Thursday, May 21, 2009

Credit Cards, Asymmetric Information and the Role of Government in Preventing Bad Choices

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?...  


Jeff Alworth said...

I recall that your analysis of Oregon's payday loan reform was much the same. I think this is one of those ocassions where people of good conscience may disagree.

The government has a role in regulating behavior. It does it all the time. It regulates behavior to minimize its own cost, but also personal damage or injury to individuals. You may hold to a darwinian view that a desperate person is fully responsible for entering into a usurious contract. That the information is "symetric" is enough for economists.

But in a society where a vast underclass have to scrape by without health insurance, in dangerous jobs that pay poverty wages, and live in substandard housing (or cars), the virtue of information seems like cold soup indeed.

Dennis said...

I would echo Jeff's comments, and add that an economic analysis isn't the only game in town.

Further, when you said this...

The private costs of poor choices are enough to ensure efficient market outcomes....I cringed. From where I'm sitting, it's very clearly not true, at least not in this case (I assume you agree that it's not universally true, either, or at least is affected by additional factors). The decision-making process people use is both far more complicated than this would imply and far less rational. Second, if the 'market' were offering people a variety of choices (such as fair contracts with reasonable interest rates, reasonable being defined as 'possible to pay without declaring bankruptcy'), then it seems unlikely we'd find ourselves in the situation we're in. However, the combination of information asymmetry and semi-collusion on the part of credit card companies means the 'market' here is just not that competitive between companies.

C'mon - you undermine your own point with the cheeseburgers line, even =)

Jessica said...

I agree with the previous commenters and I would like to add that implicit in your arguement is an offer out there that is materially different. But, I'm not sure that there exists a credit card with terms currently that mirror what the government is now regulating. So, even with full information, there isn't a product available.

Patrick Emerson said...


What you mention, I would argue, does not argue for regulating credit card contacts as much as bolstering social insurance institutions.


First, yes, I do assume that credit cards are fairly competitive. If this were not true, than yes the government potentially has a role in regulating pricing. I have no facts, but they seem pretty competitive to me based on all the money they spend on advertising and mailings.

Second, economic analysis may not be the only game in town, but it is the point of this blog.

And, what, you don't like cheeseburgers?!?

Patrick Emerson said...


I agree that full information does not exist. So it makes sense that there have been abuses, because firms can take advantage of consumers.

I am not so sure you can't find credit cards with simpler terms (what about AmEx for example), but with more transparency, I would expect much simpler contracts, with a host of options.

Jeff Alworth said...

Patrick, I don't think the two are mutually exclusive, but I wholeheartedly agree.

Dennis said...


It seems they could be competitive within a narrow range - i.e. they all have high interest rates and contracts I'd find abhorrent, so they are really competing in the margins.

I happen to love cheeseburgers, along with a whole host of other things that are not good for me.

Jack said...

Good article. Really informative. I need some help about credit card. I need credit report clean up. I need to clean up some false information from my credit report. Can you please help me. Thanks.