Full text of Inside the Vault : Fall 2006

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THE
An Economic Education Newsletter from the Federal Reserve Bank of St. Louis

Volume 11, Issue 2 Fall 06

Just Sign Here: Bottom-Line Personal Finance Myths

C

onsumers must make many
financial decisions, from
basic spending and saving to
complex investment choices and
retirement planning. What does an
individual need to do or know to be
financially literate? At a minimum,
consumers must be able to keep
track of their cash resources and all
payment obligations, know how to
open a savings account and how to
apply for a loan, and have a basic
understanding of health and life
insurance. In addition, a financially
savvy consumer knows how to compare competing offers and plan for future
financial needs, such as paying for college,
buying a car or house, and retiring.
Unfortunately, this type of financial
knowledge is in short supply. A survey conducted in 2006 by
the Jump$tart Coalition found that 12th-graders could correctly
answer only 52 percent of the questions on a basic financial skills
quiz. Although adults sometimes do better on tests like these,
statistics indicate that U.S. households do not consistently demonstrate the basic skills of financial literacy. (See table at right.) This
lack of basic financial knowledge often results in poor financial
management, including such behaviors as using payday lenders or
check-cashing services, incurring late fees on credit cards, or passing up employer-matching contributions to retirement accounts.
Being aware of some common personal finance myths—beliefs,
rules of thumb or marketing pitches that are misleading or untrue—
may help consumers make better-informed financial decisions.

Myth #1: “All that matters is your monthly payment.”
When a consumer is financing a car or a house, borrowers
are often assured that, despite the staggering sum of total interest payments, the only relevant question is, “Can you make the
monthly payment?” Your monthly payment is not all you need
to know about your loan, of course. The effective annual rate
you are paying, the fees, the term to maturity, numerous contract
contingencies and other details also matter a great deal. Borrowers
who believe this myth may not understand all the costs involved
in a loan, or they may not consider the trade-off they are accepting
between less-burdensome early payments and more-burdensome
later payments.

Myth #2: “Rising house prices make
us all richer.”
Over the past several years, house prices
in many regions have increased significantly,
perpetuating the “housing wealth” myth. To
see the fallacy in this myth, imagine a simple
economy with exactly two home-owning households. Suppose the “market value” of each house
was $200,000 as of yesterday. Today, both households believe their houses have doubled in value.
One household sells its house to the other for
$400,000, pocketing a $200,000 capital gain—an
apparent increase in the economy’s housing wealth.
But the first household needs somewhere to
live, and the second household has an extra, empty

Indicators of Basic
Financial Literacy
Financial Behaviors
		
		

Percentage of consumers
who engage in this
financial behavior

Pay bills on time

88

Balance checkbook monthly

67

Have emergency savings

63

Track expenses

49

Use a spending plan or budget

46

Save for long-term goals such as
education, car, home or vacation

39

Compare offers before
applying for a credit card

35

dwelling. So, household one buys household two’s original house
at the inflated price of $400,000, generating a $200,000 gain for
household two. Neither household has more cash or other assets
than it had before, and each owns one house as before. What has
changed? We can say that the housing wealth of the economy has
doubled, but it has no economic significance—it is a myth.
Continued on back cover

Q.
A.

Q.
A.

What types of transactions are
usually made through ACH credit
and debit transfers?

ACH credit transfers include
direct-deposit payroll payments, Social
Security benefits and tax refunds, and
payments to contractors and vendors.
ACH debit transfers include direct debits
of consumer and business accounts for
the payment of mortgages, bills and tax
obligations.

What is the automated
clearinghouse (ACH)?

Q.
A.

The automated clearinghouse
(ACH) is an electronic clearing system for
exchanging credit (payment applied to an
account) and debit (payment subtracted
from an account) transactions among
participating depository institutions.
The Federal Reserve banks operate an
automated clearinghouse, as do private
organizations.

Mexico at the bank, using a debit card at
an ATM or by requesting additional cash
back when making a purchase with a
debit card.

Q.
A.

Why is using an ACH network a good
way to send money to Mexico?

ACH is a very inexpensive and safe
way to transfer money and is already in
place in most financial institutions in the
United States.

What is Directo a México?

