Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
on
The Federal Government’s Role in Empowering Americans to Make Informed
Financial Decisions
before the
Subcommittee On Oversight Of Government Management, The Federal
Workforce, And The District Of Columbia of the Committee On Homeland Security
And Governmental Affairs;
United States Senate;
Room 342, Dirksen Senate Office Building
April 30, 2007
Chairman Akaka, Senator Voinovich and members of the Committee, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC)
regarding the federal government’s role in empowering Americans to make informed
financial decisions.
My testimony will discuss a number of specific programs undertaken by the FDIC aimed
at improving financial literacy and enabling individuals and families to build wealth. In
particular, my testimony describes the FDIC’s Money Smart program and the results of
a recently completed survey of the program’s effectiveness. This study substantiates
the long term beneficial changes in behavior that result from financial literacy education.
In addition, my testimony will discuss the importance of integrating financial education
into school curriculums and FDIC activities in this area. Finally, my testimony will briefly
touch on FDIC efforts to increase access to financial services and to provide
alternatives to predatory lending for consumers.
The Importance of Financial Literacy
Today’s financial landscape is far more complicated than just a generation ago when
many individuals’ financial transactions were limited to checking and savings accounts
and perhaps a home mortgage with their local bank. Deregulation and technological and
market innovations over the past forty years have vastly expanded the types and
providers of financial services available to the average consumer. In the current
financial marketplace, transactions are increasingly occurring outside of bank branches,
electronic payments are usurping cash and checks, and new credit products are being
created to reach all sectors of society.
A consequence of the growth in new financial products and services that have facilitated
the “democratization” of credit is that financial knowledge has become an essential
ingredient for intelligent consumer choice. While innovations in the financial services
industry have dramatically improved many households’ access to credit, this improved
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
on
The Federal Government’s Role in Empowering Americans to Make Informed
Financial Decisions
before the
Subcommittee On Oversight Of Government Management, The Federal
Workforce, And The District Of Columbia of the Committee On Homeland Security
And Governmental Affairs;
United States Senate;
Room 342, Dirksen Senate Office Building
April 30, 2007
Chairman Akaka, Senator Voinovich and members of the Committee, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC)
regarding the federal government’s role in empowering Americans to make informed
financial decisions.
My testimony will discuss a number of specific programs undertaken by the FDIC aimed
at improving financial literacy and enabling individuals and families to build wealth. In
particular, my testimony describes the FDIC’s Money Smart program and the results of
a recently completed survey of the program’s effectiveness. This study substantiates
the long term beneficial changes in behavior that result from financial literacy education.
In addition, my testimony will discuss the importance of integrating financial education
into school curriculums and FDIC activities in this area. Finally, my testimony will briefly
touch on FDIC efforts to increase access to financial services and to provide
alternatives to predatory lending for consumers.
The Importance of Financial Literacy
Today’s financial landscape is far more complicated than just a generation ago when
many individuals’ financial transactions were limited to checking and savings accounts
and perhaps a home mortgage with their local bank. Deregulation and technological and
market innovations over the past forty years have vastly expanded the types and
providers of financial services available to the average consumer. In the current
financial marketplace, transactions are increasingly occurring outside of bank branches,
electronic payments are usurping cash and checks, and new credit products are being
created to reach all sectors of society.
A consequence of the growth in new financial products and services that have facilitated
the “democratization” of credit is that financial knowledge has become an essential
ingredient for intelligent consumer choice. While innovations in the financial services
industry have dramatically improved many households’ access to credit, this improved
access has not always resulted in improvements in household welfare. Lack of
adequate financial knowledge can lead consumers to make poor financial decisions.
