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Note: another version of the following article appears in the
December 2002 issue of the Minneapolis Fed's The Region magazine.
Numerous complaints of so-called predatory lending have been reported
in recent years. According to these reports, certain lenders take
advantage of unsophisticated borrowers by persuading them to agree
to loan contracts that are not in their best interest. In this context,
that means the loans are overpriced or overly restrictive after
adjusting for risk, in that the borrower could easily do better
by shopping around a little, or, in extreme cases, by simply doing
nothing. The extreme cases include loans seemingly rigged to yield
default and foreclosure, so borrowers lose their homes or home equity
to the lenders.
By its nature, predatory lending is difficult to track and measure,
but growing anecdotal and circumstantial evidence has convinced
many observers that it is a serious problem. In 2000, a national
task force organized by the U.S. Department of Housing and Urban
Development and the U.S. Department of the Treasury (Treasury) collected
information about predatory lending from around the country. The
task force reported that "there is a growing body of anecdotal
evidence that an unscrupulous subset of . . . actors . . . engage
in abusive lending practices . . ." 1/ Some
policymakers have recently modified consumer regulations and laws
in an attempt to curb predatory lending, providing further evidence
that the problem is perceived as a serious one.
However, regulations and laws intended to curb predatory lending
may have undesired consequences. They may impede the operation of
legitimate credit markets, making it difficult for financially vulnerable
individuals to access credit. Partly for that reason, policymakers
are exploring other approaches to reduce predatory lending. Increasing
the financial knowledge of borrowers is one appealing approach.
If successful, it could make borrowers less susceptible to predatory
loan offers and improve the operations of legitimate credit markets.
With these hopes in mind, Federal Reserve System governors, the
secretary of the Treasury, leading members of Congress and others
have endorsed financial literacy training as a promising antidote
to predatory lending.
It seems logical that delivering appropriate financial training
to vulnerable borrowers will help them ward off predatory lenders.
But is there evidence that this approach actually works?
Unfortunately, direct evidence on training aimed at preventing
predatory lending is hard to find, due in part to the difficulties
involved in monitoring predatory lending. So this article focuses
on a more limited question: does financial literacy training of
any kind bring about positive behavioral change? Several recent
studies examine the effectiveness of certain forms of financial
literacy training, and a review of these studies supports cautious
optimism about the ability of well-designed educational programs
to bring about responsible financial decision making. This optimism,
in turn, supports further exploration of financial literacy training
as a tool for reducing abusive lending practices.
Reviewing the evidence
For decades, financial literacy training has been offered in many
different forms and settings, to many different audiences. Efforts
to measure the effectiveness of this training are typically organized
around its subject matter and audience. Accordingly, this review
of the research on financial literacy training is organized into
three commonly studied categories:
- General financial literacy offered to high school students;
- Training related to retirement and savings planning, offered
by employers to employees; and
- Homebuying and homeownership training, offered to mortgage applicants
or to homeowners who are having difficulties making their payments.
High school financial literacy training
Basic financial literacy education has been available for decades
in many high schools, but only recently has its effectiveness been
studied. The recent studies are far from comprehensive, but they
suggest both short-term and long-term effects.
Evidence of short-term effects comes from studies of students exposed
to the High School Financial Planning Program® (HSFPP)
curriculum between September 1997 and January 1998. For the studies,
which were conducted by researchers from the University of Minnesota
and the University of Wisconsin, over 4,000 students from 188 high
schools across the United States returned surveys after completing
the HSFPP curriculum. More than 400 of those students completed
a follow-up survey three months later, and their teachers were also
surveyed.
The studies have some limitations, since their results are based
entirely on the students’ and teachers’ subjective assessments and
no control group was used to benchmark the results. Notwithstanding
these limitations, the authors conclude that "teaching personal
finance in high schools can positively impact the financial knowledge,
behavior, and self-efficacy levels of teens." 2/
Immediately after completing the HSFPP curriculum, almost half of
the students in the study reported increases in their financial
knowledge. Of special note, "the area where the most students
increased in knowledge was in understanding the cost of credit,"
3/ which could help reduce their subsequent susceptibility
to predatory lenders. In addition, about a third of the students
reported changes in behavior, especially in tracking expenses and
setting and achieving money-management goals. Teachers generally
agreed with their students’ self-assessments, indicating a "marked
change in knowledge and behavior in students after participating,"
with "the most changes in the areas of consumer credit, car
insurance, time value of money and tracking expenses." 4/
And of the subset of students who completed follow-up surveys three
months after their training, nearly 40 percent had started saving
money and 31 percent reported that opening a savings account was
the most important financial planning activity they engaged in after
completing the course.
