Credit, Consumers and the Law

After the global storm

Karen Fairweather, Paul O'Shea, Ross Grantham

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317158073
• Edition: 1
• Topic: Law
• Subtopic: Law Theory & Practice
• Index: Law

Consumer law, particularly consumer credit law, is characterised by increasingly complex regulation in Western economies. Reacting to the Global Financial Crisis, governments in the UK, the EU, Australia, New Zealand and the United States have adopted new laws dealing with consumer credit, responsible lending, consumer guarantees and unfair contracts. Drawing together authors from all of these jurisdictions, this book analyses and evaluates these initiatives, and makes predictions as to their likely success and possible flaws.

Part I
Issues and themes

1
Consumer law

Paternalism, fragmentation and centralised enforcement

Karen Fairweather, Paul O’Shea and Ross Grantham

1 Introduction

The emergence over the last half-century of a body of law that had a sufficiently homogeneous core that it could be identified as ‘consumer law’ is one of the major developments in the law of most common law jurisdictions. Although consumer law necessarily rests on the underlying contract between the parties, the extent of legislative intervention and the aims of that legislation have increasingly carved consumer law out as a body of law distinct from the general law of contract. A law of consumer credit emerged as a distinct sub-species of this body of consumer law – distinct in the sense that granting of small loans, the financing of the purchase of consumer goods and residential mortgages were recognised as giving rise to similar issues. Consumer credit has also become more globalised. This was made plain by the Global Financial Crisis (GFC), in which the interconnectedness of the world’s financial system was laid bare. It is also apparent in the regulatory responses of individual jurisdictions which demonstrate both remarkable similarities as well as clear divergence.

The chapters in this book seek to analyse the regulatory responses to the GFC and its impact on consumer law generally and consumer credit in particular in a number of different jurisdictions, primarily the United Kingdom, United States of America and Australia. In doing so, the aim is to encourage comparison and to stimulate analysis of the different approaches taken in the different jurisdictions, enabling more general conclusions to be drawn about the appropriate nature and form of regulation. In turn, these general conclusions may be used to inform policy and law making.

2 Themes and issues

As might be expected, the regulatory responses to the GFC and more recent legislative activities reflect the particular features of the jurisdiction in question. These features include the complexities of a federal as opposed to a unitary legislative system, demands of harmonisation within supra-national legal systems such as the European Union (EU), the different effects of the GFC on different jurisdictions, the different times those effects were felt and the changing ideology of those holding political power. Nevertheless, the chapters also reveal a number of important common themes and issues. Of these, three in particular are worth highlighting as representing fundamental changes in the approach to the regulation of consumer credit: the rise of an overtly paternalistic approach, whereby consumers are seen to need to be protected from themselves; moves to address the fragmentation in consumer law and consumer finance regulatory regimes through enhanced convergence; and the increasing centralisation of the enforcement of consumer law through the establishment of powerful national regulators with extensive administrative powers to ensure compliance.

2.1 The rise of paternalism

Classical liberal theory, which underpins the common law of contract¹ and, therefore, consumer law, both justifies and limits what should be done to address unfairness and inequality. John Stuart Mill famously said that ‘the only purpose for which power can be rightfully exercised over any member of a civilised community, against his will, is to prevent harm to others. His own good, either physical or moral, is not a sufficient warrant’.² In the context of contracts, this may be interpreted as allowing people, in particular consumers, to make bad bargains. It is clearly against paternalism, which favours using regulatory power over consumers ‘for their own good’.

While Mill’s classical liberalism is usually referred to in discussions of civil society as a whole, he did touch on questions of contracts and trade which he described as ‘a social act’.³ He argued against the control by governments of prices and the quality of goods but he did so for the mostly utilitarian reason that, in his view, it did not work to ‘produce the results which it is desired to produce by them’.⁴ Mill seemed somewhat conflicted on the ‘doctrine of free trade’ as he called it. On the one hand he considered that ‘restrictions on trade, or on production for the purposes of trade, are indeed restraints and all restraint qua restraint is an evil’. On the other, he did identify certain questions, arising out of the potential for harm to others, which may be resolved by the imposition by government of laws to prevent, for instance, frauds, maintenance of public health and the protection of workers in dangerous occupations. Ultimately, these matters should be resolved by the principle that ‘leaving people to themselves is always better ceteris paribus than controlling them, but that they may be legitimately controlled for these ends is in principle undeniable’. Interestingly, Mill may have been an unconscious philosopher of consumer law since he took most exception to those ‘interferences’ which are ‘objectionable not as infringements on the liberty of the producer or seller but on that of the buyer’.⁵

The intrinsic value of the liberty of buyers or consumers to make choices, even bad ones, in a free market was championed in the 1960s and 1970s by economists such as Milton Freidman,⁶ and political scientists such as Robert Nozick.⁷ It found legal expression in the work of the so-called ‘Chicago School’, in particular Richard Posner, which combined law and economics to argue that the proper goal of any legal system regulating contracts, and therefore consumer transactions, was the efficient operation of markets. To the proponents of the law and economics approach even breaches of contracts may be tolerated if they are efficient and economic.⁸ Overall, both parties, consumers and suppliers, benefit from participation in economic transactions. If there is a resultant inefficient and uneconomic allocation of resources, for instance a rise in consumer bankruptcies or property repossessions, this indicates a market failure which may justify regulatory intervention. Milton Friedman acknowledged the importance of these market failures when he said that ‘the possibility of coordination through voluntary cooperation rests on the elementary – yet frequently denied – proposition that both parties to an economic transaction benefit from it, provided the transaction is bilaterally voluntary and informed’.⁹ Consumers should, therefore, if fully informed about their choices, be left to make them.

