy League graduates, etc.) can sell their eggs (that is, their services) at much higher prices.
Tuesday, March 19, 2013
Elvis Kool Dumervil, the star defensive end for the Denver Broncos, has been in the news recently based on an alleged mix-up involving a contract renegotiation with the team. I have read multiple reports and still cannot figure out exactly what happened from a contractual formation standpoint. But here's my current understanding and analysis...
Dumervil's contract with the Broncos, like most NFL player contracts, had an "opt out" of sorts for the Broncos. Under the contract, the Broncos could either pay Dumervil $12 million to play next season--and have that entire amount count against the team's salary cap--or cut him ("cut" being the sports term for "fire") and only have a portion of his salary count against the team's cap. Without getting into too much detail, each team has a maximum amount of money it is allowed to pay in player salaries per year, subject to various adjustments. If the Broncos were able to reduce how much Dumervil's salary would count against their team's cap, they conceivably would have been able to spend more money to sign other players and improve their team; hence their interest in keeping the cap number down.
To avoid a bad salary cap consequence and still keep Dumervil, the Broncos sought to renegotiate a middle ground. They offered to keep versus cut Dumervil but for a reduced salary amount of $8 million. According to various reports, that offer was only open until 1pm MDT on Friday, March 15th. The Broncos set that deadline because they faced a deadline of their own set by the NFL. Specifically, the only way the Broncos could avoid the full salary cap hit of $12 million under NFL rules was to cut Dumervil by 2pm MDT (or show that they had re-signed him to a different deal). If they cut him prior to 2pm MDT, they'd only take a $5 million hit; if they cut him anytime after 2pm MDT, they'd take a $12 million hit.
In the early afternoon of March 15th, Dumervil reportedly rejected the Broncos' $8 million offer over the phone (thereby terminating the Broncos' offer, most likely). However, Dumervil later told the Broncos that he had changed his mind. The Broncos then renewed their $8 million offer but specified that Dumervil could accept only by faxing his acceptance to them prior to the NFL's 2pm deadline. When the Broncos did not receive a fax from Dumervil by that time, they cut him. Dumervil's agent has said that the fax was sent to the Broncos at 2:06pm due to some delay in getting a fax from Dumervil.
When the story first broke, some media outlets were reporting that a fax machine malfunction was to blame. Thus, many commentators initially expressed frustration that a bungled or late transmission via fax, a now-outdated device, could have such a significant impact. When I heard those reports, it seemed that the media outlets, like some first-year law students, were overemphasizing the need for a writing and deemphasizing the parties' actual intent. As we teach our students, a signed writing often is not required; contracts are formed all the time without that formality. Subject to the statute of frauds and other exceptions, a contract can be formed without a writing, faxed or otherwise. And, unless the offeror limits the form of acceptance to a signed and faxed writing, the acceptance may be communicated in any reasonable manner. In sum, it is intent of the parties that controls. Thus, if the Broncos really wanted to sign Dumervil to a new $8 million deal (that could be completed within 1 year of its making) based on his verbal agreement, no rule of contract law would have prevented it. In other words, if Dumervil truly had communicated his acceptance to the Broncos, the absence of a faxed signature from Dumervil would not prevent contractual formation unless: (i) the Broncos had stated that acceptance could only be via fax or similar writing; or (ii) the contract was one that could not be performed within a year or otherwise subject to the statute of frauds. We would need more facts to analyze both of those issues.
Of course, another possibility outside of traditional contract law (and the proverbial elephant in the locker room) is that the NFL likely has its own rules regarding contractual formation under its collective bargaining agreement or through some other mechanism. That's the part of the mystery about which I have no information at this point. Some reports seem to indicate that the NFL's rules somehow prevented contractual formation and that the Broncos are seeking a change of heart from the NFL. Perhaps someone more familiar with the NFL's rules can comment on that. In the meantime, I think Bronco fans can stop blaming general contract law and continue blaming the Broncos and the NFL. At least for now.
[Heidi R. Anderson]
This is the first in a series of posts on Oren Bar-Gill's recent book, Seduction by Contract: Law Economics, and Psychology in Consumer Markets. The contributions on the blog are written versions of presentations that were given last month at the Eighth International Conference on Contracts held in Fort Worth, Texas. This post is contributed by University of Texas Law Professor Angela Littwin.
