Financial Literacy: A Primer for Policymakers

April 2005

Full Text Contents

Financial Literacy for Students ...........2
Financial Literacy for Adults...............4
How Effective Are Financial
Literacy Programs? .........................6
Legislative Policy Options ..................6
Appendix. Recent State
Legislation Regarding Financial
Literacy ......................................9
Notes ........................................13

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By Heather Morton

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American consumers have more credit options today than ever before. With the availability of goods and services at an all-time high, it is critical that people be educated about their finances. Many Americans find themselves deep in debt and not saving as much as they once did. Record numbers of homeowners are refinancing their mortgage loans to take advantage of the lowest rates in history, and college students receive many unsolicited credit card offers. In addition, record numbers of consumers are declaring personal bankruptcy—well above 1.5 million bankruptcies were filed in 2003. A higher income does not automatically trigger financial knowledge; even well-educated, higher-income consumers may live paycheck to paycheck because they lack the skills to budget or manage their money.

Annual percentage rate, balance transfer fees, private mortgage insurance, reverse mortgage, prepayment penalties, balloon payments, and negative amortization are among the important financial terms that consumers should understand to make informed financial decisions in their lives. Recent surveys show that many Americans lack the basic financial knowledge necessary to spend their money wisely; save for the future; and manage money challenges such as a job loss, financing a college education, or a catastrophic injury. In a recent survey conducted on behalf of, more than half the 1,000 survey participants scored 67 or fewer points out of a total 100—the equivalent of a “D” or an “F” grade in school. Jump$tart Coalition for Personal Financial Literacy’s fourth biennial survey found similar results.  Students in Jump$tart’s survey did a better job of answering questions about income and spending (answering 62.9 percent and 55.4 percent of these questions correctly, respectively) than they did about money management and saving (45.4 percent and 41.0 percent, respectively).

What is financial literacy? At its core, the concept of financial literacy is money management knowledge and skills. A financially literate person is able to read, analyze and communicate about financial issues. This includes the ability to balance a checkbook, read and understand a contract, and plan for retirement and the future. Financial literacy is not a static skill; individuals need to be able to continue to gain new knowledge and skills as their circumstances and financial systems change.

Today, consumers have numerous choices that affect their financial well-being as they select checking accounts, savings accounts, retirement accounts, credit cards, long-distance and local telephone services, Internet and broadband services, electric utility services, health care plans, and cellular telephone services, among other financial choices. Alan Greenspan, chairman of the Federal Reserve Board, recently noted, “Today’s financial world is highly complex when compared with that of a generation ago. Forty years ago, a simple understanding of how to maintain a checking and savingsaccount at local banks and savings institutions may have been sufficient. Now, consumers must be able to differentiate between a wide range of financial products and services, and providers of those products and services.”

Financial literacy is also part of any comprehensive strategy to help lower-income families build assets. The Pennsylvania Governor’s Task Force for Working Families concluded that, “ … a lack of financial training and education coupled with the absence of basic forms of asset protection like health and life insurance, can expose working families to serious and often preventable misfortunes, limit their opportunities to accumulate assets, hold back their upward mobility, and actually strip them of everything they’ve worked for.”

Many groups are becoming involved to help consumers gain financial skills. Educators, community organizations and financial institutions are actively creating financial literacy programs so that consumers will be better equipped to make financial decisions. State legislators and other policymakers also are crafting policies to ensure that consumers gain the financial know-how to deal with the ever-increasingly complex financial markets.

Not only do financial-savvy consumers help themselves, but they may also help keep the marketplace more efficient. In classic economic theory, rational and knowledgeable consumers provide the checks and balances that help to keep the unscrupulous out of the marketplace. Although educated consumers may help prevent fraud and other unscrupulous practices, financial literacy is not the only solution to fraudulent behavior.

Financial literacy cannot replace consumer protection laws that address the unscrupulous in the financial market. North Carolina Commissioner of Banks, Joseph A. Smith Jr., said, “The imbalances in the marketplace can be corrected, if they are corrected at all, by a number of means. Governmental intervention is one such means; consumer financial literacy is another. Governmental intervention and consumer financial literacy are not alternatives, rather they complement each other.”

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