Tuesday, December 24, 2013

Financial literacy in school is common sense

On my plane to London and then Milan, Italy , a few days ago, I picked up the Financial Times, a newspaper I particularly like, but that I normally read online. The week-end edition had a FT Money section, which was reviewing the main events of 2013. As I was browsing through the articles, I noticed one that was titled: “Cheer up, 2013 wasn’t as bad as we thought” by Jonathan Eley. It was about the UK and the author listed five reasons why 2013 was actually much better than it looked. I reported below his number 4 reason in quotation marks:
“Children will be taught about money. What was the best thing the government did this year? For me, it wasn’t putting Aim shares into Isas; it was putting financial education into the national curriculum. This passed barely noticed, won’t come into effect until next year, and will take many years to bear fruit. But it’s vital. We cannot expect young people to take responsibility for their own financial future unless we give them the skills and knowledge to do so.” 

 I report the link to the article at the end of this post, if you want to read the other four reasons why 2013 was not as bad.

I was pleasantly surprised to read this article, but it also made me realize that adding financial literacy in school has become common sense. Anyone who understands the changes in the current financial environment can see that the new generations will need new skills and these skills are best acquired in school. It is a simple argument and I hope not just the UK but other countries as well will think of adding financial literacy in school in the new year.

As I landed in Milan, I was determined to do some qualitative testing on my favorite subject: my little niece Giorgia. So after the many hugs and kisses I get when I come back to Italy and while I was looking at the new drawings she did for me, I asked her whether she was interested in learning about money. I was not even done asking the question that she jumped from the chair and she went to get her piggy bank. I was amazed by how much money she had in there. It was obvious that we had to go beyond the lesson on money, we had to talk about investment. So I told her that she should not leave the money in a piggy bank, she had to put the money at work. And while I was thinking of creative ways of explain that to her, she told me the she and her schoolmate Michelle were thinking if Santa Klaus needed help with his toy factory, an idea suggested by one of the parents.

 The morale of this story can be summarized as follows:
1)      It is never too early to talk about money to children;
2)      It is best if money is learned at school, so we do not have to spend our time thinking of ways to teach money ourselves (I do it for living, but in my case as well I would prefer to play checkers with Giorgia);
3)      It Santa Klaus were to do an IPO, we will be ready to invest. For the moment, indexed funds will have to do;
4)      The new year will not be as bad if we have financial literacy in school. 

Here is the article. The online version was titled: Five reasons why 2013 was better than it seemed

Monday, December 9, 2013

Keynote Address to CITI-FT Financial Education Summit 2013

My (short) keynote address to the CITI-FT Financial Education Summit 2013, “Moving Financial Capability Forward: Innovation, Scale and Impact,” held in Honk Kong on December 4-5, 2013.

It is an honor to speak at a conference that marks the 10th anniversary of an event held here in Hong Kong in 2004. One had to be visionary back then to think of financial capability and I want to acknowledge the wisdom of the Citi Foundation.

Robert Lucas, a Nobel Prize economist from the University of Chicago, once said that once you start thinking about economic growth, you cannot stop thinking about it. For me, this has been true about financial literacy. I have worked on the subject of financial literacy for more than 10 years and I want to use my short remarks today to talk about this important component of financial capability.

Financial literacy is a basic but essential skill for living in the 21st century. It is what reading and writing was for previous generations; somebody who could not read and write could not fully participate in society, just as today, somebody who is not financially literate cannot fully participate in the modern economy. We need to equip people with the basic skills necessary to live in the modern world and this has to start at school. I want to emphasize four reasons why we need financial literacy in school:

