One of the recurring themes of this blog, possibly the central theme, is that we Americans do not know what we need to know about personal finance. For this I blame everybody, the financial advice gurus, the media, the government, a cultural bias against things monetary, and, perhaps most of all, our own lazy and childish selves.
If the problem is ignorance, then the obvious cure is education. Why not mandate a high school or college course on personal finance? This is a question I have discussed in passing a few times (e.g. here and here) mostly to point out that things are so bad I doubt we could find enough teachers.
Just to be clear, my only objections to teaching personal finance in schools are ones of practical implementation. In principle, more exposure to the issues of personal finance can only be a good thing. Even a disorganized course taught by a confused teacher could not make the situation worse. Or could it?
There is an outfit called the Jump$tart Coalition for Personal Financial Literacy which did a survey of college students in 2008. They found that students who had taken a personal finance course in high school scored lower on a test of financial literacy than those that hadn’t. Oops.
This discovery has been well analyzed in what turns out to be a rich academic literature on the efficacy of personal finance classes. There are even, if you look hard enough, blogs that discuss it. I found this stuff at The Psy-Fi Blog. (I like that blog a lot. A recent post about bank regulation was entitled Basel, Faulty? If you, like me, think that’s clever, you’ll like the blog.)
As amusing as I would find it that what high school courses that do exist are actually counter-productive, that sitting through them actually makes you dumber, I don’t think that is what is going on.
Firstly, it has to be acknowledged that "financial literacy" encompasses a vast and vaguely defined body of material. It is very possible that what Jump$tart quizzed the college students on was not covered in their high school classes. In particular, Jump$tart seems to use checkbook balancing as a litmus test skill. You might as well ask college students if they know how to use the Yellow Pages and properly clean a phonograph record.
Secondly, and more importantly, most of those high school classes were not required courses but were electives. That introduces a significant bias. It could be that those who took the classes tended to do so because they were particularly challenged when it came to personal finance. Or it might be the case that these were relatively easy electives in high school and that weaker pupils tended to take them instead of, say, AP Chemistry.
The Jump$tart study did find a consistent correlation between financial literacy scores and being a good student in general. Students with higher SAT scores, more years of college, and more planned years of college, did better on the quiz. Apparently, better students do better on quizzes. Fascinating.
They also found a correlation with undergraduate major. Science and engineering types did best, with nursing and arts bringing up the rear. Business/economics was, interestingly, in the middle of the pack. I take this as a useful demonstration that a) the academic field of finance is only distantly related to personal finance and b) personal finance is ultimately about numbers. It is not really financial illiteracy we are talking about but financial innumeracy.
There are those who conclude from the apparent fact that high school personal finance courses have no effect that the situation with regard to educating the masses is hopeless. Psy-Fi called the post that started me on this Freedom of Financial Choice is a Myth, arguing that expecting people to understand our modern financial landscape is unrealistic. The blog quotes from a paper by a law school professor who argues, and I am paraphrasing a bit, that efforts to educate the masses are misplaced. Instead we need more government regulation to protect these simple people from the sophisticated profit-maximizing bankers.
I do not think that personal financial education is inherently hopeless. I just think that right now we are bad at it. We can get better, but it will take much effort and some time. In a way I actually think the problem is worse than those that are ready to give up on financial literacy classes. We cannot expect a high school course to be a magic bullet if we do not know what to teach the students.
Moreover, conceding that 90% of people will never understand personal finance and should therefore be kept on the straight and narrow by benevolent regulation is no longer a practical option. Let us not forget that, at least with regard to investing, this was essentially the regulatory regime we had fifty years ago. Revisionist history has it that those regulations were abolished by a cabal of greedy businessmen and other Republicans. But that is not what happened. Mostly those rules, like the limits on what interest banks could pay on deposits and the separation between commercial and investment banking, were overtaken by events. By the time they were formally rescinded they had been practically irrelevant for some time.
Obviating the need for widespread financial literacy through regulation would be getting the genie back in the bottle. It is is one thing to complain that the financial lives of ordinary consumers are now inappropriately complex, but quite another to reverse the trend by banning some of the complicating newish inventions, such as IRAs, ARMs, credit cards, and on-line stock trading.
But the biggest problem with conceding that the masses will never understand our modern money world is that we live in a republic. Most inconveniently, the government that would keep the 90% from harming themselves and others is selected by that same 90%. And they generally don’t vote for politicians from the other 10%. Assuming they even exist.
Since the very start of this blog I have written about how much of the Great Recession was due to millions of ordinary people acting foolishly by, for example, buying more house than they could afford. But they also act foolishly by electing representatives who have even less common money sense than they do.
It might be possible to use government regulation to protect the simple people from the sophisticated profit-maximizing bankers. But then how do we protect the sophisticated profit-maximizing bankers from the simple people?