Bankruptcy policy in light of manipulation in credit advertising

Theoretical Inquiries in Law

Volumn 7, Issue 2, 2006, Pages

  Harris, Ron ^a   Albin, Einat ^a  

^a TEL AVIV UNIVERSITY   (Israel)

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EID: 33751063574     PISSN: 15653404     EISSN: 15653404     Source Type: Journal    
DOI: 10.2202/1565-3404.1132     Document Type: Review

References (118)

1. A campaign launched by Bank Leumi, on Israeli TV, press, and Internet in March 2005. Bank Leumi is the second largest bank in Israel. Its credit to the public is NIS 169 billion ($39.3 billion). The campaign was designed by the McCann-Erikson Israel advertising agency.
2. For a press release, see Bank Leumi, Press Releases, http://www.leumi.co. il/Leumi/Article/0,2777,117762,00.html (last visited Dec. 24, 2005).
3. Other relevant biases that we will not discuss include belief perseverance (the tendency of a person to stick to her original hypothesis or explanation after one is constructed) and confirmatory bias (the use people make of additional information presented to them to support and strengthen their beliefs). Both of these biases lead to a more general phenomenon known as motivated reasoning (the tendency of people to utilize a variety of cognitive mechanisms to arrive at the conclusion they desired all along). Some heuristics that are often mentioned: the availability heuristic (giving weight to information that is easily brought to mind, such as past experience of yourself or your acquaintances, or information that is presented dramatically, instead of statistical data); the representativeness heuristic (the tendency to make judgments based on the resemblance to a scheme or stereotype), and anchoring - people's tendency to make judgments according to an initial value.
4. Neil D. Weinstein, Unrealistic Optimism about Future Life Events, 39 J. Personality & Soc. Psychol. 806 (1980).
5. Events such as "will be injured while skiing" were excluded.
6. Above average (choices ranged from 10% to 400% above the general probability), average (no deviation from the general probability), or below average (10% to 100% below the general probability). To clarify: the students could be told that 2% of the students in the group would be involved in a car accident. When asked what the probability was that they personally would be involved in an accident they were given a few choices: 2% (no deviation), 0% (100% below average), 4% (100% above average) and 10% (400% above average).
7. Judgment Under Uncertainty: Heuristics and Biases (Daniel Kahneman et al. eds., 1982);
8. Choices, Values and Frames (Daniel Kahneman & Amos Tversky eds., 2000).
9. For some recent studies, see Mary Helweg-Larsen & James A. Shepperd, Do Moderators of the Optimistic Bias Affect Personal or Target Risk Estimates? A Review of Literature, 5 Personality & Soc. Psychol. Rev. 74 (2001);
10. Paul C. Price et al., Perceived Event Frequency and the Optimistic Bias: Evidence for a Two-Process Model of Personal Risk Judgments, 38 J. Experimental Soc. Psychol. 242 (2002);
11. Cynthia T. F. Klein & Mary Helweg-Larsen, Perceived Control and the Optimistic Bias: A Meta-Analytic Review, 17 Psychol. & Health 437 (2002);
12. Edward C. Chang et al., Cultural Variations in Optimistic and Pessimistic Bias: Do Easterners Really Expect the Worst and Westerners Really Expect the Best When Predicting Future Life Events?, 81(3) J. Personality & Soc. Psychol. 476 (2001);
13. Geeta Menon et al., We're at as Much Risk as We Are Led to Believe: Effects of Message Cues on Judgments of Health Risk, 28 J. Consumer Res. 533 (2002).
14. Hamish G. Seaward & Simon Kemp, Optimism Bias and Student Debt, 29 N.Z. J. Psychol. 17 (2000);
15. Stephen E.G. Lea et al., Student Debt: A Psychological Analysis of the UK Experience, in Frontiers in Economic Psychology 1, 430 (Ellen Nyhus & Sigurd V. Troye eds., 1995);
16. Saul Schwartz, Personal Bankruptcy Law: A Behavioural Perspective, in Consumer Bankruptcy in Global Perspective 61 (Johanna Niemi-Kiesiläinen et al. eds., 2003).
17. Seaward & Kemp, supra note 8, at 19.
18. Norman I. Silber, Observing Reasonable Consumers: Cognitive Psychology, Consumer Behavior and Consumer Law, 2 Loy. Consumer L. Rev. 69 (1990);
19. Schwartz, supra note 8;
20. Oren Bar-Gill, Seduction by Plastic, 98 Nw. U. L. Rev. 1373 (2004);
21. Richard M. Hynes, Overoptimism and Overborrowing, 2004 BYU L. Rev. 127;
22. Jason J. Kilborn, Behavioral Economics, Overindebtedness and Comparative Consumer Bankruptcy: Searching for Causes and Evaluating Solutions (June 2005) (Cegla Center conference paper), available at http://ssrn.com/abstracts=690826.