1.      The young face formidable challenges. One challenge is how to deal with an aging society. My Center organized a Global Financial Literacy Summit some weeks ago. It was held in Amsterdam in partnership with the World Pensions Summit. The discussion on planning for retirement was considered in combination with financial literacy in schools. In other words, preparing for retirement can be thought of as starting in school, where young people can learn the basics of financial decision making. On a selfish note, one of the reasons to focus on the young is that if they do not do well financially, they will move back in with us!
2.      Equality. Financial literacy is very unequally distributed in the population. A group that is particularly vulnerable is women. In all of the surveys I have done across countries, women always come out as the group that knows the least in terms financial literacy. We need to have financial literacy in schools to make sure women have equal access.
3.      Financial literacy is at the basis of democracy. How can we ask people to vote on economic reforms that they don’t understand? This is to say that financial literacy is not just about one’s personal finances; individual knowledge and decisions can impact the community, the country, and the global economy. We need to update the curricula to acknowledge this.
4.      Finally, we need financial literacy in schools because this is where young people are, and it is more scalable and cheaper to impart this knowledge while the young are still in school.

       As evidence that financial literacy is now considered a basic skill, like reading and writing, in 2012 the OECD Programme for International Student Assessment (PISA) added financial literacy to the list of topics it measures when it evaluating the knowledge of 15-year-olds. I look forward to the release of the financial literacy data, expected in June 2014, but for now I am happy to report that Hong Kong did extremely well in mathematics, reading, and science. These findings have been just released and Honk Kong came out in the top five in each topic (3rd in math, 2nd in reading, and 2nd in science)

I want to focus on financial literacy today because recent work in the United States has tried to dismiss its importance. I need to mention to you that financial education in US schools normally consists of a one-semester course taught in the senior year of high school (and often by teachers who report—when surveyed—that they do not feel qualified to teach the topic). I do not need to see an evaluation to predict that this sort of education does not work. We do not learn anything—not math, geography, history—by taking one course at the end of high school. We need to start early and build upon basic knowledge. We need experimentation, new ideas, and the help of technology. We need initiatives like the ones I heard about on the bus to dinner and during dinner last night. And we need to evaluate them to see what works, and then do more of what works.

       To summarize, the points I have touched upon are . . .
-          Financial literacy/education
-          Focus on women
-          The importance of evaluation

You may say Wait, but these are the topics we discussed ten years ago. Have we come full circle? Progress has been made, but my message today is that there is still work to do.

I think we may find inspiration from a city like Hong Kong. I am blown away by it. If a city can find a way to grow so much and so fast, if it can build these tall skyscrapers that light up at night to transform Hong Kong into a city of light, surely we can find a way to tackle financial literacy. Welcome back to this great city!

Monday, October 7, 2013

The Financial Fragility of American Families

I would like to continue writing about the research we have been doing, and I discuss in this post the financial fragility of American families. This is a topic I have written about before—I started this research project some years ago, during the financial crisis—but the work is continuing and it is important to examine how families are doing in the wake of the financial crisis.

Financial fragility is measured by a new and simple survey question, which was originally used in the 2009 Global Economic Crisis Study and was later added to the 2012 National Financial Capability Study.  The question is worded as follows:

“How confident are you that you could come up with $2,000 if an unexpected need arose within the next month?”  

Respondents could reply:
  • I am certain I could come up with the full $2,000
  • I could probably come up with $2,000
  • I could probably not come up with $2,000
  • I am certain I could not come up with $2,000
The amount was meant to reflect an unexpected expense, such as a car or home repair, a large medical expense (e.g. an emergency room visit), or another urgent need that had to be addressed in a month’s time. When asked in 2009, we found that about half of American families were certain they could not or probably could not come up with $2,000 in 30 days. This is a high proportion, perhaps telling us what a profound effect the financial crisis was having on the finances of so many families. But when the question was asked again in 2012, 40% of families said they were certain they could not or probably could not come up with $2,000 in 30 days. The proportion of those who were certainly not able to come up with $2,000 was about the same as it had been in 2009, about 25%; in other words, one in four families was certain they could not deal with an unexpected expense both during and in the years following the financial crisis.

