Banking and Financial Services
Congressional Newsletter
A series of periodic updates to Congress on RAND's work in banking and financial services

As we move from Financial Literacy Month in April to May, we turn to the upcoming RAND Behavioral Finance Forum on May 10, which is focused on consumer financial protection. Dr. Jonathan Zinman, a member of the forum, will speak at the May event.

What Can We Do to Help Consumers and Prevent the Next Financial Meltdown?

Jonathan Zinman

Jonathan Zinman is a tenured Associate Professor of Economics at Dartmouth College, and Director of the new U.S. Household Finance Initiative of Innovations for Poverty Action. He also serves as a member of the Consumer Advisory Council to the Federal Reserve Board, a Visiting Scholar at the Federal Reserve Bank of Philadelphia, a member of the RAND Behavioral Finance Forum, a research affiliate of Innovations for Poverty Action (IPA) and the M.I.T. Jameel Poverty Action Lab, a research associate of the National Bureau of Economic Research, a Research Advisory Board member of stickk.com and HelloWallet, and a member of the Sage/Sloan Foundations working group on Behavioral Economics and the Regulation of Retail Financial Markets. He applies his research by working with policymakers and financial institutions around the globe and works directly with institutions to develop and test innovations throughout the retail space that are profitable for firms and beneficial to their clients.

What kinds of consumer protection actions have been taken after the financial meltdown?

Some sensible steps have been taken to prevent fraud. The research we have right now indicates some limitations and tradeoffs associated with a couple traditional approaches to protection -- namely price regulation and upfront disclosure -- that are worth taking into consideration.

But you're a behavioral economist. Don't you think consumers need protecting?

Evidence from the intersection of psychology, economics, and other disciplines suggests many consumers do struggle with financial decisions (and other decisions involving trade-offs over time). But evidence on whether traditional approaches to protection make consumers better off -- or make markets work better -- is mixed at best.

But wouldn't many consumers benefit if financial institutions were forced to charge them lower rates or fees?

Some might benefit, but price regulation "rations" consumers out of the market, and there's no convincing body of evidence showing that consumers would necessarily be better off. Even if consumers struggle to make good financial decisions, if they are rationed out of the market (even if the market is a pretty expensive one, like credit cards or payday loans), the evidence shows that one possible response might be that they end up borrowing in an even more-expensive and less-regulated market.

What about disclosure regulation? Don't we want people to make informed decisions?

Absolutely. Key issues here are who provides the information, and when. As for the who, many lenders have strong incentives to either not disclose or to neutralize the effect of good disclosures with intuitive but misleading product presentation. So mandated disclosure can be expensive to enforce effectively and end up raising prices overall (my paper with Victor Stango on Truth-in-Lending finds effects along those lines). As for the when, there's growing evidence that an exclusive emphasis on upfront disclosure is misplaced: People forget or discover later that some information they ignored upfront (e.g., penalty fee schedules) is actually important. So, we need to look broadly -- beyond the upfront disclosure-- at how financial service providers and third parties communicate with consumers.

So, what can be done to protect consumers?

Evidence suggests focusing on the context in which people make decisions. Getting and maintaining consumers' attention about financial decisions seems to be at least as effective as actually informing them. There is evidence indicating that developing products designed around how people actually make financial decisions and that help people make better decisions seems to be more effective than price regulation.

Do attention-getting interventions actually work?

There is some evidence they do. Three banks randomly sent reminders to new savings account customers and found that deposits increased. This builds on similar evidence from clinical trials on medication compliance and other behaviors. In another study, we found that people who took surveys that simply mentioned overdrafts were subsequently less likely to pay overdraft fees, both in the short-term, and over the long-term as they took more such surveys.

Does product development based on behavioral economics actually work?

Much more work remains, but the evidence so far is encouraging. Save More Tomorrow has been very effective at increasing workplace retirement contributions. Commitment savings accounts, where people voluntarily restrict access to their own balances or even post performance bonds, have been shown to help people save more. We are now applying many of the same levers used in behavioral savings product design -- commitment, attention, and simple decision aids -- to debt reduction. For many people, the best investment they can make is paying down debt. Our pilot test of Borrow Less Tomorrow finds strong demand for this new product, and there is some preliminary evidence that it is in fact helping people reduce debt loads.

There's a lot of interest in using behavioral economics to inform policy. What are your thoughts?

The approach is hugely promising. But in many cases I feel like we're a few years away from having a good evidence base for writing policy prescriptions. Most of the empirical evidence so far is about how behaviorally motivated interventions can change behavior, not about whether those changes actually improve overall consumer outcomes or market efficiency. For example, we've learned a lot about how to get people to make more deposits into savings or investment accounts. But we know a lot less about whether people undo the long-term effects of that behavior by simultaneously borrowing more.

So are policymakers misguided in looking to behavioral economics for insights?

Not at all. It's just a question of timing -- of how robust we think the evidence base should be before changing policy. I'm confident researchers can continue working with other stakeholders to fill in the evidence gaps, design innovations for both products and policy that meet consumers where they're at, and implement successful innovations at scale. But this work will take some time, and to me, taking behavioral economics seriously means taking a holistic view of consumer decisionmaking and its richness. And that means we shouldn't be satisfied with blunt approaches to policy, or with coarse measures of whether behavioral interventions actually help people make better decisions and produce better-functioning markets. We should set the bar high because we're on track to clear that bar with room to spare.

RAND Behavioral Financial Forum: Consumer Financial Protection

On May 10, 2011, the RAND Corporation is hosting the 2011 Behavioral Finance Forum (BeFi) in Washington, D.C. The purpose of the meeting is to discuss trends and new policy options in consumer finance with academics, industry experts, members of Congress, their staff, and other policymakers. The agenda is replete with top-academics pitching new ideas and discussing emerging issues in the area of consumer financial protection, including sessions on protecting consumers from themselves and from borrowing mistakes and making decisions about home ownership.

Agenda: http://www.rand.org/events/2011/05/10/event.html

Read more about the Financial Literacy Center and view videos from the 2010 Financial Literacy Research Consortium: http://www.rand.org/labor/centers/financial-literacy.html

RAND CONGRESSIONAL RESOURCES STAFF

Lindsey Kozberg
Vice President, Office of External Affairs

Winfield Boerckel
Director, Office of Congressional Relations

Nancy Camm
Senior Financial Services Legislative Analyst, Office of Congressional Relations

RAND Office of Congressional Relations
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