I am currently teaching a seminar on credit cards, so I was thrilled to present on the work of a major thinker in the field. If there’s one person whose name is synonymous with the behavioral economics of credit cards, it’s Oren Bar-Gill. His work has been influential within the academy and outside of it. The recent federal overhaul of credit card law, The Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act), was heavily influenced by law and behavioral economics. (Here’s another CARD Act link for those who want a summary instead of the whole statute.) Credit cards are also a great topic for Contracts, because with credit cards, contract design is the entire game.
The credit card chapter in Seduction by Contract is very successful. If you want a primer on exactly what the trouble is with credit cards, this chapter is perfect place for you. The crux of Bar-Gill’s argument is that credit card issuers use complexity and cost deferral to seduce consumers into borrowing more in the short-term than they would prefer in the long-term. He illustrates how specific credit card pricing features play into the imperfect rationality of optimism-biased consumers. He concludes by discussing the recent CARD Act and with policy proposals centered on use disclosure.
Convincing people that credit card contracts are complex is an easy sell. One way Bar-Gill does so is by simply listing all the of types fees consumers can pay (i.e., overlimit fees or application fees). There are nineteen of them. And this number doesn’t even include types of interest. I can also add that in my seminar, we have a day in which I ask the students to find and read a credit card contract. Student routinely say that this is the hardest reading they have done in law school.
What’s even more interesting than the complexity itself is the purpose of it. Credit card issuers use complexity as a way of shielding their pricing model from consumers. Issuers provide benefits through short-term, more salient product features (like teaser rates and rewards) and assess costs through long-term, less salient product features (like late fees and default interest rates). This pricing structure enables – or rather requires – issuers to compete for consumers via deception.
Bar-Gill’s policy proposal, use disclosure, addresses this deception directly. Use disclosure would require credit card issuers to give consumers information on how they use their credit cards. The CARD Act does some of this, but Bar-Gill proposes taking it further. Under Bar-Gill’s proposal, consumers would receive an electronic file that they could take to a new issuer or an intermediary, like Bill Shrink, to get a new total-cost credit card quote. Use disclosure seems like a great way to encourage consumer behavioral learning. My one critique is that consumers would have to learn the hard way. I think that many consumers would have to get in real trouble with credit cards before the behavioral learning would take place.
This is why my only disappointment with the chapter is that Bar-Gill stopped with use disclosure. I wanted to see him explore the CARD Act in more detail and offer more policy ideas. So I’ll end this blog post as I ended my talk, with a plug to read his paper with Ryan Bubb, Credit Card Pricing: The Card Act and Beyond (Cornell L. Rev., 2012), which addresses both of those points and more.
[Posted, on Angela Littwin's behalf, by JT]
Monday, March 18, 2013
For those of you who missed the discsussion Oren Bar-Gill's book at the Eighth International Conference on Contracts held in Fort Worth, TX last month, we will be providing a written version of the panel over the next week or so. As we did at the conference, each commentator on the book will address a different substantive chapter (the introductory chapter sets out the model that informs the three substantive chapters). Professor Bar-Gill will then weigh in with his responses at the end.
The participants are as follows:
Professor Angela Littwin will address Seduction by Contract's chapter on credit cards. Professor Littwin studies bankruptcy, consumer, and commercial law from an empirical perspective. Most recently, she has written about pro se filers in bankruptcy and the relationship between consumer credit and domestic violence. She was one of the principal investigators on the 2007 Consumer Bankruptcy Project, which has been the leading study of consumer bankruptcy for the past 25 years.
Professor Littwin received her undergraduate degree from Brown University and graduated from Harvard Law School in 2002. After law school, she clerked for the Honorable Rosemary Barkett of the U.S. Court of Appeals for the Eleventh Circuit and founded ROAD (Reaching Out About Depression), a community-organizing project for low-income women. Prior to her appointment at the University of Texas School of Law, she was a Climenko Fellow and Lecturer on Law at Harvard Law School.
Professor Littwin teaches bankruptcy, secured credit, and a seminar on the regulation of credit cards at the University of Texas School of Law, where she has been on the faculty since 2008.
