Contractual Inequality

Most individuals strive to satisfy every obligation laid out in standard form contracts such as mortgages, insurance plans, or credit agreements. Sophisticated parties, however, adapt and modify their obligations during contract performance by negotiating for lenient treatment and taking advantage of unclear terms. The common law explicitly authorizes variance from standardized contract terms during performance. When the same standard terms create value for sophisticated individuals and destroy value for others, the result is contractual inequality. Contractual inequality has grown without scrutiny by courts or scholars, enabling regressive redistribution of resources and creating economic inefficiency by sowing distrust in markets for consumer contracts. To document the magnitude of contractual inequality, this Article provides novel empirical evidence from a case study of residential mortgage contracts. Data from a large nationwide sample show that many mortgage servicers choose not to utilize their power to foreclose on a borrower in default, with more than one-third of nonpaying borrowers avoiding foreclosure. Servicers disproportionately foreclose on borrowers in poor neighborhoods, regressively redistributing over $500 million in wealth to high-income communities each year. Moreover, servicers’ unfettered freedom to choose who undergoes foreclosure may have reduced the value of mortgages to consumers, increasing market inefficiency. Courts and regulators need not turn a blind eye to contractual inequality, allowing private market forces to determine the exercise of contract rights. This Article argues that lawmakers should gather information about inequalities in contract performance and disseminate such data to private and public enforcement authorities. By bringing these inequalities to light, lawmakers can take a first step toward more efficient contract markets and a more equal society

Beyond Payment and Delivery Reform: The Individual Mandate’s Cost-Control Potential

Obamacare\u27s individual mandate, minimum coverage requirements, elimination of cost-sharing for preventive care, and minimum medical loss ratios work together to decrease patients\u27 decision costs, steering patients to particular choices that Congress deemed most efficient. If those regulations succeed in improving the efficiency of patients\u27 healthcare and insurance choices, then the resulting demand-side forces can help to decrease prices. This brief Essay does not attempt to evaluate the regulations\u27 success; it merely highlights the cost-control implications of Obamcare\u27s demand-side measures, noting that discussions of cost control should not focus exclusively on the statute\u27s supply-side effects

