Fuzzy Math, Disclosure Regulation and Credit Market Outcomes

Disclosure regulation in credit markets is often put forth as a critical form of consumer "protection", but there is little hard evidence on why consumers need protection or whether disclosure regulation affects market outcomes. We address these two gaps. First we provide a new microfoundation for the widespread emphasis on consumer protection via mandated interest rate disclosure. The microfoundation is payment/interest bias: most consumers tend to substantially underestimate a loan interest rate when inferring it from a principal, maturity and monthly payment. This bias may provide lenders with an incentive to shroud interest rates and market "low monthly payments" when not constrained by regulation. Second and most critically, we find that an individual-level measure of payment/interest bias is correlated with rates on actual installment loans, but only on loans from lenders facing relatively lax Truth-in-Lending enforcement. Identification comes from variation across time in the general stringency of Truth-in-Lending enforcement, and from variation across lenders in the strength of enforcement. Our results hold even when we control for unobserved heterogeneity at the household level by examining households with multiple loans from lenders facing different enforcement. The results suggest that mandated interest rate disclosure can prevent lenders from catering to a cognitive bias in how consumers perceive interest rates, and highlight the importance of effective enforcement of disclosure regulation in affecting market outcomes.