Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price

Abstract

Obtaining a home loan is the most significant, complex, and long-term economic transaction in which many Americans will ever engage. Yet despite the importance of the transaction to the individuals involved and their households and communities, many Americans are not obtaining home loans at competitive price terms, prices that a market of borrowers engaged in effective price-shopping would produce.

Current federal law governing home lending requires that borrowers be given an avalanche of disclosures, but has few substantive requirements for home loans. My thesis is that for significant borrower segments shopping in today's market, the disclosures currently mandated by federal law for home loans do not effectively facilitate price shopping.

To understand what drives borrower decisions, I take the literature on decisionmaking from the psychology and behavioral economics fields and apply it in depth for the first time to the problem of predatory lending. To do that requires an understanding of how the home loan marketplace has historically operated, a history that continues to "frame" home loan decisions for borrowers in that marketplace, and how that marketplace has, unbeknownst to many, changed. Therefore, in Part I of this Article, I explain how the twentieth-century market of standardized home loans at uniform low prices rationed to low risk borrowers was largely replaced in the 1990s with risk-based pricing of a broadened supply of creatively structured home loans. Next, I provide evidence that loans at prices beyond what the cost and credit risk presented by the borrower would garner from a competitive market are flourishing in today's market. Part II explains that the current legal regime of disclosure fails to effectively facilitate price shopping because it is based on an unrealistic, rational actor model of borrower behavior.

In Part III, I set forth a more realistic picture of consumer decisionmaking, one that recognizes the influence of intangible cognitive and emotional costs on internal decisionmaking processes, and the influence of socioeconomic context on external decisionmaking outputs. Next, I show how sellers of home loans exploit widespread cognitive heuristics, biases, and emotional coping mechanisms to sell overpriced home loans to a significant segment of the borrowing population. Here, I work both the cognitive and the emotional sides of the decisionmaking aisle, and I delve deeply into the data on how people really make decisions about their loans. Implicit in my methodology is a critique of those legal scholars who attempt to apply the decisionmaking literature to legal problems at a theoretical level, without checking their claims against real-world data.

Part IV explains why the home loan market has not fixed the problem. I then offer a proposal for using the law to restructure the marketplace, to increase price competition, and to reduce the prevalence of predatory overpricing of home loans.

Although this Article is thus focused on the problem of predatory home lending, it contains valuable lessons about when and how disclosure can realistically be used in legal regulation more generally. Substantive regulation of contract terms or product or service attributes can create inefficiencies and can be a drag on innovation, both of which can hurt consumers. But giving consumers more information in today's information-saturated economy is not enough to assure good or even truly autonomous decisionmaking. We may at times have to intervene in the market to create the conditions necessary for consumers to use disclosures to arrive at decisions that are efficient, autonomous, and good for them, their households, and their communities.

JEL Classification: D1, D4, D8, G2, K23