CFPB–A Poster Child for Regulation

From FOTB Jean Sternlight posted today on the ACSblog:

The Consumer Financial Protection Bureau (CFPB) just issued a new rule prohibiting financial service providers from using forced arbitration to prevent their customers from suing the company in class actions.  While many of us believe this rule is a “great win for consumers,” others are trying to gut it in Congress, in the courts, or through administrative action by the Comptroller of the Currency.

The new CFPB rule is critically important in its own right, but it is also interesting to view the battle over this rule as a microcosm of the fight we so often see between free market devotees and fans of regulation. Bankers, credit card issuers, payday lenders and the Chamber of Commerce have urged for many years that consumers should be free to “choose” to resolve disputes through individual arbitration – supposedly a quicker, cheaper better mode of dispute resolution as compared to litigation and class actions.  In contrast, those who oppose forced arbitration assert that such arbitration is unfair for consumers and bad for society as a whole.  Ultimately this battle between free marketeers and pro-regulation forces turns on principles of economics, psychology, and political philosophy, as I have detailed elsewhere.

While those who oppose regulation urge that financial consumers should be free to choose to resolve future disputes through individual arbitration rather than through class actions, empirical studies and common sense tell us that consumers do not knowingly choose a contract based on the arbitration clause.  We do not focus on such clauses, we do not usually understand them and our human psychology leads us to be overly optimistic that no disputes will arise in any event.  Nor would it make sense for all consumers to spend the time and energy to try to figure out such clauses.

We also cannot count on the miracle of Adam Smith’s invisible hand to ensure that financial service companies act in the best interest of consumers.  The lack of perfect competition, customers’ lack of complete information, the impact of clauses on third parties and the unequal initial distribution of resources all ensure that the market will not miraculously do what is best for customers.

Philosophically, how can one argue with a straight face that clauses imposed unknowingly in small print contracts are supported by principles of freedom or autonomy?  As Professor Hiro Aragaki has explained, perhaps autonomy supports freedom from contracts of adhesion more than freedom of contracts of adhesion.

So, we need regulation. What should the regulation look like? Is forced arbitration the quicker, cheaper, better form of dispute resolution that its advocates suggest? Do class actions help consumers or do they only enrich the lawyers who bring them? The CFPB used extensive empirical investigation to answer these questions.  It found that (1) financial consumers are typically unaware of the arbitration clauses to which they are subjected; (2) only miniscule numbers of financial consumers actually bring claims in arbitration; and (3) financial class actions, e.g. over improper check bouncing charges, have brought billions of dollars of benefits to millions of consumers and also imposed non-monetary sanctions, all helping to deter future illegal conduct.  Thus, CFPB concluded that, at minimum, it should prevent financial companies from using arbitration to insulate themselves from class actions.  It issued the rule to achieve that end.  The new CFPB rule also requires companies to submit additional information to CFPB regarding their arbitration programs so that CFPB can conduct additional analyses and decide whether more/different regulation may be needed.

Hurrah for the CFPB!   Its new rule is supported by psychology, economics, and political philosophy.  Nonetheless, the new rule is under serious threat.  Congress may consider proposals to gut the rule as early as next week, and the Acting Comptroller of the Currency is threatening to void it on the ground that allowing financial consumers to sue in class actions would threaten the soundness of the banking system.

The CFPB says otherwise, and expresses surprise that such a claim is being made at the tail end of a very public three year study.

Let’s now all take what steps we can to preserve this rule against the attacks that are coming in Congress, from elsewhere in the bureaucracy, and in the courts.

One thought on “CFPB–A Poster Child for Regulation”

  1. Taking from the retrospect of the Senate vote to overturn this measure, we get the impression that freedom to contract is more important than freedom from contracts. Neither condemning nor condoning the measure, I am nonetheless curious to know to what degree that extends. Many of these are contracts of adhesion by default, but most of them (that I am aware of at least) have clauses that say you can opt out within 30 days. With the substantive view normalizing arbitration, will that remain the case?

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