Economism and Arbitration Clauses

By James Kwak

As banking scandals go, Wells Fargo opening millions of new accounts for existing customers so that it could pump up its cross-selling metrics for investors is about as clear-cut as it gets. It’s up there with HSBC telling its employees how to get around U.S. regulations in order to launder money for drug cartels, or traders and treasury officials at several banks conspiring to fix LIBOR.

Holding Wells responsible, however, was a bit trickier. The bank agreed to restitution (i.e, refunding the fees it had collected from its customers for the phony accounts) and a paltry $185 million in fines. When customers sued for damages, however, Wells hid behind its mandatory arbitration clauses, which were so broadly written that they even applied to accounts that the customer never intended to exist and that the bank had fraudulently created. Wells eventually reached a settlement with the class of plaintiff customers, but the settlement amount was no doubt influenced by the bank’s ability to compel arbitration.

The Consumer Financial Protection Bureau has proposed to eliminate the Wells Fargo defense by prohibiting class action waivers—clauses that take away customers’ right to participate in class action lawsuits—in arbitration clauses of financial contracts. (Class actions are crucial to deterring and punishing systematic fraud against consumers, because the harm to any single person will not be worth the expense of pursuing a lawsuit; without a class action, no one will sue, and the company will escape unharmed.)

Republicans, not surprisingly, are opposed to the proposed CFPB rule because … markets! The argument against regulations such as a ban on class action waivers is simple and elegant. A class action waiver is just a contract term open to negotiation. The waiver clause is bad for the consumer; therefore, its existence in the contract implies that the consumer must have gotten something else in exchange for that clause—lower fees, free checking, a lower interest rates, whatever. In a free market, customers have a choice: those who want the right to pursue a class action can pay a higher price for it, while those who don’t care about that right can trade it in exchange for a lower price. When a big, bad regulator like the CFPB comes along, and bans waivers altogether, it harms the latter group, who now must pay a higher price for a right they don’t want in the first place.

As law professor Jeff Sovern points out in a new paper, this is just a classic example of economism. Courts love making deductions from first principles of introductory economics; see, for example, Frank Easterbrook in IFC Credit Corp. v. United Bus. & Indus. Fed. Credit Union: “As long as the market is competitive, sellers must adopt terms that buyers find acceptable; onerous terms just lead to lower prices.” The problem is that the conclusions they arrive at are often simply not true in the real world. Sovern, who has done empirical research on arbitration clauses, points out what should be no surprise to any actual human being: few people understand them, which makes it difficult to see how they could be getting anything in exchange for agreeing to them. In one study, Sovern and his co-authors showed hundreds of people a contract that included a class action waiver in ALLCAPS; afterward, four times as many people thought they could still participate in class actions as realized that they could not.

A variant on the argument above is that, in a free market, banks will treat their customers well because it’s good for business. That is, when customers complain, banks will correct any errors they have made, because otherwise the customer will close her bank account or credit card. This argument is so preposterous that it doesn’t even warrant the ten-point rebuttal that Sovern gives in his paper. As anyone who has ever been a customer of any large company could point out, this still gives banks the incentive to rip off their customers unless they know that 100% of those customers will notice and take the effort to complain.

It’s unlikely that anyone actually believes that consumers understand arbitration clauses and take them into account when making buying choices. These arguments aren’t meant to be taken seriously. They are air cover for banking executives who like taking advantage of customers and politicians who want to do favors for the financial lobby. That’s the purpose of economism, and why it continues to be so influential.

10 thoughts on “Economism and Arbitration Clauses

  1. The idea that you can negotiate these is beyond preposterous. There isn’t a bank or brokerage firm in the country that will let you open an account without an arbitration provision now. Even if you wanted to pay extra for the privilege. And if you can’t go down the street and open up an account elsewhere, then they don’t have to give you anything in exchange for making you give up your right to litigate in court (or participate in a class action). It’s just an adhesion contract.

  2. Casey, when satan makes the rules, and the people willingly give the devil his due, how does one expect the place to be any different than it already is? The collateral damage is a done deal, the consequences will continue to be paid in private as the truths are exchanged for skeletons and put in the public closet. There are no other choices once you are committed to privatizing the profits and socializing the losses, that’s how the system was newly created by the blind mice of Federal Reserve, institutions and congress, and continues to operate to this day. And the good news for gvt is, we cant do anything about it, the bad news for the gvt, it’s unsustainable and a God they don’t believe in will come to clean up the mess one day.

