Ben S Bernanke: Increasing economic opportunity - challenges and strategies
Remarks by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal Reserve
System, at the Fifteenth Congressional District of Texas' Fifth Regional Issues Conference,
Washington DC, 13 June 2006.
* * *
I am pleased to be here to discuss some strategies for helping families, particularly lower-income
families, improve their economic and financial well-being. Families today face a financial marketplace
that is increasingly complex, with numerous products and service providers from which to choose.
Today I will touch on several approaches for helping people of modest means take advantage of these
financial opportunities while managing the risks and avoiding possible pitfalls.
Today's financial marketplace
Technological advances have dramatically transformed the provision of financial products and
services in recent years. To cite just one example, the expanded use of computerized credit-scoring
models, by reducing the costs of making loans and by increasing the range of assets that lenders can
sell on the secondary market, has made possible the extension of credit to a larger group of
borrowers. Indeed, we have seen an increasingly wide array of products being offered to consumers
across a range of incomes, leading to what has been called the democratization of credit. Likewise,
technological innovation has enhanced financial services, such as banking services, and increased
the variety of financial products available to savers.
The range of providers in consumer financial markets has also increased, with the number of nonbank
entities offering credit and other financial services having risen particularly quickly. For example, a
recent study of alternative providers of financial services found the number of nonbank check-cashing
establishments doubled in the United States between 1996 and 2001.1 Payday lending outlets, a
source of credit that was almost non-existent a decade ago, now number more than 10,000. And data
from the Survey of Consumers Finances, a triennial survey sponsored by the Federal Reserve Board,
indicate that the share of households with a loan from a finance company increased from 13 percent in
1992 to 25 percent in 2004.
Financial challenges of lower-income families
Despite the increased complexity of financial products and the wider availability of credit in many
forms, U.S. households overall have been managing their personal finances well. On average, debt
burdens appear to be at manageable levels, and delinquency rates on consumer loans and home
mortgages have been low. Measured relative to disposable income, household net worth is at a fairly
high level, although still below the peak reached earlier this decade.
Families with low to moderate incomes, however, face special financial challenges. These families
generally have less of a cushion to absorb unanticipated expenses or to deal with adverse
circumstances, such as the loss of employment or a serious health problem. Results from the Survey
of Consumer Finances show that the median net worth for households in the lowest income
quintile-those whose income placed them in the bottom fifth of the population--was only $7,500 in 2004, well
below the median for all survey respondents of $93,000.2 The Survey data also indicate that
households in the lowest quintile were significantly less likely than the average respondent to maintain
a checking or savings account; almost 25 percent of those families were "unbanked," compared to
less than 10 percent of families in the other income quintiles. The reasons given for not having an
account varied: Some respondents said they would not write enough checks to make having an
account worthwhile, but others were dissuaded by minimum balance requirements or said that they did
not have enough money to justify opening an account. In some cases, a lack of knowledge about the
services that banks offer or even a distrust of banks is likely a factor.
The Survey also found that lower-income households are less able than others to manage their debts.
A greater fraction of these households had debt-to-income ratios of 40 percent or more or had a
payment past due at least sixty days. The data also reveal that only 40 percent of families in the
lowest quintile own a home, compared with a homeownership rate of 69 percent among all families
surveyed. Finally, the data on retirement account ownership show an even larger gap, with only 10
percent of lowest-quintile families holding a retirement account, whereas 50 percent of all families
responding to the survey reported participation in some type of retirement savings plan.
How can these disparities be addressed? Some general approaches to helping families of modest
means build assets and improve their economic well-being include community economic development,
financial education, and programs that encourage saving and investment. In the remainder of my
remarks, I will discuss each of these approaches briefly and offer some insights into their effectiveness
based on research and experience.
Community economic development
In my time with the Federal Reserve, I have had a number of opportunities to meet with community
economic development leaders--representatives of groups working to assist lower-income families
become homeowners, start small businesses, better manage their finances, and save for the future. In
fact, my first trip as a Federal Reserve Board member was to Brownsville, Texas, where I saw how a
grassroots nonprofit organization is helping to build communities and to provide residents with the
chance to build wealth through homeownership. The Community Development Corporation (CDC) of
Brownsville works with multiple funding partners--governments at all levels, financial institutions,
foundations, and corporations--to construct housing and to design innovative loan products that
enable low-income families to qualify for mortgage credit. For example, because of the mix of funding
sources, mortgage loans can be offered with features such as down-payment assistance or a
belowmarket interest rate. The CDC of Brownsville also offers a program that allows prospective
homeowners to acquire "sweat equity" in a property by working on construction teams to help build
their own new home and those of other participating families.
