Maryland Law Review Volume 65 | Issue 3 Article 3 Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price Lauren E. Willis Follow this and additional works at: http://digitalcommons.law.umaryland.edu/mlr Part of the Banking and Finance Commons, and the Property Law and Real Estate Commons Recommended Citation Lauren E. Willis, Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price, 65 Md. L. Rev. 707 (2006) Available at: http://digitalcommons.law.umaryland.edu/mlr/vol65/iss3/3 This Article is brought to you for free and open access by the Academic Journals at DigitalCommons@UM Carey Law. It has been accepted for inclusion in Maryland Law Review by an authorized administrator of DigitalCommons@UM Carey Law. For more information, please contact [email protected]. MARYLAND LAW REVIEW VOLUME 65 2006 NUMBER 3 © Copyright Maryland Law Review 2006 Articles DECISIONMAKING AND THE LIMITS OF DISCLOSURE: THE PROBLEM OF PREDATORY LENDING: PRICE LAUREN E. WILLIS* INTRODUCTION ................................................. 709 I. PREDATORY LENDING AND THE HOME LOAN MARKET ...... 715 A. The Home Lending Revolution ........................ 715 1. The Twentieth Century Marketplace: Standardized Terms, Limited and Advertised Prices, and Low Risk. 715 2. The Brave New World of ProliferatingProducts, Price, and R isk ........................................ 718 3. Evidence of Predatory Home Lending ............... 729 B. A New Definition of Predatory Lending ................. 735 II. FEDERAL LAW REGULATING THE PRICING OF HOME- SECURED LOANS: DISCLOSURE AS PANACEA ................ 741 A. The Rational Actor Decisionmaker Model ............... 741 B. CurrentFederal Law .................................. 743 C. Even a Rational Actor Could Not Use the Federal Disclosures to Price Shop in Today's Marketplace ........ 749 1. Logistical Problems of Timing and Expense .......... 749 2. Incomplete Information ............................ 750 * Associate Professor, Loyola Law School, Los Angeles. B.A., Wesleyan University; J.D., Stanford Law School; former Trial Attorney, U.S. Department of Justice, Civil Rights Division, Housing Section. Helpful comments and suggestions from Rick Banks, Bob Chang, Mark Kelman, Alexandra Natapoff, Katie Pratt, Russell Korobkin, Eric Talley, and Fred Tung, and participants at talks given at the American Law and Economics Associa- tion's 2005 Annual Meeting, University of Southern California Law School, University of Michigan Law School, Loyola Law School, and University of San Diego Law School, are gratefully acknowledged. Thanks also to students Sara Benson, David Chan, and Michael Simidjian for research assistance. MARYLAND LAve REVIEW [VoL. 65:707 3. FinancialIlliteracy ............................... 751 III. How THE SUBPRIME HOME LOAN INDUSTRY MAKES USE OF CONSUMER PSYCHOLOGY IN TODAY'S MARKETPI.ACE TO SELL OVERPRICED HOME LOANS .......................... 754 A. Heterogeneous Behavioralism Meets the Home Loan M arket .............................................. 754 1. A New Schematic of InternalDecision Processes: Recognizing the Influence of Intangible Transaction C osts ............................................ 754 2. The Importance of Socioeconomic Context on Decisonmaking Outputs ........................... 759 3. Segmenting the Market by Vulnerability Rather Than Risk and Cost.................................... 762 B. Heuristics, Biases, and Coping Mechanisms That Shape Borrower Decisionmaking.............................. 766 1. Reducing the Decision to a Few Salient Attributes .... 766 a. Cognitive Responses to Information Overload .... 767 b. Abbreviated Reasoning: A Response to Emotional D istress...................................... 769 2. Ignoring the Price: Focusing on the "Yes" and the "N ow ". ......................................... 772 a. Avoidance: Response to Ego Threats ............ 772 b. Myopia and Certainty Effects: Discounting over Time and Probability ......................... 776 3. Framing the Price: Capitalizing on the Evaluability of the M onthly Payment ............................. 780 a. The Evaluability Bias: Oversimplifying to Cope with Incomprehensibility ....................... 780 b. Number Problems: Percentages, Large Numbers, and Truncation .............................. 781 c. Framing Effects: The Invisibility of Financed Fees and Costs .................................... 785 d. Exploiting Borrower Reliance on the Monthly Paym ent ..................................... 788 4. Disclosures, the Loan Seller's Sword and Shield ........................................... 789 a. Information Overload and Stress-Truncated Reasoning, Again ............................ 790 b. Motivated Reasoning, Decision Process Framing, and the Endowment Effect ..................... 