Against Financial-Literacy Education

AuthorLauren E. Willis
PositionAssociate Professor, Loyola Law School, Los Angeles

Associate Professor, Loyola Law School, Los Angeles. Helpful comments and suggestions from Anita Allen, Jennifer Arlen, Regina Austin, Oren Bar-Gill, Jean Braucher, Dorothy Brown, Erik Gerding, Alexandra Natapoff, Chris Sanchirico, Reed Shuldiner, and participants at talks given at the NYU Law School Law and Economics Colloquium, the University of Pennsylvania Law School Faculty Workshop series, the 2008 Annual Meeting of the Association of American Law Schools, the 2008 Federal Reserve Bank of Cleveland Policy Summit, the 2007 Jurisgenesis Conference at Washington University in St. Louis, the 11th International Conference on Consumer Law in Cape Town, South Africa, and the 7th International Conference on Financial Services in Brussels, Belgium, are gratefully acknowledged. Much thanks also to Stacy Wiesbrock, John Ohanesian, Leigh Ferrin, and Laura Cadra for research assistance.

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I Introduction

Whereas quality personal financial education is essential to ensure that individuals are prepared to manage money, credit, and debt, and to become responsible workers, heads of households, investors, entrepreneurs, business leaders, and citizens;

Whereas increased financial literacy empowers individuals to make wise financial decisions and reduces the confusion caused by the increasingly complex economy of the United States;

Whereas a greater understanding of, and familiarity with, financial markets and institutions will lead to increased economic activity and growth;

. . . Now, therefore, be it Resolved, That the Senate . . . designates April 2007 as 'Financial Literacy Month' to raise public awareness about-

(A) the importance of financial education in the United States; and

(B) the serious consequences that may result from a lack of understanding about personal finances . . . .

- United States Senate, March 20071

Financial literacy provides the foundation to build wealth and fully participate in the economy . . . . By understanding basic financial principles and putting them to use, you can be on the road to improving the lives of your household and your community.

- NAACP Financial Empowerment Guide2

[T]here needs to be financial education measures in place.

- President George W. Bush, regarding home-mortgage foreclosure rates, August 20073

Although the cry for financial-literacy education has been audible for decades, the volume has recently increased.4 Why? Technological advances Page 200 allowing industry to create and profit from more complex and riskier financial products offered to a broader array of people, in conjunction with political dominance of an ideology favoring deregulation, have dramatically altered this marketplace. The consumer-finance revolution has given Americans more apparent choices and formal control over their financial decisions. But with that choice and control comes added responsibility to make financial decisions well or to face potentially disastrous health and welfare results.

Households today must make more of their own decisions in every personal-finance arena, from credit to insurance to retirement planning. Although defined-benefit pension plans once covered many workers, most retirement plans today, if offered at all, are defined-contribution plans, requiring individuals to decide how much to save and how to invest.5 Similarly, employer-sponsored health insurance has declined, leaving more Americans to find their own policies.6 As for credit, lenders once required consumers to show evidence of sufficient income to afford their mortgages, given their other financial obligations. over the past few years, lenders have offered loans requiring little or no documentation, meaning that borrowers must determine for themselves what payments they can afford, or risk losing their homes.7

Largely unfettered consumer choice paired with seller disclosure has been the dominant model of credit, insurance, and investment-product Page 201 regulation for decades in the United States. As the products have become more complex and the consequences of consumers' inability to understand them more dire, financial-literacy education has become a necessary corollary to the disclosure model. This education is widely believed to turn consumers into active market players, motivated and competent to handle their own credit, insurance, savings, and investment matters. Financial-literacy education is that rare public policy that entices across the political spectrum. Liberals envision an empowered consumer, confidently navigating the marketplace. conservatives divine a responsible consumer, who understands her decisions and therefore can be held accountable for them. Free-marketers see flourishing innovation and abundant choices.

The vision of financial regulation through education depends on the belief that personal-finance literacy programs not only can improve decisions, but can do so to the degree necessary for individuals to protect and even increase their welfare in the modern financial marketplace.8 But what evidence supports this belief? Given what is known about the marketplace and human decisionmaking, how plausible is the belief? What are the costs of financial-literacy education and are these costs commensurate with the benefits it reasonably can be expected to provide? Is there any alternative but to pursue financial literacy?

My prior work has demonstrated that the belief in the effectiveness of financial-literacy education lacks empirical support.9 This Article argues that the belief is implausible. The gulf between the literacy levels of most Americans and that required to assess the plethora of credit, insurance, and investment products sold today-and new products as they are invented tomorrow-realistically will not be bridged. Educators would need to impart a sophisticated understanding of finance because rules of thumb are not useful for decisions about complex products in a volatile market. Further, financial literacy is not sufficient for good financial decisionmaking; heuristics, biases, and emotional-coping mechanisms that at times interfere with welfare-enhancing personal-finance behaviors are unlikely to be eradicated through education, particularly in a dynamic market. To the contrary, the advantage in resources with which to reach consumers that financial-services sellers enjoy puts firms in a better position to capitalize on Page 202 decisionmaking biases than educators who seek to train consumers out of them. The confluence of these factors renders financial-literacy instruction dramatically more difficult than education in other life-skills domains, such as language literacy, sex education, or anti-smoking campaigns.10

Harboring a belief in the efficacy of financial-literacy education may be innocent, but it is not harmless; the pursuit of financial literacy poses costs that almost certainly swamp any benefits. First, requiring all individuals to act as their own financial experts is inefficient. People are financially illiterate not because they are stupid, but because they have better things to do with their time. The hours of study they would need to invest to attempt to reach literacy are unlikely to generate positive returns. The waste of time and money alone is reason enough not to pursue financial-literacy education. But there appear to be other costs as well. For some, personal-finance classes increase confidence without improving ability, potentially leading to worse decisions. When individuals find themselves in dismal financial straits, the regulation-through-education model blames them for their plight, shaming them and deflecting calls for effective market regulation. Opportunity costs should not be overlooked; a single-minded focus on education inhibits the development of other policy tools for improving the financial welfare of Americans.

This Article proceeds as follows: Part II summarizes my prior work finding no reliable empirical evidence that financial-literacy programs are effective. Part Ill explains why it is implausible that this education could teach consumers how to make welfare-enhancing decisions about credit, insurance, and investments. Part IV exposes some of the costs of pursuing financial regulation through personal-finance education. Part V concludes.

II Does Financial-Literacy Education Work?
A What Is Financial-Literacy Education?

Financial-literacy education is education about financial concepts undertaken with the explicit purpose of increasing knowledge and the skills, confidence, and motivation to use it. Although higher education is correlated strongly with increased financial literacy,11 the regulation-through-education model does not aspire to universal college education. Instead, financial-literacy education is conducted through...

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