Americans are Innumerate and Broke

And not just the ones I tell stories about from my clinical law teaching.  Some of our readers have written in to say that these clients of ours, these title loan and payday loan customers, are idiots or worse yet, should be institutionalized for their stupidity. Most of my stories about our clients have to do with not being able to do complex math.

Now we learn that most consumers think that 36 months is longer than three years.  And these are “regular” Americans, not those dullards who use sub-prime credit.  A study in the Journal of Consumer Research proved that as a result of something called the “unit effect,” no doubt a behavioral bias similar to framing, “people typically fail to realize that the unit of quantitative information is arbitrary.”

As one cool math blog reports, this “unit effect” leads to anomalous conclusions: to most consumers, the difference between an 84-month warranty and a 108-month warranty looks bigger than the difference between a 7-year and a 9-year warranty. A 95 out of 100 rating looks better than 9.5 out of 10. Is it any wonder at all that interest rates stated by the month or bi-monthly make it hard to calculate the cost of credit?

Are There Things You Can Do Now to Make for a Better Retirement Later?

An  article in this morning’s Wall Street Journal money insert, Ready to Retire? Here is a Five Year Retirement Plan, made me high-tail it to the gym. Thinking about retirement is both scary and fun, and we'va all seen plenty of mistakes made on the way to retirement. Sure, people have failed to save enough, but most of the mistakes I am talking about have nothing to do with money. People just don’t think through how they’ll spend their time in retirement and then they age overnight when they find they have nothing meaningful with which to define themselves, and even nothing to think about when they get up in the morning. This article gives readers hands-on how-to steps for planning retirement, with one part about the money and one part about the rest, for each of the five years prior to retirement.

New Consumer Regulation: Education and Disclosure Is Not Enough

Elizabeth Warren’s appointment as special advisor to the president was widely hailed as an achievement for consumer advocates. Professor Warren has long been a strong advocate of the middle class and famously compared financial products to flaming toasters.

The creation of a new agency brings new possibilities and new risks for consumer advocates. Most importantly will be the agency’s approach to regulation. In a two-part posting, I will comment on two key aspects of the new agency’s direction. The first revolves around understanding of consumer behavior and the second around firm behavior.

Part 1:

A core component of the CFPB mission is based around the idea that banks provided risky products to consumers that didn’t understand them. There is abundant evidence that consumers didn’t understand the products they bought; however, it’s far from clear that this is a sufficient role for the CFPB. I’ll argue here that in addition to disclosures, education and information, we need explicit regulation of the products as well.

Effectively, this boils down to a simple question: if banks want to offer a risky product (a flaming toaster) to consumers that fully understand its dangers, should the bank be permitted to offer it?

On the Road Again

I'm off to the 2010 William J. O'Neill Great Lakes Regional Bankruptcy Institute in Cleveland. Tomorrow, attendees have the privilege sad duty of holding down their lunches while hearing me speak about bankruptcy filers. The whole conference is supposed to be a great event, and I'm looking forward to it. I'm sorry that I haven't posted on it further in advance. If I have a few moments, I'll post on any interesting developments that come out of the conference.

HAMP--Is It Really All About the Money?

Are mortgage servicers really refusing to modify mortgage loans solely because of all of the "ancillary fees" they can generate from a completed foreclosure? Is the problem really all about the money or is there something more to it?

The New York Times reported about ten days ago that the HAMP mortgage servicers were reluctant to engage consumers in modifications because the companies collect such lucrative fees on delinquent mortgage loans. There is certainly a substantial body of evidence to support the "lucrative fees" disincentive theories. For example, the Federal Reserve Bank of Boston recently shed some light on this problem with a new study that concluded that only 3% of the seriously delinquent mortgages had been modified due to the "the simple fact that the lenders expect to recover more from a foreclosure that from a modified loan." And, the number of reported bankruptcy cases where mortgage servicers have been sanctioned for imposing unlawful, illegal and unreasonable "collateral and ancillary fees" is substantial and perhaps monumental in their numbers.

