It’s so hard to agree on how to police our credit market place that policymakers (and sometimes advocates) often give up on regulation and call instead for more financial literacy and counseling. It’s not surprising that so many financial literacy courses are funded by creditors. It’s easier to put the burden on consumers to “get educated” and then blame the consumers if they end up in financial distress.
Although most of us agree that education and counseling can be useful, there are costs to promoting financial literacy as a substitute for regulating the market. Professor Lauren Willis points out a number of these costs in a 2008 article.
There is a shocking lack of evidence that financial literacy is effective. As Professor Willis details in her article, a number of studies show that financial management programs have no effect on literacy or behavior. This doesn’t necessarily mean that the courses cannot have an impact on decision making, but the jury is still out. This is hardly a strong foundation for the millions of dollars that are poured into financial education and the faith that this will somehow improve consumer financial decision making.
There is general consensus that long-term, individually tailored programs delivered in small settings are the most likely to be effective. The problem is that these courses are too expensive to provide on a large scale. Further, this type of counseling might be more effective because the providers not only teach, but often intervene on behalf of consumers.
It is very difficult to close the gap between the current financial literacy levels of the average American and the increasingly complicated credit marketplace. Even good courses get outdated fast. There never was a glorious time in the past when we had a more financially literate population, but there was a time when the market was not so complicated.
Most of us do not understand basic credit math, let alone adjustable rate mortgages and credit derivatives. In her fascinating book on J.P. Morgan and its role in creating derivatives, Gillian Tett quotes one of the original creators of these products, Blythe Masters that “Financial engineering was taken to a level of complexity which was unsustainable.” Many on Wall Street can’t even understand the products they push on consumers!
Those who believe in financial literacy have a challenge in delivering a clear message to consumers. The public education campaigns that work best usually have a straightforward message, such as “Don’t smoke” or “Don’t drink and drive.” The message is more nuanced when it comes to finances. Some financial literacy instructors believe that consumers should not go into debt at all. Others say use credit in moderation and only if you understand it. NCLC tracked some of these biases in a 2007 report on the bankruptcy education mandate. The director of one course, for example, told participants that “debt is dumb.” Another told victims of predatory lending that they had no one to blame but themselves.
Perhaps most important, even good financial education rarely affects consumer biases such as over-confidence and optimism about the future. Even when armed with information and education, most consumers are able to consider no more than five features of a particular credit product. This helps explain why so few consumers consider more “obscure” terms such as arbitration clauses or default fees. Creditors design their products and advertising to exploit these biases. Researchers such as Professor Alan White write about how predatory lenders frame their products in ways that obscure risks and overstate benefits.
Low-income consumers do not collectively make worse decisions nor have more biases. The difference is that that the consequences of “bad decisions” are so much worse for the lowest-income and most vulnerable consumers. For student loan borrowers, for example, the erosion of the safety net means that there is less cushion to soften the fall.
