How to spell ‘solvency’
In the not-so-distant past, redlining -- the practice of denying financial services to people based solely on their race, sex, surname or address -- deprived many Americans of the opportunity to build a prosperous life. Today many of us still suffer financially. But this time around, we’re limited by too many choices rather than too few.
Financial illiteracy has become the new redlining. Vast numbers of us go to college and own homes and cars. Our kids tote the latest cellphones, and our living room television sets have been replaced by lavish home entertainment centers. But we don’t know how to budget for our households or how to balance our checkbooks. Homeowners who misunderstood or ignored the inherent risks of adjustable-rate mortgages are losing houses to foreclosure in record numbers. (In California, 31,676 households foreclosed in the last quarter of 2007, more than twice as many as the previous record in 1996.) Shoppers who ignored the fine print on credit card agreements helped push consumer bankruptcies up 40%, to 801,840, in 2007. The average college student graduates with $2,200 in credit card debt and is more likely to drop out of school because of financial hardship than because of academic failure.
In part, the problem stems from complexities in today’s credit markets. Forty years ago, a bank making a loan cared whether a borrower could pay it back because the bank held on to the loan in its portfolio. But over the last decade, lenders have been just as likely to package loans, sell them off to faceless investors and wash their hands of further responsibility. With little at stake, lenders have the incentive to loan out more and more money. In the process, they often saddle borrowers with loans they can’t afford or understand.
Policymakers are addressing the most flagrant abuses, such as deceptive marketing of onerous sub-prime mortgages, by clamping down on fraud, simplifying financial disclosures and removing the obstacles that have made it hard for lenders and borrowers to renegotiate loan terms, even when it benefits all the parties involved. But the government shouldn’t act like a nanny -- which means that all of these efforts will be for naught if Americans don’t master basic financial skills.
We must learn to save and budget if we want to keep buying more stuff, not to mention if we want to retire with security and comfort. We must understand the concept of compound interest -- how it works in our favor when we put money each month into our 401(k)s, and hurts us when we pay only the minimum on our credit card bills. We must learn that low monthly payments don’t equal affordability. We must read fine print. We must be aware of the seductive power of marketing and separate our wants from our needs. We must recognize that brokers, bankers and salespeople are trying to make a buck and aren’t necessarily our friends. At the same time, the 10% or so of us who are “unbanked” or “underbanked” -- off the financial grid -- must develop basic trust in financial institutions and must understand that opening bank accounts and establishing credit are prerequisites to success in the 21st century.
Fortunately, efforts to improve financial literacy in the United States are gaining momentum. President Bush created the Treasury Department’s Office of Financial Education in 2002. On Tuesday, he unveiled the President’s Advisory Council on Financial Literacy, which will be co-chaired by investment guru Charles Schwab and Los Angeles-based financial literacy advocate John Hope Bryant, and which will make recommendations for new education strategies and programs in the public and private sectors. The idea isn’t to remove all risk, or to crimp consumer choices. It’s to create a market that empowers citizens, as participants, to build and share in the national wealth -- to live the American dream.