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Neutral Third-Party Counselling as Nudge Toward Safer Financial Products?

The Case of Risky Mortgage Loan Contracts

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Nudging - Possibilities, Limitations and Applications in European Law and Economics

Part of the book series: Economic Analysis of Law in European Legal Scholarship ((EALELS,volume 3))

Abstract

This paper discusses the idea of neutral counselling as a measure of improving decisions of borrowers when choosing a mortgage loan. The developments regarding foreign-currency mortgage loans, popular in Central and Eastern Europe in recent years, illustrate how incorrect mortgage choices may have detrimental effects on borrowers and their families. Taking a sceptical approach toward mandated pre-contractual disclosure as a protection measure for borrowers, the paper advocates neutral counselling of mortgage applicants in case they are offered risky types of mortgages. Drawing on the experience of an American mortgage counselling programme, a set of recommendations is made regarding the design of a possible neutral mortgage counselling scheme. While the counselling solution has imminent limitations, it displays clear potential toward improving the process of financial decision-making.

It is a terrible thing when, for example, unsophisticated people are inveigled into an unaffordable mortgage on unconscionable terms. But this happens (and the mortgage crisis occurred) despite the magnificent edifice of disclosures that was conscientiously debated when it was adopted, that has been repeatedly revised and expanded, and that has been supervised by an agency that has poured effort and expertise into it (Ben-Shahar and Schneider 2013, p. 184).

This research has been financed by the National Science Centre, Poland within the framework of the research project: 2015/17/B/HS5/00495.

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Notes

  1. 1.

    Rzeczpospolita from 26 January 2015, http://www.ekonomia.rp.pl/artykul/710047,1174464-Kim-jestes-frankowcu-.html?referer=redpol; Rzeczpospolita from 5 February 2015, http://www.ekonomia.rp.pl/artykul/710047,1177051-Gdzie-mieszkaja-frankowicze.html?referer=redpol; The Economist from 15 November 2014, Forint exchange, http://www.economist.com/news/finance-and-economics/21632651-hungarys-government -gives-struggling-borrowers-break-forint-exchange .

  2. 2.

    See the official position of the Austrian Financial Market Supervision Authority (Österreichische Finanzmarktaufsicht, FMA) on foreign currency loans: Position der Finanzmarktaufischt zu Fremdwährungskrediten und Informationen zur derzeitigen Lage, https://www.fma.gv.at/de/sonderthemen/fremdwaehrungskredite.html.

  3. 3.

    Balogh and others 2011, p. 1.

  4. 4.

    The Economist from 15 November 2014, Forint exchange, http://www.economist.com/news/finance-and-economics/21632651-hungarys-government -gives-struggling-borrowers-break-forint-exchange.

  5. 5.

    Rzeczpospolita from 2 March 2015, http://www.ekonomia.rp.pl/artykul/1183012.html.

  6. 6.

    Rzeczpospolita from 2 March 2015, http://www.ekonomia.rp.pl/artykul/1183012.html.

  7. 7.

    The development of exchange rate of franc versus PLN is accessible at the website of the Polish central bank (Narodowy Bank Polski), http://www.nbp.pl/homen.aspx?f=/kursy/kursyen.htm.

  8. 8.

    Rzeczpospolita from 2 February 2015, reports on struggles of borrowers http://www.ekonomia.rp.pl/artykul/710047,1176120-Oferta-sprzedazy-mieszkan-zadluzonych-we-frankach.html?referer=redpol.

  9. 9.

    The Economist from 15 November 2014, Forint exchange, http://www.economist.com/news/finance -and-economics/21632651-hungarys-government -gives-struggling-borrowers-break-forint-exchange.

  10. 10.

    As this contribution was submitted, the Polish Parliament was working on a draft law allowing borrowers to convert outstanding foreign-currency mortgage loans into the Polish currency, under specific requirements.

  11. 11.

    See the interview with the former Head of the Polish Financial Supervision Authority (Komisja Nadzoru Finansowego), Stanisław Kluza, accessible at http://www.polskieradio.pl/42/273/Artykul/1358788,Stanislaw-Kluza-o-franku-banki-powinny-wziac-odpowiedzialnosc.

