The Warybuyer Speaks! Thoughts on Credit Card Defense, Debt Collection, Credit Reporting and Auto Fraud

Judge Posner has commented on the bankruptcy bill and suggested that it will result in a reduction of interest rates and a transfer of wealth from imprudent borrowers to prudent borrowers, which if true would arguably be a good thing. However, I don’t think that will be the case.

Most credit card issuers use risk-based pricing, so rates for prudent borrowers presumably will not be changed in response to the bill, as those rates don’t presently contain any significant bankruptcy premium.

Unfortunately for high-risk, high-rate borrowers, the market mechanisms that would drive rates down in response to the reduction in bankruptcy risk rarely apply. For the most part, these borrowers were originally extended credit at favorable rates, but because they were late in making payments (2 late payments in 6 months is a common standard) or because their credit score has dropped they get hit with penalty rates of 24% or more. These rates are imposed retroactively to their existing balances, not just to new transactions, so these borrowers’ ability to reduce the impact of the penalty rate by simply switching to another credit card provider for new charges is substantially reduced. Moreover, these borrowers’ capacity to transfer balances to competing cards is often limited compared to that of low-risk borrowers. As a result, the credit card companies that impose these rates may do so with only limited risk of losing revenue to competitors, and therefore have limited incentive to pass their reduced bankruptcy costs to these borrowers.

Is there a sweet spot in the risk curve where the bankruptcy premium in current rates is significant and where competition will require a reduction of the premium? I doubt it. Even if such a sweet spot does exist, I doubt it poses much of a threat to credit card company profits.

Rather than precipitating a transfer to the prudent from the imprudent, the bankruptcy bill will result in a transfer to the politically connected from the politically unconnected.

Craig Williams applauds JAMS decision to resume enforcing arbitration clauses as a return to neutrality. I think it’s the opposite. One of the inherent problems with arbitration is the competition between arbitration fora for business from the people who write arbitration clauses. Shortly after JAMS announced its initial decision on class action bans, it was reported that Citibank and Chase dropped JAMS from their arbitration agreements. Rather than a return to neutrality that should be applauded, the JAMS flip-flop offers yet another example of the inherent bias of arbitration providers in favor of the banks and others who hire them.

All the ruckus about the latest version of the big bad bankruptcy bill has once again brought into focus the abusive practices of credit card companies. The idea that better disclosure will cure this problem is a pipedream. The real issue is the credit card companies’ ability to change the terms of their contracts with their customers at will, for any reason at all, and to apply those new terms retroactively to existing transactions. There is no reason that a credit card company shouldn’t be able to change its contract with a customer, but it should only be able to do so for transactions going forward. That’s the only way that card holders can make rational decisions about whether to incur debt. How can I decide whether it’s a good idea to buy something on credit if I don’t know whether the interest rate is going to be 6.9% or 28.9%?

More importantly, allowing credit card companies to retroactively rewrite their contracts enables them to be predators. They don’t have to carefully consider anyone’s credit worthiness-they just have to sign them up. If they sign up someone who isn’t a good risk, they just compensate by raising that person’s rate. That’s why they can flood college freshmen with credit card offers. They are able to avoid the consequences of bad credit decisions by re-rating their loans after the fact.

All of the credit card host states, South Dakota, Delaware, Nevada, and others, have special provisions in their state law that allow this kind of contract modification. Do you know why they do? Because it is contrary to a basic principle of contract law. Under the common law and the Uniform Commercial Code that govern most contracts in this country, a contract is only binding if both parties agree to it. If a party wishes to modify a contract, it must obtain the other party’s agreement. The retroactive credit card agreements don’t pass muster under this standard. The credit card companies’ amendments are effective upon mere notice to the card holder; actual agreement is not obtained because they get special permission from their host states to amend their contracts this way.

As a result, laws which were intended to force peoople to live up to their consensual agreements, such as the bankruptcy laws, are now being used to force people to live under the terms of unilateral commands. Doesn’t that sound like the difference between commerce and slavery to you?

I had a conversation today with someone who read my earlier post on law schools. She pointed out that by the time someone is in law school, they should have already been taught about values. She’s right of course. It’s not the province of the law schools to teach values themselves and that’s not my complaint. The missing element in legal education is teaching law students to evaluate the legal principles they are learning and to understand what the impact of the law is on their underlying system of values. For example, is tort reform about making the legal system more just or is it just about transferring wealth from plaintiffs to defendants? Is there a difference between those two things? Shoudn’t it be the responsibility of lawyers to seek answers to those questions, rather than have the defense bar champion every change in the law that might favor their clients and the plaintiff’s bar doing the same thing?

Someone asked me about my law school experience today. As always happens when that subject comes up, all sorts of negative feelings started percolating. Despite the fact that I attended a well-respected school (the University of Texas) I found law school to be the most intellectually stagnant, stultifying experience of my life. At the core of the uselessness of my law school experience was the constant disregard for value. By that I mean law students are not (and this has been the case since before the turn of the last century) taught how to identify the values that underly the legal arguments they make or how to evaluate the impact of a particular legal argument on a client, the legal system, or society as a whole. Instead of seeking truth, law students are taught to seek victory. Socrates would chug the hemlock if he saw what American law schools have done to his method.

Our law schools turn out capable, polished, sophisticated advocates who lack any internal compass. Of course, if one sees lawyers as merely hired guns, an internal compass is not necessarily a desirable thing. But look what happens to lawyers over the course of their careers. While they may start out as hired guns, toiling in the bowels of some giant downtown law factory or scrambling for scraps on the courthouse steps, they become the leaders of our society. Setting aside the judiciary, how many legislators and executive office holders are lawyers? Don’t we want those people to have the skills to decide what has value and what does not?

Has the fundamental emptiness of the standard law school curriculum laid the framework for our current political climate, in which spin counts for more than the truth, where posturing, demogaugery, and imagery are more important than great ideas?