Maybe Financial Literacy Is NOT the Answer to Student Overborrowing, Part 1

According to an essay that appeared in the Pacific Standard, “there is a certain line of thinkingâ��embraced by Wall Street and politicians of both partiesâ��that holds that one of the major causes of the Great Recession was the publicâ��s lack of financial literacy.” The piece goes on to say that the root problem wasnâ��t just an unchecked mortgage industry or an investment sector that wagered billions on Byzantine mortgage-backed securities; the ignorance and greed of Main Street Americans, which made them easy marks, played a major role too. To fend off further economic calamity and keep families afloat, many financial literacy advocates believe our best hope is to teach people to live within their means, to carefully check mortgage documents before signing them, and…

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According to an essay that appeared in the Pacific Standard, “there is a certain line of thinking—embraced by Wall Street and politicians of both parties—that holds that one of the major causes of the Great Recession was the public’s lack of financial literacy.” The piece goes on to say that the root problem wasn’t just an unchecked mortgage industry or an investment sector that wagered billions on Byzantine mortgage-backed securities; the ignorance and greed of Main Street Americans, which made them easy marks, played a major role too. To fend off further economic calamity and keep families afloat, many financial literacy advocates believe our best hope is to teach people to live within their means, to carefully check mortgage documents before signing them, and to save enough money to survive a prolonged period of unemployment. All we need are the right educational tools.

Answering the call, financial literacy initiatives, both public and private, have proliferated wildly over the past several years. There’s Sesame Street’s “For Me, For You, For Later,” in which Elmo and his preschool-age fans learn the basics of spending, saving, and living within one’s means as the furry Muppet decides to forgo a $1 “stinky ball” in order to save up enough money to purchase a glittery “fantastic ball” instead. At the other end of the age spectrum, there’s Money Smart for Older Adults, a joint project of the Federal Deposit Insurance Corporation and the Consumer Financial Protection Bureau designed to teach the elderly how to avoid falling for financial scams.

The leading cause of bankruptcy is not overspending, nor lack of adequate financial planning, but the financial free fall caused by a health crisis.

In between, there are numerous online games, like Financial Football, a co-production of Visa and the NFL that quizzes players about things like compound interest and identity theft as they make their way toward a virtual end zone. There are programs for children and teens peddled by personal finance gurus like Dave Ramsey. And there are untold numbers of special school curricula, many created by financial services outfits like Capital One or your local credit union, which offer education with a side of brand awareness. (Banks relish the opportunity to get their names in front of future customers and their parents in a warm and virtuous context.)

Government, too, stands squarely behind these efforts. More than a dozen states now require that their students take a class in personal finance before they can receive a high school degree. And the Obama administration—acting under the terms of the Dodd-Frank financial reform law—has set up a federal Office of Financial Education housed in the Consumer Financial Protection Bureau. “Financial education supports not only individual well-being, but also the economic health of our nation,” said Federal Reserve Chairman Ben Bernanke in a speech last year. In case that doesn’t make clear what’s supposedly riding on this effort, in 2012 the U.S. Senate held a hearing titled “Financial Literacy: Empowering Americans to Prevent the Next Financial Crisis.”

There’s only one problem: mounting, resounding evidence shows that financial literacy education doesn’t work. Dave Cannon’s experience is not the exception but the norm. “We have this idea that if we teach kids good habits they will use them. But it’s just not true,” explains John Lynch, a consumer psychologist at the University of Colorado’s Leeds School of Business. Not all behaviors are governed by rational intentions. “A kid in the backseat of a car,” Lynch says, “is not thinking about Sex Ed.”

FINANCIAL LITERACY PROMOTION MAY sound perfectly sensible—who wouldn’t want to teach children and adults the secrets of managing money?—but in the face of recent research it looks increasingly like a faith-based initiative. Consider one recent paper, scheduled for publication in a forthcoming issue of the journal Management Science. In a meta-analysis, Lynch and the marketing experts Daniel Fernandes and Richard Netemeyer compiled the results of more than 200 studies of financial literacy programs, adjusting for subjects’ family background and personality traits that had been ignored in the previous research. The result? Financial education has a “negligible” impact on subsequent financial decisions and behavior. Within 20 months, almost everyone who has taken a financial literacy class has forgotten what they learned.

These findings echo the results of another recent working paper, by the economists Shawn Cole at the Harvard Business School, Anna Paulson at the Federal Reserve Bank of Chicago, and Gauri Kartini Shastry at Wellesley College, on the efficacy of state laws requiring financial literacy to be taught in schools. Their conclusion: “State mandates requiring high school students to take personal finance courses have no effect on savings or investment behavior.”

Another study, from 2009, tested the financial literacy of recent high school graduates who had taken a highly regarded personal finance class. They did no better than graduates who had not taken the class. One of the study’s authors, the economist Lewis Mandell, was a founder of the modern financial literacy movement, but the evidence has prompted him to turn his back on the mainstream financial literacy paradigm.

Reluctant to give up entirely on educating consumers, a number of scholars—including Lynch and Mandell—are now pushing for a model of financial literacy promotion known as just-in-time education. Instead of teaching personal finance in schools, the idea goes, a combination of education and coaching should be offered at the point of sale, or when people have reached a point in their lives when they actually need a given financial service. Don’t offer retirement education in high school or even college. Wait until someone starts a new job and needs to understand and manage a 401(k).

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