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Financial wellness credit
- 1. Resources for Credit and Behavioral Economics Deborah Kozdras dkozdras@usf.edu USF Stavros Center http://stavros.coedu.usf.edu http://tinyurl.com/StavrosCredit Workshop funded by:
- 2. Why did I do that?
- 4. Habits (Heuristics) & Biases
- 5. Fruit Vs. Chocolate (Read and van Leeuwen, 1998) • Deciding today, would you choose fruit or chocolate for next week? • 74% choose fruit • Deciding today, would you choose fruit or chocolate for today? • 70% choose chocolate
- 6. Framing
- 8. An Apple or a Donut?
Editor's Notes
- Ever look back at financial decisions and ask: Why did I do that? Turns out, science can probably answer the question. Welcome to the Nobel Prize-winning field of "behavioral economics." Its mission: to look at how we humans are hardwired to perceive things such as value, abundance, scarcity and the future -- then analyze at how that relates to our financial decisions. 1. Buy now, pay later Do you tend to spend more when you pull out the plastic than when you count out the cash? Study after study finds that it's true for most of us. Part of the reason: With cash, your brain registers that the money is really spent, says Douglas E. Hough, associate scientist with the Johns Hopkins Bloomberg School of Public Health. You pull it out of your wallet, count it out and hand it to the cashier. That money is literally gone. With a credit card, you hand it over, but the clerk gives it right back. "You don't see the result of the transaction until a month later," he says. Hough points to economist Amy Finkelstein's work as a good example of how we let ourselves be taken by out-of-sight payments. Finkelstein, an MIT economics professor, found that states that had electronic toll collection systems would raise toll rates more than states that didn't, Hough says. Consumers don't notice those changes in the same way when they aren't handing money to a toll taker or throwing it into a bucket, says Hough. Instead of counting and doling out quarters, "it just shows up in a bill" once a month, he says. And, when you don't pay cash at that moment in time, "The mind is almost saying 'I'm getting it for free,'" Hough says.
- Actually, behavioral economists and psychologists have studied consumers’ credit decisions for decades, especially using consumer survey techniques. Their studies have been empirical, and many are concerned with the extent to which consumers’ behavior is rational. Standard economic theory is concerned with specific goals such as utility maximization, evaluation of all available alternatives, choice of the alternative that best achieves the goal, and consistency in choice. In contrast, behavioral economists expand this concept of rationality. They view rational behavior as purposive and deliberative but not necessarily strictly optimal. They note that consumers often simplify, taking shortcuts and using “rules of thumb.” Consumers are often satisfied to take small steps toward goals (adaptive and satisficing behavior) rather than making the effort to achieve the optimum. Culture, group membership, attitudes, past experience, and even biases may influence the decision process. default bias—what most of us might simply call laziness or inertia. Default bias suggests that people are much more likely to stick with the status quo than what we might expect given the bene ts of switching to another option. In studies of retirement savings, for example, re- searchers have found that default bias plays a signi cant role in determining whether or not employees participate in a 401(K) plan. Until recently, the default option for most 401(K) plans was non-participation, meaning that employ- ees had to actively choose to participate. Changing the default option to participation—with no other changes to the bene ts—leads to signi cantly higher participa- tion in the 401(K) plan.7 Michael Barr, Assistant Secretary for Financial Institutions at the Treasury Department, has proposed that these ndings be applied to loan products as well: lenders would be required to offer borrowers a standard mortgage option (e.g. a xed rate, self-amortiz- ing 30 year mortgage loan), and borrowers would have to actively ‘opt-out’ to receive a more risky product such as an adjustable rate or interest-only mortgage.8
- Behavioral economists have also focused on how choices and information are framed—for example through advertising or disclosures—and are beginning to understand how even small changes may in uence con- sumer decisions about nancial products. Studying dis- closure laws, Michael Collins found that a simple, nega- tively framed message can prevent borrowers from taking on a risky loan, not unlike the health warning on a pack of cigarettes. States that required borrowers to sign a dis- closure that simply read “You Could Lose Your Home” before taking out a high-cost subprime loan signi cantly increased the likelihood that a borrower would reject the loan offer, compared to the less dramatic standard HOEPA disclosure.9 In South Africa, a controlled experiment on loan offers found that those that contained a picture of an attractive woman increased loan uptake. In contrast, loan offers that displayed too many loan options decreased uptake, consistent with the hypothesis that presenting Framing refers to the way our decisions are affected by the way information is presented. For instance, framing can influence whether we see a glass as half empty or half full. The same glass framed different ways can be perceived differently depending on the context. In the above strip, Dogbert and his client describe as "dumb" those shoppers who think something labeled as "50 percent off" must be a bargain. Yet the client considers himself a "genius" when he falls victim to the same bias.