Thursday, August 07, 2008

Agreeing to Disagree: Credit Cards and Contract Absolutism

The Federal Reserve recently solicited comments from the public about problems in the credit card industry. Yesterday's lead editorial in The New York Times, "Listen to the 56,000," takes its title from the number of responses that poured into the Fed from the public, a torrent of complaints that covered a range of more-than-questionable industry policies, including “universal default,” which the Times describes as "the practice of raising interest rates on accounts in good standing when a borrower falls behind on other bills." The editors call upon Congress to step in with stronger protections against various abusive practices.

While I agree that better laws are needed, I have come to think that this is yet another area where we are so tied up in our own rhetoric that much-needed reform will fall victim to absolutist posturing. The problem is in our use of classical contract terminology to describe modern impersonal transactions. We all sign (or click through) a "cardholder agreement," which has the look and language of a formal contract. In most such documents, we (the cardholders) seem to be agreeing to all of the things that we are now complaining about. Moreover, even if some industry practices are not actually in the agreements that we signed, the typical contract allows the company to change its policies at any time and without notice. So what are we complaining about?! Suck it up, be a grown up, and live by our promises, right? This is ultimately the argument against helping people in danger of defaulting on mortgages as well. If the company is not actually committing fraud, anything that it does within the letter of the agreement is fair game.

Moreover, there is at least a plausible argument for each of these policies. Universal default, after all, can be defended by pointing out that a company will naturally view a loan as being at greater risk if the borrower is found to be in arrears elsewhere. Higher risk means higher rates. Even the foundational "unconscionability" case in the 1L Contracts class, Williams v. Walker-Thomas Furniture, describes a practice to which a well-informed borrower might agree in exchange for other consideration.

The problems with that basic assumption (that the two parties have agreed to the terms of the contract in the way that offer/acceptance logic presumes) are legion, and legal scholars have increasingly drawn on psychological theories to describe the cognitive limitations that lead us quite rationally to "agree" to things with which we would not agree. My purpose is not to rehash those arguments here but to point out that, as usual, the political debate will be about absolutes rather than line-drawing. Anything that Congress proposes as a consumer protection measure will be attacked as: (1) undermining freedom of contract and/or being paternalistic, and (2) ultimately harming those whom it purports to help. (The banks "warn of unintended consequences, mainly that less credit would be available to consumers.")

The only possible answer to #1 is that, yes, of course these laws will prevent some contract terms from being available that some parties might have agreed to in a face-to-face, hard-nosed negotiation; but we're making a policy decision to limit some of the options based on an assessment that the credit card contracting process doesn't look like the simplified world that even classical contract theorists like Williston understood a century ago to be over-stylized. As to #2, again, yes. Some credit really should not be extended to some consumers. This is not a surprise to anyone. In fact, reducing credit card indebtedness is, in other contexts, often held up as an important public policy goal.

"But they agreed!" Again, my argument is not that every credit card agreement should be invalidated or that Congress should adopt every policy proposal that might be gleaned from those 56,000 complaints. What it should do, though, is understand that we already live in a world where "agreements" are sometimes invalid or will not be recognized. Even though this is not a hot-button political issue in the category of taxes or terrorism, though, we can still expect that it will be sound-bitten beyond recognition. As is so often the case, I hope to be proven wrong.

-- Posted by Neil H. Buchanan


egarber said...

I wonder if some of the problem is structural. I'm reminded of the post a while back about fragmented ownership.

In much the same way as with mortgages, credit card debt is sold off onto the secondary market -- meaning there's incentive for credit card companies to cut corners on front-end creditworthiness. They no longer have skin in the game once the debt is resold, so what's the risk, really? I think that might account for over-extended credit in the first place.

Of course, it can reach a point (maybe it has?) where so many are in trouble that the fine print has to be invoked, basically pounding the very people who can least absorb it.

I guess my point is that spreading around risk encourages companies to be too loose in the first place. In the end, we'd be much better off if people were denied credit at the outset, if they pose that much risk.

On your post, I think you're right that the debate will get lost in absolutes.

Tam Ho said...

This post and Prof. Colb's post from yesterday focus (among other things) on a theme that I find interesting: the inapplicability of catchy-sounding inflexible "first principles" in light of empirical facts.

Thus, the theoretical argument against "discrimination" sounds like a great idea if we were creating the world anew, but loses its force when one considers the history of this country. Likewise, the "freedom to contract" argument against consumer protection sounds good until one realizes that often, there is no meaningful negotiation (and thus, no choice, or freedom - at least for the consumer) in these contract-of-adhesion situations anyway.

The approach of "starting from first principles" and then going from there, no matter what results it commits you to, probably has the appeal of appearing logically rigorous, fair, principled, etc. But in reality, it's just the same as the puerile game of "logical gotcha" that I used to play with my parents.

Upon their denying me permission to do something, I would corner my Mom or Dad (or both simultaneously, if possible - their increased numbers only made it easier for me to pick and choose statements to deconstruct) into asserting a principled reason for the prohibition, upon which point I would offer a counterexample precedent (e.g., of a past instance that fell on the same side of the asserted principle as the current situation, but where they granted me permission) or hypothetical that would break their principle, and then accuse them of inconsistency or arbitrariness, or of being ad-hoc if they revised their answer to account for the apparent inconsistency. They never actually changed their mind, but I always walked away with the perception of a moral victory.

What I didn't realize until later in life was that my cleverness hardly meant that they didn't have good reasons for their decisions. But due to the complexity of language and the world, it's just impossible to come up with a rigid set of principles that applies under all possible circumstances.

Unfortunately, as Prof. Buchanan notes, rigid, absolutist principles lend themselves far better to marketing and propaganda than do accurate explanations of the world. If only I knew back then that it was actually my parents who were scoring the moral victories for putting up with my sophistry.

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