Fuzzy Math, Disclosure Regulation and Credit Market Outcomes: Evidence from Truth-in-Lending Reform

Consumer installment lenders prefer to market “low monthly payments” and shroud interest rates. Why not voluntarily disclose rates? We show that when an interest rate is not disclosed, most consumers substantially underestimate it using information on the monthly payment, loan principal and maturity. This “fuzzy math” or “payment/interest bias” helps explain why lenders shroud rates and thereby violate the Truth-in-Lending Act (TILA) even under the threat of fines and litigation. So does TILA have any teeth? We identify within-household interactions between policy-induced variation in the strength of TILA enforcement across lenders and time, payment/interest bias, and interest rates on actual loans. More biased households pay roughly 400 basis points more than less-biased households, but only on loans from lenders facing relatively weak TILA enforcement. TILA compliance seems costly for lenders, leaving the overall welfare effects of mandated disclosure ambiguous. The results link a cognitive bias to firm strategy and market outcomes, and show that mandated disclosure can attenuate those links. Other keywords: household finance, disclosure regulation, consumer protection, price discrimination, consumer credit, psychology and economics, behavioral economics, behavioral industrial organization, cognitive bias, exponential growth bias JEL codes: D01, D03, D1, D4, G2, K2, K42, L5 * Contact: [email protected], [email protected]. Thanks to Jonathan Bauchet, Leon Yiu, and Zachary Nass for research assistance, to Bob Avery and Art Kennickell for discussions on the 1983 Survey of Consumer Finances, and to Andrew Bernard, Stefano DellaVigna, Xavier Gabaix, Jon Skinner, Chris Snyder, Doug Staiger, Todd Zywicki, and seminar/conference participants at the AEA meetings, Dartmouth, the Federal Reserve Board of Governors, the Federal Reserve Banks of Chicago, Philadelphia and Boston, the Federal Trade Commission, NBER Summer Institute (Law and Economics), and Stanford for helpful comments. Special thanks to the legal and research staff at the Federal Trade Commission, including Matias Barenstein, Lynn Gottschalk, Jesse Leary, and Carole Reynolds, for sharing regulatory and institutional details. Fuzzy Math, Disclosure Regulation and Credit Market Outcomes: Evidence from Truth-in-Lending Reform