Filter Results CategoriesCart
Highlight Updates

1.3.1 Unfettered Consumer Credit Market Leads to Extensive Abuse

As indicated by the history of credit regulation, discussed in § 1.2, supra, there is a constant tension between those favoring efforts to prevent credit abuses and those who favor the unfettered working of a free market. What is clear, though, is that an unfettered consumer credit marketplace leads to massive fraud, abuse, overcharges, and oppressive credit terms. This much is evident looking at the actual facts of the first decade of this century. Consumer credit regulation is necessary, regardless of the claimed efficiencies gained through a deregulated market.89

There are many reasons why creditors left to their own will take unfair advantage of consumers. Credit transactions by their very nature are complicated, beyond most consumers’ ability to understand.90 Take the typical credit card agreement that goes on for pages of fine print, whose terms are never read, and that exhibits pricing sufficiently complex that it can puzzle economics professors.91

Car buyers never understand that the car dealer, who they think is finding the best deal for them, is actually marking up the risk-based interest rate that the lender is offering. Consumers may not understand that a creditor is seeking out the most expensive credit insurance product to sell, because that product will offer the highest return for the creditor. Consumers are in no position to shop around or even compare a credit insurance price with that offered by other insurers. This situation is exacerbated when people of color purchase cars. Research shows that racial and ethnic disparities exist with car loan interest-rate pricing, even after controlling for credit risk, suggesting that the difference in rates is due to discretionary dealer markups.92 A recent survey showed that African American and Latino car buyers negotiated on price just as often as white buyers and their levels of comparison shopping matched white buyers.93 Nonetheless, African Americans and Latinos were nearly twice as likely to be sold multiple add-on products as white consumers, and more borrowers of color reported receiving misleading information about their loans from car dealers.94

Often fees and other charges come into play after the credit is extended, and in ways never understood by the consumer. Computing rebates for unearned interest using the Rule of 78s is one example. So is a card issuer raising the card interest rate because the consumer is disputing a credit obligation completely unrelated to the credit card issuer. The true cost of credit can also be hidden in fees, charges, and other costs not included in the APR.

This complexity of a credit transaction exacerbates the inability of many Americans to understand credit terms. Roughly 40% of the U.S. population lacks the literacy to fill out job applications or a bank deposit slip correctly.95 The overwhelming majority of the U.S. population does not understand how to calculate interest, given the amount borrowed on a loan and the number and amount of payments. The 1992 National Assessment of Adult Literacy used a typical advertisement for a home equity loan as one of its measures of “quantitative literacy,” and only 4% of the adults sampled could calculate how much interest would be charged.96 Deficiencies in quantitative literacy are particularly pronounced for non-whites and older consumers,97 precisely those groups most often targeted by abusive lenders. Unsurprisingly, consumers with the worst quantitative literacy are the most likely to default on risky products like subprime mortgages and the most likely to engage in multiple cash-out refinancings on their homes.98

Many, if not most, consumers make systematic errors of judgment in evaluating credit.99 Most consumers, even educated consumers, focus on the payment to estimate the cost of a loan.100 This focus on the payment works fine as a short-cut if the loans being compared are fixed-rate loans of the same time to repay, but it gravely misleads borrowers comparing loans of different lengths or with adjustable-rate periods. Worse, virtually all consumers, when given a payment stream, underestimate the effective interest, on average by as much as thirty-eight percentage points.101 Moreover, contract terms often are designed by creditors to encourage harmful choices by borrowers.102

Added to consumers’ difficulty understanding credit terms is the fact that creditors, not borrowers, draft loan documents, and that the terms of credit contracts offered to consumers are basically non-negotiable. A potential borrower can “take it or leave it” and go elsewhere, though sometimes the “elsewhere” is not so easy to find. Thus not only are oppressive credit terms not easy to understand, but they are buried in a take it or leave it contract.