23. Ellen J. Langer, The Illusion of Control, 32 J. Personality & Soc. Psychol. 311 (1975).
24. Mark Fenton-O'Creevy et al., Trading on Illusions: Unrealistic Perceptions of Control and Trading Performance, 76 J. Occupation & Organizational Psychol. 53 (2003).
25. Frank P. McKenna, It Won't Happen to Me: Unrealistic Optimism or Illusion of Control?, 84 Brit. J. Psychol. 39 (1993).
26. Elizabeth C. Redmond & Christopher J. Griffith, Consumer Perceptions of Food Safety Risk, Control and Responsibility, 43 Appetite 309 (2004).
27. See Elizabeth Warren, Jay Westbrook & Teresa Sullivan, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in America (1989);
28. Elizabeth Warren, Jay Westbrook & Teresa Sullivan, The Fragile Middle Class: Americans in Debt (2000);
29. Elizabeth Warren, Jay Westbrook & Teresa Sullivan, Consumer Debtors Ten Years Later: A Financial Comparison of Consumer Bankrupts 1981-1991, 68 Am. Bankr. L.J. 121 (1994).
30. To be clear, Warren, Westbrook, and Sullivan did not argue that bankrupts failed because of their biases. Their research purposes and methodology did not touch upon biases. We are the ones to make this connection by linking two distinct bodies of literature.
31. Joseph P. Forgas & Kipling D. Williams, Social Influence - Introduction and Overview, in Social Influence -Direct and Indirect Processes 4, 4 (2001).
32. Robert B. Cialdini, Influence -the Psychology of Persuasion (1993).
33. Automatic compliance is the most extreme form of compliance with influence. There are other more moderate forms of positive response that are still relevant to our argument.
34. Ellen Langer et al., The Mindlessness of Ostensibly Thoughtful Action: The Role of "Placebic" Information in Interpersonal Interaction, 36 J. Personality & Soc. Psychol. 635 (1978). This Study was mentioned by Cialdini, basing one of his claims. Cialdini, supra note 18, at 4-5.
35. Robert B. Cialdini, Influence - Science and Practice 100 (2001).
36. Id. at 101.
37. Feldman and MacCoun, in a recent article, argue for the relevance of the social influence literature to law and economics and to legal policy in general. See Yuval Feldman & Robert J. MacCoun, Some Well-Aged Wines for the "New Norms" Bottles: Implications of Social Psychology for Law and Economics, in The Law and Economics of Irrational Behavior 358 (Francesco Parisi & Vernon L. Smith eds., 2005).
38. Such theories are presented in various textbooks. For one such example, see Robert J. Barro, Macroeconomics 91-132 (1997).
39. For some introductions to this literature, see David Laibson et al., A Debt Puzzle, in Documentes de Trabaju 80 (2000);
40. David Laibson et al., Estimating Discount Functions from Lifecycle Consumption Choices, available at http: //post.economics.harvard.edu/faculty/ laibson/papers/EstimatingDiscountFunctions16aug2005.pdf (Aug. 2004);
41. Zhikang Chua & Colin F. Camerer, Experiments on Intertemporal Consumption with Habit Formation and Social Learning, available at http://www.hss.caltech.edu/~camerer/savingsjpe7.doc (Apr. 2006);
42. Shane Frederick et al., Time Discounting and Time Preference: A Critical Review, 40(2) J. Econ. Literature 351 (2002);
43. Christopher J. Harris & David Laibson, Hyperbolic Discounting and Consumption, in 1 Advances in Economics and Econometrics: Theory and Applications, Eighth World Congress 258 (Mathias Dewatripont et al. eds., 2002).
44. Another is often called the multiple selves, when we are twenty-five we decide to start saving for retirement at thirty, when we are thirty we decide to start saving only at thirty-five. We may commit ourselves irrevocably at twenty-five to start saving at thirty. But by the time we reach thirty this commitment will contradict our genuine preferences. We will not enter here the discussion in economics and philosophy of the inconsistency of preferences over time.
45. A hyperbolic discounter may prefer to receive S100 in a year over S140 in two years, but $120 in seven years over $100 in six years.
46. See sources cited in supra note 15.
47. Persuasive communication research is one of the main aspects of social influence research. See Forgas & Williams, supra note 17.
48. Daniel J. O'Keefe, Persuasion -Theory and Research 15-16 (1990).
49. Our definition does not deal with persuasion and manipulation that do not relate directly to borrowing. We are aware of the fact that manipulation with respect to consumption of goods and services may lead to additional borrowing even when there is no manipulation by the lender. Parts of our discussion may be relevant to such manipulations. However, they are beyond the scope of the present Article.