Does Anybody Know If Credit or Foreclosure Counseling Helps?

The infusion of millions of dollars to pay "counselors" to forestall foreclosures on behalf of consumers who are delinquent on their mortgage payments seems as American as apple pie and should perhaps help some homeowners. These dollars are split among neighborhood non profits, specialized housing counseling organizations and a considerable amount has flowed to providers that have historically spent most of their time counseling consumers with credit card delinquencies. A group of United Way supported family and children service agencies also receive some of these funds.

Anecdotal reports indicate that the housing counselors are a cut above the historic credit card counselors. The credit card counseling industry agencies were mostly begun by creditors and their funding has always been supported by payments from creditors. The housing counseling organizations began with funds from HUD and the Ford Foundation and the extensive new dollars have come from the Federal government through a central organization called Neighbor Works. The neighborhood organizations obtain their funding all over the lot. The cultures of the various organizations differ a good deal among themselves and between the various types of providers.

Anticipating Refund Anticipation Loans

I've clearly become predictable in my posts, as someone recently wrote to me wondering where is my annual tax-time rant against refund anticipation loans (RALs). In fact, I have written about them twice before on Credit Slips, here and here. But I think this annual lending "opportunity" deserves another round of criticism; this is a bad product that just won't seem to die. The number of RALs held fairly steady between 2006 and 2007, around 9 million loans.

RALS are 1 to 2 week loans administered by tax preparers and banks working together. The loans are secured by the taxpayer's expected refund.  In their new report on RALS, the National Consumer Law Center and the Consumer Federation of America find that a typical RAL is about $3,000 and carries an APR of 77% to 140%. While the high APR for a RAL makes it similar to other short-term loans such as payday loans, there are some unique justifications for regulating or discouraging RALs that go beyond the high price paid by consumers.

Getting to Know Suze

Last spring, during our Debtor World conference here at the University of Illinois, it was a pleasure to get to know James Scurlock, the director/producer/writer of Maxed Out. If you have not see the movie, now is a good time. WIth the credit crisis now crashing down, Scurlock has to at least be a nominee in the "I Saw It Coming" category. Scurlock has a column at Slate entitled, "If You Suze Like We Knew Suze, You Wouldn't Listen to Her Advice." Check it out.

Suze Orman's defenders have risen to her defense in the comments to Scurlock's column, slamming Scurlock for daring to question her. Scurlock started his column with an Orman quote: "'Tell me what I need to know,' people often say to me. 'Here is what you need to know,' I answer." My sense is that Orman doesn't sell financial advice as much as she sells a sense of security. Scurlock's column tells people that Orman may not have all the answers, and one of the surest ways to incur someone's scorn is to tell them the world is a more complicated place than he or she would like to believe.

Regulation Cannot Depend on Irrational Markets

At this point, it is all too clear that financial markets can get things wrong. This is not an isolated phenomenon. No, getting it wrong tends to be the name of the game for financial markets. Understanding that financial markets regularly underestimate or overestimate the risks of investing is crucial to the proper design of financial market regulations.

This is a Financial Crisis like Any Other – Treat it Like One

I wanted to thank Bob Lawless, Elizabeth Warren and Credit Slips to invite me back as guest blogger. It seems an appropriate time to discuss topics in two of my areas of expertise -- financial crises and retirement income security -- as they are directly related to the current financial turmoil.

The markets are crashing. This is a standard financial crisis, as many other countries experienced over the past twenty or so years. In a crisis four risks materialize: default risk, maturity risk, interest rate risk, and exchange rate risk. We are spared from the last one since the dollar dropped well before this crisis. The problem is that we are not adequately addressing the remaining risks.

Enjoyable but not Educational? Debtor Financial Management

In May, the Executive Office for the U.S. Trustee released another of the studies mandated by the new bankruptcy law. I expressed optimism in this symposium piece that this research may be a bright spot to emerge from BAPCPA but the results so far have been quite mixed (the pretty good and the awful). The latest study purports to evaluate the postbankruptcy financial education that all individuals with consumer debts are required to complete to receive a discharge. The study considered three curricula: one developed by the Chapter 13 trustees (TEN), one developed a private credit counseling agency, and the EOUST's own program.

