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David, that situation is well modeled as ignorance. So either there are models of ignorance supporting your case, or you need to describe a different situation.
Disclosure vs. Bans: Reply to Robin Hanson
A little while back I wrote a post arguing that the existence of abusive terms in credit card contracts (such as huge jumps in interest rates for being one day late with a payment) do not satisfy the conditions for standard economic models of asymmetric information between rational agents, but rather are trickery, pure and simple. If this is right, then the standard remedy of mandating the provision of more information to the less-informed party, but not otherwise interfering in the market (the idea being that any voluntary agreement must make both parties better off, no matter how strange or one-sided the terms may appear, so any interference in contracts beyond providing information will reduce welfare), is not the right one. There is no decent argument that those terms would appear in any contract where both parties knew what they were doing, so if you see terms like that, the appropriate conclusion is that someone has been screwed, not that Goddess of Capitalism, in her infinite-but-inscrutable wisdom, has uncovered the only terms that, strange as they may seem to mere mortals, make a mutually beneficial contract possible. The goal is to get rid of those terms, and the most direct way to do that is simply to prohibit them. There are some good reasons to be reluctant to have the government go around prohibiting things, so mandatory disclosure might still be a good policy (though the Federal Reserve has investigated this and concluded that it isn't), but the goal would be to use the disclosures to eliminate the abusive terms. There is no justification for the standard economist's agnosticism about whether the terms are good or not: they're bad and the only question is how best to get rid of them.
Robin Hanson left some comments to that post, in which he made the point that since people voluntarily choose these terms, they must like them and so prohibiting them would have to mean protecting people against their will. I answered that while I'm enough of a paternalist to be willing, under some circumstances, to impose limited protections on people even if those people would oppose them, that I didn't think that was an issue here, as I would guess (though I have no proof), that the Federal Reserve's recent decision to ban certain credit card practices was probably very popular, even (especially?) among the people who are harmed by those practices. Robin's reply, as I understand it, is that this may be true, but since people can't simultaneously want to accept credit cards with those terms and at the same time favor banning those terms, it must be the case that they either don't understand the terms of the credit card contracts or they don't understand the effects of the ban. Somewhere there must just be some missing information, and therefore we must be back where we started, with the problem being a lack of information that could be resolved by providing more information.
I think clarifying this disagreement is worth a seperate post, which I'll write up in the next few days.
Not knowing "which companies are tricking them most" is ignorance, and standard models of ignorance can apply.
But ignorance in rational agent models of asymmetric information don't cause people to be tricked, so it's can't be ignorance of that sort.
It seems perfectly plausible to me that people understand that the deck is stacked against them, while at the same time not knowing exactly how to protect themselves and so falling for some of the tricks, and would be perfectly happy to have a government they trusted simply remove the bad stuff from the menu. I know that's how I see it.
"""being one day late with a payment or being one dollar over your credit limit jumps your interest rate to 29.99% forever"""
I hear this all the time as an example of wicked behaviour, but I wonder if people have data to back it up. Is there no signal in missing a payment by a few days? I know that if I were to miss a payment, it would be due to some minor issue such as I having been out of town when the bill arrived or such. The credit card company only knows that the payment didn't arrive. Add in a bit of modelling stupidity (having an input boolean variable PAYMENT_LATE into the model) and you might get a jacking up of prices as the rational response.
All my credit cards jacked up their interest rates pre-emptively after the new regulations were announced (not that I have ever carried a balance on any of them). This indicates that it was not only about bait-n-switch (some of those cards, I have had for years).
I am honestly asking for data, not being knee-jerk pro-credit-card-companies.
If credit markets worked the way they were supposed to, the terms on which you could get credit would indeed depend on objective measures of your credit-worthiness. Any adverse event would appropriately cause the credit markets to downgrade their opinion of you, and worsen the terms on which you get credit. But I have never heard anyone seriously suggest that the data bear out a conclusion that being a day late with a payment indicates that you are a credit risk so massive that a 29.99% interest rate is appropriate.
I don't know if those policies were popular, but if they were popular, that might be because people didn't understand their consequences. Again the key point is how can an accountable government force people to protect themselves who don't want to be protected? My guess is that they would prefer private means of protection, but since those private means are not allowed, they must settle for the public means you offer. You argue that the reason we need public means is that private means will not work because they don't want to be protected. But if they don't want to be protected, why do they support laws protecting them?
As you know, there are limited instances in which I would support the government protecting people against their will. But I suspect that a lot of legal protections against predatory conduct are popular, even among the people whose conduct is restricted. One possible reason for this is that they don't understand that the policy restricts their freedom (but then they also don't understand that the lack of the policy will get them exploited, and I'd rather have them helped for reasons they don't understand than harmed for reasons they don't understand).
But another possible reason is that they correctly understand that right now credit cards without those exploitative terms are mostly unavailable (the primary exception that I know of are employee credit unions). They "voluntarily" choose them because there's no way to get a credit card otherwise. They might perfectly rationally support regulations that will improve the menu of options from which they will make their voluntary choice.
Ah, but now you're changing the argument! In the post, you argued that it's OK to interfere because people are being tricked (an argument for which I have some sympathy). Now, you're arguing that it's OK to interfere because the only purpose of the cards is to match borrowers with lenders. That, I dont agree with at all.
People choose a card for many different reasons. I can imagine people choosing to (perhaps falsely) signal their high wealth by choosing a high-rate card (their friends will assume they pay it off every month). They might choose the "trick" card to give themselves an incentive to pay on time. They may enjoy trying to "outwit" others by paying the card off on time and letting others cover the issuer's expenses.
