Sweeping new rules on banks are meant to protect consumers against greedy lenders and risky financial offerings. What they won’t do is protect consumers from themselves.
There’s a long list of villains who contributed to the financial meltdown of 2008 and the economic blowout that followed: shady lenders, reckless Wall Street firms, naïve policymakers and torpid regulators who couldn’t find a rat in a sewer. But American consumers weren’t exactly innocent bystanders. Millions of Americans fueled the problem by bingeing on debt, living beyond their means and using their homes as piggy banks. For every booby-trapped mortgage, there was a borrower happy to commit to monthly payments his income couldn’t cover.
The sweeping Dodd-Frank financial-reform legislation will make it harder for banks to prey on vulnerable consumers eager to hear they can afford luxuries far beyond their means. It will set up a new Consumer Financial Protection Bureau designed to police the soundness of financial products the way other agencies safeguard pharmaceuticals, toys or the food supply. Regulators from Washington will now sniff out financial scams, rein in usurious lenders, unearth hidden fees and limit loans to people who can afford them. Jubilation. Washington rides to the rescue. Again.
But a new army of protectors won’t make consumers smarter, and the mere presence of a fresh government watchdog could persuade some people that they don’t need to worry about protecting themselves. That would be a big mistake. Many Americans are in precarious financial shape, and there will always be risks the government can’t do anything about. Here are four things consumers still need to do for themselves, without relying on the government or anybody else:
Learn more about money. Financial illiteracy is a major problem. Many of the bad loans that boomeranged back on the banks wouldn’t have happened if borrowers knew they were agreeing to a ballooning interest rate or taking on mortgage payments way beyond standard thresholds for affordability. The new law recognizes this, setting up an “Office of Financial Literacy” meant to make consumers smarter. But no government agent is going to come to your home at a convenient hour to offer a free tutorial on personal finance. People still need to do the work themselves and learn how to spot scams, manage debt, invest safely and resist foolish enticements.
How many times do we need to be told that if a deal seems too good to be true, it probably is? Every day, apparently. There were dozens of excellent personal-finance books and Web sites before the recession—including a government Web site, established in 2006—and they did nothing to prevent an epidemic of bad decision-making. One more government agency devoted to the cause probably won’t make a difference.
Save more. In the halcyon years after World War II, Americans routinely saved 10 percent of their after-tax income. How quaint. Beginning in the mid ‘80s, the savings rate drifted down to the low single digits, bottoming out near a paltry 1 percent in 2005. It’s rebounded since then, but is still less than 4 percent. Most families should be saving 6 to 10 percent of their income, to pay for their kids’ college and prepare for retirement. More would be better. The government, however, wants people to spend money, because it will boost the economy today—allowing politicians to take credit for it during the next election. So don’t expect Washington to encourage saving, even though it’s what most people need to do.
Reduce debt. Since we save less these days, we borrow more—staggering amounts, actually. Americans on average have a debt-to-income ratio of about 122 percent, which means the average amount of individual debt equals nearly 15 months’ worth of earnings. That has come down a bit from a peak of 133 percent in 2007, but economists feel it should be 100 percent or lower. (Between 1960 and 1985, it never went above 70 percent.) The government is actually doing its part here—but not intentionally. Tougher rules on banks are reining in risky loans, which means some profligate spenders can’t add to their debt even if they want to. But if you’re only paying down debt because the bank lowered your credit limit, you haven’t really reformed your finances. You’ve just hit the limits of tolerable spending, and you’ll probably keep pushing those limits when credit gets looser.
Come up with creative financing. While clamping down on risky lending, banks and their government overseers have also denied credit to many who legitimately need it. Scarce credit is especially hard on small-business owners, who often use bank loans or credit cards to pay suppliers or stay current on rent. The stranglehold on small business is one reason hiring is weak and the whole economy is fragile, because small business accounts for an outsized portion of new jobs. The government thought it would solve this problem by bailing out the banks, which in turn would inject more money into the economy, but it hasn’t worked out that way so far. So, many people who desperately need credit have had to tap friends or family, mortgage assets, hastily improve their creditworthiness and find unconventional sources of money. The government might make the loan itself simpler, but getting to the bargaining table is up to you. Get used to it.