Directo a México is a program that
is offered by the Federal Reserve banks so
that money can be transferred by Mexican workers in the United States to their
homes in Mexico using ACH. Transfers
are carried out to and from bank accounts
chosen by the account holders. Money
may be withdrawn by the recipient in

The content for Q & A was compiled by Billy Britt,
economic education specialist at the St. Louis Fed’s
Little Rock Branch, and was largely adapted from
Directo a México Frequently Asked Questions
at www.frbservices.org/Retail/pdf/
DirectoMexicoFAQ.pdf.

Economic Snapshot
Third Quarter 2006
Q4-05

Q1-06

Q2-06

Q3-06

Growth rate —
Real Gross Domestic Product

1.8%

5.6%

2.6%

1.6%*

Inflation rate —
Consumer Price Index

3.2%

2.2%

5.0%

2.9%

Civilian Unemployment Rate

4.9%

4.7%

4.6%

4.7%

* Advance Estimate

Total Consumer Credit Outstanding
SOURCE: Board of Governors of the Federal Reserve System

Billions of Dollars

3,000

2,000

1,000

0
1960

1970

1980

1990

2000

2010

Shaded areas indicate recessions as determined by the National Bureau of Economic Research

What do the shaded areas in the graph indicate?
The shaded areas indicate recessions as determined by the National Bureau of Economic
Research (NBER). A recession is a significant decline in economic activity spread across the

economy, lasting more than a few months and normally visible
in real GDP, real income, employment, industrial production
and wholesale-retail credit. For additional information about
the criteria NBER uses to determine recessions, visit www.nber.
org/cycles/recessions.html.
What types of credit are included in the consumer
credit data?
Both revolving and non-revolving credit are components
of these data. Revolving credit allows borrowers to use
or withdraw funds up to a pre-approved credit limit. The
amount of credit available to borrowers decreases as funds
are borrowed, and the amount of credit available to borrowers increases as funds are repaid. Borrowers may repay
the borrowed amount in full at any time. Borrowers may
also repay over time; the repayment is subject to minimum
payment requirements. Examples of revolving credit include
credit cards and lines of credit.
Non-revolving credit involves a contract agreement in
which a down payment or trade-in is usually made. A
predetermined amount is paid periodically until the entire
debt is paid. Finance charges are added to the price and
are included as a portion of the payment. Examples of
non-revolving credit include home mortgage loans and
automobile loans.
With the exception of the recession that occurred
from March 2001 through November 2001, what
do you observe about consumers’ use of credit
during recessions?
During most recessions, growth of consumer credit tended
to flatten out, which indicates that consumers’ use of credit did
not increase at as a great a rate as it did during expansions.

Bulletin Board

June 18-22 and 26-27, 2007
Making Sense of Money and Banking

Federal Reserve Bank of St. Louis

This is a seven-day, three-credit course open to elementary and secondary teachers
and other educators interested in integrating money and banking topics into social
studies, language arts and math. The course will feature guest speakers from the
Federal Reserve Bank of St. Louis, as well as tours, hands-on activities, simulations for
classroom use and breakout sessions for elementary and secondary teachers. Registration through either Southern Illinois University at Edwardsville or the University of
Missouri-St. Louis is required. Three hours of graduate credit will be awarded to
educators completing the course.
To register for ECON 500B-501 through SIU-E, contact Mary Anne Pettit at
618-650-2583.
To register for ECON 5055: Money and Banking through UM-St. Louis, contact
Barbara Flowers at 314-516-5561. Ask about scholarships for practicing teachers
in Missouri.
For more information, contact Mary Suiter, manager of economic education
at the Federal Reserve Bank of St. Louis, at 314-444-4662 or toll-free at
1-800-333-0810, ext. 44-4662, or e-mail mary.c.suiter@stls.frb.org.

NEW!
Federal Reserve Resources

&
Tools

Tips
D

o you have a great idea for using a
Federal Reserve publication in your
classroom that you are willing to share?
If so, visit www.stlouisfed.org/education/
resourcetools. At this site, you can add
a tip or tool that you want to share,
and you can access tips and tools other
educators have shared.