Here recent publications include:
- Escaping Battered Credit: A Proposal for Repairing Credit Reports Damaged by Domestic Violence, 161 University of Pennsylvania Law Review 363 (2013);
- Coerced Debt: The Role of Consumer Credit in Domestic Violence, 100 California Law Review951 (2012); and
- The Do-It-Yourself Mirage: Complexity in the Bankruptcy System, in Broke: How Debt Bankrupts the Middle Class at 157 (Katherine Porter, ed., Stanford: Stanford University Press, 2012).
Professor Littwin's post can be found here.
Professor Alan White, who will comment on the book's chapter on mortgages, joined the faculty at the CUNY School of Law in 2012. He teaches consumer law, commercial law, bankruptcy, comparative private law and contracts. He is a nationally recognized expert on credit regulation and the residential mortgage market. Professor White is a past member of the Federal Reserve Board’s Consumer Advisory Council, a member of the American Law Institute, and is currently serving as reporter for the Uniform Law Commission’s project on a Residential Real Estate Foreclosure statute. He is quoted frequently in the national media, including the New York Times, the Wall Street Journal and the Washington Post, in connection with his research on the foreclosure crisis. He has published a number of research papers and articles on housing, credit and consumer law issues, and testified before Congress and at federal agency hearings on the foreclosure crisis, bankruptcy reform and predatory mortgage lending.
Before becoming a full-time teacher, Professor White was a supervising attorney at the North Philadelphia office of Community Legal Services, Inc., and was also a fellow and consultant with the National Consumer Law Center in Boston and adjunct professor with Temple University Law School and Drake University School of Law. His legal services practice included representation of low-income consumers in mortgage foreclosures, class actions, bankruptcies, student loan disputes, and real estate matters. Mr. White received his B.S. from the Massachusetts Institute of Technology and his J.D. from the New York University School of Law.
His recent publications include:
- Losing the Paper – Mortgage Assignments, Note Transfers and Consumer Protection, 24 Loyola Consumer Law Journal 468 (2012)
- Credit and Human Welfare: Lessons from Microcredit in Developing Nations, 69 Washington & Lee Law Review 1093 (2012)
- The Impact of Federal Pre-emption of State Anti-Predatory Lending Laws on the Foreclosure Crisis, 31 Journal of Policy Analysis and Management 367 (2012) (with Lei Ding, Carolina Reid and Roberto Quercia)
- The Impact of State Anti-Predatory Lending Laws on the Foreclosure Crisis, 21 Cornell Journal of Law & Public Policy 247 (2011) (with Lei Ding, Carolina Reid and Roberto Quercia)
- State Anti-Predatory Lending Laws and Neighborhood Foreclosure Rates, 33 Journal of Urban Affairs 451 (2011) (with Lei Ding, Carolina Reid and Roberto Quercia)
Alan's first post is here.
Alan's second post is here.
Alan's third post is here.
Alan's fourth post is here.
Professor Nancy Kim will address Seduction by Contract's chapter on cell phone contracts.
Our readers are likely familier with Professor Kim, who joined the faculty of the California Western School of Law in fall 2004. She has also taught as a visiting faculty member at The Ohio State University, Moritz College of Law, Rady School of Management at the University of California, San Diego and Victoria University in Wellington, New Zealand.
Prior to joining the faculty at California Western, Professor Kim was Vice President of Business and Legal Affairs of a multinational software and services company. She has worked in business and legal capacities for several Bay Area technology companies and was an associate in the corporate law departments at Heller, Ehrman, White & McAuliffe in San Francisco and Gunderson, Dettmer in Menlo Park.
While in law school, Professor Kim was Associate Editor of the California Law Review and Associate Editor of the Berkeley Women’s Law Journal. After graduating from law school, she was a Women’s Law and Public Policy Fellow at Georgetown University Law Center and a Ford Foundation Fellow at UCLA School of Law. Professor Kim is a member of the State Bar of California and a past recipient of the Wiley W. Manuel Award for pro bono services for her work with the Asian Pacific American Legal Center.
Professor Kim currently serves as Chair-elect of the section on Contracts and as a member of the executive committee of the section on Commercial and Related Consumer Law of the American Association of Law Schools. She is a contributing editor to the Contracts Law Prof Blog, the official blog for the AALS Section on Contracts. Her scholarly interests focus on culture and the law, contracts, women and the law, and technology.
