THE BASIS POINT

Can Washington Cure Consumer Financial Illiteracy?

 

One of the reasons I began writing this commentary many years ago (during the Coolidge Administration as I recall), was the repeated confusion among mortgage industry folks when I would explain bond market mechanics. Right down to the basics like: when fixed-income prices fall, rates rise, and vice versa.

I continue to hear stories about how little consumers know about their mortgages, and how it seems Congress expects all the regulation to teach them about mortgages and finances. Yet Washington can’t get their act together to launch the Consumer Financial Protection Bureau, the one piece of financial reform that might actually help.

Last year a study conducted by Dartmouth University, and any survey of telemarketers, showed that many home owners don’t know the terms of their mortgage or the interest rate that they’re paying, or how compound interest works. Unfortunately now, more than ever, people have to take so much responsibility for their financial lives. Pensions have been replaced by 401(k)’s, health insurance decisions are left to the employee, etc.

Of course, the less consumers know, the more they run into trouble – like refinancing low interest mortgages or buying overpriced credit insurance.

Financial illiteracy is an example of “rational ignorance” where the costs of paying attention outweigh the benefits. On top of that, loan agents have seen clients where the less they know, the more overconfident in their abilities they tend to be.

It even has a name: the Dunning-Kruger effect where people who don’t know much tend not to recognize their ignorance, and therefore fail to seek better information.

Less knowledgeable borrowers are usually less likely to do research before obtaining a mortgage. Well informed borrowers are more likely to ask for help.

So it seems that not only do we need regulations to protect the consumer, but also proper financial education – the financial equivalent of driver’s ed.

But until Washington can sort through it’s Consumer Financial Protection Bureau politics and get it up and running, The Basis Point is here to help. We try hard to keep our financial commentary clear for consumers.

Political Battle Threatens Centerpiece of Financial Reform (WaPo)


 

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