April 10, 2013

President Trumpets 'Financial Capability' While Undermining It

Hester Peirce

Former Senior Research Fellow
Summary

The President proclaimed April to be National Financial Capability Month, a new twist on what used to be called financial literacy month. Who can argue with wanting to make sure that people have "access to the information and tools that empower them to operate safely and smartly in the marketplace"? The strategy being employed to achieve this objective is the problem. At the same time the government is talking about financial capability, its regulatory policy is undermining-not building up-financial capability.

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The President proclaimed April to be National Financial Capability Month, a new twist on what used to be called financial literacy month. Who can argue with wanting to make sure that people have "access to the information and tools that empower them to operate safely and smartly in the marketplace"? The strategy being employed to achieve this objective is the problem. At the same time the government is talking about financial capability, its regulatory policy is undermining-not building up-financial capability.

A person who is capable of doing something has the necessary skills and ability to perform the task. She does not look to someone else to make decisions for her, although she may go to others for advice. Financial capability, therefore, presumably means the ability to effectively work through financial decisions.

Part of the financially capable consumer's decision-making process is asking a lot of tough questions of the businesses offering her their financial products and services. Competition gives these companies an incentive to provide the consumer with a useful, reasonably-priced product or service. She knows, however, that those companies are not as interested in her welfare as she is and don't understand her everyday realities and long-term plans the way she does. She employs a healthy skepticism in evaluating the options companies present her and does not assume that they know which product or service would best serve her needs. If something sounds too good to be true, the financially capable consumer demands more information and walks away if she does not get it.

Regulators like to talk about financial capability and they set up lots of programs to foster it. When it comes to regulating, however, they send a very contrary message. Their regulations assume financial incapability. The regulatory framework seeks to reassure consumers that the products and services out there have a regulatory seal of approval. It has the effect of lulling them into believing that everyone has their best interests in mind and discouraging them from thinking critically about the products and services they are buying.

Take the Bureau of Consumer Financial Protection's recently adopted mortgage rules. Under the rules, lenders must ensure that borrowers have the ability to repay their mortgages. Providers of "qualified mortgages"-mortgages that the bureau thinks won't harm consumers-enjoy certain legal protections from subsequent challenges by borrowers that the lender did not appropriately assess their ability to repay. These regulations send the message to consumers that they need not put any thought into taking out a mortgage, because the lender-operating under the regulator's strictures-will make sure they get the right loan.

As another example, look at the Securities and Exchange Commission's reluctance to implement the JOBS Act, a package of reforms intended, among other things, to lift some of the constraints on capital raising. A general disbelief that investors can make sound financial decisions underlies the agency's unwillingness to lift the ban on advertising certain securities offerings or to allow investors to participate in equity crowdfunding.
Regulators have an important role to play in facilitating useful disclosure about securities and financial products and shutting down fraudsters. Regulators can't do their job effectively, however, if they discourage investors and consumers from taking a central role in their own protection.

Financial education campaigns don't empower consumers if regulators are simultaneously adopting rules that deprive investors and consumers of their ability and responsibility to make decisions. Why should Americans heed the President's call to "observe this month with programs and activities to improve their understanding of financial principles and practices"? As long as the U.S. regulatory system presumes consumers and investors to be financially incapable, they won't be able to put those principles into practice.