Disparities Arising from Standardized Contracts

Signing a standardized contract is just the beginning of a relationship between consumers and firms. Many such transactions proceed without incident, but when disputes arise, conversations between consumers and firms are usually the first step to address conflicts. Consumers can gain a great deal of value from cooperative firms that are willing to renegotiate contract terms as circumstances change. Conversely, unresponsive or unyielding companies can cause consumers to lose money, in some cases leading to financial ruin. Companies can affect the value transactions create through their discretionary choices. In recent work, I used data on mortgage contracts to shed light on who wins and loses from firms’ discretionary choices during performance of a contract. Mortgage servicers make decisions that can have huge impacts on borrowers, including responding to borrower claims of financial hardship, offering loan modifications, setting up repayment plans for borrowers who missed payments, and deciding when to foreclose on borrowers in default. Since the 2008 financial crisis, mortgage servicers have been widely criticized for inefficiency and negligence in these choices, due to poor incentives and weak infrastructure. Regardless, servicers have been tasked with the essential role of helping households in default during the COVID-19 crisis. Data on servicing show that servicers regularly offer borrowers discretionary debt relief, even when they are not required to by law. More than 40 percent of loans that are three to four months behind on payments avoid foreclosure, and instead they are modified, cured, or paid off by refinancing or sale. Mortgages that do end in foreclosure are different from those that do not; foreclosed homes are disproportionately located in lower-income neighborhoods. This pattern holds even when comparing similar loans on similar properties, held by similar borrowers, suggesting that servicer behavior drives this difference. Given the high costs of foreclosure, both to the parties and to local neighborhoods, I estimate that servicers’ discretionary behavior is redistributing more than $500 million from poor to rich neighborhoods every year. This is just one example of standardized contracts being enforced differently for different populations. A growing literature in consumer contracts has shown that the “real deal,” or the value a contract creates for an individual, differs greatly from the “paper deal” that can be gleaned from written contract terms. The paper deal is weighted heavily in favor of companies, created by an imbalance in bargaining power and resulting in few rights for borrowers. The real deal may be significantly better for privileged consumers who can negotiate with companies, but those benefits do not extend equally to all customers. In related work on retail returns, Meirav Furth-Matzkin finds evidence that black retail customers are disproportionately held to strict written terms, relative to white customers. Similarly, Arka Bandhyopadhyay shows that mortgage forbearance benefited white borrowers disproportionately during the COVID-19 crisis. Despite these pervasive patterns, there is little information about contract performance and few legal mechanisms that can help bring this phenomenon to light. Policymakers need further data to address concerns about equity and to minimize inefficiencies that these patterns create. Unequal treatment during contract performance can cause consumers to distrust companies, which is then exacerbated by the inability of firms to commit to cooperative behavior. For instance, many low-income minority borrowers avoid banks and formal financial services providers, and they choose instead to work with check cashers and other alternatives. One reason may be disadvantaged borrowers’ rational expectation that banks will treat them more stringently compared to their privileged peers. In theory, banks can choose to waive fees for privileged customers but not disadvantaged ones. But my work demonstrates that no legal mechanism requires banks to treat all customers equally. Inequalities in contract performance, however, are not necessarily all bad. As research by Susan Cherry and coauthors shows, companies sometimes use their discretion to help individuals in acute need of funds by allowing them to delay or skip payments for a period of time. When these benefits accrue disproportionately to disadvantaged populations, they can act as a mechanism for progressive redistribution of wealth. Moreover, by decreasing the chance of negative outcomes such as foreclosure, targeted benefits can improve the efficiency of markets for contracts. Therefore, the first step is to understand the scope and magnitude of inequalities in contract performance, with special focus on the treatment of disadvantaged consumers. To do so, companies must disclose data on choices they make during performance, at least to regulators and sophisticated parties. Information on bank fee waivers, or on debt servicer forbearance, linked with consumer characteristics, would help regulators and scholars understand whether companies are engaging differently with certain classes, such as people of color, and falling afoul of anti-discrimination law. On the other hand, the data may reveal that some companies have targeted their performance in favor of disadvantaged populations, which could help their reputation. Importantly, data on consumer contract performance would fill a gap in information between companies and their customers. Companies are repeat players that have access to credit scores and datasets about customers’ social media use, friend network, and advertisement preferences, which help them predict how each consumer will behave. Consumers know much less about companies’ standard business practices, when and how to negotiate, and how their experience compares to that of other consumers. Disseminating information to regulators and to consumers through informed intermediaries can generate more productive relationships between companies and their customers, no matter the written terms of the contract

