Making Firms Liable for Consumers' Mistaken Beliefs: Theoretical Model and Empirical Applications to the U.S. Mortgage and Credit Card Markets

Abstract

I show that an introduction of a liability on firms proportional 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 magnitude of: 1) decrease in the gap between the beliefs and the effective terms of the contract due to the introduction of the liability, 2) decrease in output or increase in price, and 3) efficiency of administering the liability. I do not find a statistically significant output decrease (price increase) when several large U.S. credit card issuers dropped mandatory arbitration clauses (that effectively precluded class action lawsuits) or 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.