There is a growing disconnect between the complexity of modern finance and the pace at which Americans adapt to it. This disconnect makes Americans ever more vulnerable to mistake and fraud. Disclosures alone will not resolve the problem, and we cannot expect financial institutions to make up for the fundamental gap of knowledge in many otherwise educated Americans when it comes to even basic financial concepts.
There's a great deal at stake. Americans will need more than a rudimentary understanding of financial concepts if they are to cope with the generational shift from defined benefit to defined contribution retirement plans. A working knowledge and understanding of financial concepts is even more critical given the dubious prospects of traditional government-sponsored safety nets, which are becoming less secure every day as the government falls deeper into debt. Most Americans likely will be on their own in the pursuit of a comfortable retirement, and it is far from clear that they have the financial knowledge to avoid the potholes.
Quite the contrary. In a recent survey 55% of working adults said they did not know how much they need to save in order to retire. That jumps to 74% for people in the 18-to-24 age bracket — a startling number even when you factor in the frivolity of youth. The results were released earlier this month. They reflect the importance of President Obama's designation of April as National Financial Literacy Month, but also show how very far we have to progress to make this more than just a Hallmark greeting card moment.
The current debate on financial regulation too often fails to appreciate the tenuous grasp that most Americans have on what market professionals consider to be basic financial products. And yet, a successful market-driven, free society depends upon citizens who have a solid foundation of financial knowledge.
It is not realistic to expect broad comprehension of the triparty repo market, the VIX or synthetic collateralized debt obligations, but with a homeownership rate of 67%, the country's financial stability is correlated with the number of its citizens who understand the basics of their mortgage, including the differences between a fixed-rate and adjustable-rate mortgage. As the mix of other financial products only grows more complex, how will ordinary citizens make informed judgments about insurance, bank and securities products?
A 2010 working paper by the Federal Reserve Bank of Atlanta examined the link between financial literacy and subprime mortgage delinquency and concluded that foreclosure starts were two-thirds lower for individuals with the greatest numerical ability, which was one of the researchers' two measures of financial literacy. The sample population for this paper consisted of subprime borrowers who had obtained mortgages in 2006 and 2007.
As the country confronts issues of economics, climate, energy, national security, general education and infrastructure it will be all too easy to neglect financial literacy. And there is much that we can do, both for consumers and policymakers in charge of regulating financial markets. Some suggestions:
- Make a renewed commitment to incorporating basic financial concepts into traditional educational curricula. The coursework must begin in elementary and middle schools to achieve maximum efficacy. Regional Fed banks are to be commended for providing a wealth of classroom material on financial literacy, such as the Federal Reserve Bank of Dallas's interactive Building Wealth program. But much more needs to be done.
- Help the scores of financial literacy nonprofit organizations find common goals, standardized programs and a single, more compelling voice. The important grassroots work of organizations including the Coalition for Debtor Education, the National Academy Foundation and the National Endowment for Financial Education can be amplified by working hand in hand with government-sponsored programs, including the Federal Deposit Insurance Corp.'s MoneySmart and the Treasury Department's Financial Literacy and Education Committee.
- Ensure that the Consumer Financial Protection Bureau achieves its goal of improving financial literacy, particularly for low- and moderate-income Americans. Congress must also give the CFPB the resources that it needs to carry out this mission successfully. Indeed, I believe that the CFPB could achieve much of its mandate and dial down concerns about regulatory overload if it focused serious attention on consumer education.
- Ratchet up initiatives by financial institutions and their trade groups. Banks in particular have an opportunity to simultaneously do good and advance their long-term interest by educating potential customers. Much is done now in this area by several of the trade groups and banks. Integrating the hard lessons of the past several years into their financial education programs should be a priority.
If we are to have free markets that can innovate in a space as complex as finance, financial education is not a luxury, but a core competency for navigating a vigorous financial system without becoming confused, deceived or prone to unsustainable choices. Fostering financial literacy matters immensely to banks, because the alternative — a more and more paternalistic regulatory regime — threatens to stifle financial markets, to the even greater detriment of all participants.
