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A second look at new credit card laws

May 28, 2009

Credit Cards, Asymmetric Information and the Role of Government in Preventing Bad Choices
By Patrick Emerson
Oregon Economics Blog

The new credit card (and guns) bill is about to be signed into law and it begs the question: what is the market failure that this government intervention is suppose to correct?  After all, credit card contracts are full information – all the facts are there for credit card applicants to review – and if a private citizen in the United States wants to enter in a legal contract with another entity, why should the government prevent this?  The answer lies in whether you believe that by making extraordinarily dense and complicated contracts an asymmetric information problem exists despite this ‘full disclosure.’ 

Most consumers cannot make sense of the contracts, supporters of the bill say, and companies deliberately make contracts dense and confusing so that they can slip all kinds of nasty little provisions designed to take advantage of customers once they are in debt to the company.

If this is true than a bill that regulated the type of contract language that can be used, how explicit the terms must be, how accessible the language is to an average person not trained in the law is justified.  But if this regulation was successful in making consumers informed about what type of contract they sign, does the government have any role in regulating the type of contract they sign?  As an example, what if the contract very clearly stated: interest rate may be changed at any time by the issuer without prior notice.  If I was quite happy to agree to this provision, why should the government prevent me from entering into a contract such as this.  The bill just about to become law does precisely this.

The answer from some circles is that you have to protect people from their own tendencies to make bad choices.  But is this really the role of government?  Some bad choices impose serious costs to society like not wearing a seat-belt – in a crash your are more likely to be seriously hurt and many people will rely on public assistance to pay their medical bills and even those insured will have to pay higher premiums on average. Do bad choices in the credit card market impose such social costs?  I doubt it.  I know we are in an economic crisis partly fueled by just such credit shenanigans, but again the lack of full information is a main culprit and I am supposing that this part of the problem is solved through regulation.

I like, therefore, the parts of the credit card bill that stipulate more transparency, but I dislike the restrictions on the type of contracts that will be allowed.

I think that we need to be careful that government does not start to try and explicitly guide behaviors that have no or little social cost.  I am fine with mandating that nutrition information be available to customers of restaurants upon request but if we required restaurants to include such information on menus as some have suggested, I think we cross the line in this regard.  The private costs of poor choices are enough to ensure efficient market outcomes.

Now, where is that double cheeseburger with king sized fries I ordered?…

By Patrick Emerson
Oregon Economics Blog

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Dona May 28, 2009

You make some good points. However, as I found out, in order to keep a good credit score you have to maintain some outstanding credit. I had no outstanding credit, no car payment, was renting, paying my utilities on time and my credit score kept going down. (I do find it interesting that if you don’t pay your rent and utilities that it will effect your credit score, but paying them on time doesn’t.) Within 6 months of buying my house, and all other things staying the same, my credit score was higher than it ever had been. If you are having to use a credit card to prove you are credit worthy you make a great target for these companies. Paying them off monthly doesn’t work as I tried that, didn’t help my credit score. I do agree with the premis of your statements, it’s just too bad that people are so money hungry that they will abuse others. Unfortunately it puts the government in control of another part of our lives.

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