One of the central reasons liberals have been pressing for aggressive regulation of consumer financial products is that they are rightly concerned about the state of financial literacy among Americans. John Carney wrote a terrific backgrounder on financial literacy for Clusterstock last month, and his basic argument is that investments in improving financial literacy haven’t been terribly successful.
Lisa Fairfax at the Conglomerate blog dug up a 2008 studythat shows that our efforts to invest in financial literacy have a grim rate of return. Eleven years ago the Jump$tart program began measuring financial literacy and discovered the average financial literacy score for high school students was 57.3%, which is frighteningly low. After a decade of effort to improve financial literacy, including hundreds of efforts at the state and federal level, the average score declined to 48.3%.Jump$start notes that high school students who take financial literacy courses do not fare any better than those who don’t.
Low levels of financial literacy are rooted in low levels of literacy and numeracy. Rather than focus on financial literacy per se, Carney suggests that we should instead emphasize broader and perhaps easier-to-implement policies aimed at creating wealth. This will, in a virtuous circle, contribute to higher levels of literacy and numeracy.
Another approach is to allow private actors to facilitate the emergence of new and innovative financial products that are simpler and more transparent. Felix Salmon has blogged about a very promising development. Yodlee.com, a company that handles online transactions for most major banks, is creating a platform for developers to create new services designed to help consumers manage their money.
[Anil Arora, CEO of Yodlee] talked about the rate of uptake of personal computers from the mid-1980s to the mid-1990s: although the technology improved enormously over that time, the rate of growth of the user base never really took off. And then the internet arrived, and suddenly PC penetration skyrocketed. Maybe the advent of easy and transparent collaborative tools will be the precipitating factor which finally brings US banking out of the era of checks-in-the-mail and into the 21st Century — especially if the stick of improved customer satisfaction is combined with the carrot of a Consumer Financial Protection Agency cracking down on fee income. In fact, the CFPA might even build its own widgets designed to set off a red flag whenever a bank tried to offer a non-compliant product. Yodlee has all that information right now; it’s just that no one’s really using it. With the release of a set of APIs in January, all that will change. Almost certainly for the better.
I really like Arora’s point regarding the uptake of personal computers, and historian Robert Wiebe made a similar point on the rise of literacy levels in the United States during the first half of the nineteenth century: without an extensive network of well-funded schools, vast numbers of Americans became literate as universal white manhood suffrage and a changing economy gave people an incentive to become literate. This is turn led to an explosion of business-model innovation, as well as art and culture. And it all happened “spontaneously.”
The danger of a top-down approach to “consumer financial product safety” is, as Carney writes, that it will work to the advantage of politically-connected insiders rather than consumers.
The behavioral economics types want the government to craft rules that would nudge the illiterate to make smart choices. Unfortunately, this program is hobbled by the reality of government operations. Instead of nudging the illiterate toward wise financial decisions, any paternalistic program will likely nudge people toward decisions that benefit influential special interest groups.
Incredibly, many liberals believe that we can avoid this problem by putting Elizabeth Warren, clearly a smart and well-intentioned person, in charge. If you believe that, I have a bridge I’d like to sell you.