Her book, Wrap Contracts: Mass Consumer Contracts in an Information Society is due out later this year. Some of her publications can be found here.
Nancy's first post is here.
Nancy's second post is here.
Finally, Oren Bar-Gill will respond to the comments on his book. Oren Bar-Gill is a Professor of Law and Co-Director of the Center for Law, Economics and Organization, New York University School of Law, where he has taught since 2005.
Professor Bar-Gill’s scholarship focuses on the law and economics of contracts and contracting. Before joining the faculty at NYU, he was at Harvard University, where he was a Fellow at the Society of Fellows, as well as an Olin Fellow at Harvard Law School. Professor Bar-Gill holds a B.A. (economics), LL.B., M.A. (law & economics) and Ph.D. (economics) from Tel-Aviv University, as well as an LL.M. and S.J.D. from Harvard Law School. Bar-Gill served in the Israeli JAG, from 1997-1999, where he participated in criminal, administrative and constitutional proceedings before various courts including the Israeli Supreme Court and the IDF Court of Appeals.
A list of his publications can be found here.
Professor Bar-Gill's contribution to our forum can be found here.
We look forward to a lively exchange, and we hope readers will feel free to weigh in.
Thursday, March 14, 2013
A Brooklyn-based appellate court recently upheld a trial court ruling (946 N.Y.S.2d 66) that a prenuptial agreement was uneforceable due to fraudulent inducement. The Cioffi-Petrakis v. Petrakis ruling surprised family law experts in New York and nationally because prenuptial agreements like this one generally were seen as unassailable. The Wall Street Journal quotes several prominent divorce lawyers, stating that the ruling is "a game-changer" with "huge implications" that will "be quoted in every single case going forward."
Some appear to contribute the shocking result to Ms. Perakis's lawyer, Dennis D'Antonio, who is a contract litigator and not a family lawyer. Mr. D'Antonio stated told the WSJ that he presented the case as a contract case: "The matrimonial bar tends to do things the way they always did, and they approached the prenup as something you can't challenge," D'Antonio said. "We applied old-fashioned contract law."
Ms. Petrakis alleged that her husband lied to her in order to get her to sign the agreement. Specifically, he reportedly stated that he would tear up the agreement after the couple had a child (the couple had three children together). After she still refused to sign, Mr. Perakis threatened to call the whole thing off 4 days prior to their wedding after Ms. Perakis's parents already had spent $40,000.
The trial court stated the applicable standard as follows: "To sustain a claim for common-law fraudulent inducement, a plaintiff must demonstrate the misrepresentation of a material fact, which was known by the defendant to be false and intended to be relied upon when made, and that there was justifiable reliance and resulting wrong." Ms. Perakis alleged facts sufficient to satisfy that standard. Specifically, the court stated:
"The court credits the wife's testimony...that her fiancé told her 'not to worry' and 'we'll work everything out' to be convincing. Similarly convincing is her testimony that she was told by her fiancé that, 1) if she didn't sign the prenuptial agreement they wouldn't be getting married in a week, 2) that 'everything they get after the marriage would be theirs' and 3) 'after they had a family he would tear up the agreement.' The court concludes that, based on the such promises, the wife called Mr. Hametz to arrange to sign the prenuptial agreement."
The appellate court opinion is rather short. It affirms that contracts may be deemed uneforceable due to fraud or duress but makes no sweeping statements regarding prenuptial agreements. For Ms. Perakis, the result is rather significant. The agreement stated that she would get only $25,000 per year. Her husband reportedly is worth $20 million.