Most credit contracts are written in language far beyond what the average American can read and understand. The Government Accountability Office, as part of its study of credit cards, retained a usability expert to review credit card agreements and disclosures, who found that credit card agreements required reading at a 15th grade level—or three years of college. By comparison, nearly half of American consumers read at no more than an 8th grade level, the level at which most credit card solicitations are written.103

An unregulated free market system rewards creditors who hide the real cost of credit.104 Little wonder then that too many creditors understate or obscure the real cost of credit.105 The experience of the first decade of the twenty-first century has taught us if nothing else that there are many, many individuals and even large banks and other major corporations who are tempted by such easy profits.

The ease with which a creditor can take unfair advantage can lead to extreme abuse when the consumer also is desperate to borrow money. Without adequate credit regulation, consumers are easily exploited when their financial circumstances require an immediate loan no matter the long-term cost.106 Matters can get even worse where the consumer is unable to repay the high-cost loan and thus is forced to find yet additional high-cost credit to pay off the first loan. This spiral of debt makes consumers even more vulnerable and open to exploitation. Consumers who are illiterate, uneducated, frail, or less than fluent in English are especially vulnerable.107 Worse, abusive sellers and lenders frequently target borrowers who are perceived as vulnerable, including members of racial groups historically excluded from mainstream credit, on the belief that the borrowers are, in some sense, still a captive market.108

Last, but not least, lenders design some loan products in such a way that a proper assessment of ability to repay, the hallmark of responsible lending, is irrelevant. Instead, these lenders concern themselves with their ability to collect and with the form of collateral. Examples of these loans include used car purchase loans in which the value of the car is inflated, and payday and auto title loans.109

Footnotes

  • 89 {82} See, e.g., Peter H. Morris, Recommitting to Regulation of the Consumer Credit Lending Industry Through Legal History, 10 Dartmouth L.J. 56 (2012); Steven Mercatante, The Deregulation of Usury Ceilings, Rise of Easy Credit, and Increasing Consumer Debt, 53 S.D. L. Rev. 37 (2008); Matthew Sherman, Ctr. for Econ. & Policy Research, A Short History of Financial Deregulation in the United States (2009). See also John Y. Campbell, Restoring Rational Choice: The Challenges of Consumer Financial Regulation 16–26 (Jan. 2016), available at http://scholar.harvard.edu (arguing that consumer financial mistakes create another rationale for intervention).

  • 90 {83} See Till v. SCS Credit Corp., 541 U.S. 465, 124 S. Ct. 1951, 1962–1964, 158 L. Ed. 2d 787 (2004) (recognizing that the subprime auto finance market is not “perfectly” competitive and that creditors have much more information about the market than do consumers); Jeanne M. Hogarth & Ellen A. Merry, Designing Disclosures to Inform Consumer Financial Decisionmaking: Lessons Learned from Consumer Testing, 97 Fed. Res. Bull. (No. 3) 3 (2011); Shelley Smith, Reforming the Law of Adhesion Contracts: A Judicial Response to the Subprime Mortgage Crisis, 14 Lewis & Clark L. Rev. 1035 (2010); Richard Lord, American Nightmare: Predatory Lending and the Foreclosure of the American Dream (Common Courage Press 2005); Patricia A. McCoy, Rethinking Disclosure in a World of Risk-Based Pricing, 44 Harv. J. on Legis. 123, 139–149 (2007) (discussing lack of price transparency); Elizabeth Renuart, An Overview of the Predatory Lending Process, 15 Housing Pol’y Debate 467 (2004); Kathleen C. Engel & Patricia A. McCoy, A Tale of Three Markets: The Law and Economics of Predatory Lending, 80 Tex. L. Rev. 1255 (2002). Cf. Sumit Agarwal, John C. Driscoll, Xavier Gabaix, & David Laibson, The Age of Reason: Financial Decisions Over the Lifecycle 37 (Feb. 11, 2008) (finding that older and younger borrowers pay more for credit than midlife borrowers across a range of credit products, perhaps because older and younger borrowers do not understand “shrouded attributes,” such as the relationship between higher LTVs and higher APRs).

