Arbitration and Regulation

23:58 Fri 26 Oct 2007
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Americans reading this blog may or may not be aware that many companies they do business with, especially credit card companies, have binding mandatory arbitration clauses in their contracts. This means that in disputes, the consumer cannot take legal action through the courts and must instead go through an arbitrator—one selected by the company.

Naturally, this tilts the resolution of cases in one direction. Furthermore, the majority of credit card companies appear to use these clauses, making it difficult to use a credit card without giving up your rights to legal protections in disputes. Disputes can include your being the victim of fraud or identity theft, and the credit card company holding you responsible for covering resulting losses.

Arbitration doesn’t have to follow any of the same rules that the court system does, and can only be overturned by the court system for egregious procedural errors—not for simple wrongness or unfairness.

It’s clear, therefore, that a) this kind of arbitration sets up a completely unfair scenario for the consumer and b) other considerations make the contract negotiations between consumer and company totally unequal. Despite how thing perhaps “should” work in a supposedly free market economy, there aren’t too many companies offering contracts without arbitration clauses, partly because many people aren’t even aware of the issue.

Therefore legislation has been proposed to remedy this situation, the Consumer Fairness Act of 2007. Binding mandatory arbitration (as opposed to voluntary arbitration agreed to by both parties after a dispute has arisen) would be defined as a deceptive trade practice and effectively outlawed.

I support this legislation, and would vote for it if I had that power. However, it does raise certain issues. The first is the possibility that eliminating the ability of the companies to cut costs in this way will lead to higher charges for all consumers. I’m not convinced that this is true, but if it were true, I would still be for it, because it’s clearly fairer to spread that increased cost among all consumers than it is to place that burden solely on those unlucky enough to end up in a dispute with their credit card company.

This becomes more complicated if the credit card companies instead were to offer contracts both with and without arbitration clauses—but the ones with the clauses had better rates. They’re not doing this now, of course, but if they were to do that, it’s hard to argue that the consumer should be prohibited from availing of the lower-rate cards (even if this could be proven to be economically irrational—consumers should be allowed to make economically irrational decisions, although perhaps not completely without limits.

What difference in rates and terms would be acceptable, however? Regulation would have to be crafted to prevent the credit card companies from simply making the non-arbitration contracts prohibitively expensive or onerous. Over the years, that regulation would likely be chipped away, and we might end up back where we are now—but at least we would have had relief for a while.

The legislation as it stands is a much blunter object, and simply removes the practice from consideration for the companies. In practical terms, this is a good thing, and I very much doubt that many will suffer because of it (except the arbitration industry, but people who make a living doing binding mandatory arbitration work are not people I’m going to worry about). However, it’s important here, as always, to be very aware that we’re not just prohibitng the companies from using this objectionable practice, but are also prohibiting any consumer from signing up for it. In the long run, the balance between protection from rapacious and powerful forces (such as the credit card companies) and not encroaching too far on individual freedoms is very difficult to maintain, leading to untold miles of red tape and a legal/regulatory system that requires an entire priest/seer-like caste to interpret. Yes, that’s more or less where we are today.

Adding this regulation here, of course, is also eliminating an entire branch of “private law” that these companies have been growing on their own, so in that sense is in keeping with the idea that we should be moving towards fewer laws, not more of them.

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