Recent problems in the subprime mortgage market illustrate how increasingly complex
products can lead to poor product choices for consumers who do not fully understand
them. Beginning in 2003, complicated new financial products -- particularly, the so-
called “2/28” or “3/27” mortgages and other hybrid adjustable rate mortgages (ARMs) --
exploded in popularity in the subprime market. These loans are characterized by a low
initial starter rate that increases significantly after the first two or three years under
complex formulas, creating a “payment shock” of 30 percent or higher and rendering the
loan unaffordable for many borrowers. In some cases aggressive or misleading
marketing of the lower starter rates, without full disclosure of the significantly higher
costs, obscured key features and costs of the loans. Moreover, there often existed other
options than a hybrid ARM -- such as a fixed rate loan with the same lender -- that
would have avoided the payment shock altogether for only a marginally higher payment
in the early years of the loan.1
In a July 2004 study,2 the Consumer Federation of America (CFA) concluded that the
consumers most likely to purchase complex ARMs were among the least likely to
understand these products. In a 2006 follow-on study,3 the CFA found that consumers
using interest-only and payment-option ARMs were more likely to be from a middle- to
lower-income population segment, minorities, and have weaker than average (less than
700 FICO) credit scores. These findings, while inconclusive, raise questions about the
marketing of these products and are consistent with other research that raise issues
about the level of understanding of some consumers regarding sophisticated mortgage
products. Better informed consumers could have recognized that the tradeoffs
presented by these products -- a lower payment during the first few years with a later
reset to a high, if not unaffordable payment -- did not make financial sense in their
situations and that the long term costs of these products were much more expensive
than more appropriate fixed rate products, in spite of the low starter rate.
The rapid proliferation of hybrid ARMs versus other options suggests that many
borrowers either did not understand or were not told about other, less volatile, products.
While financial literacy is not a panacea and does not excuse irresponsible lending, a
more informed consumer population might have recognized the problems with these
products and demanded appropriate fixed rate products -- limiting the issues we
confront today in the subprime mortgage market. I have called for national standards to
address many of the problems and abuses that are now coming to light in the subprime
mortgage market. These standards could impose underwriting based on the borrower's
ability to repay the true cost of the loan, especially among the non-bank lenders
currently operating with little or no regulatory oversight. It should also address
misleading or confusing marketing that prevents borrowers from properly evaluating
loan products. However, even with new national standards, there is only so much
regulators and the legal system can do. A comprehensive solution requires consumers
who have sufficient financial educational tools to protect themselves against
inappropriate or, in some cases, predatory products.
adequate financial knowledge can lead consumers to make poor financial decisions.
Recent problems in the subprime mortgage market illustrate how increasingly complex
products can lead to poor product choices for consumers who do not fully understand
them. Beginning in 2003, complicated new financial products -- particularly, the so-
called “2/28” or “3/27” mortgages and other hybrid adjustable rate mortgages (ARMs) --
exploded in popularity in the subprime market. These loans are characterized by a low
initial starter rate that increases significantly after the first two or three years under
complex formulas, creating a “payment shock” of 30 percent or higher and rendering the
loan unaffordable for many borrowers. In some cases aggressive or misleading
marketing of the lower starter rates, without full disclosure of the significantly higher
costs, obscured key features and costs of the loans. Moreover, there often existed other
options than a hybrid ARM -- such as a fixed rate loan with the same lender -- that
would have avoided the payment shock altogether for only a marginally higher payment
in the early years of the loan.1
In a July 2004 study,2 the Consumer Federation of America (CFA) concluded that the
consumers most likely to purchase complex ARMs were among the least likely to
understand these products. In a 2006 follow-on study,3 the CFA found that consumers
using interest-only and payment-option ARMs were more likely to be from a middle- to
lower-income population segment, minorities, and have weaker than average (less than
700 FICO) credit scores. These findings, while inconclusive, raise questions about the
marketing of these products and are consistent with other research that raise issues
about the level of understanding of some consumers regarding sophisticated mortgage
products. Better informed consumers could have recognized that the tradeoffs
presented by these products -- a lower payment during the first few years with a later
reset to a high, if not unaffordable payment -- did not make financial sense in their
situations and that the long term costs of these products were much more expensive
than more appropriate fixed rate products, in spite of the low starter rate.
The rapid proliferation of hybrid ARMs versus other options suggests that many
borrowers either did not understand or were not told about other, less volatile, products.
While financial literacy is not a panacea and does not excuse irresponsible lending, a
more informed consumer population might have recognized the problems with these
products and demanded appropriate fixed rate products -- limiting the issues we
confront today in the subprime mortgage market. I have called for national standards to
address many of the problems and abuses that are now coming to light in the subprime
mortgage market. These standards could impose underwriting based on the borrower's
ability to repay the true cost of the loan, especially among the non-bank lenders
currently operating with little or no regulatory oversight. It should also address
misleading or confusing marketing that prevents borrowers from properly evaluating
loan products. However, even with new national standards, there is only so much
regulators and the legal system can do. A comprehensive solution requires consumers
who have sufficient financial educational tools to protect themselves against
inappropriate or, in some cases, predatory products.