  • 91 {84} See, e.g., Andrea Freeman, Payback: A Structural Analysis of the Credit Card Problem, 55 Ariz. L. Rev. 151, 166–169 (2013) (discussing the many abusive practices of the credit card industry, including that credit card agreements are overly complex); Michael LaCour-Little & Cynthia Holmes, Prepayment Penalties in Residential Contracts: A Cost-Benefit Analysis, 19 Housing Pol’y Debate 631, 631–632 (2008) (“Given the embedded options they contain, mortgages are among the most complex of financial instruments.”); Ronald J. Mann, Boilerplate in Consumer Contract: “Contracting” for Credit, 104 Mich. L. Rev. 899, 900 (2006) (arguing that credit card contracts are particularly complex in economic terms, since they aggregate multiple small transactions that occur over differing economic circumstances).

  • 92 {85} Charles Kerwin Kofi, Erik Hurst & Melvin Stephens Jr., Rates for Vehicle Loans: Race and Loan Source, 98 Am. Econ. Rev. 315 (2008); Ayres, Ian, Further Evidence of Discrimination in New Car Negotiations and Estimates of Its Cause, 94 Mich. L. Rev. 109 (1995).

  • 93 {86} Delvin Davis, Center for Responsible Lending, Non-Negotiable: Negotiation Doesn’t Help African Americans and Latinos on Dealer-Financed Car Loans 2–3 (Jan. 23, 2014). available at www.responsiblelending.org.

  • 94 {87} Id.

  • 95 {88} Nat’l Ctr. for Educ. Statistics, National Assessment of Adult Literacy (2003); U.S. Dep’t of Educ., National Ctr. for Educ. Statistics, Adult Literacy in America (Sept. 1993) (available from the U.S. Gov’t Printing Office, GPO stock number 065-000-00588-3), discussed in, e.g., Alan M. White & Cathy Lesser Mansfield, Literacy and Contract, 13.2 Stan. L. & Pol’y Rev. 233, 235–242 (2002); Mary Jordan, Literacy of 90 Million Is Deficient, Washington Post, Sept. 9, 1993, at A1. Cf. Mark Kutner, Elizabeth Greenberg, Ying Jin, Bridget Boyle, Yung-Chen Hsu, Eric Dunleavy & Sheida White, Literacy in Everyday Life: Results from the 2003 National Assessment of Adult Literacy 13 (2007), available at http://nces.ed.gov (22% of the U.S. population has less than basic proficiency in quantitative literacy).

  • 96 {89} U.S. Dep’t of Educ., Nat’l Ctr. for Educ. Statistics, Adult Literacy in America 100 (NCES 1993-275) (3d ed. Apr. 2002), available at http://nces.ed.gov (the ad included all the information necessary to make the calculation: number and amount of monthly payments, and loan principal.). See also U.S. Dep’t of Educ., Nat’l Ctr. for Educ. Statistics, Literacy in Everyday Life: Results from the 2003 National Assessment of Adult Literacy iv (Apr. 2007), available at http://nces.ed.gov (finding no statistically significant changes in prose and document literacy since the 1992 survey, although more adults, scored in the intermediate level on the quantitative literacy scale, resulting from decreases both in adults with “below basic” skills and in adults with “proficient” skills. Note: it is not clear whether the 2003 survey instrument included any credit math questions. Id. at 87–89.); Annamaria Lusardi & Olivia S. Mitchell, Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth, 54 J. Monetary Econ. 205, 207, 216 (2007) (finding that less than 18% of surveyed adults between the ages of fifty-one and fifty-six could calculate compound interest at 10% on $200 over two years); Macro Int’l, Inc., Design and Testing of Effective Truth in Lending Disclosures 52 (2007), available at www.federalreserve.gov (“[V]ery few participants could accurately describe how interest charges were accurately calculated”); Annamaria Lusardi & Olivia S. Mitchell, Financial Literacy and Planning: Implications for Retirement Wellbeing 4, 7 (Pension Research Council, Working Paper No. 1, 2006), available at www.dartmouth.edu (noting that only 67% of surveyed adults, many over fifty, could correctly determine whether, after five years of interest at 2% on $100, they would have less than, more than, or exactly $102); Danna Moore, Wash. St. U., Soc. & Econ. Sci. Research Ctr., Survey of Financial Literacy in Washington State: Knowledge, Behavior, Attitudes, and Experiences (Tech. Rep. 03-39, 2003), available at www.researchgate.net (finding approximately 30% of respondents do not understand that if interest compounds, it builds on itself).

