CFPB’s Theory of Consumer Protection: Less Choice, More Cost

Signaling its intent to proceed with business as usual, despite ongoing controversy over its leadership and structure, the Consumer Financial Protection Bureau (CFPB) recently finalized a rule restricting the ability of financial services companies to use arbitration clauses in their contracts. 

An arbitration clause requires the parties to the contract to take any dispute to arbitration, a privately operated hearing procedure that typically has a legally binding effect. Arbitration is often attractive because it can be quicker and less expensive than a case brought in court. It also typically means that the plaintiff cannot join together with other plaintiffs to bring a class action suit. This is the crux of the issue. 

Supporters of the new rule claim that these clauses, buried in fine print and ubiquitous in almost all parts of American legal life, allow banks and credit card companies to get away with abuses that would otherwise be checked by class action litigation. An unlawful practice that costs every customer $5 is almost assuredly not worth the cost or hassle of going to court over. However, bring together a class of one million customers (most of whom will never realize they’re part of the class at all), and there’s real money at stake. Enough money to entice a lawyer to litigate and, let’s be honest, control the entire process for a chance at the typical fee of 33 percent of whatever is recovered. 

Is this true? Were companies able to get away with practices that netted them cash while harming consumers because the harms were so diffuse? Maybe.  Probably. Without speculating about what kinds of practices companies may have engaged in or how wide-spread any were (I have no intention of impugning an entire industry, but every industry has its bad eggs), to the extent litigation was required to check any particular misconduct, if the harm per customer was marginal, it is unlikely anyone would bother with litigation. 

But that does not necessarily argue in favor of this rule. The rule will likely increase litigation costs for some companies. That’s kind of the point, right? To force the companies into court instead of using the often cheaper option of arbitration? Those costs will likely be passed along to customers in the form of higher fees. Before the CFPB’s rule, nothing prevented companies from drafting contracts without arbitration clauses. (Also, to be clear, before the rule nothing prevented a company and a customer from deciding together that they preferred to go to court. It’s just that if the contract had an arbitration clause, no one party could decide unilaterally to take the issue to court.) 

If customers were really upset about arbitration, it seems they would have presented a terrific market for a company that would offer them contracts free of arbitration clauses. The trade-off would likely have been slightly higher fees for their products to off-set the costs. That is, effectively the trade-off the new rule presents: no arbitration clause, but higher costs. To my knowledge, no one offered this trade-off. Given the competitiveness of the market, it seems that if there were customers willing to pay for a product, banks and credit card companies would have offered it. The fact that no one did suggests to me that arbitration clauses are not that important to consumers. Not important enough, at least, to justify higher costs. This makes the rule a bit strange. It forces on consumers an option they never chose, all in the name of protecting their best interests.