Combating Financial Illiteracy

Apropos of recent discussions on using regulation to prevent future financial crises, here is an interesting article detailing efforts (on a global basis) to fight the problem of “financial illiteracy”. The basic idea is that a situation like the mortgage crisis is nothing more than a symptom of financial illiteracy, and a better educated populace can prevent future economic calamities.

From the Economist:

EVERYBODY wants it. Nobody understands it. Money is the great taboo. People just won't talk about it. And that is what leads you to subprime. Take the greed and the financial misrepresentation out of it, and the root of this crisis is massive levels of financial illiteracy.

I agree 100%, as improved financial literacy would’ve not only prevented the subprime crisis, it would’ve prevented the mortgage crisis and the personal credit bubble as well. A financially literate consumer wouldn’t have signed on for a mortgage they can’t afford, or perceived purchasing a personal residence as a form of investing that justified taking on a risky mortgage. A financially educated populace will do more to combat future financial crisis than any regulations the government could cook-up, the financial sector can’t sell ill-conceived financial products to a populace who can see through their collective idiocy.

While I’m fully behind efforts to combat financial illiteracy, the thing that concerns me is the question of: “who defines financial literacy”? Will it be the legions of personal finance authors who parrot the same thing from book to book, and are basically selling a novice level narrow view that may or may not support an agenda of some kind? While some of the bad information out there is better than outright ignorance (in some cases at least), a truly effective financial literacy program needs to go beyond a lot of the anecdotal wisdom.

Let’s not forget that during the housing boom many people thought they WERE making smart decisions, and were the victims of misinformation from lenders, personal finance scribes, etc. In fact the real problem is that people were told to always expect positive results from making certain types of decisions, as opposed to being taught to think about their financial situations and make decisions based on math and personal considerations.

The thing that worries me the most would if a national financial literacy program was aimed at giving people answers and/or blueprints, as opposed to teaching them how to think. As the real financial message that the masses needs to hear is that finance is just mathematics, in fact, it’s rather simple math.

As a result the best way to approach any financial decisions is to crunch the numbers, factor in personal considerations and THEN make a decision. I.e. we’ll be better off if we buy this cheaper house (even if this neighborhood might not see as much appreciation), as we won’t be as vulnerable to economic shocks, and can put more money towards savings, investments and retirement.

Sources:

The Economist: “Financial Literacy: Getting it right on the money” – April 3, 2008.

Comments

[nukldrager]

Excellent!!!

[customer man]

I agree with your points but feel that it is more than just literacy as the we are wired to go for the easy, emotinally comfortable choice. Also more transparency and risk disclosure by the vendors would make it easier for the customer to know better what was being offered.

[User 48501]

AMEN!

[Markham]

Customer Man - I agree with you on the issue of emotional wiring, it's not just about educating people with knowledge, it's about changing their mindset.

Transparency and risk disclosure will help, but the person receiving the information needs to be able to understand it.

The example I've given off-line is that if the disclosure is perfect but written in German, it's not going to help people who only speak English.

-M

[Kiisu]

While I agree with the sentiment, I believe there is also an underlying assumption that should be examined. Namely, the educated never make stupid, unwise or irrational decisions, never misread the environment, and never misdiagnose the solution... which if true would mean lawyers would never break the law, doctors would always be in perfect health, ministers would never sin, etc. Yet even a casual glance gathers numerous counter-examples.

That cursory examination leads me to believe that while education is absolutely essential, education-by-itself is insufficient. Making good decisions also involves avoiding hubris (I'm guilty of that one, big time), understanding when and where to apply the rules (not too good at that one either), understanding the limitations of the rules (I've blown that one numerous times), and a host of other things I've not mentioned (and probably misunderstand).

At times indeed, the culprit is "what I know that ain't so"... which dear experience has shown to be one of my major failings.

[ericinNE]

"The thing that worries me the most would (be) if a national financial literacy program was aimed at giving people answers and/or blueprints, as opposed to teaching them how to think." -
That skillset is rooted in the use of logic, and that's the one thing that is rarely taught in school. Why Rudolph Carnap is not required reading (or at least some abbreviated synopses thereof) starting in middle school, is beyond me. The constantly reinforced notion that emotional gratification is the primary goal of existence has served to make the average human being a slave to that desire.
You're right, Mr Lee. It's just math, and logical consideration of consequences. Of course, math has become the #1 skill that is most lacking in the general population. Asked anybody under 30 to figure a randomly chosen percentage of any number bigger than two digits, lately? It's scary how many people don't have an even basic understanding of anything more complicated than simple addition/subtraction. ARM's, point spreads, floating rates, etc.? Please!! The odds of making a bad decision are way more, than that of making a good decision, for those that "just don't get" math, and aren't in the habit of using logic in their decision making process. Sometimes I think the lending community is relying on that, especially the credit card companies.