Watch Out — Moral Hazard!

6
Jan

Moral hazard is a great economic concept for financial consumers to understand. Moral hazard can mean that people have the tendency to do what benefits them most, even if it means not behaving responsibly.  Moral hazard can also be linked to information asymmetry, which is a scenario where one member of a transaction has more information than another.

Information asymmetry is also a key concept to understand as a financial consumer, as it can be played out as one person in a financial transaction having more information than the other person. When it comes to financial transactions, the consumer can sometimes be the one in deficit. While this is not always a problem, an awareness of the possibility is critical especially in complicated financial transactions. An understanding of information asymmetry also can help a consumer find the right kind of financial expert to add to their team in a financial transaction.

Today’s economics lesson is leading us to a look at the collaboration between Bank of America and Sal Khan of Khan Academy, which yielded their financial education website called Better Money Habits. While free, available financial information is generally a good thing, the Better Money Habits website is an opportunity to look at the possibility of moral hazard and information asymmetry from the perspective of a financial consumer.

Nancy Folbre, a professor emerita of economics at the University of Massachusetts, Amherst, and a recipient of the MacArthur Foundation “genius” fellowship, wrote last week in the New York Times’ Economix blog about her concerns with the information provided on the Better Money Habits website. Her analysis included the following points. According to Dr. Folbre, Better Money Habits does have some useful information, but does not seem to include some financial information that some consumers may need, including:

  • Information on how to shop effectively for lower rates
  • Encouragement to pay off entire credit card balances immediately
  • Information on more cost-effective loan alternatives

Dr. Folbre sums up her analysis with the thought that perhaps “it is a good idea to go to a source that does not stand to gain from its own advice.” As Bank of America is by some accounts the third-largest issuer of credit cards in the U.S., the bank could stand to gain from providing more information about credit card use than about its alternatives. If an institution is purposefully presenting selective information to benefit itself, this dynamic is a great example of moral hazard and information asymmetry. These economic dynamics with financial repercussions are critical reasons that consumers need to understand money and the financial system, and learn how to educate and advocate on behalf of themselves.

Understanding certain economic principles provides a depth to financial understanding that goes beyond simply a capability. At Financial Nutrition, we work to integrate a depth of economic principles into our teaching of financial concepts and behaviors. We believe that through teaching foundational concepts of economics and finance as well as practical applications, students become confident and well-versed in their understanding of money and the financial system. Girls gain a foundation for acquiring knowledge and learning positive behaviors, resulting in confidence in money management that can lead to financial security and success.

We are going to be putting more of these economic concepts into a financial context for you in the coming weeks, so stay tuned!

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