  12. 12.

    The Economist from 15 November 2014, Forint exchange, quoting a bank official: “Now, with the benefit of hindsight, we can see that it was a mistake,” says a senior official at an Austrian bank that issued lots of franc loans, “Most of the clients did not recognise the risk and in some cases we did not inform them properly.”

  13. 13.

    Balogh and others 2011, p. 4.

  14. 14.

    Rzeczpospolita from 3 February 2015 “Dlaczego frankowicz wygra w sądzie”, http://www.ekonomia.rp.pl/artykul/1176588.html, quoting some typical provisions of foreign-currency indexed mortgage loan contracts.

  15. 15.

    In order to maintain stability of the Polish financial system, the Swiss Central Bank was forced to provide liquidity to the Polish Central Bank in the beginning of 2009, cf. Schweizerische Nationalbank, Geschäftsbericht 2009, available at http://www.snb.ch/de/iabout/pub/annrep/id/pub_annrep_2009.

  16. 16.

    Judgment of the Court of Justice of the European Union of 30 April 2014, Case C-26/13, Kásler vs. OTP Jelzálogbank Zrt, ECLI EU C 2014, p. 282.

  17. 17.

    Para 22 of the Judgment, Kásler vs. OTP Jelzálogbank Zrt.

  18. 18.

    Judgment of the Court of Justice of the European Union of 26 February 2015, Case C-143/13, Matei vs. SC Volksbank Romania, OJ C 138, 27.4.2015, par. 26.

  19. 19.

    This point is well illustrated in the Matei vs. SC Volksbank Romania case. When borrowers questioned the fairness of the ‘risk charge’ due under the mortgage credit contract, the lender just proposed to re-name the ‘risk charge’ to ‘Credit Management Charge’, since charging this commission was expressly authorised by applicable regulations, however, without at the same time modifying the content of terms defining the charge. Similar features in the U.S. mortgage lending practice are described by Bar-Gill 2012, pp. 120–123.

  20. 20.

    Rzeczpospolita from 5 February 2015, http://www.ekonomia.rp.pl/artykul/710047,1177051-Gdzie-mieszkaja-frankowicze.html?referer=redpol.

  21. 21.

    On definitions of predatory loans see Willis 2006, pp. 718–729, Engel and McCoy 2002, p. 1284, Stark and Choplin 2010, pp. 9–18.

  22. 22.

    For a comprehensive discussion of lenders liability for violating duties to provide information or advice see Tereszkiewicz 2015.

  23. 23.

    Stark and Choplin 2010, p. 71, Table 1: Fourteen cognitive and social psychological factors that cause disclosure forms to be ineffective.

  24. 24.

    Housing Action Illinois, Findings from the GB 4050 Predatory Lending Database Pilot Program 2007, quoted after Stark and Choplin 2010, p. 20.

  25. 25.

    Stark and Choplin 2010, p. 22, drawing on Tversky and Kahneman 1980, pp. 207–232.

  26. 26.

    Shafir et al. 1993, pp. 11–36.

  27. 27.

    Willis 2006, pp. 780–781.

  28. 28.

    Stark and Choplin 2010, p. 26.

  29. 29.

    See Kahneman and Tversky 1979, pp. 263–291.

  30. 30.

    Stark and Choplin 2010, p. 27, drawing on Frederick, Loewenstein and O’Donoghue 2002, pp. 351–401.

  31. 31.

    Thaler and Sunstein 2009, p. 140.

  32. 32.

    See Willis 2006, pp. 798–806.

  33. 33.

    Regarding a similar pattern in ‘self-presentation’ of insurers see Feinman 2009, p. 553.

  34. 34.

    Stark and Choplin 2010, p. 17.

  35. 35.

    Stark and Choplin 2010, p. 17.

  36. 36.

    Lusardi 2008; Meier and Sprenger 2013, pp. 159–174.

  37. 37.

    Willis 2011, pp. 431–432.

  38. 38.

    Willis 2011, pp. 431–432, claims that financial education would have “paradoxical effects on autonomy ”.

  39. 39.

    Rzeczpospolita from 2 March 2015, http://www.ekonomia.rp.pl/artykul/1183012.html.

  40. 40.