In many areas, at least half of the surveyed students did not report
gains in their financial knowledge or changes in their behavior.
Although this may seem discouraging, the authors indicate that it
is partly due to the fact that many students had already adopted
responsible financial behaviors before their training. In other
words, the gains reported for this curriculum in large part reflect
a "leveling up" of the knowledge and behavior of individuals
who were not already financially savvy. This theme runs through
many of the studies summarized here.
Reports that the benefits of financial literacy training persist
months later are encouraging. But the benefits need to persist for
years or even decades to be effective against predatory lending.
At least one study suggests that they do. The study, conducted by
researchers B. Douglas Bernheim, Daniel M. Garrett and Dean M. Maki,
takes advantage of the fact that, historically, some states have
at times mandated financial literacy education in high schools.
The study is based on financial and demographic data collected
in 1995 from a national sample of 2,000 individuals between the
ages of 30 and 49. Allowing for other factors that affect financial
behavior, it found that adults who attended high school when their
states mandated financial literacy training generally save more
and accumulate more wealth than other adults. Their net worth is
higher—by an amount equivalent to one year’s earnings—than the net
worth of adults who attended high school when their states did not
mandate financial literacy training. In other words, exposure to
state-mandated financial literacy education appears to be associated
with more frugal adult financial behavior, even 30 years later.
As with the short-term benefits of high school financial literacy
training, the long-term benefits may result from leveling up the
knowledge of some individuals. When the researchers measured the
effects of mandated training, they made a distinction between "individuals
whose parents did and did not save more than average." 5/
They found that the long-term benefits of financial literacy training
are concentrated among individuals who reported that their parents’
savings rates were at or below the average. The researchers concluded
that "the consistency of this pattern . . . provides considerable
support to the view that financial education at school is a close
substitute for financial education at home." 6/
In other words, high school financial literacy training appears
to be especially effective for individuals who did not learn the
basic habits of household saving from their parents.
Ninth District Financial Literacy Standards
According to a recent study funded by the National Endowment
for Financial Education, fewer than half of all states cover
personal financial management in their required coursework
for grades kindergarten through 12 (K-12). Only three of those
states—Florida, Illinois and Rhode Island—require high school
students to complete a personal finance course in order to
graduate.
None of the six states in the Ninth District has such a requirement
in place, but all six include economics and, to some degree,
personal finance in their academic content standards. Content
standards are defined expectations of what students need to
know in particular subject areas, and many school districts
use them as the basis for their K-12 curricula.
In addition to including economics and personal finance in
their current content standards, several Ninth District states
have recently considered legislation related to financial
literacy education. Summaries of the relevant content standards
and legislative actions appear below.
Michigan: Economics content standards from the Michigan
Department of Education (MDE) emphasize an understanding of
individual and household choices, business choices, economic
systems, trade and the government’s role in the free-market
economy. (For more information, visit www.michigan.gov/mde.)
Legislation: A 2001 amendment to the state’s revised
school code requires the MDE to develop or adopt model financial
education programs for grades K-12.
Minnesota: Economics and business content standards
from the Minnesota Department of Children, Families and Learning
introduce the concepts of resource management, decision making
and informed consumerism in middle school. In grades 9–12,
the emphasis is on personal and family resource management,
financial analysis and economic systems.
Legislation: Several financial education bills were
defeated in the Minnesota legislature in 1999 and 2001, including
one requiring personal and family financial management and
investment education for all high school students.
Montana: The Montana Office of Public Instruction’s
content standards for social studies emphasize the basic economic
principles of production, distribution, exchange and consumption.
By high school graduation, students are expected to understand
financial institutions and the common products they offer.
Separate standards for career and vocational/technical education
emphasize basic monetary skills and financial management.
(For more information, visit www.opi.state.mt.us.)
Legislation: Senate Joint Resolution No. 2, passed
in 1999, urged the Montana Board of Public Education to integrate
economic principles and retirement planning into the K-12
curriculum in order to improve retirement planning and saving.
North Dakota: The North Dakota Department of Public
Instruction’s social studies content standards emphasize supply
and demand, economic systems and resource management. Specific
knowledge in support of these standards includes an understanding
of budgets, checking, savings, credit, interest and financial
institutions. (For more information, visit www.dpi.state.nd.us.)