In an earlier post, I discussed the 2009 data, and I want to focus now on the 2012 data. While financial fragility is more pervasive among the young, among African Americans and Hispanics, and among those with low income and low educational attainment, it is still high among many families.  Let’s look at a group that should be better able to weather a shock: older respondents on the verge of retirement (age 56–61). This group should be close to the peak of wealth accumulation and is expected to have accumulated resources to both keep consumption stable upon retirement as well as when facing a short-run shock. But according to the data, about 36% of older respondents stated they could not come up with $2,000 in 30 days.

There are other indicators in the data corroborating the finding of financial fragility among older adults. For example, about 40% of respondents in this group state they have too much debt. And debt they do have: they have mortgage debt and credit card debt. They have borrowed on their retirement accounts, and they have used payday loans and pawn shops. And medical expenses seem to be contributors as well, as a whopping 24% of older respondents report having unpaid medical bills. So, even those at a point in the life cycle when they should be well-equipped to deal with shocks are, in fact, financially fragile.

The worst of the financial crisis may be over, but many American families—even those who are expected to have accumulated wealth—are far from being insulated from shocks.  A protracted government shutdown may take a toll on the families of public employees.  And if it affects the confidence of the American public, it may make other families feel more insecure too.  After a Great Recession, we need to find ways to strengthen the capacity of families to deal with short-term shocks. It seems we are instead adding more of those shocks.

Monday, September 30, 2013

Debt and Debt Management Among Older Adults

I am writing this post and several subsequent ones on research findings. I spent a lot of the summer in front of the computer, looking at data, running regressions, scratching my head, walking around my office, and writing papers. Some of you might think that this sounds like a boring way to spend the day, but in fact, I am truly happy when I can spend time in the office or at home doing research.
The latest project I have been working on is in conjunction with my longtime co-author, Olivia Mitchell from the Wharton School. We examine debt and debt management among adults on the verge of retirement. We focus on debt for several reasons. First, debt generally rises at interest rates higher than those that can be earned on assets. For this reason, debt management is critical for those seeking to manage their retirement assets. Second, not only do families have greater opportunities to borrow to buy a home and to access home equity lines of credit but they also need lower down payments to buy a home. Additionally, as sub-prime mortgages proliferated, credit became increasingly accessible to consumers with low credit scores, little income, and few assets. Consumer credit, such as credit card borrowing, has also become more accessible, and this type of unsecured borrowing has increased over time. Third, in many states, alternative financial services have proliferated, including payday loans, pawn shops, auto title loans, tax refund loans, and rent-to-own shops.  Fourth, a focus on debt may help to identify financially fragile families who may be sensitive to shocks and unable to afford a comfortable retirement. Last, the recent financial and economic crisis was largely driven by borrowing behavior, so understanding debt may help us avoid a repeat of past errors.
What do we do to examine debt? We use data from the Health and Retirement Study (a great data set which, as the name implies, provides a lot of information for understanding retirement readiness) and compare three different cohorts of people on the verge of retirement: those who are age 56–61 at three different time periods: 1992, 2002, and 2008. We look not only at the debt these three groups of older adults hold at the time they are surveyed but also at how much debt they have in relation to their assets. We have the following findings, which I list here for ease of presentation (okay, call me nerdy).

·         Americans today are more likely to arrive at retirement with debt than in the past. Of the cohort surveyed in 1992, about 64% held debt, whereas by 2008, over 70% of the group surveyed held debt. This tells us that people retiring in the next several years (the baby- boom generation) are more likely to carry debt into retirement compared to previous cohorts.

·         Not only has the number of people holding debt increased, but the value of this debt also grew sharply. For those interested in values, median debt more than quadrupled from about $6,200 in 1992 to $28,300 in 2008 (in 2012 dollars) and many boomers (the 2008 survey cohort) had large amounts of debt (over $100,000) with respect to previous cohorts, something to worry about if interest rates increase.

·         A key reason that debt rose so rapidly for the 2008 (boomer) cohort is that this group spent more on housing than earlier cohorts. As a result, boomers are now more likely to have loans outstanding on their primary residences. Boomers are also more likely to carry non-housing debt.

