Your financial illiteracy is good for banks

By October 21, 2020Education, Finance
The Hutch Report

One of the fallacies of education is that if somebody has a list of impressive academic achievements, they are highly knowledgeable and intelligent. Yet knowledge does not equate to intelligence. Knowledge is the collection of skills and information a person has acquired through education and experience. Intelligence is the ability to apply that knowledge. Equally, just because someone lacks knowledge of a particular subject doesn’t mean they can’t apply their intelligence to help solve problems.

The chasm that exists between knowledge and intelligence is no clearer than in the field of personal finance, as Americans face a record $13 trillion in debt. Although the current Covid pandemic did take many by surprise, a recent article in Time magazine highlights: 

“While some face new challenges resulting from loss of income or uncertainty for the future, for many the current economic crisis only exacerbates already present stressors related to monthly bill payments, consumer debt balances, lack of emergency savings, or even just putting food on the table.”

Basic math skills is a requirement for all public schooling, yet the ability to use standard addition, subtraction, multiplication and division to solve problems seems to be lost when it comes to dealing with money. Colleges may make students take biology, history, and other classes as general education requirements, but learning anything about saving, investing, and how financial markets work is purely an option.

In a previous article (Are you educated?) we highlighted the current weaknesses in the education system and the need to rethink methods and curruculum that may be more suited and effective in today’s fast changing world. It maybe important to now ask, “Should financial literacy be an educational requirement?”

You would think the answer would be a resounding “yes” but this is not the case. There are a large number of businesses that thrive on keeping the population financially illiterate. In their book: Simple: Conquering the Crisis of Complexity, Irene Etzkorn and Alan Siegel point out that “banks, credit card companies, insurers and other types of businesses find ways to make money from the fine print nobody can read or understand,” and that “lawyers have inundated us with mind-numbing disclaimers, disclosures, terms, instructions, amendments and amendments to amendments” to “avoid lawsuits or other potential problems.”

Every time a bank’s client uses their debit card, write a check or withdraw funds, the balance in their bank account goes down. According to the Center for Responsible Lending, “Banks collected more than $11.68 billion in 2019 through abusive overdraft practices that drain consumers’ checking accounts.” 

Not understanding personal finance means that most clients don’t understand the fees they are charged, how credit card interest charges accumulate, how to construct or stick to a budget, and so many more facets of basic money management. Some are lacking in knowledge, some in intelligence and those that lack in both are a windfall for financial institutions.  In finance, as in healthcare, when people don’t know what they are paying, service providers have no real incentive to lower costs.

The financial industry has made it a practice to make sure that investing is very complicated. They have a tendency and flair for developing the most complex names possible (even the guys selling these products are not entirely sure of what they mean), examples such as collateralised mortgage obligations, leveraged index funds, credit default swaps, or synthetic CDOs. As Mark Hanna put it in The Wolf of Wall Street, “The name of the game: moving the money from your client’s pocket to your pocket.”

Boris Vallée, a PhD in Finance from HEC Paris, points out that, “The fact that banks use persuasion techniques, by giving products magical names such as ‘Unicorn’ or ‘Elixir’ in an environment where we should be thinking rationally is illustrative of their targeted strategy.”

Banks are a business and expect to make profits but there is a good argument to show that they have taken this way too far. They don’t call them “predatory banks” for nothing. 

The growing wealth inequality gap and the increasing level of personal debt may have some ringing the alarm bells to make some changes. 

A new report from the Council for Economic Education found that the number of states that require a high school student to take a personal finance course — either a standalone class or integrated into other coursework — in order to graduate has risen to 21.

According to a 2019 report by Montana State University researchers Carly Urban and Christiana Stoddard, financial education decreases the likelihood of holding credit card balances, and the education reduces higher-cost private loan amounts for borrowers. 

This bodes well for future generations, however, what is the solution for the current portion of the population that left school years ago, financially illiterate and mired in debt? That is not immediately clear as household debt surged in 2019, marking the biggest annual increase since just before the financial crisis, according to the New York Federal Reserve.