Prof. Shiller and Financial Advice

Robert Shiller (he of Irrational Exuberance fame) has a column in today’s New York Times linking the current financial crisis with fundamental mistakes made by the financially illiterate masses. Well, golly.

I am a fan of Prof. Shiller’s. His books are worth reading (if a bit dense for the non-economist) and he is an engaging public speaker. He is one of the very few who can look at the global recession and rightly say “I told you so.”

But the good professor is still a college professor. Academics can be very smart and insightful but they tend to have difficulty with the realities of the world that the rest of us live in. Shiller’s basic suggestion is that some of the government bailout money be used to start “a major program to subsidize personal finance advice for everyone.” This, I suppose, because the Federal Government has such a stellar track record on education.

He cites a “paper” presented at a recent academic conference that he says shows that people who fail “financial literacy tests” tend “to make serious investment mistakes.”

First off, the paper looks like a PowerPoint presentation to me. Second, it doesn’t say much about bad decisions, in fact it concludes that the financial illiterates were no more likely to take out an ARM than a fixed rate mortgage. (Although they were a lot less likely to understand the difference.) And thirdly, the test of financial literacy is really just a few fourth grade math problems that happen to be about money. It’s not a literacy test, it’s an intellegence test.

So it turns out that dumb people sometimes do dumb things. Fascinating. I think the most important realization from this is that there are banks that will give a mortgage to somebody who doesn’t know the price of a $300 sofa marked down 50%.

What Shiller is missing is that there is no need to subsidize the production of personal financial advice. We’ve got lots of that already. Foolish choices were not made because of a lack of access to advice. They were/are made because of a lack of access to good advice.

Why This Blog

This is not an advice blog, really. It is a blog about advice, and as a side-effect it contains some advice of its own. But the main topic here is the advice given by others and how bad it is. And not just any advice. I mean to talk about advice on a single subject of almost universal interest: money.

Money, or to use its proper name, personal finance, is one of the major genres of advice in the media, up there with dieting and sex. Of course, I’ve never read a dieting book and I’ve never flipped through a sex manual without a smirk, so for all I know the advice given on those topics is similarly lousy. But I have read a lot of personal finance books, articles, and blogs, and I’ve even managed to sit through some TV shows and heard some rather tedious radio call-in shows on money. Some are better than others. Some have good production values and a few are even entertaining. But they all seem to fall down on content. The best ones give advice that is only approximately sound and the worst say things that are just flat out wrong.

My qualifications for giving personal financial advice, and for criticizing the advice of others, are thin. Then again, the qualifications of the established experts in this field seem no more substantial. Mostly, what they have that I do not is the circular proof that they are qualified to give advice because that is what they do professionally.

I am an unemployed finance guy. To be more specific, I used to run a hedge fund. (The fund’s end was not dramatic, BTW. No frauds or spectacular losses. We had a mediocre year and my partner decided he wanted to do something else with his life, so we closed up shop.) I studied economics at an Ivy League college, got an MBA in finance at another Ivy, and have the usual assortment of licenses and letters after my name. All told, I have spent twelve years being paid rather nicely to invest other people’s money. So listening to what I have to say about personal finance is not the craziest thing you could do, even if I do not have my own TV show. Yet.

Then again, I am unemployed. That’s not exactly a unique situation right now, particularly in my line of work, but still a person might reasonably wonder: if I was really as smart about this stuff as I apparently think I am, would I have the free time to write this blog? That’s a good question for which I have no answer. But it does bring up a fundamental difference between advice on money and advice on, for example, dieting and sex.

Writing a book or blog is a natural next step for a person who is very good at dieting or sex. There is only so much weight a person can lose and only so much sex a person can have. (So I am told.) Opportunities to do either of those things at a higher or more advanced level are limited. So sharing the secrets with others in exchange for fame/money is about all you can do.

This is not the case with money. A person good at money generally keeps working at adding zeros to his net worth until he can buy an island to retire to. So who, you might reasonably ask, writes all those books and gives all those seminars? People who are clever about money but so naturally generous that they want to share their insights with others rather than profit by them personally? Can I interest you in a bridge I have for sale over the East River?

There is another, much more serious, difference between advice on dieting or sex and advice on money. If the advice everybody got on dieting and sex was faulty, that would be somewhat unfortunate for the nation. We would be a little chubbier and a little less happy in bed. But if bad advice on money is widespread and followed we’re all in big trouble. If, to imagine a far-fetched example, millions of people were told to buy more house than they could afford, the inevitable housing price bubble might set off a crisis in the capital markets that could plunge the whole world into a recession.

Left wing types like to fantasize that the economy is controlled by a small and sinister elite. That might have been true somewhere at sometime, but it is very far from the reality of the here and now. Ours is an economy controlled by millions of ordinary people, each with responsibility for a tiny bit of it. If a lot of them do a bad job of running their slice of the pie, then we all suffer, even those of us who are clever and thoughtful about money.

The premise of this blog is twofold: that personal finance advice ought to be taken seriously and that it needs to be a lot better than it is now.