Editor: David Reiss
Brooklyn Law School

December 8, 2014

Solving Complexity in Consumer Credit

By David Reiss

Kathleen Engel posted Can Consumer Law Solve the Problem of Complexity in U.S. Consumer Credit Products? to SSRN. The abstract reads,

People like to know and understand the total cost of credit products they are considering. They also like to know and understand products’ terms and features. Given these preferences, issuers of credit should market products with transparent features and simple pricing. That is not the case. In fact, over the last few decades we have seen a plethora of complex terms in products such as mortgage loans, credit cards, and prepaid debit cards.

As credit products have become ever more complex, consumers have more choices and can select products that satisfy their particular needs and preferences. No longer are borrowers limited to a 30-year, fixed-rate mortgage. If they know they will be moving in a few years, a 3-year fixed-rate mortgage with a low interest rate that converts to a 27-year adjustable rate mortgage based on the LIBOR might be the right product for them. However, for borrowers who do not understand the complexities of a 3-27 mortgage loan, the low, initial interest rate could be a costly lure. Confusion is commonplace. In one study giving consumers a choice between two credit cards that varied only in terms of the annual fee and the interest rate, forty percent of the participants chose the more expensive card.

One would expect that consumers, who cannot decipher terms and calculate the cost of complex products, would turn to those with easy-to-understand terms. There are some simple products on the market. Instead, consumers often misperceive that the more complex products are less expensive than the simple ones. They, thus, shun the products that would be in their best interest.

In this paper, I explain why borrowers make sub-optimal choices when selecting credit products. I then analyze whether extant laws could be used to address obfuscating complexity. I ultimately conclude that policy-makers should look to extra-legal remedies to protect consumers against exploitative complexity.

I find those “extra-legal remedies” to be the most interesting part of this paper. Engel writes,

The approach I find most appealing is to use digital technology to help consumers make decisions. A software program would act like an agent, helping consumers determine what they could afford, what product would best meet their needs, and, lastly, would generate bids from providers of the product. Several goals motivate this idea: (1) the approach is preventative; (2) it does not require the courts to interpret vague standards; (3) it is less costly than litigation; (4) it protects unsophisticated consumers without requiring them to become sophisticated; and (5) it permits consumers to “pull” the information they need to select a product, rather than having issuers “push” hundreds of pages of information to them on multiple products. (24-25)

The paper does not explore how consumers would access this “choice agent,” but it is certainly an idea worth exploring. As some of my recent posts suggest, it is hard to rationally regulate for the entire population of consumers as they are a heterogeneous bunch. But it is important that we keep trying. Engel’s paper has some interesting ideas that are worth pursuing further.

| Permalink