In a BusinessWeek op-ed, Bar-Gill and Davis propose third-party boards police consumer credit card contracts

In a BusinessWeek op-ed, Bar-Gill and Davis propose the creation of third-party boards to police consumer contracts with credit card companies

In a May 5 op-ed in BusinessWeek, Professor Oren Bar-Gill and Kevin Davis, Beller Family Professor of Business Law, propose a solution to the common credit-card issuer practice of luring customers with attractive terms only to change those terms a few months or even weeks later. On April 30, the House passed legislation partially addressing the issue, and the Senate is gearing up for action on parallel legislation, but Bar-Gill and Davis argue that the proposed reforms would not eliminate the ability of card issuers to unilaterally change the terms of card contracts.

“The bills presume that Congress can identify bad changes and ban them once and for all,” the authors write. “But there is reason to doubt Congress’ ability to effectively distinguish good changes from bad ones, especially since the fairness and efficiency of rates, fees, and other contractual terms can change with economic circumstances.”

The authors propose a system that would require changes to contracts to be approved and certified by a third party called a Change Approval Board (CAB). The issuer and cardholder would add the CAB to their contract, but the CAB would have to approve any changes the issuer proposes to make. Since contracts can only be modified with the consent of all parties, the CAB could prevent any unjustified term change by withholding consent.

“The CAB would provide fair-minded issuers a means of ensuring customers that only mutually beneficial term changes will be made,” the authors write. “It would allow issuers to offer credit-card contracts that retain the benefits of flexibility while substantially reducing the costs of unfettered discretion.”

Bar-Gill and Davis envision that the CAB could be a government-sponsored body appointed by the Federal Reserve Board, the Federal Trade Commission, or the proposed Financial Products Safety Commission. They also see private CABs, each applying different certification standards based on particular circumstances.

“Risk-averse cardholders who care deeply about their peace of mind would choose a contract with a higher initial interest rate and a CAB that imposes stricter conditions on changes,” they write. “Cardholders who prefer a lower interest rate but are willing to accept the risk of rate hikes if they miss a payment, or if their credit rating falls, would choose a more lenient CAB. In short, market forces can play a significant role in shaping the system.”

The authors point out that no new legislation would be required, at least for private CABs, and that ideally the market would create the system on its own.

“The CAB system promises to deter abusive term changes while retaining the flexibility to change credit-card contracts when change is justified,” they write. “We encourage Congress and regulators to consider this solution as they move to address credit-card rage.”

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