INTRODUCTION

Consumer contracts are characterized by an asymmetry between the two parties: the seller of a good or the provider of a service on the one hand and the consumer on the other. One party is usually a highly sophisticated corporation, the other-an individual, prone to the behavioral flaws that make us human. Absent legal intervention, the sophisticated seller will often exploit the consumer's behavioral biases. The contract itself, commonly designed by the seller, will be shaped around consumers' systematic deviations from perfect rationality. Such biased contracting is not the consequence of imperfect competition. On the contrary, competitive forces compel sellers to take advantage of consumers' weaknesses.

This broad theme is developed within a detailed case study of the credit card market and the credit card contract. Credit cards present a significant socio-economic phenomenon. In 2000, consumers used 1.44 billion credit cards, i.e., almost fourteen cards per household, to purchase an estimated $1463 billion of goods and services. The average household completed $14,000 of credit card transactions, about 33% of the median household income.1  Not only are credit cards important, they are also dangerous. Credit card debt, which amounted to $683 billion in 2000, is a notoriously prominent component of overall consumer debt and a leading culprit in consumer bankruptcy cases.2

Congress has repeatedly debated different policy responses to the credit card problem.3 Recent legislation targets surprise jumps in credit card interest rates.4   Credit cards also figure prominently in the pending bankruptcy reform legislation.5   The Supreme Court is similarly concerned about the credit card market, having recently reviewed the definition of finance charges under the Truth-in-Lending Act.6   Last, but not least, the academic literature has engaged the credit card debate, examining the need for legal intervention in the credit card market and proposing different policy solutions to the credit card problem.

This Article seeks to reframe the credit card debate and, using insights from behavioral law and economics, to offer a fresh perspective on the causes and potential cures of the credit card problem.  As a first step, the Article offers a broader perspective on the credit card contract, extending beyond the interest rate dimension. Several unique features of the credit card contract, such as low introductory rates that appear alongside high long-term interest rates, zero annual and per-transaction fees, large penalties for late payment and for deviations from the credit limit, and low (and even negative) amortization rates, must all be considered. In particular, a theory of credit card pricing must explain why (non-introductory) interest rates, as well as late and over-limit fees, are set well above marginal cost, while annual and per-transaction fees are set below marginal cost (and, accounting for the benefits programs associated with most credit cards, might even amount to setting a negative price).

The behavioral theory developed in this Article explains the staggering levels of credit card borrowing and sheds light on the unique design of the credit card contract. At the foundation of the proposed theory is a combination of behavioral biases that results in the underestimation of future borrowing.

The first underlying bias involves imperfect self-control, or an underappreciated weakness of the will. Perhaps the first story of imperfect self-control is that of Ulysses and the Sirens.7  Ulysses ordered his crew to tie him to the mast of the ship, knowing that while he wished to avoid the danger of the Sirens, the sound of their enchanting Song would cause him to disregard all danger and steer ship and crew towards certain doom. But not everyone has Ulysses's foresight. While on the treadmill, the dieter may promise himself that he will forsake dessert when he dines out that evening. …