Across these providers, 97 percent of bankruptcy debtors reported that they would recommend the program to others and 97 percent agreed with the statement that their overall ability to manage their finances had improved as a result of the educational course. This is consistent with a finding from the Consumer Bankruptcy Project that Dr. Deborah Thorne and I reported here--debtors seem to believe that financial education is useful. However, there were very, very few measurable improvements in debtor's actual financial knowledge after the course and only about 22 percent of debtors who could be interviewed three months later had adopted any recommended change to their financial practices. The findings seem to suggest that while financial education makes people feel optimistic about their financial prospects, it may have a much, much more limited effect on knowledge and behavior. The policy take-away remains ambiguous. Like so many other things, whether bankruptcy financial education continues will probably turn more on politics and public perception than hard evidence in either direction.

Financial Literacy Education Under Attack: Man’s Search for Meaning

As a provider of financial literacy education, I read with great interest Professor Lauren Willis’ recent article Against Financial Literacy Education. It is a creative, must-read for anyone interested in the subject and adds greatly to the literature in this area.

Professor Willis is rightly concerned about financial literacy education being used as a proxy for meaningful reform. She also doubts whether it works, noting that credit industries support it but would clearly lose if it did work. She also claims that most financial products (she focuses on investments not credit) are now so complex that no one can help us understand them. We just need good advisors, she implicitly claims, not our own educational framework. I appreciate her work because it helps me know what to watch out for and compensate for. I reach different conclusions, however. I think financial literacy can work, if it is carefully designed to be meaningful. Otherwise it is worthless, I agree.

Meaningful consumer credit regulation would certainly be far better for society than financial literacy education, if we could only pick one, but we can have both. Plus, education, if it works, can be passed on from generation to generation and no one can take it away from us, whereas consumer protection laws (as we have seen) come and go like the wind.

Should We Not Disclose Credit Card Information?

The paper Professor Richard Wiener (Univ. of Nebraska), a psychology professor, discussed presents findings that are completely contrary to economic predictions. Standard economic theory would predict that if consumers are given complete information, they will act rationally and not overspend where the costs of spending outweigh the benefits of consuming. However, the preliminary conclusions he and his co-authors reach in Limits of Enhanced Disclosure suggest that giving consumers additional credit card disclosures does not reduce consumer spending and, in some instances, may make consumers spend even more.

The Very Big Men Who Sort Out Debt

During the last session this morning, Professor Stephen Lea (University of Exeter) provided a psychological perspective on debt in poor households in Britain. He initially listed the people he believes to be the cast of characters involved in debt. First, there are consumers, and their friends and families. On the creditor side, he made a distinction between business creditors (like utilities) and credit businesses (banks, debt collection agencies – whom he labels "the very big men who are left to sort out the mess"). Because of England’s long tradition of credit counseling, he also included credit counselors in the cast.

Is Financial Education a Good Idea and Whose Idea Is It Anyway?

Educators find it hard to be against education, and I am no exception to that rule. But some evidence from JumpStart Coalition, which promotes financial education for young people, is cause for pause. Its last survey of high school students, conducted among 5775 12th graders in 37 states in 2006, found that those who had taken a financial literacy course actually did slightly worse on its financial literacy test than students who had not taken a course. See www.jumpstart.org/fileuptemp/2006GeneralReleaseFinal%202.doc (Thanks to Professor Lauren Willis of Loyola of Los Angeles School of Law for pointing out this information in an excellent presentation on financial literacy education at the Association of American Law Schools annual meeting in NYC earlier this month.)

There are many possible explanations for the JumpStart survey result. JumpStart also found that kids from more affluent families did better on the test. It is not surprising that factors and influences other than taking a course have a lot to do with learning about finances. It is also possible that the courses the students took were not very good, either in the content or teaching methods.