·         Debt ratios have also increased, making recently surveyed (younger) cohorts more leveraged than older ones. For example, boomers have a much greater ratio of mortgage to home value to pay off and will have to service mortgage debt well into retirement. They are also much more likely to have debt equal to or greater than their liquid assets, meaning they will likely have to sell off less liquid assets (or borrow more) to pay their bills.

To get some insights into explanations for such debt and debt ratios, we turn to a data set that I have mentioned often in previous posts, the National Financial Capability Study. This is another rich set of data and because two waves are now available—2009 and 2012—we can look not just at the boomers of the same age group as were surveyed with the HRS, but also at older households in the wake of the financial crisis. The news derived from these data is not good either and reiterate the finding that many older Americans are exposed to illiquidity and/or problems with debt management.  Here are some more numbers:
·         Not only do older adults carry costly credit card debt but many have already tapped into their retirement accounts, and more than one in five have used high-cost methods of borrowing, such as payday loans, in the period from 2007 to 2012.

·         About 40% of older adults state they have too much debt, confirming the high values and ratios we see in the Health and Retirement Study data.

·         While older adults should be close to the peak of their wealth accumulation, in fact more than 35% state they could not come up with $2,000 in 30 days, one of our measures of financial fragility. Thus, many older Americans are vulnerable to shocks.

Several variables can be linked to the conditions of having too much debt and being financially fragile: having experienced a sharp decrease in income, number of dependent children, poor health, and low education and income. Financial literacy also strongly correlates with both high debt levels and financial fragility.
While protective legislation can be useful in situations where people lack opportunities to make repeat financial decisions, so as to learn from them, it can also be useful to better inform Americans of potential consequences of decisions such as buying a home, cashing out their 401(k) plans, or taking out credit card loans. As Olivia and I concluded in our recent review of financial knowledge and financial success, “the costs of raising financial literacy are likely to be substantial, but so too are the costs of being liquidity-constrained, over-indebted, and poor.”
I offer below the links to the data sets we have used in our study as well as to the Senate’s Special Committee on Saving, where Olivia testified on September 25, 2013.

Monday, September 23, 2013

The Influence of Teachers and Teaching

I moved over the summer, and it was as hard as moves are predicted to be. It took a lot of time and created its share of stress, but fortunately nothing broke and the new place is a lot nicer and very enjoyable. A friend told me that when you move, you lose something and you find something. Sure enough, a few things went missing, and who knows what happened to those boxes. But I also found a big envelop full of letters and correspondence that was sent to my old address at Dartmouth. Somehow it ended up on a shelf under a pile of papers and I never opened it. I looked inside and found some foreign correspondence, old issues of the Economist, and then a letter in a thick, elegant envelope. I opened it and found a wedding invitation. It came from one of my former students; she was in my class several years ago and also worked for me as a research assistant. I remember her vividly: a very petite Asian student who did not speak very much in class but who ranked at the top of the course. With my Italian mamma attitude, I felt protective of her; she looked so much younger for her age than the other students, and so fragile. But in fact, she had an iron will and when she was admitted to an excellent law school, she decided that the town where it was located was not ideal for a foreign student—the reasoning of a mature person who knows what she is looking for.  She had been put on a waiting list at some other schools and ultimately ended up at another Ivy League institution. And now she was inviting me to her wedding in California. I read the invitation several times, thinking of that petite student in the classroom.

As teachers, we tend to forget how much of a difference we can make for our students: we can motivate them to study more and harder, we can provide opportunities for them to ask a lot of questions, to challenge existing ideas, and we can push them to do more. The Committee on the Status of Women in the Economics Profession, also known as CSWEP, asked many famous economists how they chose their career. In many cases, the answer was that a teacher influenced them to choose economics or to go to graduate school or pursue an academic career.

