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Did Financial Illiteracy Contribute to this Crisis?

I don’t have any hard proof and it may take a while to determine if financial illiteracy did contribute to our current crisis but based on what I have seen and what I have read - I believe the answers Yes.  The mortgage crisis is just the beginning.  If we are significantly challenged with managing debt what does the future hold for retirement savings?  The mortgage crisis is a symptom to a much bigger problem – the lack of financial literacy in our country.

Personal Experience

In one of my previous jobs I witnessed the devastating impact that predatory lending practices were having on individuals and their communities.  In 1999, I worked for a municipal agency that was working with not-for-profit organizations warning legislators and the public of the problems with predatory home lending (a subset of subprime lending).  Legislation never materialized but we also had public outreach which included public meetings.  These public meetings were always well attended.

I witnessed whole city blocks being destroyed by foreclosure after foreclosure typically as a result of one mortgage broker.  I heard horror stories about how people where caught in the vicious cycle of payday loans – using one extremely high cost loan to pay-off the previous high cost loan and never being able to break free of payday loans.  I educated groups of single moms about benefits of Tax Assistance Program and the perils of Refund Anticipation Loans.  Even more recently (after mortgage crisis became public), I know of a “common law” married couple that recently received a mortgage that they could not afford.  Yes, it is still happening.

Besides the obvious outside forces of misrepresentations and possibly fraud, the common factor among the people I encountered was a lack of understanding of debt management and more broadly basic personal finance concepts.  People did not understand the concepts of mortgage rate/interest rates, particularly adjustable rate mortgages.  People had no concept of budgeting or where their money was going.  These are basic fundamental concepts of personal finance – I would argue that these are life skills that are necessary to function in our society.

Circumstantial Evidence

Below is just some the circumstantial evidence that a lack of financial literacy has had a role in our current economic crisis:

• Mortgage foreclosures increasing,
• Credit card defaults increasing,
• 2008 Financial Literacy Survey by Princeton Survey Research Associates International
.

Again, the biggest problem is managing debt and basic overall money management.  But now the problem is being magnified 100x because people are losing their jobs.

There is no question that personal responsibility is vital to financial literacy.  People still have to create a budget, track spending and save/invest.  It is not unreasonable to expect people to be more protective of their assets and income.  But, it is unreasonable to expect people who never been exposed to basic personal finance concepts all of sudden be able to manage credit cards, a mortgage/rent, student loans, auto loans and other living expenses without significant problems.

Education can increase financial literacy in the U.S.  But education alone is not enough.  Studies have shown people continuing bad behaviors despite having a basic personal finance education.  The way we provide personal financial education is critical.  The basic “home economics” type curriculum may not be enough.

Could it be that our current financial system is too complex for most people?  How many people understand adjustable rate, balloon payment mortgages or negative amortization?  How many people understand “minimum monthly payments” on credit card statements is misleading?  Our financial system may be so complex that people just choose to ignore it completely or allow “experts” to guide them through the complexities.  If people ignore the complexities while continuing to operate in the financial system, such as using credit cards, we are creating an endless cycle of crises.  Over reliance on “Experts”, such as mortgage brokers/lenders, financial planners and investment advisors, is very risky particularly when those “experts” are unscrupulous.  Our consumer/personal finance system must be simplified and regulated.  We cannot afford to have significant amounts of people’s wealth and well-being at risk in the “markets” and unprotected.

The future looks bleak but our history shows that we can overcome significant challenges.  This economic crisis provides us an opportunity to make great positive changes in our lives.  Now is not the time for small thinking.