[Heidi R. Anderson]
Wednesday, March 13, 2013
Ariel C. Avgar, J. Ryan Lamare, David B. Lipsky & Abhishek Gupta, Unions and ADR: The Relationship between Labor Unions and Workplace Dispute Resolutions in U.S. Corporations, 28 Ohio St. J. on Disp. Resol. 63 (2013)
Howard S. Bellman, The Importance of Impasse Resolution Procedures to Recent Revisions of Wisconsin Public Sector Labor Law, 28 Ohio St. J. on Disp. Resol. 37 (2013)
Michael Carrell & Richard Bales, Considering Final Offer Arbitration to Resolve Public Sector Impasses in Rimes of Concession Bargaining, 28 Ohio St. J. on Disp. Resol. 1 (2013)
Charles B. Craver, The Use of Alternative Dispute Resolution Techniques to Resolve Public Sector Bargaining Disputes, 28 Ohio St. J. on Disp. Resol. 45 (2013)
Joel Cutcher-Gershenfeld & Saul A. Rubinstein, Innovation and Transformation in Public Sector Employment relations: Future Prospects on a Contested Terrain, 28 Ohio St. J. on Disp. Resol. 107 (2013)
Martin H. Malin, Two Models of Interest Arbitration, 28 Ohio St. J. on Disp. Resol. 145 (2013)]
Lamont E. Stallworth & Daniel J. Kaspar, Employing the Presidential Executive Order and the Law to Provide Integrated Conflict Management Systems and ADR Processes: The proposed National Employment Dispute Resolution Act (NEDRA), 28 Ohio St. J. on Disp. Resol. 171 (2013)
Tuesday, March 12, 2013
In Book II, Chapter 1 of Crime and Punishment by Fyodor Dostoevsky (pictured), beginning on page 192 in the version to which I have linked, the novel's protagonist, Rodion Romanovich Raskolnikov, describes an oral agreement with his landlady. The context is as follows:
The day after Raskolnikov has committed a double homicide, he is called to the police office. He is understandably unnerved and fears that the authorities are on to him. Moreoever, he is about to fall into a fit of delirium and is in no condition to keep his wits about him before the police. However, when he arrives, it turns out that he has been called in as a debtor. The supersilious assistant superintendent informs Raskolnikov that he has been called in on an I.O.U. that he made out to his landlady, the widow Zarnitsyn, for 115 roubles. It appears that the good widow has assigned the I.O.U. to one Mr. Tchebarov who is now seeking recovery.
Raskolnikov, relieved that he has not been called in for murder, explains to the authorities why he is so surprised to be expected to pay his debt. He informs them that he had had his rooms with the widow Zarnitsyn for three years. Early in his time there, he promised to marry the widow's daughter, and since he was practially a son-in-law, the widow extrended credit to him. But the daughter had died of typhus.
Some time after that, the widow came to Raskolnikov and, while claiming that she still trusted him, offered that she would trust him more if he gave her an I.O.U. for the full amount of the debt that he owed her for the lodgings -- that would be the 115 roubles. He signed the I.O.U. based on her assurances that, once he signed, she would trust him and would never, never seek to enforce it. Raskolnikov adds a sort of laches argument that the widow had waited until he had lost his lessons and had no source of income whatsoever to seek to recover on the I.O.U.
The authorities were not interested in these details, instructing Raskolnikov: :"You must give a written undertaking, but as for your love affairs and all these tragic events, we have nothing to do with that." If any of our readers has any familiarity with 19th-century Russian law, feel free to weigh in, but it does seem like Raskolnikov has only the weakest of fraud in the inducement claims and so his testimony as to the widow's promise, though perhaps admissible despite the written agreement, will carry little weight. Of course, Raskolnikov would have to show that the widow knew, at the time she promised not to enforce the I.O.U. that she in fact would do so. And does it matter that such a promise should not be taken seriously on any account, or were 19th-century Russians really so romantic that they valued signed undertakings even if they had no intention of enforcing them?
Or, even absent a showing of fraud, Raskolnikov's parol evidence might be relevant to show the parties' frames of mind. Although the document looks legally binding, perhaps neither party regarded it as such. Both had in mind only a written affirmation of their mutual obligations -- the landlady avowed her trust and Raskolnikov evidenced his trustworthiness through his willingness to sign. The I.O.U. is no more enforceable than a written pledge to be best friends forever.
There is also the additional issue. The widow did not seek to enforce the I.O.U.; she assigned it to Tchebarov, whom she likely did not inform of her promise to Raskolnikov. If the I.O.U. really is unenforceable, then the transfer of it ought not to make it any more so, and if the widow has committed some sort of fraud, it might arise from passing on an I.O.U. that she knows to be worthless as though it were of some value.