Fuzzy Math, Disclosure Regulation and Credit Market Outcomes: Evidence from Truth in Lending Reform

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Abstract
Consumer installment lenders prefer to market “low monthly payments” and shroud interest rates. Why not voluntarily disclose rates? We show that when an interest rate is not disclosed, most consumers substantially underestimate it using information on the monthly payment, loan principal and maturity. This “fuzzy math” or “payment/interest bias” helps explain why lenders shroud rates and thereby violate the Truth-in-Lending Act (TILA) even under the threat of fines and litigation. So does TILA have any teeth? We identify within-household interactions between policy-induced variation in the strength of TILA enforcement across lenders and time, payment/interest bias, and interest rates on actual loans. More biased households pay roughly 400 basis points more than less-biased households, but only on loans from lenders facing relatively weak TILA enforcement. The results link a cognitive bias to firm strategy and market outcomes, show that mandated disclosure can attenuate those links, and highlight the importance of enforcement costs.