    This topic attracted important literature in recent years. A major critique of mandated disclosure stems from Ben-Shahar and Schneider 2013. For a more positive approach toward disclosure see A. Schwartz 2015, p. 1374. See also Bar-Gill 2012, pp. 32–43.

  41. 41.

    Sunstein and Thaler 2009, p. 146.

  42. 42.

    Sunstein and Thaler 2009, pp. 146–147.

  43. 43.

    Craswell 2006, p. 576.

  44. 44.

    Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010, OJ L 2014, L 60, p. 34.

  45. 45.

    The academic literature on the Mortgage Credit Directive is still rather limited. An interesting introduction is provided by the British Financial Conduct Authority in its Consultation Paper “Implementation of the Mortgage Credit Directive and the new regime for second charge mortgages”, CP 14/20, September 2014, available at http://www.fca .org.uk/your-fca /documents/consultation-papers/cp14-20.

  46. 46.

    Consideration 7 of MCD.

  47. 47.

    Willis 2006, p. 794.

  48. 48.

    Rightly Trebilcock and Elliot 2001, p. 75.

  49. 49.

    On this danger Craswell 2006, pp. 576–580.

  50. 50.

    Trebilcock and Elliot 2001, p. 75.

  51. 51.

    Willis 2006, p. 823.

  52. 52.

    Trebilcock and Elliot 2001, p. 65; see also Tereszkiewicz 2011, pp. 851–873.

  53. 53.

    Beatson et al. 2010, p. 361.

  54. 54.

    I use the term ‘informational behaviour’ drawing on the illuminating analysis of Craswell 2006, p. 566.

  55. 55.

    Terms ‘neutral’ and ‘independent’ are used here largely as synonyms, as are terms ‘advice ’ and ‘counselling ’.

  56. 56.

    Trebilcock and Elliot 2001, p. 76, Stark and Choplin 2010, pp. 26–27.

  57. 57.

    Mill 1947, p. 89.

  58. 58.

    Trebilcock and Elliot 2001, p. 69.

  59. 59.

    Trebilcock and Elliot 2001, p. 69.

  60. 60.

    Ben-Shahar and Schneider 2013, p. 13, p. 190, proposing a broad concept of ‘information intermediaries’, comprising consultants, aggregators, and even savvy shoppers.

  61. 61.

    Consideration 63 of MCD.

  62. 62.

    Cf. Financial Services Authority (UK), Consultation Paper 11/31, Mortgage Market Review: Proposed package of reforms, par. 1.109: “Most customers believe that if they speak to an intermediary, they have been given ‘advice ’, no matter how many times they may be told that they are not being given advice and whatever form of service disclosure they are given confirming this position”; available at http://www.fca .org.uk/your-fca /documents/consultation-papers/fsa-cp11-31.

  63. 63.

    On the concept of ‘advice ’ under Directive 2004/39/EC on markets in financial instruments (MiFID I) see Moloney 2010, p. 200.

  64. 64.

    This position was part of English law of private sureties, see Trebilcock and Elliot 2001, p. 75.

  65. 65.

    Burrows 1995, p. 140.

  66. 66.

    Bates and Van Zandt 2007, p. 39.

  67. 67.

    “Pilot program area means areas designated as such by Department due to the high rate of foreclosure on residential home mortgages that is primarily the result of predatory lending practices. The Department shall designate the pilot program area within 30 days after the effective date of this amendatory Act of the 94th General Assembly.” See Bates and Van Zandt 2007, p. 18.

  68. 68.

    Agarwal and others 2009, p. 2.

  69. 69.

    Agarwal and others 2009, p. 2.

  70. 70.

    Bates and Van Zandt 2007, p. 16. This led to the high-FICO borrowers being counselled conditional on their mortgage contract choice.

  71. 71.

    All mortgage loan applications were entered into a central database.

  72. 72.

    Bates and Van Zandt 2007, p. 23.

  73. 73.

    Agarwal and others 2009, p. 8.

  74. 74.

    See Bates and Van Zandt 2007, p. 39, Figure 1, on the basis of 38 Illinois Administrative Code 346.

  75. 75.

    Agarwal and others 2009, p. 3.

  76. 76.