South Dakota: Under the South Dakota Department of
Education and Cultural Affairs’ content standards, economics
is one of four core areas of social studies education. Basic
economic concepts are introduced in the early grades. In later
grades, lessons in economic systems and practices are conveyed
through a variety of history courses. Separate content standards
for consumer and family resources emphasize resource management,
personal and family financial planning, consumer awareness
and insurance decisions. (For more information, visit http://doe.sd.gov.)
Wisconsin: The Wisconsin Department of Public Instruction’s
core academic standards for economics include concepts of
production, distribution, exchange and consumption, with some
emphasis on consumer rights and decision making. Separate
content standards for business education emphasize savings,
checking, credit and investments. (For more information, visit
www.dpi.state.wi.us.)
Legislation: Wisconsin Senate Joint Resolution 31,
dated April 11, 2001, urges the educational community to explore
ways of teaching personal finance to junior and high school
students. A 2002 report from the Governor’s Task Force on
Financial Education recommends a financial education requirement
for all students.
Legislative information was obtained from the Jump$tart
Coalition for Personal Financial Literacy at www.jumpstart.org.
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Workplace financial literacy training
Many firms offer employees financial literacy materials or training,
usually with a focus on retirement savings plans. Surveys conducted
in the 1990s found that roughly three-fourths of companies provided
some financial education in the workplace, in the form of summary
plan descriptions, newsletters, one-on-one counseling or participatory
workshops. The vast majority of those who offered it covered topics
such as asset allocation and retirement income. 7/
These surveys also indicate that a key reason why employers provide
financial literacy training is to boost their employees’ savings
plan participation and contribution rates. This may be partly due
to the fact that, under many retirement savings plans, contribution
limits for highly compensated managers and executives are eased
if other employees’ participation and contribution rates increase.
Well-designed programs of workplace financial training seem to
change behavior, especially among employees who are not highly compensated.
A number of studies of workplace savings plans generally agree on
the following points:
- Providing generic information, especially in written form, is
the least effective method of delivering financial training and
sometimes appears to have little or no effect.
- The more specific the information is to the firm’s plan or the
individuals’ situations, and the more frequently and personally
it is offered, the more effective it is.
- Well-tailored information, especially if it is offered frequently
or in person, can raise overall employee retirement plan participation
and contribution rates at least as effectively as generous employer-matching
programs can. (In employer-matching programs, employers supplement
their employees’ contributions to a retirement savings plan, up
to a specified limit. For example, an employer might contribute
an extra 50 cents for each dollar contributed by an employee,
up to a fixed percentage of the employee’s salary.)
- With the exception of employer matching and financial education,
retirement plan provisions have relatively isolated and limited
effects on employee behavior.
- The effects of workplace financial training are concentrated
among nonhighly compensated employees and appear to be reduced
or nonexistent for highly compensated employees.
These studies provide consistent evidence that financial literacy
training in the workplace can induce more prudent retirement savings
behavior, at least among employees whose participation and contribution
rates are initially low. However, many of the studies have significant
gaps, such as failing to provide information about employees’ savings
behavior outside the workplace—leaving open the possibility that
increased participation merely reflects a shift of existing savings
into employers’ plans. A few studies attempt to fill these knowledge
gaps, and they bolster the view that the positive effects of workplace
financial training are real and extend to the employee’s household
generally. For example, a study that measured all forms of savings
found that the median total savings rate for employees—including
savings outside the workplace—is about 20 percent higher when the
employees can obtain financial training at work. 8/
The study also found that spouses of these employees tend to participate
at higher rates in their own employers’ plans. 9/
The screening problem
Screening, or the bias that can be introduced through a
study’s selection process, makes it difficult to determine
whether the effectiveness of some homeownership education
and counseling (HEC) training is due to the training itself
or the traits of the HEC participants. Researchers continue
to devise statistical procedures to adjust for screening effects
and correct other study flaws, but it is still difficult to
define and measure the success of HEC programs. (This difficulty
need not imply that HEC programs are without merit, for the
screening function itself may be valuable. See the McCarthy
and Quercia study referenced in the main article below for
comments on how the screening provided by HEC programs has
helped facilitate increased lending to low-income communities.)
Screening effects are also a problem in some studies that
focus only on recipients of high school or workplace training.
However, in these cases, the gap is covered by other studies
that focus on whole populations for whom training was available,
without differentiating between the individuals who chose
to pursue the training and those who did not. Some of these
studies also provide evidence that even the availability of
training was not correlated with any preexisting interest
in or tendency toward financial prudence. (For example, see
the Bernheim, Garrett and Maki study of high school training
and the Bernheim and Garrett or Bayer, Bernheim and Scholz
studies of workplace training discussed in the main article.)
