The Economics of
Consumer Lending
Todd J. Zywicki
Professor of Law
George Mason University School of Law
Research Fellow, James Buchanan Center
Program on Politics, Philosophy, and Economics
Overview
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Substantive Regulation of Consumer Credit
Alternatives to Substantive Regulation
Consumer Credit Issues in the United
States
Macroeconomic Effects of Consumer Credit
Substantive Regulation
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Effect of Regulation: Intended
Consequences
Effect of Regulation: Unintended
Consequences
Term Substitution/Repricing
 Product Substitution
 Rationing
 Dynamic Effects and Competition
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Term Repricing
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Interest Rate
Fixed or Variable
Annual Fee
Quality (Benefits, Hours, Customer Service)
Price of Goods
Points
Term
Collateral
Costs
Insurance
Downpayment
Balloon
Prepayment Penalty
Grace Period
Default & Foreclosure
Product Substitution
Product Substitution
Rationing
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Historical Evidence
Redistribution Effects
Empirical Evidence on Effects of State
“Anti-Predatory Lending” Laws
Rationing
“Predatory Lending Laws Can Cause Headaches,”
Parma Sun Post (July 10, 2003):
When David Sanderson recently applied to a lender for a second mortgage, he was
denied for an unusual reason. Undeterred, he went to another lender and was
denied again. Same thing happened at a third institution. In all three cases, he was
given the same reason for the denial—the lenders thought he lived in Cleveland and
claimed that the city’s anti-predatory lending law prevented them from giving him the
loan he needed. ***
Since Cleveland’s anti-predatory lending law caps interest charges, some lenders don’t
give second mortgages or home-equity loans to Cleveland residents having potential
credit risks.
But Sanderson lives in Fairview Park, a small, inner-ring suburb west of Cleveland.
“When we were applying for loans, the companies would key in our zip code, and
Cleveland would come up,” he said.***
Desperate for a solution, Sanderson contacted his suburb’s City Hall. Fairview Park Mayor
Eileen Patton wrote a letter on his behalf, verifying he was a resident of the suburb.
“Her inquiry into the matter must have accomplished something, because we received a
call from one of the companies that initially turned us down, and offered to finance
us,” Sanderson said. “Sometimes it pays to e-mail the mayor.”
Patton said she and City Council have received similar requests from six other residents
who encountered the same problem as Sanderson’s.
Dynamic Effects
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Term Substitution, Nonstandardized
Terms, & Competition
Annual Fees & Competition
Retail Market & E-Commerce
Wealth Accumulation
Substantive Regulation: Conclusion
General Consensus of Economists that
substantive regulation Ineffective and
Counterproductive in Light of Unintended
Consequences
Alternative Regulatory Regimes
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Disclosure
Education
Markets and Common Law
Disclosure Regime: Pros
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Pros
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Market Failure: Information Costs/Asymmetry
Standardization: Comparative Shopping
Better than Substantive Regulation (Usury):
Attempts to improve, rather than supplant
market process
Safe Harbor
Disclosure Regime: Cons
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Cons
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Standardization: Inability to Tailor Information to
Consumers, One Size Doesn’t Fit All
Clutter/Information Overload
Raises Costs of Finding Information You Want:
Benefits, Transactors, Frequent Flyer Cards
Risk of Political/Normative Disclosures: What
Consumers Should Care About
Term Substitution
Safe Harbor: Technical Compliance, Lawyerly
Disclosures
Typical “Schumer Box” Disclosure (Reg Z, Appendix G)
Annual percentage rate
(APR) for purchases
2.9% until 11/1/00.
Other APRs
Cash-advance APR: 15.9%
Balance-transfer APR: 15.9%
Penalty rate: 23.9%. See explanation below.*
Variable-Rate
Information
Your APR for purchase transactions may vary. The rate is determined monthy by
adding 5.9% to the Prime Rate**
Grace period for
repayment of balances of
purchases
25 days on average
Method of computing the
balance for purchases
Average daily balance (excluding new purchases)
Annual fees
None
Minimum finance charge
$.50
Transaction fee for cash
advances:
Balance-transfer fee:
Late-Payment fee:
Over-the-credit-limit fee:
3% of the amount advanced
*Explanation of Penalty
**The Prime Rate used to determine your APR is the rate published in ___ on the __
day of the prior month
After that,
14.9%
3% of the amount transferred
$25
$25
Standardization: Other Disclosures Found in Schumer Box
International transactions
3% of the U.S. dollar amount of the transaction, whether originally made in U.S.
dollars or converted from a foreign currency.
Different rates for bank
customers
Your APR may vary.
Preferred Pricing:1
For Chase Banking Relationship Accounts - Purchases and Balance
Transfers/Balance Transfer Checks: For both outstanding and new purchases and
balance transfers the non-introductory rate is determined monthly for accounts
with Elite Pricing by adding 3.99% (or 7.99% for accounts with Premium Pricing),
to the Prime Rate.3 For all purchases from account opening, and for both
outstanding and new balance transfers after 3 months for accounts with Standard
Pricing, the rate is determined monthly by adding 14.99% to the Prime Rate.3
For Chase Credit Card Accounts Only - Purchases and Balance Transfers/Balance
Transfer Checks: For both outstanding and new purchases and balance transfers
the non-introductory rate is determined monthly for accounts with Elite Pricing by
adding 4.99% (or 8.99% for accounts with Premium Pricing), to the Prime Rate.3
For all purchases from account opening, and for both outstanding and new
balance transfers after 3 months for accounts with Standard Pricing, the rate is
determined monthly by adding 14.99% to the Prime Rate.3
Cash Advances/Cash Advance Checks for all accounts: The rate is determined
monthly by adding 15.99% to the Prime Rate (not less than 19.99% for accounts
with Elite and Premium Pricing, or not less than 23.99% for accounts with
Standard Pricing).3
Non-Preferred Pricing/Default APR - For all balances for all accounts: The rate is
determined monthly and is up to the Prime Rate plus 23.99%.3
Education
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Government Programs: Assessment
Purpose of Education?
