Persuasion in Household Finance: New Evidence, New Applications

1. Persuasion in Household Finance:New Evidence, New Applications Jonathan Zinman Department of Economics Dartmouth College Federal Reserve Bank of Boston Consumer Protection Week Conference March 29, 2006

2. Plan for the Talk • Two new pieces of evidence showing that persuasion has strong effects on consumer borrowing decisions • Practical implications of this type of evidence • Sprinkled with related findings on savings decisions

3. Study #1: What Psychology Worth? By: Bertrand-Karlan-Mullainathan-Shafir-Zinman • Researchers worked with large consumer lender in South Africa to send direct mail: • To former, experienced clients • With randomized interest rates • Very expensive (200% APR), short-term (4-month) loans • Market looks like a cross between payday loans and old small loan/finance company personal loan market • With randomized presentations of substantively identical offers….

5. What Drives Consumer Financial Decision-Making? • Say you got this letter…. what might drive whether you take a loan or not? • Economics says: price • Psychology says: price and lots of “contextual” factors • Mood (emotions) • Complexity of decision (so some presentations more effective/salient than others) • Firms often refer to this as “value-based” features

6. So How Test Importance of Psychology in an Economic Decision? • Design marketing “features” that are based on “what works” in lab experiments in psychology • Lender randomly assigns these marketing features in direct mail • Measure impact of marketing on loan demand (takeup decision)

7. Marketing Features Tested • Table size (information overload) • Comparison to competitor (gain-loss) • Photo (cue) • Race (mis)match • Gender (mis)match • Promotional giveaway (“congruence” frame) • Suggestions • Priming call • Loan use

8. Findings:Marketing Treatments • Some “worked” (increased takeup), some didn’t • When work, marketing effects very large • On average, marketing effects very large • Effective marketing increases loan demand as much as a 20-30% drop in the interest rate • Effective marketing dulled price sensitivity

9. Study #2: “Fuzzy Math” • Stango & Zinman project studying a particular, prevalent cognitive bias and its impacts on financial decisions & markets • Motivation…. do you ever wonder why “monthly payments” marketing is so prevalent?

11. Marketing Payments,not (loan) prices • The more things change the more they stay the same….

12. The Denver Post March 12, 1980 La Prensa de Minnesota March 31-April 6, 2005.

13. Our Explanation for this: “Payment/Interest Bias” • Give consumers all other loan terms but NOT the interest rate, and they systematically and dramatically UNDERESTIMATE the interest rate associated with a loan (offer)….

16. Payment-Interest Bias: Facts • First documented in 1960s and 1970s • Early finding impetus for Truth-in-Lending • But largely ignored by social scientists since early 1980s • So most recent data is 1983 • Stango & Zinman first to systematically explore possible impacts of this bias on decision-making, the functioning of financial markets

17. Payment-Interest Bias: Findings • Conditional on a rich set of household characteristics and/or loan characteristics, biased consumers are: • Less likely to comparison shop for loans • More likely to shop on non-price terms • More likely to have financed a recent large purchase • More likely to borrow from nonbank lenders (finance companies, retailers) • More likely to pay higher interest rates when borrowing from nonbank lenders • Some evidence that consumers are less price sensitive when borrowing from nonbank lenders • Less likely to have saved in the past year • And they have much less wealth

18. Related Policy Issues • Disclosure • “Predatory Lending” • Our findings echo stylized facts: • Violations (still) prevalent, and incredibly so in our sample period (Fortney 1986) • Non-bank lenders much more likely to be prosecuted (GAO 2004) • These lenders use marketing techniques that highlight monthly payments and obscure true borrowing costs

19. Practical Implications What do in light of this type of evidence? • Problems with Traditional Approaches: • Education • Information • Prohibition • New Approaches

20. Problems with(Financial) Education • “Education” = teaching problem-solving skills • Decisions are complex • Biases are prevalent, may be deep • Lack of numeracy • E.g., payment-interest bias incredibly widespread • Lack of comfort with numbers, finance even among numerate • Key decisions are often low-frequency– little opportunity for learning-by-doing, reinforcement • Examples: car purchase (with loan), retirement plan

21. Problems withInformation-Provision • “Information” = disclosure, teaching decision heuristics • Problems: • “Information overload” • Resistance

22. Problems with Prohibition • The usual economic costs, plus: • Underground markets may be even more “high-touch”, able to exploit biases

23. New Research Suggests and Develops New Approaches • Product Presentation • Social Marketing • Product Development

24. New Approaches toProduct Presentation • Not fancy marketing, but…. • “Optimizing defaults”: • switching 401k defaults from “don’t participate” to “participate” has huge impacts on savings, even when there is a clear opt-out (Madrian and Shea; Laibson and co-authors) • showing a different example loan maturity has huge effect on maturity chosen (Karlan & Zinman 2005) • Concise is nice: beware of information overload • BKMSZ on loans • Iyengar et al on savings • Mental accounting and goal-setting (Karlan, Mullainathan, and Zinman ongoing)

25. New Approaches: Social Marketing • Use marketing to spur more deliberate (better?) decisions • What’s good for the (rapacious corporate?) goose is good for the (benevolent?) gander • Examples: • Punam Keller on mammograms: appeal to family rather than self • Karlan-Mullainathan-Shafir-Zinman: designing marketing approaches to encourage saving

26. New Approaches:Product Development • Can we stop consumers from borrowing too much? Don’t know yet. • But we can help them save more…. • Economists have developed 2 successful “commitment savings” products motivated by evidence from psych and econ: • SMART: Thaler and Benartzi (2004) • SEED: Ashraf, Karlan, and Yin (2006)

27. New Approaches RequireProcess Innovation • Psychologically-driven interventions inherently require continued testing and fine-tuning • Lack of general psych theory • Importance of particular contexts • Sophisticated firms (credit card companies, Amazon) have recognized this, built randomized-control evaluation of pricing and marketing strategies into their day-to-day operations • Academics are now working in partnership with smaller firms, NGOs, and public agencies to bring these tools to the masses

28. Closing Thought • Evaluate: • is what you (or your grantees) are doing effective? • do a “gold-standard” (randomized-control) evaluation whenever possible • get outside (academic) help • Innovate • again, collaborations w/researchers can be productive • Disseminate

29. A Virtuous Cycle