Analyzing “contract regulation”

1. Analyzing “contract regulation”

2. Basics on contracts (1) The problem of potential traders Defining the exchange: When? Ex ante, ex post (relational contract) How? By contract, law (default vs. mandatory rules; retroactive) By whom? Parties, third party, one party (standard-form contracts) Enforcing the agreement: How? = By whom? Third party (judge), one or two of the parties (future trade), other market participants (reputation) What’re the parties’ possible objectives? Efficiency = maximizing gains from trade (surplus, “the pie”) Redistribution = Exploiting the counterparty (appropriating it) … always? Or do their goals change over time? Ex ante, priority on efficiency; ex post, on exploitation if final

3. Basics on contracts (2): The dual role of contract clauses • More than merely defining the content of exchange, • introducing incentives ( surplus) • dividing the surplus • Example: “clauses” in a simple incentives model: Wage = α + β * Performance • β motivates surplus • αredistributes surplus

4. The case of “standard-form contracts” • Costs & benefits of having one of the parties writing the contract: partiality vs. savings & knowledge • Role of competition • Why is “salience” important? Is it constant over time? • Does it improve with regulation? At what cost? • Will a monopolist draft inefficient clauses? • Not if he can extract rents otherwise (α) • Yes if need to increase its control over pricing: • imagine that buyers willing to pay a higher price prefer strong warranty  monopolist may offer 2 contracts with high (low) price and strong (weak) warranty (a “tie in”) • What about uniform clauses in an industry? • Is it driven by collusion? • Or by price competition in selling the optimal product?

5. Are judges a solution, a problem or both? When “ex ante”, parties want for judges to decide efficiently ex post (Counterfactual hypothesis) But when ex post, each party wants for the judge to decide… in her favor Judges’ difficulties  solutions? Self interest: corruption, applause, morality? Cognitive: e.g., hindsight bias Example: mortgage interest rate “floors”: Now it looks “obvious” that interest rates were going to be low Judicial “populism” after the recession?

6. Analyzing contract “regulation” (by judges or the law) • Consider the rationale for default and mandatory rules: • Default rules: reducing transaction costs • Mandatory: avoiding externalities, rationality • Key: Must identify effects on two types of contracts b/c enforcement causes • Distribution in existing contracts  Justice? • (In)efficiency in future contracts  Justice?

7. The case of mortgage clauses • Information asymmetry  • Mandatory intervention of a notary (even Shiller…) • Lenders should offer variable-rate insurance • Rates dropped  Clauses litigated, not enforced: • Interest rate “floors” and “swaps” etc. • Supreme Court says “notary intervention merely formal. Ergo, irrelevant. Transparent?” • Courts do not enforce swaps • Lessons on regulation? On judges?

8. Who could have imagined this?Euribor at 3 mos.

9. Does hindsight bias lead judges to see balanced transactions as unbalanced?Or do they use popular bias as an excuse to act “morally”, punish selfish bankers, etc.? Ex ante, probabilities = 0.5 (6, 0) Fair deal: (3, 3) (0, 6) but ex post, with hindsight, probability > 0.5, e.g. 5/6  Unfair deal: (1, 5)

10. Arruñada & CasariCredit enforcement experiment • Socially optimal to lend b/c it produces a surplus of 24 = (34-10) • Lender makes a profit (lends 10, gets back 17) • The surplus goes mostly to the borrower (gets 17 instead of 0) • Including minimum earnings, lenders are rich, borrowers are poor: 33 50 16 67 50 60 With loan & return With loan & default Without loan

11. Arruñada & Casari—Main result 1: Surplus in the economy GDP

12. Humans withdraw cooperation for good—our backward looking robots do not • Human lenders (loans in blue, comply opinions in white squares): • Robot lenders:

13. Conclusions • Very different results despite judges’ incentives being “correct” in all treatments • “Paradox of the borrowers:” When borrowers hold rights, they reduce market efficiency • When lenders hold rights, borrowers end up better off • Lesson: allocation of rights relevant even if incentives are “correct.” Why? • Our explanation: people in some roles are better placed to decide & enable market exchange

14. Evolution of residential mortgage market, Spain

15. For team 5?: new mortgage rules • “A mortgage loan is 3,300€ more expensive today than in September” • (“Un crédito es hoy 3.300 euros más caro que en septiembre” (El Mundo, April 7, 2019)

16. A case for project 7 and others: reputational blackmail—Ausbanc • Are consumer organizations “angels”? • Dangers of a Manicheam view of economic agents • Role of institutions—in particular, judges • A case of judicial failure? • A media failure?