I used to teach freshmen at Dartmouth, and I remember the faces of students in class, the mixture of curiosity and terror at taking their first economics course, which, on campus, had a reputation for being very difficult. Because of the work I had done on financial literacy, I knew that female students needed different arguments in order to find the course interesting and relevant.  And they needed encouragement to participate in class, ask questions, and volunteer their opinions. And I knew that technical terms—economics jargon—were off-putting for everybody, so I started the course simply and built both the “language” of economics and finance and its principles day by day. Truth be told, most of the students enrolled in economics courses because their parents told them to, so I had to prove to them that their parent were, in fact, right. (Do you see now what a tough job we have?)

When I talked to these students, many told me stories about their teachers, in some cases explaining that they had applied to highly selective colleges because their teachers had encouraged them to aim high. I heard that they loved math because their teachers made the course so good, and that they did well because their teachers cared about them. If I look back at each stage of my education, from elementary to high school to college and to graduate school, like my students, I can point to some teachers who had a profound influence on me and on who I am today. 

I am reminded of this lesson any time I start teaching a new class, any time I enter in the classroom where a new set of students are waiting. As a teacher, I have the good fortune of working with young people whose life of accomplishments has just begun.  I have a chance to influence their knowledge and, in turn, what they can do with it.

There are a few profound pleasures in life. One is receiving an invitation to the wedding of a former student. As the new academic year begins, I am reminded of the special job I have and what it means for students. For me, what I found during my move was a lot more important than what I lost.

Wednesday, July 10, 2013

After the Great Recession, where’s the financial education?

The economy may be slowly recovering from the Great Recession, but Americans continue to carry debt and still don’t understand basic financial concepts.

According to the 2012 National Financial Capability Study (NFCS), whose findings were released on May 29, 2013 here at the George Washington School of Business, Americans are more satisfied with their personal financial condition today than they were three years ago, and they are finding it slightly easier to cover their monthly expenses. But financial strain is still evident; only 41 percent of Americans make more than they spend, and in excess of one-in-five have been late with a mortgage payment in the last three years. 

Individuals are tapping their retirement assets: 14 percent reported borrowing from those accounts. In fact, many Americans are turning to high-cost borrowing methods such as payday or auto titles loans, pawnshops or tax refund advances. As many as 30 percent of U.S. adults have used these methods in the last five years, and a startling 43 percent of young respondents have done so, suggesting that the young are growing accustomed to borrowing outside of the traditional banking system.
The NFCS, supported by the FINRA Investor Education Foundation, was launched in 2009 to assess and establish a baseline measure of the financial capability of American adults. The 2012 study, which was developed in consultation with the U.S. Department of the Treasury, other federal agencies and the President’ Advisory Council on Financial Capability, updates key measures from the 2009 study and covers new topics. Its timing gives insight into what has transpired since the Great Depression.

The study found that Americans continue to grapple with debt. More than a quarter have unpaid medical bills, 14 percent report that their houses are worth less than they paid for them and 35 percent carry a balance on their credit cards. Student loan debt haunts citizens across the age spectrum—and half of those carrying loans are concerned they might not be able to pay them. While 36 percent of respondents age 18 to 34 had student loans, a surprising 19 percent of Americans age 35 to 54 still carry student loan debt. 

In tandem with these troubling statistics, the survey revealed that financial knowledge has not improved over the last three years. The level of financial literacy, as measured by questions that assess fundamental financial concepts—such as compounded interest, inflation, and investment risk—shows no change. Only 39 percent of respondents correctly answered at least four of the five quiz questions. A mere 14 percent answered all five questions correctly.  

Financial illiteracy is pervasive. And the most vulnerable demographic groups face the greatest struggle:  women, the young, the old and those with low educational attainment. The survey findings underscore the need to rigorously explore innovative and scalable ways to build financial capability in the United States.   

Despite this, we have failed to add financial education to the curriculum in most states.

In the study, fewer than 30 percent of respondents were offered financial education at a school, college or workplace. But 89 percent responded “yes” when asked whether financial education should be taught in school. A key recommendation of President Obama’s Advisory Council on Financial Capability is that financial education should take its rightful place in American schools. 