In a competitive market, the money the company makes by "tricks" is competed down: other cards will find it profitable to enter the market and charge less (even if they use the same "tricks"). So a larger cost is borne by those who fall for the "tricks". Still, those people might not be happier with the tricks removed.
For instance, suppose I forget to pay on time every five years (which is probably about right). And suppose my forgetting costs $60. Now, the government comes along and decrees that, instead of charging me $60 when I forget, they'll charge me $1 a month regardless.
I wouldn't like that. It might be irrational, but that's still my preference. Haven't you, the government, done me wrong by eliminating the "trick" that I understood but chose anyway? Does my being less happy than before rank at zero on your scale of costs and benefits?
Either those terms represent an efficient contract or they don't. The most obvious way that they wouldn't would be if they tricked you, and as a practical matter that is where most of the action is. Originally it sounded like you agreed that you were being tricked also, but in a milder sense. If you positively prefer those terms, then in your case they are efficient. But I rather doubt that these are really terms that you would have chosen.
As for the issue of competition, that's not how it works. When Laibson presented the paper I referred to in the main post, my recollection is that he said that, while the credit card industry is quite competitive, the way that competition happens is that the companies use expensive promotions to identify myopic consumers. So competition doesn't benefit consumers, and in the end it doesn't even benefit the credit card companies! It's pure social waste.
A person who was aware that they might succumb to being tricked, might voluntarily agree to a legal regime which authorized judges to void contracts that seemed to be attempts to trick them. On the other hand, if they were not aware of this vulnerability, one might benefit them by forcibly preventing them from being tricked. But it is hard to see how a political regime which does this to them is accountable to such folks. If they had influence over the political system, they would want it to stop this sort of thing. It would have be that other people who had power over politics wanted for force this protection onto them. This brings us to an image of a powerful political elite forcing their protections on unwilling others, for the good of those others. Is this how you see politics?
Robin, as you know from our paternalism debate, I do support a limited paternalistic agenda in what I would describe as "well functioning" societies. But as a practical matter, it is often simply not the case that the kinds of prohibitions that I'm talking about would have to be shoved down the throats of the people they are intended to protect. If you had to guess, would you think that the Fed's recent action referred to in the post would be popular or unpopular with the general public? Or with credit card customers?
Suppose the terms "if you are even one day late with a payment, your interest rate jumps to 29.99% forever" are in very large print on the contract, and the cardholder has to read it and initial it (or, perhaps, copy it out in full!) before the card is approved.
And suppose that consumers accept those terms even after understanding them.
Would that weaken your argument?
(The reason I ask: I am fully capable of paying off my balance every month. Sometimes I forget. When I forget, it costs me $80 in interest. I am capable of borrowing money at a rate that would cost me only $10 in interest for that kind of debt.
Therefore, I see the interest I paid as a bit of a "gotcha". But I am willing to accept it. I figure it's part of the cost of the card, that it's going to cost me $80 or so every few years on the rare occasions I forget.
I entered the agreement knowing that was there, and I would do so again. I figure there are indeed people out there who would voluntarily accept the "one late payment and your interest rate is 29.99%" condition too.
Maybe they think they would just apply for a low-interest card and transfer the balance, but, when push comes to shove, they're just too lazy to do that. Or maybe they might figure that other people might forget to pay, but not them. Or maybe a host of other reasons. )
You're right that not every case is equally severe. But even in your relatively mild case, it's still a "gotcha." The term is there because the credit card company knows that people will sometimes not understand or will forget. It's got nothing to do with efficiently matching people who want to lend money with people who want to borrow money (which is one of the primary legitimate function of credit markets), it's got to do with figuring out how best to screw people over. Since there is no reason to believe that that contract got to be that way for any efficient purpose, there's no reason for any great reluctance to interfere with it through policy.
There seems to be a believe hidden there that government just needs to declare something illegal in order for it to disappear. However each law is just an invitation to find loopholes. There is ample evidence in Europe that regulations do not work.
In Germany we have so many laws that nobody can ever hope to know all that is or is not legal. So whenever any government starts to regulate the market in order to prevent deliberately confusing contracts, it will end only when the law is so complex that there are no more simple contracts because all of the law is implicitly part of any contract.
The only protective measure government must take is a divorce right. There must always be a way for any party in a contract to leave that contract with a jury deciding on just compensation for gained benefits or caused costs. Anything beyond that is a recipe for disaster.
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Mandating Information Disclosure vs. Banning Deceptive Contract Terms
The possibility that well-intentioned regulations will be evaded is indeed a problem, and in some cases it limits what is possible. But other regulations are relatively clear and well-enforced, particularly when they have the necessary political support.
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So, you are saying that some people can be made better off by overriding their voluntary contracts with others. That is most definitely true in many cases.
The problem, I think, is that how do you judge which contracts are "fair" and which aren't (and so should be overridden)? There will certainly be disagreement about which contracts are fair (and which contract participant should be given a better deal). Whoever is "the decider" is (if they are altruists) essentially comparing the utilities of different people to each other and redoing the contract so that utility can be maximized (between both people).
As far as I can tell, there is no difference between directly comparing the utilities of two different people (and choosing which should be made higher) and preference for one person or another of "the decider". Is there really an objective rule that would tell us the answer or would it always (in practice) come down to however "the decider" decides to remake the contract (in preference of one party over the other)?
[Please forgive me if this post didn't make any sense, it is late and I am very tired.]
This is the primary problem with paternalism, and a good reason why it should be limited.