By the numbers, Americans are not a very financially literate people. According to a Standard & Poor’s Global Financial Literacy survey only about 57 percent of the adult population is financially literate, and only about one out of three can answer simple questions about inflation, compounding interest or investment diversification.
Part of the problem, Affirm CEO and founder Max Levchin told Karen Webster in a recent conversation, is just basic financial education and the fact that many Americans aren’t getting it. Taking an example from his own life, he noted that both he and he wife were raised in Eastern Europe, and by the time they were nine their parents would hand them money and send them to the store for bread, milk and other sundries. Don’t overpay, don’t forget your change and don’t get robbed were the only instructions they were given — and that was more than sufficient.
“I would never today so much as hand my nine-year-old a dollar and tell him to go buy ice cream, I’m not even sure he would know what to do,” Levchin told Webster.
There is nothing wrong with his nine-year old who is otherwise a bright child, Levchin was quick to affirm. But how money works — and how we relate to it — has changed drastically but subtlety over the last generation. And when we talk about financial literacy, he told Webster, there is an educational component. We are doing the next generation a disservice if they graduate high school not knowing basic things about how revolving credit lines work, or what compounding interest means.
But really changing the financial literacy picture and making consumers apply sound principles isn’t a matter of affecting what customers know, but is in fact much more concerned with changing customer habits once that knowledge is in hand.
“The most important thing people have to know is this idea of credit and debt is not about good and bad,” Levchin noted.
The Changing Landscape
The phrase “neither a borrower or a lender be” was probably perfectly great advice when Polonius offered it to Laertes in Hamlet — because Hamlet was set in the year 1350 or so, and the world had very different opinions on credit. In 2019, on the other hand, it is not bad advice so much as it is ridiculous advice, Levchin noted. No one is able to purchase a homestead with the money in their back pocket, and across the board when one looks at price increases in necessities like education, the reality is unless one was born very rich, borrowing is going to be part of their life.
And that, Levchin noted, is great, actually — because in most cases people borrow funds, pay them back and are happy with the outcome.
“The problem is a lot of other usage of credit has infiltrated our lives, and while that is a benefit to many people, it has also harmed a number of them because credit doesn’t always come with an explanation of how it works.”
Take, for example, the comparison between a payday loan and a credit card. While most people would be inclined to say one is bad and the other is good — or at least neutral — the reality is they are both sources of revolving credit that give a consumer the opportunity to refinance their debt each month at interest, but those interest rates will roll into the principle and over time push it up exponentially. In either case, he noted, the consumer who is conscientious and pays off the principle within the month isn’t going to be harmed by that product. The customer who is bad about it and lets the debt mount is going to get in trouble.
The difference, he said, isn’t the product, where one is good and one is bad — it’s how the consumers’ financial habits combine with the product that creates the outcome.
The question about how to create more good outcomes is related to financial education, he noted. People should know what it means to have a revolving credit account or not be given a high school diploma till they do. But change, he noted, is going to have to come from a bigger place than just explaining to consumers conceptually how credit works.
You have to find ways to get them to apply that knowledge.
Creating The Fix
The problem with financial education in many regards is that it doesn’t help the people it was meant to help. For example, a person who was managing all their household finances via a spreadsheet might well find a financial management app a huge benefit because it would save them a lot of time. But, Levchin noted, that person wasn’t really the one who this product was trying to reach — they were already doing fine.
The customer who wasn’t making those spreadsheets, the person who was actually having a hard time making ends meet each month, the person who is actually getting eaten up by interest payments? They aren’t going to be reached by something as simple as an app pinging them and saying “don’t spend, don’t spend,” because frankly, they can ignore that. And if they have an emergency situation, or just a garden variety household management need, they are certainly going to ignore it.
For customers to change, he noted, the entire burden can’t be on them to radically shift their behavior ex nihilo. Ask anyone who has ever tried to quit smoking or go on a diet — massive paradigmatic shifts to behavior are hard to start and even harder to follow through on over time.
“Companies have to be part of the solution,” Levchin told Webster. “The punchline on all these products telling someone just don’t spend any more money is that that is not enough. It just doesn’t land with the people you want it to land with.”
Because, he noted, either companies will volunteer to be part of the solution — or regulators are going to show up and not really give them a choice. That is not his preferred outcome, Levchin said, but it is not impossible to imagine a world where regulators look at some products, decide there is not a practical way to offer them benignly to a majority of customers and decide to summarily ban them. It’s a way to fight off the risk of customer abuse, he noted, but it’s a blunt-force tool being used wrong. The trick isn’t to offer consumers fewer options, it is to offer them more, but change the offering.
Today, he noted, incentives are built around spending — swipe your card and get points or cashback or airline miles.
“I think are ways to create incentive alignment through rewards that are not that.”
By way of example, he noted that lottery or prized-linked savings offers were illegal until recently. Now they aren’t, and a good way to incent people is to tell them if they pay their bills on time and save a certain amount, they are eligible for a cash prize or raffle. Or, he noted, when customers pay off their full balance on time for enough months, card companies could lower their APR.
The bad habit, he noted, exists for a reason. It was or is rewarding to the customer who has it. To create a good habit to replace it, he said, it’s not enough to tell a customer they are doing something wrong. You have to tell them how to do it right — and then give them a reason to want to other than repeatedly telling them they should.
“What seems to have an effect on people is actually creating an incentive for good behavior instead of trying to force-feed them videos on how to balance a checkbook.”