We’re working on a new Freakonomics Radio podcast about financial illiteracy, a topic we’ve visited a few times on this blog. Two guests you’ll hear from in the episode have held the same title: chairman of the White House Council of Economic Advisors.
First up is current chairman Alan Krueger, whom I asked what would improve if Americans were more financially literate:
KRUEGER: I think first and foremost, we’d probably have greater savings. People are often in a situation where they have to live paycheck to paycheck. That’s something I think we need as a country to work to improve. Most importantly I think we can improve income growth for the broad middle class. But many people who seem to have the wherewithal to save for the future find it difficult to save. So for example, they don’t take advantage of some of the tax benefits of some of the savings plans, which is really unfortunate because they’re leaving money on the table. And when it comes time to retirement, or when it comes time to needing those savings, they have a very thin cushion. So I think the biggest difference would be if we can improve financial literacy and if as a result people act based on their own personal interest to a greater extent, I think we would see higher savings, which would in the long run translate to greater investment and probably higher income growth for the country.
You’ll also hear from Krueger’s predecessor in the job, Austan Goolsbee, who’s now back at the University of Chicago. I asked Goolsbee how big a problem financial illiteracy really is. I was surprised to hear him list it as a major contributing factor to the Great Recession:
GOOLSBEE: I think it’s pretty important at most times, but as we saw in this last financial crisis it can become unbelievably important. So just for your own sake, you know, your own retirement, or your own making sure that you can send your kid to college and this sort of thing, you’ve got to at least know the basics of how to save money — if you’re going to invest the money, where are you putting it, that you’re not taking crazy risks that you don’t understand, and things like that. But then, you know, we saw through the 2000s as we in some ways ripped up the rules of the road and took away some of the restrictions that financial institutions had in offering financial products to consumers, there were a lot of people with limited financial literacy who got into extremely complicated mortgages. And those mortgages blew up, and that the magnification of those explosions essentially caused the financial crisis and the worst recession of most any of our lifetimes.
Keep an ear out for the entire episode, in a week or so.
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As other writers are saying, people are constantly pushed to spend everything they have (and more).
The President has been on TV encouraging people to buy new cars to help GM. These same people are losing their homes, but he wants them to spend $ on a fancy new car.
And the financial reporters claim it is good news when there are more new houses being built. When there are millions of foreclosed homes already available.
So don’t blame the people for financial illiteracy.
Yes, there’s a lot of financial illiteracy among the public, but it has been exacerbated by government policies like the home mortgage interest deduction and government guarantees of low interest, low downpayment house purchases as well as taxes on investments that encourage spending and discourage investment.
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The flip side of this is that I am financially literate (B.S. in economics) and I don’t participate in many savings plans available to me because of the torrent of stories of government and corporate pensions being put through ringers because of malfeseance. Don’t think I trust social security either—it’s just I can’t get out of the system! Maybe we could create a licensing test that financially literate people could pass so that they could opt-out of social insurance plans and do their own more productive investment. Unfortunately, being literate in public economics, I also recognize that most social insurance can’t work efficiently without everyone’s participation, but I am getting sick of the excuses for these systems being plundered and/or lost. And on second thought, even if I opted out of social security, etc. the government still gets funding for it through me from taxes on investments, so…
In other news, the epidemic of computer viruses is caused by computer illiteracy. And religious misunderstanding is caused by Greek, Hebrew, and Aramaic illiteracy.
Look, the world is a complicated place. You need to understand calculus to understand derivatives. You need to understand quantum field effects to know what your computer’s hard disk is doing. You need to understand genetics and chemistry to know what your food is made of. And don’t get me started on medicine and taxes.
You can’t expect consumers to understand the products they buy, especially when the products are constantly changing in imperceptible ways. When did they start adding BHA to baby bottles? What have they replaced it with?
The only possible way for consumers to make smart decisions is if there is someone who is responsible to keep things from going terribly wrong. In the case of mortgages, that was the role of the banker. For as long as there have been mortgages, if the homeowner stopped paying, the banker lost money. So the homeowner could trust the banker to not try to sell them a mortgage they couldn’t afford, which left the homeowner to push for the most favorable interest rate and payment schedule.
When bankers turned from lenders into loan resellers, that relationship changed as imperceptibly as when baby bottle makers started adding BHA to their plastic. Nobody told homeowners that they couldn’t trust their bankers anymore, not the bankers, not regulators, not real estate brokers.
“You need to understand quantum field effects to know what your computer’s hard disk is doing.”
No, you don’t. You maybe need to understand say giant magnetoresistance to understand HOW your last generation hard disk does what it does, but understanding WHAT is pretty easy. In fact, hard disks have gone through many iterations of technology, from the first prototype (which sits in the corridor at IBM’s Almaden Research Center: http://innovation.blogactiv.eu/files/2011/08/FirstHardDrive.jpg ) to today’s terabyte drives. You can (especially these days) swap in the next generation technology without understanding how it differs, just as you can put a solid state drive in your old laptop.
Same with most of those other things, including the mortgages. You don’t need to understand the details of HOW, just knowing WHAT is sufficient, plus knowing that if you can’t understand the WHAT, it’s likely to be a sucker trap.
Financial Illiteracy? Are you kidding? Who is supposed to be able to invest for their future with honest investment markets…Economists?
Who’s kidding whom? When the big financial companies are lying and the government is only interested in protecting the wealth of the ultra-rich, what does financial illiteracy have to do with it?
You might as well blame the buffalo for not being able to better avoid the Sharp’s rifle .52-caliber bullet. Stupid beasts….
There’s very little evidence for Goolsbee’s position. Any of it.
There wasn’t a mass deregulation.
There were people who got complicated mortgages, but there’s no evidence that those limited number of “complicated” mortgages were themselves the source of the financial crisis. Goolsbee is conflating “complicated” mortgages (negative amortization, for example) with subprime mortgages and other mortgage products that were straight-forward (like ARMs, no-doc loans, etc.)
People who made a highly leveraged bet on real estate in bubble markets were, generally speaking, making an informed decision. They knew what they were doing. And they generally came out of this ok. Bankruptcy and loss of the minimal capital put in are the worst outcomes.
The financial crisis didn’t cause the recession.
Is it financial literacy that’s needed, or pure common sense? I’ve never had a personal finance class, but I had enough common sense to realize that I didn’t have enough to buy a home and sustain the payments. I also had enough common sense to know that businesses push their products because they want to make money, not because they care for me personally. It wasn’t rocket science, just a simple matter of thinking about what I had currently available, what I was likely to have in the future, and what I still needed to pay off the ridiculously high prices being asked for homes. Seems to me that a lot of people wanted to keep up with the Joneses, and believed the bankers and loan sharks because they wanted to. Not saying that Wall Street, the banks, etc., aren’t at fault too, but consumers deserve their share of the blame. They have a lot of power and rather than withholding from buying houses while prices were skyrocketing (and in effect slowing the bubble), too many chose to buy! buy! buy! and helped cause the bubble growth.
Krueger and Goolsbee flaunt their ignorance of how real people live. Most people’s salaries were static (no or minimal raises) for 5 to 10 years before the crash, depending on which study you accept. People began dipping in to savings just to stay even. Savings is ALWAYS discretionary income. That is, from what’s left after paying housing, food, clothing and transportation. Yes, some people spent what should have been savings on “improved” standards of living but not nearly enough to cause the problem. Low savings rates are a symptom not a cause of our financial woes. Get out of the “ivory tower” and down in the mud with the working Joes to find out whats really happening in the economy.