Why Financial Literacy is a Mirage

Financial literacy is today's Very Worthy Cause. If only regular people understood more about money, they wouldn't have created the real estate asset bubble, or gorged on credit cards, or--close to my heart in this blog--blown their nest egg in their 401(k)s.

It's curious how much reverence towards financial literacy always seems to stage a bull market in the aftermath of financial disasters. However, it rarely results in much. The tech stock bubble, for example, led to the Financial Literacy and Education Improvement Act of 2003 and its feeble Financial Literacy Education Commission. The FLEC, according to this year's GAO progress report, was reduced by apathy and lack of funding to relying on a single volunteer Virginia Tech grad student to evaluate the effectiveness of the U.S. government's financial literacy programs. That barely rises to the level of lip service.

What makes financial literacy such an attractive goal today? One benefit is that it deflects attention from reforming financial services. The crash was all the fault of those illiterate consumers, goes the argument. But if we turn them into amateur financial wizards, why then, who needs a Consumer Financial Protection Agency? Same with retirement planning. I've often used this blog to suggest that policy makers rethink the nation's over-reliance on 401(k)s. The typical response, most recently endorsed by trade pub Financial Planning, is that there's nothing wrong with the plans; 401(k)s would be fine if workers were just taught better how to use them.

All that may be true, if only the premise weren't absurd. How exactly are we supposed to take a nation of workers and turn them in their spare time into a nation of amateur financial athletes? One apparently serious questioner at a Ben Bernanke press conference last month suggested that Bernanke and Obama should just create a series of financial literacy videos--on, for example, "here's how a credit card works"--and send it to every household in America. (The suggestion occurs about minute seven in the clip.) It's a little bit tougher than that.

• For one thing, whatever materials the forces of financial literacy might create would be dwarfed by advertising campaigns urging you to act like a complete illiterate. What chance does "Here's How a Credit Card Works" mailed by Ben Bernanke have against "What's in Your Wallet" commercials airing endlessly on football games? That these ad campaigns are created by the same companies speaking prayerfully of financial literacy is one of the smarmy ironies of the post-crash era.


• For another, proper financial behavior, particularly investing behavior, is terribly hard to teach. Endless economic research shows that humans are wired for short-term thinking and tend to make the same mistakes over and over again-even when they know better.

The fact is, financial services companies understand better than anyone how Sisyphean it is to teach financial literacy. For two decades they've sent trainers, armed with white boards and colorful brochures, to talk employees into signing up for 401(k)s. Employees still stayed away to an alarming degree. That didn't change until the law allowed companies to enroll employees automatically in their 401(k)s. The fact is, when it comes to protecting consumers from their own mistakes, paternalism works better than pedagogy. Financial literacy is an amiable smokescreen-a way to blame consumers and head off reform that will really make a difference.

 

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