As in the case of many community development organizations, the Brownsville CDC has also made
financial education a critical element of its efforts to help lower-income residents improve their financial
status. For example, participation in financial counseling or in an education program is typically
required for a borrower to obtain a loan through the CDC or through one of its lending partners.
However, the broader aim of these programs is to improve borrowers' prospects for longer-term
success in maintaining their credit and handling their overall finances. Since 1994, through this
combination of leveraged financing arrangements and borrower education, the CDC of Brownsville
has helped make homeownership possible for more than 2,500 low-income families. I cite the
Brownsville example because of the opportunity that I had to learn about their work (and I recently had
a similar opportunity to see some impressive community development efforts in the Anacostia
neighborhood of the District of Columbia). But this localized approach to community development and
wealth-building is playing out in neighborhoods throughout the country, in most cases through
strategies tailored to the distinct needs of the particular community.
Financial education and financial literacy
Financial education has not only been integral to community development but has also begun to play
a larger role in the broader consumer market. Clearly, to choose wisely from the wide variety of
financial products and providers available, consumers must have at least basic financial knowledge.
People who understand the financial aspects of purchasing a home or starting a business, or who
appreciate the importance of saving for children's education or retirement, will almost certainly be
economically better off than those without that vital information. Financial literacy can be acquired
through many channels: in school, on the job, through community programs and counseling, or
through self-education and experience.
Studies generally find that people receiving financial education or counseling have better financial
outcomes. For example, research that analyzed data on nearly 40,000 mortgage loans targeted to
lower-income borrowers found that families that received individual financial counseling were less
likely later to become delinquent on their mortgage payments.3 Similarly, another study found that
borrowers who sought and received assistance from a credit counseling agency improved their credit
management, in particular, by reducing the number of credit accounts on which they carried positive
balances, cutting overall debt, and reducing delinquency rates.4 More broadly, the research shows
that financial knowledge is correlated with good financial outcomes; for example, individuals familiar
with basic financial concepts and products have been found to be more likely to balance their
checkbook every month, budget for savings, and hold investment accounts.5
Studies that establish an association between financial knowledge and good financial outcomes are
encouraging, but they do not necessarily prove that financial training and counseling are the causes of
the better outcomes. It could be, for example, that counseling is associated with better financial
outcomes because the consumers who choose to seek counseling are the ones who are already
better informed or more motivated to make good financial decisions. In medicine and other fields,
researchers gain a better understanding of what causes what by doing controlled studies, in which
some subjects are randomly assigned a particular treatment while others do not receive it. To translate
this idea to the analysis of the effects of financial counseling, the Federal Reserve Board's Division of
Consumer and Community Affairs is collaborating with the Department of Defense to conduct a
threeyear study of the effects of financial education. This study will evaluate the impact of various
educational programs on the financial decisions of soldiers and their families. It includes a treatment
group of those receiving financial education, with the programs each family receives and when they
receive it being determined randomly, and a control group of similar soldiers and their families who
have not received this formal financial education. Because assignments of individuals to programs will
be random, any observed changes in behavior can be more reliably attributed to the type and amount
of counseling received. Among other things, the results of this study should help us better understand
whether financial education leads to changes in behavior for participants in general or only for those at
critical teaching moments, such as the period before making a major financial decision such as
choosing a mortgage.
I would like to say just a few words about the Federal Reserve's broader role in promoting consumers'
understanding of financial products and services. Beyond conducting surveys of consumers and doing
research, we work in a number of ways to support consumers in their financial decisionmaking. For
example, through our consumer protection rule-writing authority, the Federal Reserve sets
requirements that specify the information that must be disclosed to consumers about the terms and
fees associated with credit and deposit accounts. These disclosures provide consumers with the
essential information they need to assess the costs and benefits of financial services and compare
products among different providers. We are currently reviewing many of our disclosures and plan to
use focus groups and other methods to try to make these disclosures as clear and as user-friendly as
possible.