As the NFCS made evident, it is time to heed the council’s call.   

Thursday, June 27, 2013

Wanted: Ambassadors for Financial Literacy

In a country where people talk about sums in the millions and billions of dollars, where workers must figure out how much they need for retirement then wander off on their own to make those investments, and where borrowers are bombarded with opportunities for piling on debt, one in four adults cannot do a simple 2 percent calculation. 

And fewer than one-third of Americans can answer three simple questions that assess basic numeracy, knowledge of inflation and understanding of risk diversification.
Yes, we are a country of financial illiterates.

That’s what was revealed in the 2012 National Financial Capability Study, released a few weeks ago, which evaluates adults. When you look at teenagers, the results are even more chilling. Data published bi-annually by the Jump$tart Coalition for Personal Financial Literacy showed that only 7 percent of high school students are financially literate. 

Seven percent!

But it’s not so much about the statistics. What’s most important is the behavior that results from that lack of basic financial knowledge. People who are not financially literate are less likely to plan—or save—for retirement. And they are more likely to rely on costly borrowing, paying high fees and ending up in financial trouble. A paper by Stephan Meier at Columbia Business School and other scholars published this week concluded that people who are stymied by financial concepts are far more likely to default on subprime mortgages.

The President’s Advisory Council on Financial Capability issued a report a few months ago that outlined strategies to address financial literacy. One recommendation stood out: to include financial education in school curricula. There are four compelling reasons to support this. 

First, you must be financially literate to navigate today’s complex world. This has become so evident that the OECD’s Programme for International Student Assessment (PISA) last year added financial literacy to the skills (along with math, science and reading) that it tests in 15-year-olds around the world. 

Every three years, PISA gauges the following: Are students well prepared for future challenges? Can they analyze, reason and communicate effectively? Do they have the capacity to continue learning throughout life? The goal is to see if students nearing the end of compulsory education have the knowledge and skills essential for full participation in society. 

There is a second reason to bring financial education into the schools. At age 17, young people face a life-changing decision: whether to invest in higher education. What they decide carries vast income consequences over a lifetime. It also determines whether they begin their work years with instant debt. Options for financing higher education have changed and the cost of a college education has risen rapidly. That confluence means an average college student now takes on $26,000 in education loans. Graduation celebrations are now tempered with the reality of immediate—and significant—debt.

Financial education in schools also addresses the issue of equality. Who makes up that small percentage of students who are financially literate? White males from college-educated families. And research shows that this distinction is a lifelong one. Women, African Americans, Hispanics and the poorly educated display much lower levels of financial literacy than their counterparts at every step: in school, in middle age, before retirement and after retirement. 

Perhaps not surprisingly, this inequality in knowledge translates into inequality in wealth. As they near retirement, financially literate people tend to have greater levels of wealth than their counterparts who are not financially literate. According to my calculations, about half the difference in that wealth can be explained by financial literacy.  

Finally, by anchoring financial education in schools, we ensure that people are knowledgeable before, rather than after, they engage in financial transactions. Today many transactions—from using a credit card to opening a checking account to buying a car to signing up for a cell phone plan—start at an early age. They involve decision-making that is by no means simple.

You need not wait for our politicians to bring financial education into schools. Be an ambassador. Push your local high school to add financial literacy to an existing math or English curriculum. Ask the business community to support the initiative and train the teachers. It should not take much to convince a business-savvy person that it’s more economical to learn about finances in a high school than in the school of hard knocks.

Organizations like the Jump$tart Coalition for Personal Financial Literacy and the Council for Economic Education have designed standards that can be used in teaching. They have materials for both students and teachers. 

To naysayers who claim financial education does not work, I must point out that ignorance does not work either. Give education a try. As an economist, I know people need an incentive to take action. Here it is: Without some basic financial know-how, your children will move back in with you after college.