  • 97 {90} U.S. Dep’t of Educ., Nat’l Ctr. for Educ. Statistics, The Condition of Education 2002, NCES 2002-025 (June 2002), available at http://nces.ed.gov. See also Andrea Freeman, Payback: A Structural Analysis of the Credit Card Problem, 55 Ariz. L. Rev. 151, 183–188 (2013) (describing the vulnerabilities of and stereotypes about African Americans and Latinos in the credit card market that can lead to exploitation).

  • 98 {91} Kristopher Gerardi, Lorenz Goette, & Stephan Meier, Financial Literacy and Subprime Mortgage Delinquency: Evidence from a Survey Matched to Administrative Data 4–5, 17 (Fed. Reserve Bank of Atlanta, Working Paper No. 2010-10, 2010), available at www8.gsb.columbia.edu (finding a strong and statistically significant correlation between interviewees holding subprime mortgages who defaulted and those who had difficulty with simple math questions, holding constant for income, education, credit score at time of origination, and other factors; interviewees in the bottom quartile of quantitative literacy were fifteen percentage points more likely to experience foreclosure or be behind in their payments than those in the top quartile).

  • 99 {92} See, e.g., John Y. Campbell, Restoring Rational Choice: The Challenges of Consumer Financial Regulation 16–26 (Jan. 2016), available at http://scholar.harvard.edu (survey of literature documenting that consumers make mistakes and exhibit ignorance of financial concepts, contract terms, financial history, their own difficulties with financial problem-solving, and, market incentives that drive the behavior of market players, such as salespeople and brokers); Lauren E. Willis, When Nudges Fail: Slippery Defaults, 80 U. Chi. L. Rev. 1155, 1183–1185 (Summer 2013) (citing statistics that 90% of consumers polled in 2012 who had incurred an overdraft fee in the prior year stated that they overdrew their account by mistake; noting that most consumers do not believe they will overdraft their accounts; concluding from bank and CFPB data that the opt-out intended to help frequent overdrafters avoid overdraft fees “appears to have dramatically failed to achieve this aim”); Omri Ben-Shahar & Carl E. Schneider, The Failure of Mandated Disclosure, 159 U. Pa. L. Rev. 647, 666 (2011); Elizabeth Renuart & Diane E. Thompson, The Truth, the Whole Truth and Nothing but the Truth: Fulfilling the Promise of Truth in Lending, 25 Yale J. on Reg. 181 (2008); Oren Bar-Gill, The Behavioral Economics of Consumer Contracts, 92 Minn. L. Rev. 749, 761–765 (2008); Oren Bar-Gill, Bundling and Consumer Misperception, 73 U. Chi. L. Rev. 33, 45 (2006); Susan Block-Lieb, The Myth of the Rational Borrower: Rationality, Behavioralism, and the Misguided “Reform” of Bankruptcy Law, 84 Tex. L. Rev. 1481 (2006); Lauren E. Willis, Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price 65 Md. L. Rev. 707 (2006); Matthew A. Edwards, Empirical and Behavioral Critiques of Mandatory Disclosure: Socio-Economics and the Quest for Truth in Lending, 14 Cornell J.L. & Pub. Pol’y 199, 221–223 (2005); Jason J. Kilborn, Behavioral Economics, Overindebtedness & Comparative Consumer Bankruptcy: Searching for Causes and Evaluating Solutions, 22 Emory Bankr. Dev. J. 13, 18–19 (2005); Patricia A. McCoy, Elder Law: A Behavioral Analysis of Predatory Lending, 38 Akron L. Rev. 725, 734 (2005) (detailing the difficulties faced by shoppers for subprime mortgage loans); Oren Bar-Gill, Seduction by Plastic, 98 Nw. U. L. Rev. 1373 (2004); Jeff Sovern, Toward a Theory of Warranties in Sales of New Homes: Housing the Implied Warranty Advocates, Law and Economics Mavens, and Consumer Psychologists Under One Roof, 1993 Wis. L. Rev. 13 (1993); Ren S. Essene & William Apgar, Joint Ctr. for Housing Studies, Harvard Univ., Understanding Mortgage Market Behavior: Creating Good Mortgage Options for All Americans (2007).

