Tuesday, January 20, 2009

Forget Tim Geithner, we need Suze Orman at Treasury!

Robert Shiller thinks that some of the stimulus package should go to improving financial literacy in the US:
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.

A number of government agencies already have begun small-scale financial literacy programs. For example, the Treasury announced the creation of an Office of Financial Education in 2002, and President Bush started an Advisory Council on Financial Literacy a year ago. These initiatives are involved in outreach to schools with suggested curricula, and online financial tips. But a much more ambitious effort is needed.
Clearly, many financial errors were made over the past few years (interest only loan, how can I lose?). According to Shiller, this stems from a simple lack of financial knowledge:
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.
Improving financial literacy is a low-cost, potentially high-benefit government program. Strangely, it's not discussed that often. But consider this letter to the Wall Street Journal from Duquesne University economist, Antony Davies (HT: Cafe Hayek):
In the article "Big Slide in 401(k)s Spurs Calls for Change" (page one, Jan. 8), 35-year-old project manager Kristine Gardner says in response to the 44% drop in her 401(k) last year: "There's just no guarantee that when you're ready to retire you're going to have the money." Newsflash: Higher returns are the compensation for incurring risk, and lower returns are the price of safety. Ms. Gardner's 401(k) would have been completely safe had she shifted her investment allocations into money markets. As money markets yield a paltry 1%, Ms. Gardner's real complaint isn't that 401(k)s are unsafe, but rather that financial markets require her to incur risk in exchange for being compensated for incurring risk.

Retirement consultant Robyn Credico claims that "This is the biggest test that the 401(k) plan has seen . . . and it has failed." Au contraire, 401(k) plans have worked exactly as designed. It is the workers (and their retirement consultants) who have failed. There is only one reason why the average person close to retirement should have lost 50% of his 401(k): incompetence. Most workers at that age should have long since shifted the bulk of their 401(k)s into bonds and money markets. The 401(k) is a powerful investment tool but can be dangerous when abused.

If you aren't willing to put forth the effort to learn the principles of investing, that's your choice. But don't hobble the rest of us by asking for government regulation of a tool that works perfectly well just so that you can be spared the effort of figuring out how to use it.
Shiller is much more diplomatic, but the point is the same. A market system is one of profit and loss. You can't have one without the other.

Many, if not most, of the mistakes made over the past few years could have been tempered by better financial education. This does not explain the baffling decisions made on Wall Street and it does not excuse predatory lending practices or government regulators asleep at the wheel. But it's definitely part of the puzzle.

Madame Secretary, your first address to the people:

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