JumpStart’s list of "corporate partners" gives you a pretty good idea of who wants to promote the idea of "financial literacy."  http://www.jumpstart.org/advisor.cfm  The many financial institutions on this long list presumably think financial education will not have much effect on the willingness of consumers to pay lots of interest and fees on high balances of various kinds of debt. Rather than push for financial education, maybe financial institutions should work on offering simpler products that are easier to understand and compare.

Is Cheaper Better?

As part of the 2005 amendments, consumer bankruptcy debtors must complete a financial education course to receive a bankruptcy discharge. The requirement was controversial among law professors, with some seeing the requirement as one of very few reforms that could help consumers and others viewing it primarily as a cumbersome obstacle designed to deter filings or increase the hassle and expense of bankruptcy.  As John Rao noted in his excellent post on the topic, the quality of this education left a lot to be desired. Specifically, he noted that the courses were not tailored to the particular educational needs of bankrupt families. Guestblogger Nathalie Martin shared her experiences as a financial educator on just why tailored education is vitally important.

I have no evidence that these problems have been remedied, but I can report that at least bankrupt families won't have to pay as much for their under-education in the future. I've recently gotten notices from two financial education providers, both of whom are approved nationwide by the United States Trustee. The respective costs of the services are $25 and $15. This is a dramatic drop in price from the $50 that most providers initially charged. Do you get what you pay for? Or is this a good cost-savings for consumers? The most interesting thing about both advertisements was that neither of them contained ANY mention of the quality of their course--no mention of curricular content; quality of intructors; or pedagogical methods. Instead, the programs emphasized their low cost--and non-educational features such as their acceptance of credit cards, and their immediate certificate delivery. If even the financial educators aren't competing on quality--or perceive that doing so is of no use--I think we should be pessimistic that bankruptcy financial education is going to delivery on its promise at any price. 

Financial Education: Money Talk Hits a Sore Spot

Money is a touchy subject. No matter how much you try to make discussions about how to preserve it, how much importance to place on it, etc, value neutral and nonjudgmental, people have issues.

I spend most of my free time these days trying to keep people off economic death row. While some of this work involves reviving a workable bankruptcy system, much more relates to prevention through financial education. I also believe that any financial education class must be very carefully crafted to fit the specific audience. Age and income are huge variables, so you can’t just teach a cookie cutter curriculum.

I teach a two-day financial literacy class to UNM undergrads and law students, and would love to share the details with anyone out there who is interested. Here is a start: http://lawschool.unm.edu/faculty/martin/fl-1.php.  Karen Gross gave me the idea and I have built on it. But, this year I was asked to do one hour on the topic for first year students, in part because they are in such terrible financial condition. Because the class in which this is taught is comprised of 9 sub-sections, I had the pleasure of having eight of my colleagues attend this class. We started with basic compounding interest hypos, including one exercise in which one person gave up one $4.50 latte a day for 10 years, saved, $18,000, invested it at 8% and held it for 30 years, ending up with over $150,000! We then saw the math moving in the other direction with credit card debts, learned a bit about credit reporting and scoring, a bit about bad car deals, and then broke up into groups to think of ways to economize. The students enjoyed this last part, even if some of the suggestions (selling plasma, getting paid to be in drug tests, finding a sugar mama/daddy,  or giving up long-distance relationships), were a bit extreme.

Students enjoyed the class but many of my colleagues had issues. "Wasn't it unfair to tell students they could reasonably expect to earn 8% on investments?" Um, no. "Don’t they need to use credit cards to build credit?" Uh….not really, no. "What is wrong with a car lease if you’ll be getting a new car every two years anyway?" "And expensive car payments? So what? Why does the total cost of interest matter if on a cash flow basis, you are fine. Isn’t it all about the cash flow?" These last two are stumpers all right. I guess I am both greedier and simpler than most people. I like to drive it till it dies, earn interest, not pay interest, etc.

This does tell you though that it is hard to listen to advice about money that is geared to a different crowd. Cash flow is the issue if retirement is fully funded and the kids are out of college. Otherwise, I can't imagine how a little extra dough lying around could be a bad thing…

Comments, anyone? What information would be useful in a class like this?