    Agarwal and others 2009, p. 4.

  77. 77.

    Agarwal and others 2009, p. 4.

  78. 78.

    Agarwal and others 2009, p. 4.

  79. 79.

    Agarwal and others 2009, p. 31.

  80. 80.

    Agarwal and others 2009, p. 31.

  81. 81.

    Agarwal and others 2009, p. 23.

  82. 82.

    Agarwal and others 2009, pp. 4–5.

  83. 83.

    See Bates and Van Zandt 2007, p. 39.

  84. 84.

    Stark and Choplin 2010, p. 53.

  85. 85.

    Stark and Choplin 2010, p. 55.

  86. 86.

    Agarwal and others 2009, p. 17.

  87. 87.

    Similarly, in the context of family suretyships, Trebilcock and Elliot 2001, p. 80.

  88. 88.

    Stark and Choplin 2010, p. 57.

  89. 89.

    Relating to the U.S., Stark and Choplin 2010, p. 56, recommended that the mortgage counsellors should be trained by the United States Department of Housing and Urban Development.

  90. 90.

    This concern is raised by Engel and McCoy 2002, p. 1310.

  91. 91.

    Similarly Stark and Choplin 2010, p. 56, who claim that without this assistance many borrowers may return to the original mortgage lender or broker they were working with due to psychological factors discussed in the first part of this essay.

  92. 92.

    Trebilcock and Elliot 2001, p. 79.

  93. 93.

    Stark and Choplin 2010, p. 68.

  94. 94.

    Engel and McCoy 2002, pp. 1309–1311. More generally Trebilcock and Elliot 2001, pp. 82: “The benefits of procedural protection need to be balanced against the increased cost of finance that those protections entail”.

  95. 95.

    Stark and Choplin 2010, footnote 141.

  96. 96.

    Bar-Gill and Warren 2007, pp. 159–162.

  97. 97.

    For Hungary Balogh and others 2011, for Poland Rzeczpospolita from 2 February 2015, reports on struggles of borrowers http://www.ekonomia.rp.pl/artykul/710047,1176120-Oferta-sprzedazy-mieszkan-zadluzonych-we-frankach.html?referer=redpol.

  98. 98.

    Bates and Van Zandt 2007, p. 23 with further references. See also Trebilcock and Elliot 2001, pp. 69–70, warning that having to bear advice costs could be onerous for lower income transactors.

  99. 99.

    Stark and Choplin 2010, p. 61.

  100. 100.

    Trebilcock and Elliot 2001, pp. 67–70, discuss the gatekeeper duties of lenders in the context of family sureties. Generally on a gatekeeper strategy Kraakman 1986, pp. 53–104.

  101. 101.

    The principles and scope of such liability would depend among others on the status of counsellors in a given legal order and also on the legal nature of their mandate.

  102. 102.

    See in general Ramsay 2007, pp. 578–580.

  103. 103.

    In a similar vein Ben-Shahar and Schneider 2013, p. 194: “Sometimes the choice between paternalism and libertarianism simply can’t be avoided, and substantive regulation with no opting out is needed.”

  104. 104.

    Ben-Shahar and Schneider 2013, p. 190, list some of different kinds of information intermediaries.

  105. 105.

    Trebilcock and Elliot 2001, p. 84.

  106. 106.

    Waldron 2014, Section 4.: “I wish, though, that I could be made a better chooser rather than having someone on high take advantage (even for my own benefit) of my current thoughtlessness and my shabby intuitions”.

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  1. Faculty of Law and Administration, Jagiellonian University of Cracow, Olszewskiego 7, 31-007, Cracow, Poland

    Piotr Tereszkiewicz

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    Klaus Mathis

  2. Notre Dame Law School, University of Notre Dame, Notre Dame, Indiana, USA

    Avishalom Tor

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Tereszkiewicz, P. (2016). Neutral Third-Party Counselling as Nudge Toward Safer Financial Products?. In: Mathis, K., Tor, A. (eds) Nudging - Possibilities, Limitations and Applications in European Law and Economics. Economic Analysis of Law in European Legal Scholarship, vol 3. Springer, Cham. https://doi.org/10.1007/978-3-319-29562-6_10

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