3 essays on consumer finance

Thesis: Ph. D., Massachusetts Institute of Technology, Department of Economics, 2017.Cataloged from PDF version of thesis.Includes bibliographical references.This thesis consists of three chapters on consumer financial contracts. Particularly, this thesis focuses on the regulation and design of markets for financial contracts, and their impact on household financial health. The first chapter studies the role of consumer protection law in the function of mortgage markets in the United States. Consumer protection laws are intended to improve consumer outcomes and are becoming more common, particularly in mortgage markets after the 2008 recession. Little empirical evidence exists about the benefits of these laws to consumer outcomes, relative to the potential compliance costs. This chapter studies the effect of two common types of consumer protection laws: seller standards of conduct, enforced through ex post lawsuits by prosecutors and consumers, and mandated disclosures, which require sellers to provide consumers with information to help them make better decisions. Using a natural experiment in Ohio, which introduced the Homebuyer's Protection Act in 2007, 1 study the impact of both seller standards of conduct and mandated disclosures on the performance of loans owned by Fannie Mae or Freddie Mac between 2002 and 2012. I find that imposing standards of conduct on lenders increases borrower defaults in the short term, and is correlated with a drop in foreclosures and fewer mortgage originations. Mandated disclosures decrease mortgage defaults in the short term, and the effect is correlated with smaller transactions, lower interest rates, and higher borrower credit scores. I introduce a simple model of strategic default showing that standards of conduct targeting lenders can provide incentives to lenders to be lenient towards all borrowers, increase borrower default, while mandated disclosure can induce behaviorally biased consumers to default less often. Taken together, the evidence suggests that seller standards of conduct result in lender lenience towards borrowers but operate by shifting the cost of dropping house prices from borrowers onto lenders. On the other hand, carefully designed disclosures can encourage consumers to be more responsible in repayment of loans and can decrease the overall impact of unexpected drops in house prices. The second chapter studies the impact of defined benefit pensions on retirees' consumption patterns. It is authored jointly with Professor Jerry Hausman. Retirees discontinuously decrease their consumption spending upon retirement, a phenomenon described as the retirement consumption puzzle. This chapter studies the impact of defined benefit pensions on the retirement consumption puzzle. Data from the Health and Retirement Survey shows that households with defined benefit pensions experience a significantly smaller drop in consumption spending at retirement. The difference in consumption patterns between households with defined benefit and defined contribution pensions is consistent with a drop in price of home production after retirement. Defined benefit pensions allow households to exert less effort in home production, as well as decreasing the need for precautionary savings, meaning their value is understated if home production is not accounted for. Using HRS data, we estimate the utility value of defined benefit pensions, incorporating both home production and precautionary savings. The results imply that current methods of valuing retirement income products, such as employer provided pensions and private annuities, are biased downward. The third chapter studies the purchase of annuities by retirees in Chile's privatized social security system. It is authored jointly with Gaston Illanes, of Northwestern University Department of Economics. Chile has one of the highest voluntary annuitization rates in the world, with more than 60% of retirees purchasing a private annuity. In contrast, less than 5% of US retirees purchase annuities, despite theoretical predictions that annuity value is high. Annuities in Chile are sold through a unique government-run exchange which decrease search costs and intensifies competition without imposing costs on firms. Chile also has a privatized social security system in which retirees that do not buy an annuity must take a "programmed withdrawal" of their mandated retirement savings that exposes them to more stock market risk than Social Security would. Using novel individual level administrative data and theoretical calibrations, we provide evidence that the high annuitization rate is driven by Chile's unique regulatory regime, rather than by the risk of programmed withdrawal in a privatized system. We document several features of the annuity exchange in Chile. First, annuity prices are low compared to the worldwide average. Second, annuity providers have significant market power. Third, selection exists in the market, both into purchase of annuities, and into searching for better prices. Based on these facts, we calibrate a insurance value of full annuitization compared to the privatized alternative offered by the Chilean government and compare to the value of full annuitization compared to public Social Security, such as that found in the US. The calibration suggests that privatization of social security alone cannot explain the high level of annuitization in Chile. Regulations limiting search costs can cause low prices, lower levels of adverse selection, and high brand preferences that together can explain the high annuitization rate.by Manisha Padi.1. Consumer Protection Laws and the Mortgage Market: Evidence from Ohio -- 2. Pension Plans and the Retirement Consumption Puzzle -- 3. When the Annuity Puzzle Doesn't Exist: Evidence from Chile.Ph. D

