Behavioral Retail Finance: Challenges and Solutions in Policy Implementation

1. Behavioral Retail Finance:Challenges in Moving from Research to Policy Jonathan Zinman Dartmouth College October 28, 2009

2. From R to D • From research: • On specific consumer cognitive biases, limitations • On strategic firm responses • To development, of “treatments” • Communication (info, marketing, reminders) • Process (defaults, menus, auto/easy-features) • Product terms (commitment contracts) • “Retail financial engineering”; “product development” • Key insight: communication and process may be at least as important as the terms • We’re getting good at these pieces of R to D

3. From R&D to Policy Increasingly popular premises: • We’re getting good at using “choice architecture” to change behavior • » We’re improving outcomes • Actually this remains uncertain • » We can scale up using policy • This is highly uncertain

4. Are we improving outcomes? • Not necessarily • We are getting good at treating specific behaviors, but typically we don’t yet know what happens to: • other behaviors • overall financial health • Example…

5. Are we improving outcomes?Example • Great success story: increasing workplace retirement saving • Via defaults, other process innovations • But what happens to rest of household balance sheet? • Do households reduce rainy-day savings? • Do they borrow more (at high rates)? • Do households actually increase wealth, financial resiliency? • Similar example: text-message reminders to save (Karlan, McConnell, Mullainathan, Zinman)

6. Are we improving outcomes?General Issues • Is a nudge in the right direction on one side of the balance sheet a nudge in the wrong direction on the other? • Medical analogy: are we pushing the infection from the right arm to the left arm, and declaring victory because we only examine the right arm? • Can you treat consumer biases without a more holistic approach to treatment? • Financial health is the output of very many decisions large and small

7. Are we improving outcomes?Priority To Do’s • Improve outcome measurements re: overall financial health • Savings rate • Borrowing (expensively), credit scores • *Proxies for overall financial condition • Figure outinteractions • Between biases • Between treatments

8. Scaling Up To Policy:Additional Challenges Two additional challenges: • Treatment “compliance” • Limited enforcement on regulated firms • Treatment scope • Very difficult to regulate all relevant firms

9. Treatment Compliance Challenges: Truth-in-Lending Example • Mandated APR disclosure does counter biased underestimation of borrowing costs when faced with “low monthly payments” (Stango & Zinman) • But: enforced better on banks than nonbank finance companies • So biased consumers pay higher rates when they end up borrowing from finance companies • And: (civil) enforcement is quite costly • Civil court case burden in 1970s • So biased consumers don’t actually pay lower rates when TILA better-enforced • I.e., their relative but not absolute outcomes improve

10. Treatment Compliance Challenges: Defaults for Mortgage, Overdraft • Proposal: make vanilla product the default • 30 year, fixed rate • No overdrafts paid (and hence no fees) • How ensure that lenders offer a “good” vanilla product? • Invest more making expensive “vanilla” products seem deceptively cheap? • Will lenders specialize, and crowd-out the vanilla? • Are defaults sticky when suppliers have strong incentives to change them? • If “reasonableness” standard, how and how expensive to enforce through courts?

11. Treatment Scope Challenge:Examples • Workplace defaults • Defaults, etc. offered through one broker of one type of savings product • But leave debt markets/decisions untouched

12. Treatment Scope Challenge:Examples Small-dollar (e.g., payday) loans • Key practical question: can effectively regulate all potential providers (loan sharks, overdrafts, rent-to-own, etc.)? • If not may want to encourage entry • Even biased consumers may be better off borrowing at $15 per $100 if there is an unregulated alternative that’s more expensive

13. So What Can Government Doin a Behavioral World? • The jury is still out. Be circumspect about: • Ability to treat overall financial health • Treatment scope/interaction issues • Ability to scale up • Treatment compliance and scope challenges • We’re making progress but.. the voice of Mr. Wolf • Best strategy (for now) may be to get out of way • Encourage entry, reduce any barriers to innovation • Example: workplace lending may be best solution to any problems caused by small-dollar loans • Potential for radical cost reductions and choice architecture improvements

14. What Can Researchers andSocial Entrepreneurs Do? • We’ve been thinking small (nudge revolution) • Probably need to spend more time thinking big E.g., as discussed before: • How to measure overall financial health? • How do various cognitive limitations interact with each other? • How do various treatments designed to counteract limitations interact?

15. More big issues • Complex pricing: more harm than good? • Given enforcement issues (compliance and scope) to efficient to throw haymaker than to nudge? • What can we learn from other domains where maintenance (daily decisions and big decisions) is important? • Health, cars, housing • (How) can we improve the advice market? • Closest to silver bullet, in theory?

16. Answering these questions:Need commitment to R&D (No place for shortcuts: social costs of getting policy wrong are quite high) Instead: • Theorize • Develop treatment(s) • Field Test • Evaluate: with right outcome measures • Refine • Repeat

17. Experiment Evaluate Innovate The Learning Organization:A Virtuous Cycle