The Federal Reserve System also works to promote financial education and financial literacy through
various outreach and educational activities. We provide a great deal of substantive financial
information, including interactive tools for economic education, on our education website
http://www.federalreserveeducation.org/. The website links to a wide variety of financial education
resources at the local, regional, and national levels.
Additionally, the Federal Reserved Board collaborates with educational and community development
organizations to support their efforts. Our national partners include the Jump$tart Coalition for
Personal Financial Literacy, the Conference of Mayors' DollarWi$e Campaign, Operation HOPE, the
American Savings Education Council, and America Saves, among others. At the regional level, the
twelve Federal Reserve Banks work with organizations to support financial education and financial
literacy. For example, the Federal Reserve Bank of Cleveland has worked with community financial
educators to form regional networks that combine resources and share best practices. The Federal
Reserve Bank of Chicago sponsors "MoneySmart Week," partnering with banks, businesses,
government agencies, schools, community organizations, and libraries to host activities designed to
help consumers learn how to manage money. The Federal Reserve Banks of San Francisco and
Minneapolis have worked with leaders in the Native American community to develop financial
education materials. My recent testimony to Congress on financial literacy provided information on
many other projects and programs.6 The Federal Reserve will continue to make financial education a
priority.
Strategies to encourage saving
Even if people know that they would be better off if they saved more or budgeted more wisely, we all
know from personal experience that translating good intentions into action can be difficult. (Think
about how hard it is to keep New Year's resolutions.) The field of behavioral economics, which studies
economic and financial decisions from a psychological perspective, has cast new light on consumer
behavior and led to recommendations about how to improve people's financial management. For
example, studies of individual choices in 401(k) savings plans strongly suggest that workers do not
pay adequate attention to their saving and investment decisions. Notably, despite the tax advantages
of 401(k) contributions and, in some cases, a generous employer match, one-quarter of workers
eligible for 401(k) plans do not participate. Studies have found, however, that if firms change the
presentation of the plan from an "opt-in" choice to an "opt-out" choice, in which workers are
automatically enrolled unless they actively choose to remain out of the plan, participation rates
increase substantially.7 The impact of changing from "opt-in" to "opt-out" is particularly evident for
younger and lower-income workers, who may have less financial expertise.
In addition, participants in savings plans evidently do not understand the various investment options
that are offered. A survey by the investment management firm, The Vanguard Group, found that many
plan participants cannot assess the risk inherent in different types of financial assets; for example,
many did not appreciate that a diversified equity mutual fund is generally less risky than keeping most
of one's wealth in the form of the employer's stock.8 Indeed, employees appear to invest heavily in
their company's stock despite the fact that their income is already tied to the fortunes of their
employer. More than one-quarter of 401(k) balances are held in company stock, and this high share
arises not only from an employer match but from voluntary purchases as well.9
These insights into consumer behavior have prompted some changes in the design of retirement plans
and in education programs focused on saving for retirement. More employers now feature automatic
enrollment in their 401(k) plans in an effort to boost participation. Also, some have set the default
investment option to a diversified portfolio that is rebalanced automatically as the worker ages or have
set contribution rates to rise automatically over time in line with salary increases.
However, although these changes in program design may boost saving and improve investment
choices, they are not a substitute for continued financial education. Employers, including the Federal
Reserve Board, offer financial education at the workplace to help their workers gain a better
understanding of retirement savings options. Helping people appreciate the importance of saving and
giving them the tools they need to translate that knowledge into action remain major challenges.
Conclusion
Let me close by observing that many factors influence consumer financial behavior. Financial
education is clearly central to helping consumers make better decisions for themselves and their
families, but policymakers, regulators, nonprofit organizations, and financial service providers must all
help ensure that consumers have the tools and the information they need to make better decisions.
Success can only come through collaborative efforts. I see much interest today in increased
collaboration toward these objectives, both in Washington and around the country.
Thank you for the opportunity to speak with you today. I encourage you to continue working together
to help provide increased economic opportunity in your communities, and I wish you the best of luck in
your efforts.