1. Today: Analyzing “contract regulation” But, first, some organizational reminders

2. Organizational issues
Any doubts on team composition:
First seminar: Present briefly & discuss a more specific plan on how you will develop the project
Do not forget:
For whom? Try to define your “client”
Which concepts and theories will you apply?
Even: What are the hypotheses? Which methods to test them?
Class attendance
No need to justify two absences
Weight in final grade: relevant but not mortal
More important: good participation
Good: inspired by theory, readings vs. Bad: out of the hat improvisation
Good: critical analysis of project presentations vs. Bad: formalistic o laudatory comment of project presentations
Compare private / public ordering in completion and enforcement 2

3. Analyzing “contract regulation”

4. Basics on contracts (1) The problem of potential traders
Defining the exchange:
When? Ex ante, ex post (relational contract)
How? By contract, law (default vs. mandatory rules; retroactive)
By whom? Parties, third party, one party (standard-form contracts)
Enforcing the agreement:
How? = By whom? Third party (judge), one or two of the parties (future trade), other market participants (reputation)
What’re the parties’ possible objectives?
Efficiency = maximizing gains from trade (surplus, “the pie”)
Redistribution = Exploiting the counterparty (appropriating it)
… always? Or do their goals change over time?
Ex ante, priority on efficiency; ex post, on exploitation if final
Compare private / public ordering in completion and enforcement 4

5. Basics on contracts (2): The dual role of contract clauses
More than merely defining the content of exchange,
introducing incentives ( surplus)
dividing the surplus
Example: “clauses” in a simple incentives model:
Wage = α + β * Performance
β motivates surplus
α redistributes surplus

6. The case of “standard-form contracts”
Costs & benefits of having one of the parties writing the contract: partiality vs. savings & knowledge
Role of competition
Why is “salience” important? Is it constant over time?
Does it improve with regulation? At what cost?
Will a monopolist draft inefficient clauses?
Not if he can extract rents otherwise (α)
Yes if need to increase its control over pricing:
imagine that buyers willing to pay a higher price prefer strong warranty  monopolist may offer 2 contracts with high (low) price and strong (weak) warranty (a “tie in”)
What about uniform clauses in an industry?
Is it driven by collusion?
Or by price competition in selling the optimal product?

7. Are judges a solution, a problem or both?
When “ex ante”, parties want for judges to decide efficiently ex post (Counterfactual hypothesis)
But when ex post, each party wants for the judge to decide… in her favor
Judges’ difficulties  solutions?
Self interest: corruption, applause, morality?
Cognitive: e.g., hindsight bias
Example: mortgage interest rate “floors”: Now it looks “obvious” that interest rates were going to be low
Judicial “populism” after the recession?
Efficiency vs. distribution. Judicial populism 7

8. Analyzing contract “regulation” (by judges or the law)
Consider the rationale for default and mandatory rules:
Default rules: reducing transaction costs
Mandatory: avoiding externalities, rationality
Key: Must identify effects on two types of contracts b/c enforcement causes
Distribution in existing contracts  Justice?
(In)efficiency in future contracts  Justice?

9. The case of mortgage clauses
Information asymmetry 
Mandatory intervention of a notary (even Shiller…)
Lenders should offer variable-rate insurance
Rates dropped  Clauses litigated, not enforced:
Interest rate “floors” and “swaps” etc.
Supreme Court says “notary intervention merely formal. Ergo, irrelevant. Transparent?”
Courts do not enforce swaps
Lessons on regulation? On judges?

10. Who could imagine this? Euribor at 3mos.

11. Does hindsight bias lead judges to see balanced transactions as unbalanced? Or do they use popular bias as an excuse to act “morally”, punish selfish bankers, etc.?
Ex ante, probabilities = 0.5
(6, 0)
Fair deal: (3, 3)
(0, 6) but ex post, with hindsight, probability > 0.5, e.g. 5/6  Unfair deal: (1, 5)

12. Arruñada & Casari Credit enforcement experiment
Socially optimal to lend b/c it produces a surplus of 24 = (34-10)
Lender makes a profit (lends 10, gets back 17)
The surplus goes mostly to the borrower (gets 17 instead of 0)
Including minimum earnings, lenders are rich, borrowers are poor:
With loan & return With loan & default Without loan 12

13. Arruñada & Casari—Main result 1: Surplus in the economy
GDP

14. Humans withdraw cooperation for good—our backward looking robots do not
Human lenders (loans in blue, comply opinions in white squares):
Robot lenders:

15. Conclusions
Very different results despite judges’ incentives being “correct” in all treatments
“Paradox of the borrowers:” When borrowers hold rights, they reduce market efficiency
When lenders hold rights, borrowers end up better off
Lesson: allocation of rights relevant even if incentives are “correct.” Why?
Our explanation: people in some roles are better placed to decide & enable market exchange 15

16. Evolution of residential mortgage market, Spain
2007
2015
% house sales paid with cash
50,32%
58,33%
% of mortgages not linked to purchases
68,43%
39,90%
% purchases with seller being legal person
27,69%
31,61%
% purchases with mortgage & seller being legal person
20,76%
32,77%

18. A case for project 7 and others: reputational blackmail—Ausbanc
Are consumer organizations “angels”?
Dangers of a Manicheam view of economic agents
Role of institutions—in particular, judges
A case of judicial failure?
A media failure?