From Recession: An Opportunity to Stand up for Consumers

From its beginning in the housing market, the current economic crisis has spread gradually to infect every sector of our economy. The meltdown has defied the regulatory safeguards that were designed to limit the odds of widespread economic collapse and, in the process, raised serious questions about what went wrong and how to prevent it from happening again. Among the conclusions: America’s financial regulatory system is overdue for repairs. And, the buzz in Washington is that we can convert this crisis into opportunity.

From my perspective as President and CEO of the National Foundation for Credit Counseling, among the opportunities is consumer credit—preparing consumers to use it effectively and protecting them from abuses by those who prey on individuals with credit problems. The experience of NFCC member agencies makes two things clear as we move through the recession—more people than ever before are turning to credit counselors for help and the severity of personal financial problems has grown significantly. And, while we cannot prove it empirically, the stories we hear from consumers convince us that improvements in regulation and a commitment to financial literacy should be part of our economic recovery agenda.

At the NFCC, we believe strongly that the consumer impact of the financial crisis has been worse than it needs to be because of three factors: inadequate disclosures about credit, a shortfall in regulatory oversight, and inadequate financial education. Evidence of all three failings can be found in the housing market collapse that began our current economic woes.

Part of the housing market problem was a failure of financial education because too many homebuyers didn’t fully understand even the basics about their loans. Inadequate disclosure also played a role, because it is now clear that many lenders did not provide consumers with a full picture of their complex mortgage products, how they work, and the potential risks associated with them. The regulatory system fell short by failing to properly mitigate the risks of an overheated mortgage market. Far more time was devoted to designing creative new loan products than in assuring loan quality.

As we move forward, we should draw lessons from the mortgage market to insist on a few core principles and apply them widely—improving consumer disclosures, incentives, and mandates to expand consumer financial education and enhanced regulatory oversight.

These fixes are partly the job of policymakers who can compel better disclosure and strengthen regulation to better protect consumers. Another part of the job involves what President Obama refers to as “taking responsibility”—the personal responsibility of every American to learn more about money management and the responsibility of both public and private sector leaders to make financial literacy a goal for every individual and family.

Let me explain.

Disclosure means providing consumers with the information they need to understand risks and to responsibly manage financial products, services, and loans for which they’ve signed up. To be truly beneficial, disclosure also means that the terms must be spelled out in plain language so they are easy to understand.

For example, if you take out a mortgage you need to understand basic terms such as the dollar amount of the monthly payment and the interest rate. If the loan is adjustable, you need to know when the rate will adjust and how much your payment might increase—so you can match any possible increase against your budget. The failure to clearly inform consumers—in layman’s terms—how the products work is why some mortgages are now in default.

The disclosures also must be designed with real people in mind. Today, customers who apply for mortgages and credit cards are often overloaded with stacks of paper that take too much time to read and that only a lawyer can understand. The lengthy credit card agreement that comes with a new card and the privacy policies that load up our mailboxes illustrate that when it comes to disclosure, too much information can be almost as damaging as too little. What’s needed is a balance so that disclosures are clear to consumers who are not versed in legalese, but also provide the protection necessary for financial institutions.

Moving from pro forma disclosure to the beneficial disclosure we need will require financial service companies to invest time and dollars up front. But if we get it right, lenders should save money in the long run by cutting their loss rates and consumers will be better off by avoiding credit arrangements they can’t afford.

In addition to better disclosures, we need basic and fundamental financial education about how to budget and manage finances. Last spring, 25 percent of those polled in a NFCC Financial Literacy Survey said they didn’t know enough about the home-buying process to even consider buying a house. From sad experience, we now know that millions of Americans who did buy a home didn’t fully understand it either. That is why pre-purchase counseling and education is important for everyone, particularly first-time homebuyers.

In the same survey, we learned that only 40 percent of Americans set up a budget and keep close track of their spending. Indeed, 20 percent said they have no idea how they spend their money. Most Americans have never ordered their credit report; millions say they are regularly behind in paying their bills; most do not have a sufficient emergency fund set aside; and one-third report they have no retirement savings at all. Among the most worrisome finding is the high percentage of young Americans—more than 40 percent—who do not pay their bills on time. This suggests that financial habits are getting embedded earlier and may be getting worse instead of better. Numbers like this scream of a need for better financial education to enhance the value of improved disclosures. The benefit of even the best disclosure is greatly diminished when consumers don’t know what to do with the information.

To this end, basic finance and money management should become a mandatory part of the standard school curricula in every state. Surveys show that financially literate consumers are more likely to make their loan payments on time and less likely to default. That should be a powerful incentive to everyone, especially creditors, to promote financial education. At a time when lenders are trying to reduce their risk, wouldn’t it make sense if they promoted financial education by offering better credit terms to consumers who have completed such programs? Consumers, too, would certainly be better off and avoid a lot of pain if they took part in financial education before their finances deteriorated. If ever they would embrace the concept, it should be now—a “teachable moment” because recession has helped make clear the consequences of financial literacy.

Protecting consumers also requires additional regulation and integrated oversight. Regulators must adopt meaningful disclosure rules and quality and ethical standards for consumer financial products and services. They also must exercise tough oversight of the businesses that provide financial services. As we’ve learned, regulators will need to look beyond case-by-case reviews to also identify systemic patterns that may warrant further intervention. At the same time, tough regulation must not squeeze off all credit because the responsible use of credit is important to the economy. The challenge is to make the needed fixes, but without over-regulating or choking consumer access to appropriate credit and beneficial financial products. In other words, we must be thoughtful about unintended consequences as we work to beef up the regulatory regime.

Strong regulation has become more important as the recession deepens. Struggling with debts they can’t repay, a growing number of Americans are looking for help. Many consumers are turning to nonprofit credit counseling agencies such as the member agencies of the NFCC. Nonprofit counselors are covered by very stringent consumer protection regulations that include rules for the types of services they offer, the fees charged, and even how agencies are funded. These rules, enacted by Congress just a few years ago with strong support from the NFCC, makes the nonprofit status a safe starting point for consumers who need help to stay afloat.

But other consumers, often lured by high-profile ads that promise quick fixes and easy solutions, are turning to an emerging group of “for-profit” services that, ironically, are less regulated than the nonprofit sector. Their track record is thin, and too often these businesses put their own bottom line ahead of the consumers.

At a recent FTC workshop on “debt-settlement” companies, even an executive for one such business conceded: “there are problems with the industry and fraudulent practices are more common than not.” So the agenda for better regulation must include new rules to protect consumers in their dealings with credit assistance organizations whose business model is based on profit. At a minimum, we must apply the same federal rules to the “for-profits” that apply to nonprofit credit counseling.

The ideas I’ve laid out are not a panacea. Recessions will still occur from time to time and some consumers will always struggle with money management and credit problems. But as we consider the lessons of recent experience, we have the ability to take measured steps that will strengthen regulatory oversight in the financial services arena and can empower consumers with the tools and education to better protect themselves. With better disclosure, financial education, and oversight, we can reduce the odds of consumer financial mistakes—no small feat at a time when foreclosures, bankruptcy, and loan defaults are at the top of the news. From the debacle of recession, we have an opportunity to do better. We should seize the moment.