June 30, 2010
Financial Ed 101
It’s good to see that James Surowiecki has come around to my way of thinking that better investor education is far more likely to hedge the risk of future financial scandals than throwing a few business executives in prison:
The government’s new consumer-protection agency has the authority to “review and streamline” financial literacy programs, but that’s not enough. We really need something more like a financial equivalent of drivers’ ed. There’s evidence that just improving basic calculation skills and inculcating a few key concepts could make a significant difference. One study of the few states that have mandated financial education in schools found that it had a surprisingly large impact on savings rates. . . .The point isn’t to turn the average American into Warren Buffett but to help people avoid disasters and day-to-day choices that eat away at their bank accounts. The difference between knowing a little about your finances and knowing nothing can amount to hundreds of thousands of dollars over a lifetime. And, as the past ten years have shown us, the cost to society can be far greater than that.
Surowiecki is spot-on with his observation (as is this TGR post on Surowiecki's article), but the promoters of the Greed Narrative continue to protest -- what about the innocent victims who lost their nest eggs as a result of the collapse of a company such as Enron?
Well, one of the main reasons that those victims' nest eggs ever had value in the first place was because innovative executives such as Jeff Skilling and Ken Lay transformed Enron into the world's leading energy risk management company through the creative use of futures and options contracts to hedge price risk for natural gas producers and industrial consumers.
Although it’s fine to feel sorry for someone who loses money on an investment, the Greed Narrative ignores the fact that most of those "victims" who lost their nest eggs were imprudent in their investment strategy. Taking Enron as an example, those investors should have diversified their Enron holdings or bought a put on their Enron shares that would have allowed them to enjoy the rise in Enron's stock price while being protected by a floor in that share price if it fell below a certain value. Those are the type of precautions that a prudent – and well-educated – investor would take in regard investing in a trust-based business.
Incongruously, while virtually all of those Enron "victims" hedged the risk of their investment in their homes by purchasing homeowner's insurance, few of them hedged the risk of their investment in Enron stock. Most of them simply did not understand how Enron's risk management services created their nest egg in the first place. Thus, when those nest eggs evaporated during the bank run on Enron, those investors didn't even try to understand what truly had occurred. They simply embraced the easy-to-understand Greed Narrative.
The Greed Narrative's devastating impact is that it obscures the true nature of investment risk and fuels the myth that investment loss results primarily from someone else's misconduct. As Larry Ribstein has been asking for years, do we really want to be sending a message to investors that risk is bad when it often leads to valuable innovation and wealth creation?
Do we really want to allow prosecutors and regulators to paint such beneficial transactions as frauds and then manipulate the public's ignorance to demonize innovative risk-takers?
At a time when America desperately needs innovators and entrepreneurs to create jobs and wealth, better education for investors makes much more sense than the paths we have been taking.
Posted by Tom at June 30, 2010 12:01 AM |
Dissuading people from thinking that the government is looking out for them and will help them if things don't work out is a necessary first step. School only has value to the extent students feel there are negative consequences if they don't pay attention.
More of what happened was due to greed than to ignorance, and school can't teach morals.
The Enron nest eggs were inflated in value to begin with, thus investors truly lost only a fraction of what they thought they had (same thing with Madoff; investor losses can't exceed the amount invested).
Posted by: steve sturm at June 30, 2010 1:10 PM
A couple of thoughts, Steve...a common misconception amongst the business class is that people want the government to "look out for them" and "help them if things don't work out."
That's half-true. Working people want the government to look out for them, but they don't expect them to help them out if "things don't work out."
Working people expect there to be regulations in place so that they are not taken advantage of. Many working people are operating with a high school education or less. A PUBLIC high school education or less! It's arrogant to assume that they should understand the intricacies of finance that educated and privileged persons such as yourself are privy to. This doesn't mean that they don't work their asses off their whole lives. In fact, they do -- for a (relative) pittance.
Working people are not business or investment-savvy -- and they shouldn't have to be.
Working people should, however, expect their government to work to protect them from the bamboozlement that has been building over the last generation or two through deregulation of financial products and services (especially since the 90's).
Assuming that people who work their asses off all week with no background in finance should know to tell the person running their IRA or pension or whatever to buy a "put" is ignoring the fact that these people have other people making these decisions for them PRECISELY BECAUSE it is outside their realm of expertise. This is EXACTLY why more stringent governmental regulation of financial services is essential.
All working people want is a little protection (in the form of reasonable regulation) from the banking/business/financial services world and all they get is a big, "F.U. you dumbasses, it's your own fault!" from the people raping them. They don't have the MONEY to hire c.p.a.'s or the TIME to study derivatives and c.d.o.'s ad nauseum. They work 50-80 hours a week and hope to God they don't have a major car repair or healthcare expense to pay for because they don't earn enough to save and (thanks to being in a "right to work" state as far as Texans go) they don't have health insurance.
Another thought: you say "The Enron nest eggs were inflated in value to begin with, thus investors truly lost only a fraction of what they thought they had (same thing with Madoff; investor losses can't exceed the amount invested)"
I wish I had millions of investment capital to lose like those poor sops. Let's, for a moment, assume I did...
If I invested in Madoff and was getting phantom returns from him, I might borrow against those returns and then I actually WOULD have losses greater than the amount invested. Right?
I wish I could be like Ayn Rand and do nothing but smoke cigarettes and do cocaine all day long while complaining about peons trying to raise their families. THAT would be great.
Posted by: djesno at July 5, 2010 3:52 AM
Sorry I'm two weeks late to the party.
I sort of like your response djesno. You have, however, left several unanswered questions which are fundamental to understanding the nature of your assertions. I would like to hear more about the basis of your thoughts if you are willing to share.
First, are you suggesting that "working people" are stupid or just ignorant? If just ignorant, isn't this precisely what Tom is addressing the post to, financial education? If they are intelligent they will find the time to educate themselves on important things.
Second, do you contend that "working people" are without places to invest their money which are safe or at least safer than high flying stocks? You may recall that CD's and US Treasuries, guaranteed as they are by organs of the US government.
Third, is it your perception that "working people" should be protected from themselves, from their desire to reap larger profits than those guaranteed by CD's and US Treasuries by depending upon the government to protect them from risks they don't understand? If so, how much in terms of resources and "lost opportunity costs" [described in terms of a percentage of GDP] are you willing to apply to protect people from their desire to achieve more profit than they otherwise would be able to?
One final point, is it better to have a job without health insurance than no job at all?
Posted by: Wannabepretentious.wordpress.com at July 19, 2010 12:22 PM
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