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Prevent Fraud
Make Market Work Better
North Carolina Experiment
Market and Contract
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Market is a form of regulation (common law
fraud part of market ordering)
2 Markets:
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Credit
Information About Credit: Economics of Information
Sources of Information
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Lenders: Incentives to Provide Relevant Info to
Consumers, Advertising v. Disclosures
Indirect Information: Klein & Leffler
Third-Parties: Consumer Reports, Bankrate.com
Newspapers: ex., International Conversion Fees
Behavioral Economics and
Substantive Regulation
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New Justifications for Substantive
Regulation: Consumers are Stupid
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Imperfect Self-Control
Underestimation Hypothesis
Hyperbolic Discounting
Overestimation of Repayment
Underestimation of Forgetfulness
Credit Card Issuers Prey on These Biases
Irrational Consumers?
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Are Consumers Really that Stupid?
Agarwal, Chomsisengphet, Liu, and Souleles
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Consumers generally choose correctly
Learning
Errors fall as cost of errors rises
Errors smaller than transaction costs and benefits
Revolvers More Likely to Know Interest Rates and Shop
on Interest Rates
Brown & Plache
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Revolvers more likely to select higher annual fee/lower interest
rate trade-off
Nonrevolvers more likely to carry rewards program cards and
charge more
Revolvers more likely to shift to debit cards (No float benefit)
Irrational Consumers?
Consumer Interest Rates, Washington DC, August 25, 2006
11
10
Interest Rate
9
8
7
6
5
Personal Loan
Credit Cards
Home Equity Loan
New Car Loan
Macroeconomic Effects
Is Greater Access to Credit Causing an
Epidemic of “Overindebtedness”?
See Todd J. Zywicki, Bankruptcy and
Personal Responsibility: Bankruptcy Law
and Policy in the Twenty-First Century
(Forthcoming 2007, Yale U. Press)
Substitution Effect
Non-Mortgage DSR
0.08
0.06
0.05
0.04
Non-Revolving
Plus Revolving
0.03
Nonrevolving DSR
0.02
0.01
Revolving DSR
Year
20
02
q3
19
98
q4
19
95
q1
19
91
q2
19
87
q3
19
83
q4
0
19
80
q1
Proportion of Income
0.07
Consumer Credit & Mortgages
Debt Service Ratio by Type of Debt: 1980-2006
0.12
0.1
Nonrevolving DSR
Revolving DSR
0.08
Mortgage DSR
0.06
Total DSR
0.04
0.02
Year
20
02
q3
19
98
q4
19
95
q1
19
91
q2
19
87
q3
19
83
q4
0
19
80
q1
Proportion of Income
0.14
Growth in Net Wealth
Household Net Worth
Net Worth (Billions)
60000
50000
40000
30000
20000
10000
0
1 4 3 2 1 4 3 2 1 4 3 2 1 4 3 2 1 4 3 2
Q
- -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q -Q
52 9 54 9 57 9 60 9 63 9 65 9 68 9 71 9 74 9 76 9 79 9 82 9 85 9 87 9 90 9 93 9 96 9 98 0 01 0 04
9
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2
Year
Household Net Wealth
Median Net Worth by Income Ranges
Net Worth (in Thousands)
1000
900
Median Net Worth All
Households
800
Lowest Quintile
700
Second Quintile
600
500
Third Quintile
400
Fourth Quintile
300
200
80-89.9%
100
90-100%
0
1989
1992
1995
1998
2001
2004
Household Net Wealth
Median Net Worth by Income Ranges (Lowest Quintiles)
Median Net Worth (in Thousands)
100
90
80
70
Median Net Worth All
Households
60
Lowest Quintile
50
Second Quintile
40
30
Third Quintile
20
10
0
1989
1992
1995
1998
2001
2004
Mean Net Wealth (In Thousands)
1989
1992
1995
1998
2001
2004
272.6
245.7
260.8
327.5
422.9
448.2
<20%
36.1
43.4
54.7
55.4
56.2
72.6
20-39.9
96.3
84.6
97.4
111.5
122.7
122
40-59.9
148.5
133.3
126
146.6
173.3
193.8
60-79.9
199.3
185.4
198.5
238.3
313.2
342.8
80-89.9
326.1
297.1
316.8
377.1
487
485
90-100
1438.4
1226
1338
1793.9
2410.9
2534.4
All
19
65
19
67
19
69
19
71
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
Home Ownership
Home Ownership Percentage
70
69
68
67
66
65
64
63
62
61
60
Change in Homeownership
Home Ownership by Race
75
70
65
White
60
Black
Hispanic
55
Asian
50
45
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
40
Causes of Rising Ownership
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Federal Reserve Bank San Francisco (Nov.
3, 2006): “We find that… it is likely that
much of the increase is due to innovations
in the mortgage finance industry that may
have helped a large number of households
buy homes more easily than they could
have a decade ago.”
Market Failure and Regulation
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What is the purported market failure?
Is Credit Different from Other Goods and
Services? Computers, cars, etc.
Schizophrenia of Current Approach:
Making Market Work Better versus Market
Working Too Well
Disclosure a Back Door for Substantive
Regulation, i.e., “If people only knew…”
Summing Up
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Every Form of Regulation has Costs and
Benefits
No evidence that consumers are
“drowning in debt”
No evidence of systematic consumer
irrationality
Need a Serious Model of Consumer
Behavior and Market Process