50. Jon D. Hanson & Douglas A. Kyser, Taking Behavioralism Seriously: The Problem of Market Manipulation, 74 N.Y.U. L. Rev. 630, 722 (1999).
51. These are two areas of study which developed separately but address very similar situations.
52. See Anthony Pratkanis & Elliot Aronson, Age of Propaganda: The Everyday Use and Abuse of Persuasion (1991);
53. Michael Pfau & Roxanne Parrott, Persuasive Communication Campaigns (1993).
54. Pratkanis & Aronson, supra note 34, at 5-6.
55. See, e.g., Henry F. Adams, Advertising and its Mental Law (1916);
56. Walter D. Scott, The Psychology of Advertising (1917);
57. O'Keefe, supra note 30, at 14.
58. Charles U. Larson, Persuasion - Receptions and Responsibility 338 (2001).
59. See also Advertising, Exposure, Memory and Choice (Andrew A. Mitchell ed., 1993);
60. Max Sutherland & Alice K. Sylvester, Advertising and the Mind of the Consumer (2000);
61. Cialdini, supra note 18;
62. Cialdini, supra note 21;
63. William Wells et al., Advertising: Principles and Practice (1995);
64. S. Watson Dunn, Advertising: Its Role in Modern Marketing (1969).
65. Jon D. Hanson & Douglas A. Kyser, Taking Behavioralism Seriously: A Response to Market Manipulation, 6 Roger Williams U. L. Rev. 259, 284-85 (2000).
66. See supra note 36;
67. In addition, hundreds of articles on mechanisms of advertisement were published in various journals including: Journal of Consumer Psychology;
68. Journal of Marketing Communications;
69. Journal of Consumer Research;
70. Psychology and Marketing;
71. Journal of Advertising;
72. Journal of Economic Psychology;
73. Journal of Marketing;
74. Applied Cognitive Psychology.
75. Irwin P. Levin & Gary J. Gaeth, How Consumers are Affected by the Frame of Attribute Information Before and After Consuming the Product, 15 J. Consumer Res. 374 (1988).
76. Alice M. Isen, The Influence of Positive Affect on Cognitive Organization: Some Implications for Consumer Decision Making in Response to Advertising, in Advertising, Exposure, Memory and Choice, supra note 37, at 249.
77. Debtbuster Loans, http://www.useyourbrain.co.uk/credit-cards/debtbuster- loans.htm (last visited May 23, 2005).
78. Nellie Mae, Loan Center, http://www.nelliemae.com/loancenter/ (last visited May 23, 2005). This example is brought in order to demonstrate the wording technique.
79. Daniel Kahnman & Amos Tversky, Choices, Values and Frames, 39 Am. Psychologist 341, 343 (1984).
80. Tali Freedman, The Psychology of Advertising 120-24 (2002) (Hebrew).
81. Inphonex, Basic Membership, http://www.inphonex.com/products/basic.php (last visited May 23, 2005).
82. Pratkanis & Aronson, supra note 34, at 93.
83. In this section and the next when we mention biases we are referring to all of these deviations from full rationality as one package, unless we expressly justify intervention based on only one of them or prescribe modes of intervention that address only one of them.
84. David A. Moss & Gibbs A. Johnson, The Rise of Consumer Bankruptcy: Evolution, Revolution, or Both?, 73 Am. Bankr. L.J. 311 (1999);
85. Lawrence Ausubel, Credit Card Default, Credit Card Profits, and Bankruptcy, 71 Am. Bankr. L.J. 249 (1997).
86. Ausubel, supra note 49. The rise in proportion of unsecured debts compared with secured debt among low-income families was also offered by Moss & Johnson, supra note 49, as part of the explanation.
87. In this section and the next we will focus on the credit card industry. Credit card debt comprises a significant part of consumer debt in the US. As an industry that is based on unsecured debt and that extends credit to new entrants, this industry serves as a good case for examining the unsubstantiated hypothesis that optimism bias may benefit debtors at the expense of creditors. This industry is highly visual in public debate, in studies of causes of bankruptcies and, as such, has been well-studied. The analysis offered here is applicable to other types of unsecured debt that are marketed by financial institutions and banks to consumers, such as personal unsecured loans and lines of credit. In Israel, for example, lines of credit together with debit cards perform a function quite similar to that of credit cards in the US.
88. Bar-Gill, supra note 10, at 1393-94, 1399-1401.
89. Hynes, supra note 10.
90. See Richard M. Hynes, Non-Procrustean Bankruptcy, [2004] 2 U. Ill. L. Rev. 301, 340-42, for an argument that in the US externalities should not justify generous debt relief. But each country requires individual analysis of the extent of externalities. It is likely that externalities are higher in European welfare states than in the US.