Disparities Arising from Standardized Contracts

Signing a standardized contract is just the beginning of a relationship between consumers and firms. Many such transactions proceed without incident, but when disputes arise, conversations between consumers and firms are usually the first step to address conflicts. Consumers can gain a great deal of value from cooperative firms that are willing to renegotiate contract terms as circumstances change. Conversely, unresponsive or unyielding companies can cause consumers to lose money, in some cases leading to financial ruin. Companies can affect the value transactions create through their discretionary choices. In recent work, I used data on mortgage contracts to shed light on who wins and loses from firms’ discretionary choices during performance of a contract. Mortgage servicers make decisions that can have huge impacts on borrowers, including responding to borrower claims of financial hardship, offering loan modifications, setting up repayment plans for borrowers who missed payments, and deciding when to foreclose on borrowers in default. Since the 2008 financial crisis, mortgage servicers have been widely criticized for inefficiency and negligence in these choices, due to poor incentives and weak infrastructure. Regardless, servicers have been tasked with the essential role of helping households in default during the COVID-19 crisis. Data on servicing show that servicers regularly offer borrowers discretionary debt relief, even when they are not required to by law. More than 40 percent of loans that are three to four months behind on payments avoid foreclosure, and instead they are modified, cured, or paid off by refinancing or sale. Mortgages that do end in foreclosure are different from those that do not; foreclosed homes are disproportionately located in lower-income neighborhoods. This pattern holds even when comparing similar loans on similar properties, held by similar borrowers, suggesting that servicer behavior drives this difference. Given the high costs of foreclosure, both to the parties and to local neighborhoods, I estimate that servicers’ discretionary behavior is redistributing more than $500 million from poor to rich neighborhoods every year. This is just one example of standardized contracts being enforced differently for different populations. A growing literature in consumer contracts has shown that the “real deal,” or the value a contract creates for an individual, differs greatly from the “paper deal” that can be gleaned from written contract terms. The paper deal is weighted heavily in favor of companies, created by an imbalance in bargaining power and resulting in few rights for borrowers. The real deal may be significantly better for privileged consumers who can negotiate with companies, but those benefits do not extend equally to all customers. In related work on retail returns, Meirav Furth-Matzkin finds evidence that black retail customers are disproportionately held to strict written terms, relative to white customers. Similarly, Arka Bandhyopadhyay shows that mortgage forbearance benefited white borrowers disproportionately during the COVID-19 crisis. Despite these pervasive patterns, there is little information about contract performance and few legal mechanisms that can help bring this phenomenon to light. Policymakers need further data to address concerns about equity and to minimize inefficiencies that these patterns create. Unequal treatment during contract performance can cause consumers to distrust companies, which is then exacerbated by the inability of firms to commit to cooperative behavior. For instance, many low-income minority borrowers avoid banks and formal financial services providers, and they choose instead to work with check cashers and other alternatives. One reason may be disadvantaged borrowers’ rational expectation that banks will treat them more stringently compared to their privileged peers. In theory, banks can choose to waive fees for privileged customers but not disadvantaged ones. But my work demonstrates that no legal mechanism requires banks to treat all customers equally. Inequalities in contract performance, however, are not necessarily all bad. As research by Susan Cherry and coauthors shows, companies sometimes use their discretion to help individuals in acute need of funds by allowing them to delay or skip payments for a period of time. When these benefits accrue disproportionately to disadvantaged populations, they can act as a mechanism for progressive redistribution of wealth. Moreover, by decreasing the chance of negative outcomes such as foreclosure, targeted benefits can improve the efficiency of markets for contracts. Therefore, the first step is to understand the scope and magnitude of inequalities in contract performance, with special focus on the treatment of disadvantaged consumers. To do so, companies must disclose data on choices they make during performance, at least to regulators and sophisticated parties. Information on bank fee waivers, or on debt servicer forbearance, linked with consumer characteristics, would help regulators and scholars understand whether companies are engaging differently with certain classes, such as people of color, and falling afoul of anti-discrimination law. On the other hand, the data may reveal that some companies have targeted their performance in favor of disadvantaged populations, which could help their reputation. Importantly, data on consumer contract performance would fill a gap in information between companies and their customers. Companies are repeat players that have access to credit scores and datasets about customers’ social media use, friend network, and advertisement preferences, which help them predict how each consumer will behave. Consumers know much less about companies’ standard business practices, when and how to negotiate, and how their experience compares to that of other consumers. Disseminating information to regulators and to consumers through informed intermediaries can generate more productive relationships between companies and their customers, no matter the written terms of the contract

State Politics and Mortgage Markets

This article examines whether elections for state offices that regulate mortgage lenders affect mortgage markets. Some scholars assert that election-related political uncertainty depresses economic activity; others contend that incumbents pursue policies to boost short-term growth prior to elections; and a third group claims that market activity fluctuates around partisan transitions. We test these theories using national data on mortgage characteristics and election data for two important state regulators. We first conduct event studies comparing mortgage market outcomes before and after elections. We then utilize difference-in-difference models to compare states in which partisan control of key offices switched following an election. Our results do not show consistent support for any of these theories. We find that elections have few significant effects on mortgage markets, suggesting that delegating regulatory power to elected state officials may be efficient

State Politics and Mortgage Markets

This article examines whether elections for state offices that regulate mortgage lenders affect mortgage markets. Some scholars assert that election-related political uncertainty depresses economic activity; others contend that incumbents pursue policies to boost short-term growth prior to elections; and a third group claims that market activity fluctuates around partisan transitions. We test these theories using national data on mortgage characteristics and election data for two important state regulators. We first conduct event studies comparing mortgage market outcomes before and after elections. We then utilize difference-in-difference models to compare states in which partisan control of key offices switched following an election. Our results do not show consistent support for any of these theories. We find that elections have few significant effects on mortgage markets, suggesting that delegating regulatory power to elected state officials may be efficient