Federal Reserve Bank of St. Louis
Little Rock, Louisville, Memphis and St. Louis

For more information about these Federal Reserve Bank of St. Louis programs,
go to www.stlouisfed.org/education or contact the economic education specialist
nearest you. (See bottom of page.)
Are you looking for ways to bring real-world economics into your classroom?
Consider these opportunities for fun and prizes by entering your high school students
in one or both of these two programs held in Little Rock, Louisville, Memphis and
St. Louis:
• E nter a team of five students in the Fed Challenge, a monetary policy competition
in which students take part in a mock Federal Open Market Committee forum. A
workshop for teachers, teams and coaches will be held at each of these Eighth
District cities:
• Jan. 30, 2007 – Louisville

• Jan. 31, 2007 – Memphis

• Feb. 1, 2007 – Little Rock

• Feb. 6, 2007 – St. Louis

• Invite your students to enter the Hot Topics in the News essay contest.
Essays are due:
• Dec. 13, 2006 – Little Rock

• Dec. 13, 2006 – St. Louis

• April 3, 2007 – Louisville

• April 3, 2007 – Memphis

Bank
Contacts

Little Rock - Billy Britt 501-324-8368
Louisville - David Ballard 502-568-9257
Memphis - Jeannette Bennett 901-579-4104

N

ew for Missouri teachers: Enter a
team in the first Missouri Personal
Finance Challenge. Teams of four high
school students will compete in written tests and a quiz bowl on personal
finance. The regional competitions will
be in Columbia, Kansas City, St. Louis
and Springfield. The state finals will take
place in May 2007 in Jefferson City. For
details regarding competition dates and
locations, as well as teacher workshop
dates, see http://cas.umkc.edu/mcee/
MPFC/MPFC_Index.htm.

St. Louis - Dawn Conner 314-444-8421
St. Louis - Mary Suiter 314-444-4662

Continued from front cover

Compare this concept to automobile price
changes. Do we feel richer when automobile prices rise? Probably not; in fact, many
of us would feel poorer because we know
we’ll have to spend more to buy our next
car. The point is that the value of a house or
a car is derived solely from the housing or
transportation services it provides.

Myth #3: “It’s always better to
buy than to rent.”
The renting vs. buying decision is particularly important when households are
purchasing housing services. In becoming
an owner-occupier, a household effectively
is a landlord renting a house to itself.
Some of the critical considerations in making this decision include the following:
• A household with a steady income
may be more suited to home ownership
because it is better able to undertake the
fixed financial commitment represented
by a mortgage. A household with a highly
variable income, on the other hand, may
need to reduce housing expenses relatively
rapidly if income declines significantly and
may, therefore, be better off renting.

• Because the transaction costs involved
in selling a house and moving to a new
residence are high—probably about
10 percent of the value of the house, including sales commissions, financing-related fees
and moving expenses—it may be better for
a household that expects to move within a
short period of time to rent rather than own.
• Owning a house provides a hedge
against unexpected future increases in rent.
A household that has a low tolerance for
bearing the risk of future “rent shocks” will
benefit more from owning a house than a
household that is more tolerant of such risk.
Personal finance is becoming more complex every day; yet, the widespread belief
in these myths shows that the average level
of U.S. households’ financial literacy is low.
If consumers want to make informed decisions, they need to arm themselves with
knowledge of basic economic and financial
principles and to exercise smart spending
and saving behaviors.
This article was adapted from “Consumer-Finance
Myths and Other Obstacles to Financial Literacy,”
written by Senior Economist William R. Emmons
and published as a Federal Reserve Bank of St. Louis
Supervisory Policy Analysis Working Paper 2005-03
in April 2005.

Classroom Discussion
1. What are some details about a
loan that a savvy borrower should
find out?
2. How is it possible that an increase
in the price of your house would
not result in your being better off?
3. According to the table on Page 1,
what are some conclusions that
might be drawn regarding financial
behavior? What could be done to
improve financial behavior?

For a lesson plan to accompany this
article, go to www.stlouisfed.org/
publications/itv/default.html.

prsrt std
U.S. POSTAGE
PAID
ST. LOUIS, MO
PERMIT NO. 444

Federal Reserve Bank of St. Louis
P.O. Box 442
St. Louis, Mo. 63166-0442
Inside the Vault is written by
Dawn Conner, economic
education coordinator, and
Mary Suiter, manager of
economic education, at the
Federal Reserve Bank of
St. Louis, P.O. Box 442,
St. Louis, MO 63166. The
views expressed are those of
the authors and are not necessarily those of the Federal
Reserve Bank of St. Louis or
the Federal Reserve System.
Please direct all comments
and questions about the publication to 314-444-4662 or
mary.c.suiter@stls.frb.org.