Could Behavioral Finance Play a Role in Boosting Our Economic Health?

Times are a bit bleak in these United States. Between mass shootings, hurricanes, political turmoil, a resurgent white supremacist movement, threats of a nuclear showdown with North Korea, massive consumer data breaches, and uncertainty over immigration, healthcare, and other major domestic policies, it has not been an easy year for many of us.

The resulting angst from this chaotic stew hangs over the country like thick fog, and it could go on to impact not only our individual lives, but also the country’s financial health for years to come. That was one big takeaway from a recent gathering of behavioral economists, who study how psychological and social factors affect the financial decisions of individuals and institutions, as well as the consequences for market prices, returns, and resource allocation.

Last month, the University of Michigan’s Center on Finance, Law, and Policy and ideas42 hosted a behavioral finance symposium to examine these issues and discuss new financial products being developed by the government and private sector, re-writing investment rules, utilizing technology to spark innovation and better protect consumers, and how behavioral factors might influence future national policymaking.

The Center for Financial Services Innovation (CSFI), a non-profit organization on a mission to improve the financial health of all Americans and use finance as a force for societal good, was at the symposium to detail its work helping financial institutions and service providers become part of the solution. (Also speaking at the symposium was Nobel Laureate Robert Shiller; see the sidebar at the end of the article for some of his thoughts on behavioral finance and consumer protection.)

First, let’s look at some of the grim statistics. According to CSFI, 57 percent of Americans are struggling financially; 43 percent of the country struggles to pay bills and credit payments; 30 percent say they could only make ends meet for three months or less if they were to experience a sudden drop in income; and 27 percent have less than $1,000 saved for retirement.

“The financial health of Americans is generally pretty bad—our organization has spent 13 years measuring it,” says Karen Andres, the CSFI’s vice president of network engagement.

But the current ill financial health of the country is not, as many assume, a problem of financial literacy or not knowing enough, Andres explains.

“The dominant narrative is that consumers just need better financial education, but nobody knows how to manage money better than people without it,” she says. “There are a lot of structural issues at play, like rising income inequality, and the cost of living rising at a higher rate than wages. But I think a lot of it is a mismatch between financial services and customers.”

Financial institutions are designing products based on the default assumption that their customers get a paycheck every week or two, but that’s not the case for a growing number of people, Andres points out.

“People are dealing with a shocking amount of income volatility, even people with higher-paying jobs,” she says. “If your expenses spike at the same time your income dips, you can get in real trouble.”

The CSFI defines financial health as “daily financial systems helping in the face of emergencies and seeding opportunities when they come,” Andres says. “If the daily systems are not working right and nudging good decisions, then consumers are not able to be as resilient and it creates a cascading effect. Our focus is on getting daily systems healthy.”

Much of Andres’s work involves building a network of financial services providers from a wide variety of entities and connecting them to research, ideas, and innovations. Members of CSFI’s network of more than 100 providers includes PayPal, Bank of America, Visa, JP Morgan Chase, GreenDot, Wells Fargo, and CapitalOne.

The CSFI also, in partnership with JP Morgan Chase, runs a Financial Solutions Lab, an incubator that aims to find, test, and scale promising ideas to help people improve their credit and build wealth. Every year, the lab puts out a call for specific financial services solutions and chooses up to 10 participants from hundreds of applicants, Andres says. They get cash, coaching, and access to the organization’s network while they develop and test their products. Andres says the lab is currently in the third year of a five-year program.

“The [lab participants] are not there for the money, but to be part of a community of like-minded companies,” she adds. “Some companies may have built a model using a punitive strategy, but the folks we deal with are interested in a different model.”

Andres would like to see financial product innovations like the ones CSFI’s lab churns out considered less of a bogeyman by the general public. Although industry innovation may have brought us synthetic CDOs and sub-prime mortgages, it also led to automatic 401k enrollment at many places of employment. She calls automatic 401k enrollment “probably the most successful tool ever to modify financial behavior.”

Andres, who has a background in retirement planning, experienced the challenges of modifying financial behavior firsthand during discussions with her former clients, and she’s deeply concerned about what will happen when entire generations of Americans hit retirement age with empty bank accounts. “I had engineers, even, saying, ‘Here’s $15,000 I have saved for retirement and that’s it.’”

Andres also sees structural issues at play here, especially when it comes to the role of government and employers in retirement saving. “There are big questions we haven’t addressed, and I do think we’re in for a bit of a crisis,” she says.

Andres, whose group hasn’t yet met with President Trump, says the federal Consumer Financial Protection Bureau had been working on a “more behaviorally driven” definition of financial health, which could then inform future policymaking. But that was before the election last November; since then, she’s not sure what’s been happening at the federal level. Regardless, she says she’ll spend 2018 spreading the gospel about her organization and its mission to improve the country’s economic behavior with the help of financial institutions.

“I hope that [CFPB] work will survive,” she says. “In general, our members are not clear on what a Trump Administration will mean. We’re starting to see more industry innovation, but the government will have a big role to play.”


A Conversation with Robert Shiller
Michigan native, Nobel Laureate, and Yale economics professor Robert Shiller was a keynote speaker at U-M’s behavioral finance symposium, and his research has changed the way economists study markets and behavioral finance. He is perhaps best known for his landmark book “Irrational Exuberance,” which was first published in 2000. He was seen as a Cassandra when the stock market crashed just weeks after “Irrational Exuberance” hit bookshelves arguing that the market was overvalued, an unpopular viewpoint at the time.
In Shiller’s opinion, the potential crises facing the nation when Generation X hits retirement with only minuscule amounts of savings, or an automated society displaces the human workforce, might simply be the newest manifestations of the world’s never-ending Darwinian struggle.
“As you’re trying to prevent this problem [of artificial intelligence displacing workers], it’s fighting the laws of nature,” Shiller says. “We should set up a national policy now [saying] that we won’t let this happen in our country, and maybe that will help us create something like a universal basic income in the future. I think a lot of people are worried about it. I talked about this in my book—[uncertainty about the future] could boost prices of long-term assets. Maybe that’s part of the reason the stock market is high.”
Shiller is currently working on a book that expands on a presidential lecture he recently gave regarding the current behavioral narratives driving our economy and stock market. He is worried about the Trump administration’s ability to protect consumers from the predations of financial institutions, and earlier this year, he joined other Nobel laureates in signing an open letter to the president and Congress urging them to strengthen the role of science in national policymaking.
He doesn’t see why the federal government couldn’t create an ad campaign modeling healthy financial behavior the same way the government did 30 years ago to educate citizens about the perils of drunk driving.
“We can advocate that,” he says. “The usual reaction to some [financial] abuse was to require that they put language in the contract, and Elizabeth Warren is famous for pointing out that the contracts themselves are in a sense abusive, so your standard credit card contract—how many people read that and think, well everyone else is signing it, so I’ll sign it. But it has language in it that is buried, so you have to read carefully to find it, about raising your rates if you miss a payment. People get stuck, and it doesn’t warn you that you can get caught.”
His advice for young investors with questions about retirement savings? “There’s a book by Ian Ayres arguing that young people should leverage up and borrow to buy stocks because, for them, any investment they make is really a small fraction of their lifetime wealth, so in order to keep a proper portfolio, they should be leveraging. If you’re planning on buying a house and need a down payment, maybe don’t put that in the stock market.”

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