  3. Your article could have included the killer work the Keller Rohrbak attorneys are doing in re Jabbari v. Wells Case 3:15-cv-02159-VC – there is some justice, but on whole – you are correct. Mandatory Arb Clauses’ are a scam as big as the Banks.

  4. This is fund because they wasn’t to argue basically 101ism / Economism but they wouldn’t employ anyone doing anything important whose education stopped at 101.

    Also. Consumer sovereignty should be shot to death out back. How can anyone look at a situation where no one is saving enough in their 401ks and determine that though this collective deficit exists, it does not mean that on an individual basis there is no need for protecting the consumer as they are independent agents on the same field as all their service providers.

    Guess that’s what you get when you have too many lawyers and not enough economists in the room when you’re writing laws.

  5. Trump-Russia Inquiry Looks at Potential for Wall Street Bank Money Laundering
    By Pam Martens and Russ Martens: May 26, 2017
    Exclusive: Wall Street Funds Hold Hundreds of Millions in Sanctioned Russian Bank Subject to Kushner Probe
    By Pam Martens and Russ Martens: May 30, 2017
    “America’s White House is rapidly losing the confidence of its citizens and the respect of its allies around the world. Russia may have, indeed, nefariously meddled in the 2016 election and members of the Trump campaign and transition team may have, indeed, engaged in improper or illegal acts with Russian interests.
    But there is also a mountain of facts that strongly suggest a coordinated campaign by right wing front groups using the money of U.S. billionaires to create the false illusion of a President interested in the welfare of the little guy. Until we untangle this nefarious web of interests and agendas and lay it all out clearly for the public to understand, we will never make America great again.”
    Washington Post Drops a Bombshell on Trump’s Rise to Power but Forgets Two Words — Koch Brothers
    By Pam Martens and Russ Martens: June 5, 2017

  6. Bruce, I think what you are witnessing is the paranoia of media and politicians who have lost control of their ability to influence the population and are now running a desperate “fake news” campaign to discredit anything the opposition does. It’s the latest sign that this crop of humans (save for 3 or 4 people) is a complete and utter, total loss. Which implies that it really doesn’t matter what humans do or say to each other at this point, it’s moot…… That aside,

    It has long since been known that the first time you build, make, or try something, that very first time, is the hardest one to build, make, or try to do. The next 15 or 21 are gravy after that first one is done or made. Be it arbitration, holding people, company’s, or things, accountable, the first one is always the most difficult.

    I have seen first time projects never get off the ground, never get a fair shake. I know well about the causes of probabilities, statistics, lost opportunities, and the effects of invisible extraterrestrials, the guys who gave you everything, just so they could take everything you have by being one step ahead, and invisible, all at the same time. If it was they who ran away with the cause, as a sole survivor, I ask what’s the point of the failed human being experiment?; to effectively battle invisible extraterrestrials and their beliefs for the next 60 years just to break even, it’s a sad existence indeed as all we have to do is take a look around at todays carnage. United we stand, divided we fall, okay so we fall. Try to then do it alone and then get run over, okay so lets get run over, struggle, be alone, and if the invisible extraterrestrials want you somewhere at some point in time with nothing but the ability to walk away, want to be difficult, let them know that you can be difficult too.

    As for Economism, how can the Fed always lose money, but still be up 10% year over year? It takes experienced corruption and the law of numbers to accomplish that, and why is it that the FBI is the only one who doesn’t seem to be clued in around here, have they lost control of their senses? or perhaps even their collective minds by now. If we can just get past this current gvt chit show, I think everything could be fine, for if we ever get to this point in time again, it will the absolute end rather than just a relative one.

  7. Latest release (followup)
    Russian Bank Chairman Met With Kushner, Citigroup
    and JPMorgan Chase
    By Pam Martens and Russ Martens: June 6, 2017
    “…when Gorkov came to Manhattan to meet with Kushner in December, he also “met with bankers at JPMorgan Chase, Citigroup and another, unidentified American financial institution.””

    “It would now seem likely that Senate and House Intelligence Committees along with the Special Counsel will want to hear from Citigroup and JPMorgan bankers about the precise nature of their conversations with Gorkov.”

  8. Skunk: I think what we are witnessing is large scale networking espionage and perhaps treason. Stay tuned.

  9. Hope it’s not serious, is there a pill or a prescription to cure that? Perhaps as Americans we are immune to bites from those critters.

    Been a while since we had tetanus shots over here, and I’d hate to have to confront one of those beast in the wild, they have a hide on them an inch thick and you can’t out run um.

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