  • 100 {93} See, e.g., Lauren E. Willis, Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price 65 Md. L. Rev. 707 (2006); Ren S. Essene & William Apgar, Joint Ctr. for Housing Studies, Harvard Univ., Understanding Mortgage Market Behavior: Creating Good Mortgage Options for All Americans (2007).

  • 101 {94} The median underestimation was twenty-five percentage points. Victor Stango & Jonathan Zinman, How a Cognitive Bias Shapes Competition: Evidence from Consumer Credit Markets 3–4 (Sept. 5, 2006), available at https://www.dartmouth.edu.

  • 102 {95} See Lauren E. Willis, When Nudges Fail: Slippery Defaults, 80 U. Chi. L. Rev. 1155, 1171–1174, 1182–1183 (Summer 2013) (describing how banks take advantage of cognitive biases of borrowers to discourage opting out of exploitative overdraft protection plans); Eric A. Zacks, Shame, Regret, and Contract Design, 97 Marq. L. Rev. 695, 718–731 (2014) (discussing the concept of shame and how contract preparers can exploit this emotion, as well as cognitive limitations, through contract design).

  • 103 {96} Government Accountability Office, Credit Cards: Increased Complexity in Rates and Fees Heightens Need for More Effective Disclosure to Consumers, GAO-06-929, at 38 (2006), available at www.gao.gov. See George Lowenstein, Cass Sunstein & Russell Golman, Disclosure: Psychology Changes Everything, Annual Rev. of Econ. 21–29 (Harvard Pub. Law Working Paper No. 13-30 Aug. 18, 2013), available at http://www.annualreviews.org (discussing the various difficulties that arise when attempting to make disclosures in consumer credit agreements easy to understand).

    After the enactment of the Credit Card Accountability Responsibility and Disclosure Act in 2009 and the effective date of FRB regulatory changes, the clarity of credit card disclosures and the accompanying credit card agreements has improved. For the improvements in the credit card disclosures, see National Consumer Law Center, Truth in Lending Ch. 6 (9th ed. 2015), updated at www.nclc.org/library. To review the readability of credit card contracts, see the Consumer Financial Protection Bureau’s database at www.consumerfinance.gov/credit-cards/agreements.

  • 104 {97} See Omri Ben-Shahar & Carl E. Schneider, The Failure of Mandated Disclosure, 159 U. Pa. L. Rev. 647, 691–702 (2011); Oren Bar-Gill, The Law, Economics, and Psychology of Subprime Mortgage Contracts, 94 Cornell L. Rev. 1073, 1083–1084 (2009) (“enhanced competition” likely increases prevalence of complexity and cost deferral in subprime mortgages); Oren Bar-Gill, The Behavioral Economics of Consumer Contracts, 92 Minn. L. Rev. 749, 789 (2008) (arguing that consumer misperceptions cause market distortions in pricing and other attributes of credit).

