Making Firms Liable for Consumers’ Mistaken Beliefs: Applications to the U.S. Mortgage and Credit Card Markets

Abstract

In theory, an introduction of a liability on firms, related to the difference between consumers’ beliefs and the effective terms of purchase/contract, can improve both social welfare and consumer surplus, depending on the relative magnitudes of: (1) decrease in the gap between the beliefs and the effective terms of the contract due to the introduction of the liability, (2) output decrease or price increase, and (3) efficiency of administering the liability (and the amount transferred). I do not find statistically significant evidence of (2) in two examples of instituting a similar liability: when several large U.S. credit card issuers dropped mandatory arbitration clauses (that effectively precluded class action lawsuits) and when U.S. residential mortgage creditors became liable for failing to consider a borrower's future ability to repay the mortgage, suggesting that these events improved consumer surplus and might have improved social welfare.