Thus, properly informing consumers became the principal function of consumer law. The premise was that a properly informed consumer would act in his or her own interests and, therefore, interact with similarly self-interested suppliers to produce a perfectly operating consumer market which maximised benefits for society as a whole. The influence of this thinking in consumer credit law resulted in rafts of legislation mandating comprehensive and detailed disclosure regimes for consumer credit transactions in Australia,¹⁰ the United Kingdom¹¹ and, even earlier, in the United States.¹² Disclosure and its enforcement dominated consumer law and consumers were perceived as homo economicus. ‘Truth in lending’ became the catch-cry of consumer advocates, legislators and regulators.

In the early 1990s, however, the work of behavioural economists challenged the primal role of disclosure in consumer law. Behavioural economics questions the incentives for real-world consumers to either absorb or act on information supplied to them about their transactions. In 1991, Richard Thaler published The Winner’s Curse: Paradoxes and Anomalies of Economic Life.¹³ Thaler challenged the received economic wisdom by revealing many of the paradoxes that abound even in the most painstakingly constructed transactions. He demonstrated, often with telling practical examples, that markets do not always operate with the trap-like efficiency we impute to them. In 2000, Cass Sunstein, a colleague and collaborator of Thaler, published Behavioural Law and Economics.¹⁴ It audaciously challenged the assumptions underlying traditional law and economics (and, therefore, the Posnerian Chicago School of law and economics), saying that they were based on a crude understanding of human behaviour. Sunstein presented new findings in cognitive psychology and behavioural economics which showed that people are frequently both unselfish and over-optimistic; that people have limited willpower and limited self-control; and that people are ‘boundedly’ rational in the sense that they have limited information-processing powers and frequently rely on mental short-cuts and rules of thumb.¹⁵

Taking this research on board, consumer lawyers such as Michael Trebilcock reasoned that if the value consumers put on information in terms of ‘making a better choice about what goods or services to buy and on what terms’ is not high then ‘in a world of information overload, consumer protection instruments that actually generate information that is costly for consumers to interpret or access may be counterproductive’. He suggested that this may be particularly so for statutes ‘that mandate detailed disclosure of contents or ingredients, complex details of the price, terms and conditions of a transaction or very specific caveats about the use of the product’.¹⁶ Empirical research in the United States¹⁷ and Australia¹⁸ supported his conclusion. In other words, mandated disclosure in consumer transactions will, by itself, fail to prevent market failures.

Paternalism, formerly derided, became more respectable among scholars seeking to justify more intervention in consumer markets. Sunstein and Thaler argued that ‘libertarian paternalism is not an oxymoron’,¹⁹ and Colin Camerer and co-authors made the case for ‘asymmetric paternalism’.²⁰ Consumer credit was a prime target for such arguments. As Iain Ramsay wrote in 2005, regulation of consumer credit was moving from ‘truth in lending to responsible lending’.²¹

In consumer credit there has always been an apprehension about predatory lending and flawed markets which allow loans to consumers who lack the capacity to repay them without hardship.²² The Australian Uniform Consumer Credit Code of 1996 included, for the first time, as one of the factors which courts may address when considering an unjust contract, whether or not the (consumer) could meet their obligations under the credit contract or at least without substantial hardship.²³ This may have served to discourage irresponsible lending, but such reactive measures were largely ineffective.²⁴ They were a far cry from a more paternalistic approach which mandated responsible lending so that credit providers would be prohibited from lending in such circumstances. This latter approach leads to a reduction in consumer choice in order to prevent potential consumer harm. It is ‘illiberal’ in the classical sense. It is paternalistic consumer protection. It may, of course, be necessary particularly for vulnerable consumers.

The intellectual ground work for the paradigm shift towards greater paternalism in consumer credit was well and truly laid by the middle of the first decade of the twenty-first century. Elsewhere in this book is an explication of the gradual adoption of more paternalistic approaches to consumer credit in the UK and European Union around this time. It was not until after the GFC, however, that the United States (at a federal level), New Zealand and Australia mandated pro-active responsible lending regimes.²⁵ One of the themes of this book, therefore, is how different jurisdictions with different experiences of the GFC produced remarkably similar regulatory responses, all of them more paternalistic than what had gone before. Some of the common features of these responses include: price and product controls; the mandating of responsible lending; and increased powers for newly centralised regulators. Previously fragmented consumer protection regimes became consolidated with greater and more paternalistic powers.

2.2 Curing fragmentation

Fragmentation has been a conspicuous problem in many of the consumer law regimes considered in this book. Fragmentation of mortgage regulation and supervision coupled with the doctrine of ‘federal pre-emption’²⁶ paved the way for ‘charter shopping’ in the United States in the run-up to the subprime mortgage crisis.²⁷ ‘Charter shopping’ was the practice of converting to a different type of charter (for example, national banks converting to national thrift²⁸ charters or vice versa, or state banks or non-bank lenders converting to national bank or thrift charters) with a view to ensuring that the institution was regulated by the laxest laws and regulators. In particular, the objective was to avoid the application of state anti-predatory lending laws which began to proliferate in the first decade of the millennium in response to the increasing concerns about pre...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of contributors
• Acknowledgements
• Table of cases
• Table of legislation
• PART I Issues and themes
• PART II Functional perspectives
• PART III Responsible lending and financial exclusion
• PART IV Unfair contract terms
• Index