The Fake Hope of Financial Literacy in Solving the Debt Problem

On May 16, 2013, SCEPA Director Teresa Ghilarducci joined a panel discussion hosted by the Economic Policy Institute (EPI) on Robert Kuttner's new book, Debtor’s Prison: The Politics of Austerity Versus Possibility. Below are her comments on the structural shift of risk: 

"The last 20 years has seen significant growth and change in the character of interactions between working and middle-class households and financial institutions and markets.1

With this financial development and households' increased exposure to financial risk, academic economists and others have embarked on a new inquiry, a body of study some call the "culture of finance." This is the name of an NYU seminar taught this summer featuring business faculty, anthropologists, and investment bank economists. Other scholars call this line of inquiry the "financialization of households," and even others embed it in literature as the "culture or varieties of capitalism" (see among others David Soskice and Peter Hall).2

Generally, the project seeks to understand how and why individuals and households are taking on more and more economic risk. These risks were once managed by government and employers, and sometimes social insurance arrangements or employee benefits, such as pension plans, unemployment insurance, and default risk by banks. These institutions have been replaced by financial institutions and products, and are key to the story of how corporations and banks have shifted the risk of financial loss to households.

Congressional leadership and the executive branch under both Democratic and Republican presidents have provided the leadership supporting this ideological framework and the real institutional changes that have allowed this to happen.

The financialization of American life is documented in Robert Kuttner's new book, Debtor’s Prison. The consequences are horribly described.

Households and working and middle-income families are no longer just the site of consumer demand, supply of labor, or civic engagement - they have become major sources of financial products. And worse. The site of debt.

As corporations accumulated vast hordes of cash - an estimated trillion dollars – and federal, state, and local governments slowed spending and balanced budgets, the household became the locus of macro economic stimulus. This has dramatically changed economic policy making. It has turned everything upside down.

For most of the last hundred years, corporations have been the debtors and household the savers. Corporations were rewarded with legal protections and tax favoritism for bearing this burden. The new financial position has made households take on risks, and the public policy response that follows is to arm households with basic financial literacy.

Financial literacy is like having a BB gun in a firefight with bazookas and stealth bombers. In many situations, it may do more harm than good.3 Thinking you're well-armed may make you overconfident and get into fights you would be better to avoid.

Research shows those households that think they are financially literate4 dive into financial markets and training with high fee brokers and end up buying high and selling low.

Let me be clear. The expansion of households' demand for more financial products has several sources. Accumulation is clearly driven by aspirational consumption and an understandable human drive that isn't able to bypass easy credit. Many scholars ascribe increasing indebtedness to 30 years of wage stagnation, unstable labor market experience, and changing domestic partnerships between men and women and parents.

But the primary source of indebtedness – and this is the major political point - is that financial institutions are using households in very different ways. As Damon Silvers said on this panel, corporations and financial institutions have successfully sheltered themselves from taking risk while they enjoy the returns of high risk assets.

As many of you know, my work describes the change in employee benefits, especially retirement accounts. In just 15 years, a Social Security-like institution, the defined benefit plan, has been replaced by defined contribution plans. This switch has enabled an increase in predatory practices by mutual funds, investment advisors, and retail brokers.

In 2010, President Obama announced financial literacy month by describing his administration's view of the problem, "A recent economic crisis was the result of both the irresponsible action on Wall Street and everyday choices on Main St." Why doesn't government have a critical role to play in protecting consumers and promoting financial literacy? We are each responsible for understanding basic concepts: how to balance a checkbook, save for a child's education, steer clear of deceptive financial products, plan for retirement, and avoid accumulating excessive debt.”5

In this quote, President Obama gives equal weight to the role of the financial institutions and households in the financial crises. This is not credible, and Kuttner walks you through the reasons.

The policy implications of believing that households are the location of debt and crises means that we can expect financial regulation will take the form of transparency - more information, rather than the replacement of privatized financial institutions with more appropriate social insurance programs.

Behavioral economists, such as Professor Robert Schiller at Yale and Richard Thaler at the University of Chicago and a regular contributor to The New York Times, advance an agenda that promises solutions to big social problems with very little money. The hope is that small strategic changes in the design of private financial products will elicit proper behavior from households. This approach to solving widespread social problems of financial insecurity is called libertarian paternalism. The idea is that designs such as automatic enrollment in individual retirement accounts or 401(k)s will "nudge" individuals to accumulate enough assets. If they are defaulted into proper financial vehicles, inertia will have households save and invest enough for secure retirement.

Robert Kuttner's book describes how the financialization of America blames individuals for the housing crash. It blames impoverishment in retirement funds on individual's decisions to save and not work. It blames financial insecurity on the lack of financial literacy.

We need a reality-based program to secure household economic life and grow the economy. In addition to the bright ideas outlined in Robert Kuttner's book, here are some items on that should be included on the agenda:

1. Expand old programs such as Social Security to provide dynamic and flexible programs that can meet the needs changing households in the economy

2. Improve the Affordable Care Act

3. Provide not-for-profit and professional managers to help all individuals save for retirement (the initiatives by California and other states to allow citizens to save money in alternatives to 401(k) plans is an important achievement)

Understanding good and bad debt is the beginning, and Kuttner’s book is the starting block."

Footnotes:
1. I have been influenced by Mike Rafferty and coauthor’s new paper. “Shoplifters of the world unite! Law and culture in financialized times” Mike Beggs, Dick Bryan and Michael Rafferty Department of Political Economy and School of Business, University of Sydney.

2. Peter A. Hall, David Soskice (eds.): Varieties of Capitalism. The Institutional Foundations of Comparative Advantage. Oxford: Oxford University Press, 2001.

3. A review of the literature that suggest that there is no evidence confirming that financial education improves financial literacy and that financial literacy leads to good decisions Willis, L., 2010. Evidence and ideology in assessing the effectiveness of financial literacy education. San Diego Law Review, 46: 415-58.

4. Financial education at a workplace telling workers about their empoyer match had little effect: Choi J, Laibson D, Madrian BC. 2011. $100 bills on the sidewalk: suboptimal investment in 401(k) plans. Rev. Econ. Stat. 93(3): 748-763; Hastings, Justine S., Brigitte C. Madrian, William L. Skimmyhorn. 2012. Financial Literacy, Financial Education and Economic Outcomes. NBER Working Paper No. 18412. September.

And if financial education and financial literacy leads to overconfidence then returns are significantly lower: Brad M. Barber and Terrance Odean Boys will be Boys: Gender, Overconfidence, and Common Stock Investment The Quarterly Journal of Economics (2001) 116(1):261-292, http://faculty.haas.berkeley.edu/odean/papers/gender/BoysWillBeBoys.pdf

5. In Beggs, Dick Bryan and Michael Rafferty quoted above.

 

Submit to FacebookSubmit to Twitter