  • 105 {98} See, e.g., Miller v. Americor Lending Group, Inc., 2007 WL 107664 (W.D. Mich. Jan. 9, 2007) (broker offers to arrange fixed-rate, non-negatively amortizing, pick-a-payment 2% interest rate loan and provides initial Truth in Lending Act disclosures, although knew no such loan existed); Complaint, Fed. Trade Comm’n v. Chase Fin. Funding, Inc., at 4, No. SACV04-549 (C.D. Cal. May 12, 2004), available at www.ftc.gov (adjustable-rate mortgage with initial minimum payment, based on interest at 3.5% amortized over thirty years, which results in negative amortization, since actual interest rate is much higher, advertised as “3.5% fixed payment 30 year loan”); Nationscapital Mortgage Corp. v. State Dep’t of Fin. Inst., 137 P.3d 78, 83–84 (Wash. Ct. App. 2006) (broker apparently had pattern of representing on Truth in Lending Act disclosures that borrower not responsible for broker fee); Lauren E. Willis, When Nudges Fail: Slippery Defaults, 80 U. Chi. L. Rev. 1155, 1171–1174, 1182–1183 (Summer 2013) (describing how banks take advantage of cognitive biases of borrowers to discourage opting out of exploitative overdraft protection plans); John R. Wilke, Hidden Fees in Most Mortgages Bring Scrutiny to Fannie, Freddie, Wall St. J., Jan. 14, 2005, at A1 (reporting on guarantee fees paid by lenders to Fannie Mae and Freddie Mac that are packaged in the interest rate and undisclosed to borrowers; averaging two-tenths of a percent of the loan amount per month); Gov’t Accountability Office, Alternative Mortgage Products: Impact on Defaults Remains Unclear, but Disclosure of Risks to Borrowers Could Be Improved, GAO No. 06-1021, at 22 (2006), available at www.gao.gov (describing advertisement for payment option ARM that promised 45% reduction in monthly mortgage payments and interest rate of 1.25%; interest rate of 1.25% only applied for first month, and this fact disclosed in “much smaller print” on second page). Cf. Patricia A. McCoy, Rethinking Disclosure in a World of Risk-Based Pricing, 44 Harv. J. on Legis. 123, 128–138, 142–143 (2007) (discussing limitation of current disclosure regime to provide relevant, binding information in a timely and useful manner).

  • 106 {99} See § 7.2.1.3, infra (purpose of usury laws to protect desperate borrowers from overreaching creditors).

  • 107 {100} See, e.g., Martinez v. Freedom Mortgage Team, Inc., 527 F. Supp. 2d 827 (N.D. Ill. 2007) (“Supplying Martinez with the loan contract disclosing the true terms of the agreement in English does nothing to vitiate the fraud, because Martinez was unable to read the contract. . . . ‘[D]isclosing’ the true terms of a document written in a foreign language is tantamount to no disclosure at all.”). Cf. Kristopher Gerardi, Lorenz Goette, & Stephan Meier, Financial Literacy and Subprime Mortgage Delinquency: Evidence from a Survey Matched to Administrative Data 17 (Fed. Reserve Bank of Atlanta, Working Paper No. 2010-10, 2010), available at www8.gsb.columbia.edu (finding that rate of cash-out refinancing increased among subprime borrowers, holding constant for income and education, as basic quantitative literacy declined).

  • 108 {101} See, e.g., McGlawn v. Pa. Human Relations Comm’n, 891 A.2d 757 (Pa. Commw. Ct. 2006) (finding that brokerage firm targeted African Americans through advertising in sources “oriented toward African American audiences”). See generally National Consumer Law Center, Credit Discrimination Ch. 8 (6th ed. 2013), updated at www.nclc.org/library.

  • 109 Center for American Progress, Lending for Success 5–6 (July 2015), available at www.americanprogress.org (also including risky mortgage loans originated during the years leading up to the financial crisis in this category). See also §§ 9.1 (describing payday loans), 12.1 (describing auto title loans), infra; National Consumer Law Center, Unfair and Deceptive Acts and Practices § 7.4.13 (9th ed. 2016), updated at www.nclc.org/library (describing excessive pricing in the used car context).