Transparency, Ethics and the Reasonable Man

The previous post on credit card issuer default rates deliberately avoids the question of ethics in lending.  I’ll mostly evade that again here, except for one point:  it would seem patently unethical to earn de facto interest in ways that are not readily understandable to the borrower.

By that standard, it would not necessarily be unethical to loan someone $100 revolving at 40% interest.  I give you $100 today, and you give me $140 next year, or pay $40 next year and roll it over to the following year, etc.  Ridiculously expensive, but explained up front, and readily understandable to the borrower.

But what if I instead lend you $100 at 5% interest, and buried in a long, complicated list of loan terms, in tiny print, is a fee of $30 for late payment, plus a 30% “default rate” that applies retroactively to the beginning of the loan in the event of late payment?  What if I then send no reminders?  Suddenly the effective rate is 60% for anyone who pays the first year’s interest just one day late.

A deal’s a deal.  Yes, it is.  But there is also a “reasonable man” provision in contract law, one I think has not received adequate attention in recent years.  It may be reasonable to expect someone to understand the consequences of 40% interest, but unreasonable to expect someone to understand and remember the dozens of complex features of the dozens of financial products in his life.  

We may have reached, or long passed, the point at which the complexity of personal finance exceeds the capacity of the reasonable man, who then by law cannot be considered negligent if he fails to understand something.  

Watch for something like this in coming years.  Nostradoofus has spoken.

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