791 c. Representativeness and the Veneer of Legality .... 793 d. Disclosures Blame the Borrower................. 796 2006] THE PROBLEM OF PREDATORY LENDING: PRICE 5. The Ultimate Escapefrom Decision Difficulty: Overreliance on Intermediaries... Who Can Manipulate More FramingEffects? ................. 798 IV. SOLVING THE PRICE PROBLEM ............................ 806 A. Why the Market Will Not Solve the Price Problem ........ 806 1. Exploiting Information Asymmetries: The Profitability of Price Discrimination............................ 806 2. Lack of Price Advertising .......................... 809 3. Competitive Pricing Unnecessary to Keep Customer ... 811 4. FinancialEducation Is a "Public Good" ........... 812 B. Why Should We Care About Overpriced Home Loans? .... 815 C . W hy N ot . ........................................ 816 1. Why Not Price Controls? .......................... 816 2. Why Not Suitability Standards, Unconscionability, Fraud, or Broker Fiduciary Duties? ................. 817 D. A Proposal to FacilitatePrice Shopping ................. 820 1. Radical Transparency: Simplification of Loan Products to Achieve Meaningful Transparency Through Simple, Timely Disclosures ................ 821 2. ProhibitingPrematurity of Commitment: The Consumer Chilling-Out Period ..................... 823 3. Bringing Price Competition to the Borrower.......... 825 4. Giving Wall Street Some Skin in the Game .......... 828 E. Critique of Proposals.................................. 828 C ONCLUSION ................................................... 830 A PPEN DIX ...................................................... 834 INTRODUCTION [Former Finance Company Employee:] Finance companies try to do business with blue-collar workers, people who have not gone to college, older people who are on fixed incomes, non English-speaking people, and people who have significant equity in their homes. In fact, my perfect customer would be an uneducated widow who is on a fixed income, hopefully from her deceased husband's pension and Social Security, who has her house paid off, is living off of credit cards, but having a difficult time keeping up with her payments ..... To flip [a small unsecured loan] into a ... home equity loan, we were trained to sell the monthly "savings"-that is, how much less per month the customer would be paying off if we flipped the loan. In reality, the "savings" that we were MARYLAND LAW REVIEW [VOL. 65:707 trained to sell to the customers were just an illusion. The uneducated customer would jump for the "savings," thinking that he would have more money to buy other things. What the customer would not figure out, and what we would not tell him, is that he would be paying for a longer period of time and, in the end, would pay a whole lot more. Delinquent customers made good flipping candi- dates, because we could put additional pressure on them.... We knew that these customers would almost always agree to refinance, because they did not have the money to pay on their current loan and did not want the finance company to institute foreclosure.... Our entire sale is built on confusion. Blue-collar work- ers tend to be less educated.... They can be confused in the loan closings, and they look to [loan brokers] . as profes- sionals who can handle their bill and their incomes as total financial representatives .... So they are more trusting to- ward us.... [People having difficulty meeting their present debt ob- ligations] are desperate. They will sign at whatever rate you give them and however many points you give them.... [Senator Breaux:] Is it not required by Federal regulation ... that.., information be clearly presented to the customer- that... if you refinance with us, here is how long it is going to take you, and here is how much you are going to pay-in simple English? [Former Finance Company Employee:] It is written in simple English, and it is on all the loan documents, but I can get around any figure on any loan sheet. -1998 Senate Hearing Testimony of former finance company employee, testifying anonymously' 1. Equity Predators:Striping, Ripping and Packing Their Way to Profits: HearingBefore the S. Spec. Comm. on Aging, 105th Cong. 31-37 (1998) [hereinafter 1998 Sen. Hrg.] (statement of "Jim Dough," former finance company employee). Stories from borrowers, brokers, loan officers, and others who have been witness to predatory lending practices appear here to provide some context, to make the data here more "available" than it would be if presented in only dry statistical form. 2006] THE PROBLEM OF PREDATORY LENDING: PRICE Obtaining a home loan is the most significant, complex, and long-term economic transaction in which many Americans