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Homebuyer training
According to Roberto G. Quercia of the University of North Carolina
and Susan M. Wachter of the University of Pennsylvania, homeownership
education and counseling (HEC) programs, which provide information
about the financial aspects of buying and keeping a home and are
usually directed at low-income individuals, "evolved from the
implementation of the 1968 Housing and Urban Development Act."
10/ The act authorized "public and private
organizations to provide counseling to mortgagors" affected
by certain federal programs. 11/ Subsequent federal
legislation, including the Fair Credit Reporting Act of 1970, provided
additional impetus by setting standards for granting credit and
encouraging consumer education. By 1993, more than 1,000 organizations
were receiving homeownership education funding from foundations,
federal housing authorities and states.
Federal funding of HEC helped stimulate studies of its effectiveness,
beginning with a flurry in the 1970s that has since tapered off.
Recent reviews of these studies conclude that almost all are flawed
and that, as a result, "it is astounding to consider what little
empirical evidence there is to determine how well HEC works."
12/
Several factors make it difficult to accurately assess whether
HEC leads to positive behavior changes by enhancing homebuyers’
knowledge. In the first place, it is even difficult to define an
appropriate measure of success. One indication of success might
be increased homebuying rates for low-income clients. But increased
homebuying alone can be a misleading indicator. If buyers are not
prepared for the ongoing financial burdens of homeownership, increased
homebuying could result in increased mortgage delinquencies and
defaults a few years later. So a complete measure needs to consider
both homebuying rates and subsequent delinquency and default rates,
with success indicated by some combination of more homebuying and
fewer defaults per buyer. 13/ Many studies consider
only one of these two factors.
Even if an appropriate measure of success could be established,
studies of HEC’s effectiveness often cannot adequately control for
certain factors outside of the training that affect the results.
For example, completion of HEC is often required to obtain some
kinds of private or public low-income mortgage financing. Low-income
would-be borrowers who are organized and disciplined enough to complete
the required HEC training differ, at least by those traits, from
low-income buyers who avoid or fail to complete the training. Even
if they learn nothing at all in their classes, HEC graduates will
tend to be more successful, on average, than low-income would-be
borrowers who do not complete the program. So when HEC graduates
disproportionately succeed as homeowners, it is difficult to know
whether their success is due to the training they received or merely
to HEC’s ability to "screen in" individuals who are already
well suited for homeownership. (For more information on screening
effects, see the sidebar above.)
Although assessing the overall educational success of HEC programs
is difficult, a recent study of HEC delivery methods reinforces
the common-sense view that outcomes improve when financial literacy
training is delivered face to face. The study, conducted by Abdighani
Hirad and Peter M. Zorn of Freddie Mac, tracked delinquency rates
on 40,000 mortgages originated under a program for risky borrowers
that requires participants to complete HEC. It found that borrowers
who received classroom instruction or one-on-one counseling had
significantly lower delinquency rates than borrowers who received
training via telephone counseling or self-study. 14/
Because classroom and one-on-one instruction may require more commitment
from borrowers than the alternatives do, the researchers cannot
say for sure whether the lower delinquency rates result from better
education or simple screening effects. In addition, lower delinquency
rates are only a partial measure of homebuying success, since they
do not indicate the number of people who were turned down in their
attempts to purchase homes. Nonetheless, the study is generally
consistent with other results supporting the idea that face-to-face
training is associated with desirable outcomes.
Evidence mixed but supportive
A review of the research on the effectiveness of financial literacy
training shows that training offered by high schools and workplaces
is associated with improved financial knowledge and behavior. These
associations are especially strong for low-income or less-educated
recipients, supporting the idea that financial literacy training
has the potential to curb predatory lending.
However, the efficacy of HEC is less clear, due to the difficulties
discussed above. Many predatory lending practices involve mortgages,
and the lack of solid evidence about the success of HEC casts some
doubt on the idea that financial literacy training can be an antidote
to those practices.
So, although little is yet known about financial literacy training
specifically targeted against predatory lending, the existing evidence
on other forms of financial literacy training is partly encouraging
and partly discouraging. However, the special factors that raise
doubts about the effectiveness of HEC, like screening effects, might
be overcome by developing delivery channels that reach across the
population of individuals at risk for predatory lending. For this
reason, and because of the favorable evidence on other forms of
financial literacy training, the overall body of evidence seems
generally supportive of the idea that well-designed, appropriately
delivered financial literacy training should be considered as a
tool to prevent predatory lending.
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Annual Report