91. The state is expected to maintain public order and protect property rights as well as to enforce contracts. The provision of these to the public is not considered in economic theory to constitute externalities. However, in our view, the enforcement, not only at the contractual level but also at the bankruptcy level, of loans that borrower-debtors accumulated due to their cognitive biases that were manipulated and exploited by their lender-creditors, should be classified as externalities.
92. Pratkanis & Aronson, supra note 34.
93. Id. at xii.
94. Sutherland & Sylvester, supra note 37.
95. Bar-Gill, supra note 10.
96. See Ronald J. Mann, Optimizing Consumer Credit Markets and Bankruptcy Policy, 7 Theoretical Inquiries L. 395 (2006).
97. An exception to the assumption of the informational advantage of borrowers is found in the context of lending contracts. Regulations such as the American Truth in Lending Act, 15 U.S.C. § 1601 (1982), the British Consumer Credit (Advertisements) Regulations, (2004) SI 2004/1484, and the Irish Consumer Credit Act, 1995, aim to force disclosure of the content of borrowing contracts. They require strict disclosure of information such as the effective interest rate and how it is computed, hidden fees, and penalties. The underlying assumption here is that lenders draft loan and credit contracts as standard form contracts, that borrowers do not read such contracts, and that even if borrowers were to read such contracts they could not understand or interpret them correctly. They would be overwhelmed by the length and complexity of these contracts. This regulation is not necessarily premised on the behavioral biases of borrowers.
98. Further, types of information that were in the past in the sole possession of individual debtors are now available to creditors through credit reporting agencies. The availability of low-cost information about the credit history of potential debtors is a major means of creating symmetry regarding some types of information. We do not wish to argue that creditors have equal or superior information about every relevant component of the credit transaction. Some pieces of information are still more readily available to specific debtors.
99. This term was coined by Colin Camerer et al., Regulations for Conservatives: Behavioral Economics and the Case for "Asymmetric Paternalism," 151 U. Pa. L. Rev. 1211 (2003).
100. Id. at 1212.
101. In legal discourse, the main focus of this debate is still smoking. Scholars disagree as to the effectiveness of warnings and disclosures about the health risks of smoking. See, for example, the debate between Viscusi and Slovic: compare Kip W. Viscusi, Using Warnings to Extend the Boundaries of Consumer Sovereignty, 23 Harv. J.L. & Pub. Pol'y 211 (1999),
102. and Kip W. Viscusi, The New Cigarette Paternalism, 25(4) Regulation 58 (2003),
103. with Paul Slovic, What Does it Mean to Know a Cumulative Risk? Adolescents' Perceptions of Short-term and Long-term Consequences of Smoking, 13 J. Behav. Decision Making 259 (2000), and
104. Paul Slovic, Rejoinder: The Perils of Viscusi's Analyses of Smoking Risk Perceptions, 13 J. Behav. Decision Making 273 (2000).
105. See supra note 2.
106. See Christine Jolis et al., A Behavioral Approach to Law and Economics, 50 Stan. L. Rev. 1471, 1533-37 (1998), for strategies that may render disclosure more effective.
107. Jason Kilborn, Continuity, Change, and Innovation in Emerging Consumer Bankruptcy Systems: Belgium and Luxembourg, 14 Am. Bankr. Inst. L. Rev. (forthcoming 2006).
108. Mann, supra note 61.
109. We believe that the two ends of the timeline are the more interesting points in time for analysis. Yet we do not reject the possibility of intervention at other points in time between these two ends.
110. Thomas H. Jackson, The Fresh-Start Policy in Bankruptcy, 98 Harv. L. Rev. 1393 (1985)
111. [hereinafter Jackson, Fresh-Start Policy];
112. see also Thomas H. Jackson, The Logic and Limits of Bankruptcy Law (1986).
113. Jackson, Fresh-Start Policy, supra note 72, at 1408-15.
114. Two years ago, Saul Schwartz analyzed the new Canadian bankruptcy policy supporting debtors' relief, exempt status of various assets, and so on. See Schwartz, supra note 8.
115. See id. at 74-81 for a discussion of some of these considerations from a behavioral perspective.
116. Ron Harris, The Fall and Rise of Imprisonment for Debt, 20 Tel-Aviv U. L. Rev. 439 (1996) (Hebrew);
117. Pablo Lerner, The Chief Enforcement Officer and Insolvency in Israeli Law, 7 Theoretical Inquiries L. 565 (2006).
118. Externalities toward other creditors work as follows: borrowing from a manipulating lender by a debtor increases debt, reduces the percentage of dividend made in bankruptcy, and decreases the share of non-manipulating creditors in the dividend pie.