Sunday, January 18, 2009
In this op-ed piece in today's New York Times, early housing bubble spotter and Yale economics professor Robert Shiller advocates a massive effort to improve the sorry state of financial literacy in the world.
Many errors in personal finance can be prevented. But first, people need to understand what they ought to do. The government’s various bailout plans need to take this into account — by starting a major program to subsidize personal financial advice for everyone.The fact that he felt compelled to provide the correct answer of $150 makes you wonder just how bad things really are out there today...
The significance of this was clear at the annual meeting of the American Economic Association this month in San Francisco, where several new research papers showed the seriousness of consumer financial errors and the exploitation of them by sophisticated financial service providers.
A paper by Kris Gerardi of the Federal Reserve Bank of Atlanta, Lorenz Goette of the University of Geneva and Stephan Meier of Columbia University asked a battery of simple financial literacy questions of recent homebuyers. Many of the respondents could not correctly answer even simple questions, like this one: What will a $300 item cost after it goes on a “50 percent off” sale? (The answer is $150.) They found that people who scored poorly on the financial literacy test also tended to make serious investment mistakes, like borrowing too much, and failing to collect information and shop for a mortgage.
He goes on to talk about all the wonderful improvements that could be made in the world through better education in personal finance and, while this would surely be a good thing for the basics like buying a car, buying a home, or managing the monthly budget, carrying this initiative over in to the investment area is an entirely different can of worms.
Yes, it might have helped if people had actually understood that their mortgage payment would skyrocket in a few years, but the idea of some government sanctioned investment asset allocation seems preposterous.
And avoiding the pain and suffering of the next housing bubble, whenever it might come in 2020, 2025, or later, well, that's just ridiculous.
If personal financial advisers had been subsidized years ago with the best incentives, they still might not have stopped their clients’ bubble thinking during the boom. Many advisers probably thought that housing investments were a good bet. But it’s still likely that advisers who built long-term relationships with their clients, and who pledged to look after their welfare, would have been a helpful influence, suggesting caution to those who were getting over their heads in debt, and warning that adjustable-rate mortgages could be reset upward, just as the fine print said. For these reasons, financial advisers probably would have reduced the severity of the housing bubble.Nah! That's not likely.
Those urging caution would have been outnumbered ten-to-one by those espousing what was clearly the conventional wisdom at the time - home prices only go up.
I'll never forget the guy from Citibank who, back in 2005, told a room full of engineers that the home equity they had accumulated thus far in the housing bubble process (no, not his words) was, in fact, "dead money" (yes, these were his words) and that it should be "tapped" and then put to work by buying investment real estate.
As for the retirement planning/investment choices side of things, those of you who have seen the PBS Frontline documentary, "Can you afford to retire", might remember Brooks Hamilton, the corporate benefits consultant, who, on one hand, praised 401k retirement plans for the control and flexibility they provided to employees, a small number of whom are sharp enough to navigate their way successfully through the contemporary investment landscape (up until last year that is).
For most plan participants, however, he summed up the situation thusly:
I used to ask the CEO, CFO of my major clients, often in an environment, a conference room where some young employee would bring in coffee and all, and as they would be leaving, I would ask the CEO, "Fred, let me ask you, would you allow that employee to direct the investment of your account in the 401(k) plan?" And they always thought I was some kind of idiot. It's kind of like, "Don't they teach you anything down in Texas, Brooks? Of course not. I wouldn't let them touch my account with a 10-foot pole." And I'd say, "Well, but you force them to manage their own, and they are running their money into the ground."No amount of education is likely to improve the situation for most people - just think of how the guy who comes in to empty the trash at night is doing with his 401k.
Save for the simplest stuff like understanding car loans and home mortgages, maybe a better solution would be to rethink the entire financial system - how it's so prone to making big, giant bubbles that end up hurting a lot of people.
Either that or find some way to lay the investment risk off onto someone or some group who is far better able to handle it than your typical 401k plan participant.
This week's cartoon from The Economist: