Financial Literacy: Now More Important Than Ever

Dear Fools,

Our recent financial crisis has been called an "economic Pearl Harbor" (Warren Buffett), a "once-in-a-century credit tsunami" (Alan Greenspan), and "a true atomic bomb" (George Soros). Its effects have resulted in lost jobs, foreclosed homes, and a stock market that is trying the nerves of anxious investors who've seen their portfolios decimated.

There are plenty of cautionary lessons to draw from this crisis -- recklessness, greed, ridiculous lending standards, the disappearance of risk management ... the list could go on and on.

But there's another, deeper lesson behind it all -- a lesson that hasn't received as much attention, but still bears a heavy burden. Very simply: The majority of Americans are ill-equipped and ill-prepared to participate in this global economy because they lack basic financial skills.

Panic 2008 and the lack of basic financial education
There is a direct correlation between this unfolding crisis and financial illiteracy. As economist and Yale professor Robert J. Shiller recently wrote in The Wall Street Journal, "This nation needs to consider how it can help the great mass of investors better handle financial affairs -- not only their homes, but credit, loans, medical, and retirement planning."

Another important takeaway from these past few weeks is just how interdependent and connected we are when it comes to our financial lives (and financial futures). When one group takes uneducated risks, it can directly affect the rest of us. This financial crisis has been building quietly for years, as homeowners began accumulating ever-growing quantities of mortgage debt to finance consumption. Not only were financial institutions too eager to lend, but we were also eager to borrow. The victims in today's wreckage are almost unbelievable: Fannie Mae (NYSE: FNM  ) , Freddie Mac (NYSE: FRE  ) , Wachovia (NYSE: WB  ) , AIG (NYSE: AIG  ) , National City (NYSE: NCC  ) , and increasingly, the real economy.

The best approach to combat this is to educate, and to educate early.

We, as individuals, may not be able to do much to heal Wall Street of its assorted ailments, but we can do something to help better prepare and educate tomorrow's investors and consumers. Financial literacy certainly can't fix our current economic woes, but it can help prevent bad financial decisions from happening in the first place.

Announcing Foolanthropy 2008
Foolanthropy is The Motley Fool's take on philanthropy. Last year, we narrowed Foolanthropy's focus and announced our commitment to eradicating financial illiteracy. In light of all that has happened in the financial markets in recent months, this mission is now more crucial than ever -- so crucial that for the first time in the 12-year history of Foolanthropy, all our efforts and resources will go toward helping one organization that is dedicated to arming young people with necessary financial skills.

In other words, impact is the goal of Foolanthropy 2008. While narrower in scope, we hope to make a much more profound difference, rather than spreading our collective resources among several groups.

The Motley Fool has hand-picked four uniquely qualified organizations to help us with our mission. All four of these groups meet Foolanthropy's tenets and are innovative in their various approaches to financial literacy. It's now up to you, the Fool community, to decide which one of these organizations the Fool should partner with for Foolanthropy 2008.

Without further ado, the nominees are (in alphabetical order):

  • CFED
  • DonorsChoose.org
  • Junior Achievement of the National Capital Area
  • National Council on Economic Education

Get more information on our latest crop of Foolish candidates.

 Here are the details of this year's campaign:

  • Fool community members vote on the organization they believe the Fool should support. Voting begins today (Oct. 29, 2008) and ends Nov. 6, 2008.
  • The winner will be announced on Nov. 12, 2008. The fundraising campaign will launch that day and will end Jan. 21, 2009.
  • At the conclusion of Foolanthropy 2008, in addition to money raised from our community, the Fool will donate $10,000 to the selected charity. We'll also sweeten the pot with our annual "My $0.02 Cents" campaign, adding $0.02 to our $10,000 donation for every single message posted on any of our boards, as well as for every single CAPS pitch, during the month of December.

Become involved
Put on your philanthropic hat and vote for the program you believe will make the most impact. Further descriptions of each particular organization and how our money will be put to work can be found here .

Thanks to all of you who voted! Voting is now closed, and the winner will be announced very soon. Be sure to visit the Foolanthropy discussion board. Thanks in advance for your support!

Fool on,
Tom Gardner and Marthe LaRosiliere
Foolanthropy Co-Chairs

Neither Tom nor Marthe owns shares of any companies mentioned. The Motley Fool is investors writing for investors.


Read/Post Comments (17) | Recommend This Article (108)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 29, 2008, at 2:20 PM, catoismymotor wrote:

    May I be so bold a to offer an alternative idea? Have you thought of making a donaton to the Cato Instutute? They are a center that campions individual liberty and economic freedom. I can't imagine a more fool friendly place than them.

    www.cato.org

  • Report this Comment On October 29, 2008, at 5:29 PM, GoNuke wrote:

    This is a modified version of a comment I posted elsewhere.

    Yes -investors need a lot of education.

    Unless I see tangible evidence to the contrary I assume the FOOL needs some education too -otherwise you would have advised us that the world financial system was on the brink of bankruptcy in 2007.

    You didn't need to know a lot to predict the recent crisis. Financial industry insiders understood although many must have been in denial.

    I learned what I needed to know about the dubious practices engaged in by the world's leading financial institutions in less than a week. If I had bothered to learn this last year predicting the current crisis would have been relatively easy.

    Clearly the financial industry has forgotten how much diligence is due.

    Look around. You see

    -"liar loans";

    -Alt-A mortgages;

    -bogus insurance in the form of unbacked credit default swaps issued by US firms (AIG);

    -hyper-leverage of big brokerage houses due to de-facto deregulation that was presented by the SEC as increased regulation;

    -transformation of junk debt into investment grade debt by banks using unregulated derivatives....

    55 countries have signed the Bank of International Settlements treaty which generates the regulations that banks in the signatory countries are supposed to live by. These regulations limit the risky behaviours that banks can engage in.

    Most of the first world banks, which are in signatory countries, developed derivatives specifically to contravene these regulation. Basel II capital adequacy ratios limit banks leverage based on the risk level of their loan portfolio. They are supposed to have at least 8% of the risk weighted value of their portfolios in equity -limiting leverage to 12 times. Through the use of derivatives they got their leverage up to 50 times.

    Read Paulson's recent testimony before the Senate Banking Committee:

    "The events leading us here began many years ago, starting with bad lending practices by banks and financial institutions, and by borrowers taking out mortgages they couldn’t afford."

    Read Bernanke's testimony: "...in light of the prevailing market conditions and the size and composition of AIG's obligations, a disorderly failure of AIG would have severely threatened global financial stability..."

    In other words Bernanke knew that AIG's credit default swaps were the only thing keeping the world's banks solvent and AIG couldn't meet the obligations of those swaps. Why couldn't they? Because they didn't use the proceeds of the sale of the swaps to build up an asset base that could be drawn upon to cover losses. AIG just relied on its AAA credit rating. If it needed to cover a loss it would borrow money. AIG got lots of free cash in the form of "insurance" premiums which must have been fun while it lasted. These premiums probably ended up being paid out as salaries and bonuses instead of being invested in solid assets like regulated insurers are obliged to do.

    Paulson and Bernanke clearly knew what was going on. Indeed by the time they presented their first bailout package in September they had been working on it for months. Probably since the Bear Stearns collapse in March 2008.

    The S&P 500 was at 11,500 at the end of March.

    If we had understood what Paulson and Bernanke understood in March 2008 we investors would have made much better investment decisions.

    The house of cards created by the financial community was obvious to insiders. The fact that banks wouldn't lend to each other is evidence of this. They all knew what each other had been up to. Each knew that the other was probably insolvent.

    Greenspan was wrong about financial institutions always acting to preserve themselves. The fact is that the people running these institutions got paid a lot of money when the bubble was rising. They still have all that money. Other people who worked for them also made lots of money or just did what they were told. Fuld walked away from Lehman with over a half billion dollars -the sum of his annual salary over 4 years.

    What really happened was individuals saw a way to make a lot of money in the short term so that the long term didn't matter.

    I feel fully qualified to have called this crisis in 2007 if I had bothered to study recent developments in the financial system. I followed Basel II, what I didn't know was that the banks found a way around the regulations.

    Follow this link to an essay written in 2004. It is very slow to load but it shows not only how the banks got around the regulations but that they knew what they were doing.

    http://www.sef.hku.hk/~yjtang/CRM/Picone_CDO.pdf

    The next big concern is currency volatility. The US dollar is grossly over-valued as a consequence of capital flight to T-bills. The aura of safety surrounding the US economy is probably an illusion given the extent to which the economy is shrinking.

    Become an expert in foreign exchange. Don't presume the US dollar is going to remain strong or suddenly become weak.

    There is a large foreign debt crisis in newly industrialized countries. The governments of these countries have avoided borrowing abroad but Greenspan's cheap money attracted a lot of foreign corporate borrowers. Big foreign manufacturers and banks have incurred huge $US term debt and the value of that debt has just jumped 20-30% because of the rapid appreciation of the US dollar. Learn about private sector foreign debts. Which US banks are the most exposed?

    Watch out for overly optimistic predictions of near future earnings. There may or may not be any earnings in the near future.

    The Fool's Global Gains team would have us invest in China. Having witnessed the carnage caused by inadequate regulation in the first world I find it odd that people are recommending investing in even less regulated environments.

    As a post script I would like to add that the bond rating agency models were not adequate and the elaborate mathematical risk models the derivatives industry employed used S&P and Moody's model data as inputs.

    The bond raters' models are based on historical practices -practices that did not involve the massive leverage that the recent financial players engaged in.

    You are quite right. Investors need to learn a lot more. It would help if the regulators learned more as well.

  • Report this Comment On October 29, 2008, at 8:55 PM, jdgee2 wrote:

    I'm with , GoNuke *****

  • Report this Comment On October 29, 2008, at 8:56 PM, AaronEllsworth wrote:

    I absolutely agree that people need to be more educated. But that isn't the root of the current financial mess. This mess was made by our best and brightest, and greediest, and most educated. The markets need more ethics, honesty and integrity, and policing. There needs to be more transparency. I'm convinced that people have been deceptive and dishonest with their financial accounting, and have deliberately created complexity, with the intent to confuse and convince people to invest in things that if they had known what they were actually investing in, wouldn't have touched it in a million years. We've got police on our streets to keep us all behaving properly and we need police on Wall street to keep us all behaving properly. This is one republican who believes more regulation is perfectly appropriate. Would anybody obey the speed limit if there wasn't the risk of getting a ticket? There is probably a few ethical souls out there that would, but most people would speed as fast as they could because its in their self interest to get where they're going as fast as possible. It would take a lot of crashes (and loss of life, or limb, or vehicle) to drive home to people the risks associated with such behaviour, but until those crashes happen, that risk is easy to ignore. We've been financially recklessly speeding and now we are crashing. I just hope the guilty parties suffer most of the pain.

  • Report this Comment On October 29, 2008, at 9:18 PM, stfx wrote:

    Agree with Go Nuke. Responsible parties need to step up, or be dragged up, to take responsibility for their actions or failure to act.

  • Report this Comment On October 30, 2008, at 12:22 AM, NuvoRiche wrote:

    Thanks MF for focusing on financial literacy as a phiilanthropic effort. I have been preaching for some time that this was half of the equation producing the housing market trouble, and this badly needs to be remedied. While personal responsibility is also at issue, I do not feel that the public education system has provided our citizens with adequate preparatory tools, in the form of personal finance training, to have really known what they were getting into. This is in my opinion a failure of the American public education system. Thank you for stepping in to try and fill the void.

  • Report this Comment On October 30, 2008, at 8:39 AM, ShakespearesFool wrote:

    Tom Gardner, CEO and Co-Chairman

    The Motley Fool

    ,

    Dear Tom,

    ,

    Thank you and the Motley Fool Foolanthropy Committee, for running Foolanthropy again. With all the recent losses in the market and the resulting difficulties for your company, that cannot have been an easy decision. And with the likely decline in charitable giving because of these losses, it seems a wise move to concentrate on only one charity this year.

    .

    It’s good to see that a charity you have chosen to be among this year’s Foolanthropy candidates has been supported by the community in the past.*

    .

    And each of this year’s charities looks (from the descriptions and a brief visit to their web sites) to be worthy of our support.

    .

    However, in a world where, “according to the Food and Agriculture Organization of the United Nations, more than 25,000 people died of starvation every day in 2003, and as of 2001 to 2003, about 800 million people were chronically undernourished,” it’s hard for me to concentrate on financial education for people in the richest country in the world. **

    .

    I had hoped, as I have ever since learning about it from Foolanthropy in 1999, that there would again be an opportunity to have the Grameen Foundation be a Foolanthropy Charity.

    .

    It is good to see that The Motley Fool still speaks well of Grameen.

    (http://www.fool.com/foolanthropy/2008/08/12/guaranteeing-gro....

    .

    And I hope many of us will continue to support it.

    .

    John (Being Shakespeare’s Fool since October 1999)

    .

    *Last year Foolanthropy raised $23,865 for the Corporation for Enterprise Development (before the $10,000 bonus from The Motley Fool.

    .

    **Hunger and starvation statistics from Wikipedia

    http://boards.fool.com/Message.asp?mid=26084222

  • Report this Comment On October 30, 2008, at 9:23 AM, sails2 wrote:

    Fools:

    Two comments - First, one of the most lucid pieces I have heard on this issue was a one hour piece on NPR - This American Life. A link to the program can be found on the website http://www.thislife.org/radio_episode.aspx?episode=355

    This piece shows us how incentives to disaster existed. Any regulation, to be successful, should address these incentives. The problem was not "Greed and Corruption on Wall Street." It is more folks doing what they can to maximize their return given the incentives which exist.

    Second: I am retired. My last assingment when I was working was to be responsible for training for the research staff for a chemical company. It became obvious to me that the researchers needed more information on how to manage their profit sharing which was in company stock. I went to my boss, the head of R&D for the company with a proposal to provide financial training for our staff. His response was that he did not want these folks to sell their company stock in profit sharing accounts, something they could start doing at 50. I went to Compensation and Benefits with the same proposal and got the same no. Think Enron.

    It is all about incentives.

    todsails

  • Report this Comment On October 30, 2008, at 12:42 PM, InFinLit wrote:

    Mr. Gardner, Ms. LaRosiliere, and Fools:

    Thank you for your committment to financial literacy education in the K-12 environment, which is badly needed. Each of the organizations you have chosen is a strong advocate for the cause.

    I would ask that in the future you be sure to differentiate between "financial literacy education" and "economic education," as they cover very different topics (although many people incorrectly use them interchangeably).

    Financial literacy education addresses personal finance issues: money management, personal credit and debt management, personal investing and retirement planning, and risk management (insurance).

    Economic education addresses community and financial systems issues: supply and demand, moral hazzard, capitalization, etc.

    Both financial literacy and economic literacy are important. However, we need to prioritize our efforts based on cause and effect. The average American needs financial literacy education (budgeting, understanding 28/36 personal debt to income ratios, adjustable vs. fixed rate mortgages, etc.) while only those preparing to move beyond entry level retirement investing in employer selected mutual funds NEED economic education.

    Said another way, being financially literate (understanding their cash flow and debt to income ratios) would have helped the average American avoid getting into mortgages and credit card debt they couldn't afford. This would have limited the size of the real estate and credit bubbles no matter how greedy anyone else was. This in turn might have limited the scope of the economic crisis to some degree. Without an underlying foundation of financial literacy, an understanding of Keynesian economics (or whichever theory you subscribe to), while useful and valuable, would be less likely to keep someone from buying more house and/or consumer products than they could afford.

    I also respectfully request that the next Foolanthropy effort seriously consider supporting (or at least offer the option of supporting) the following:

    1. Professional training and certification of K-12 teachers as financial educators. Training teachers for financial literacy education has a longer term impact because the teachers take that knowledge forward from one class year to the next and are more likely to integrate financial literacy into their curricula throughout the year instead of on a single topic basis.

    2. Adult financial literacy education. Don't forget the adults! If we focus only on K-12 education, it will be 2 decades or more before we begin to see substantive improvement in overall financial literacy rates. To really have an impact in less than a decade, financial literacy education needs to take a comprehensive approach and address both K-12 educational needs (for the medium and long term) and Adult educational needs (for the short and medium term).

    Thanks again to you and all the Fools supporting this philanthropic effort.

  • Report this Comment On October 30, 2008, at 2:48 PM, ShakespearesFool wrote:

    Let's try that Motley Fool reference again

    http://tinyurl.com/foolanthropy-grameen

    John (Being Shakespeare's Fool since October 1999)

  • Report this Comment On October 31, 2008, at 1:47 AM, GoNuke wrote:

    In response to sails2

    "It is more folks doing what they can to maximize their return given the incentives which exist." I agree that this is part of why systems fail. I disagree with the notion that the incentives were created or followed by innocents. It was not good intentions that motivated banks to create highly leveraged entities that hid risky assets and allowed them to contravene capital adequacy rules.

    Complex derivatives made it possible for financial institutions to create risky investment vehicles that were very profitable. People pursued the profits.

    One of the first things you learn in business school is how leverage amplifies profits and losses. By the third day of MBA school I knew that high debt:equity ratios were dangerous.

    Regulations designed to protect the world from the dangers of over-leverage were consciously circumvented by people who had been to business school. They were not innocent.

    The anti-regulatory attitude of the Bush administration and the "so called" free marketeers is simply misguided. To be free the markets must be transparent. Without regulation there is enormous incentive to obfuscate. I've spent a lot of time in board rooms. Capitalism is amoral not immoral. We harness individuals innate desire for wealth (a.k.a. greed) to maximize total wealth generation. Regulation is the harness -it keeps the system fair.

    Fairness is a great incentive. The American dream is based on fairness -that anybody can work hard and get ahead.

    Fairness rewards merit. Meritocracies outperform all other systems. Regulation is designed to ensure fairness. Our financial system has been rewarding unfair behaviour.

    I noticed a reference to the Grameen Bank -a brilliant example of how fairness can drastically improve productivity. In poor countries wealth is unfairly distributed. Most people don't have fair access to capital. Even a small loan -of less than $50, used to buy a goat or a hand tool can generate an enormous increase in productivity/income for the borrower. Micro-credit loans are usually paid back quickly and the default rate is very low.

  • Report this Comment On October 31, 2008, at 1:59 AM, GoNuke wrote:

    “The Fortune at the Bottom of the Pyramid. Eradicating Poverty Through Profits”

    http://www.whartonsp.com/press/reviews_detail.asp?promo=1654

    "If a large international bank were to start lending to the poor at interest rates, reflecting higher risks and start-up costs, of say 20% (compared with around 10% in rich countries), "the whole anti-globalisation lobby would probably be against it. Yet the alternative is for the poor to borrow at 500% from a money lender. Whose side are the activists on?" If you are on the side of the poor, he says, "surely you need to help get rates down from 500% to 20%. After that, you can work on getting them from 20% to 10% like in the rich world."

  • Report this Comment On October 31, 2008, at 2:56 PM, Nesley86 wrote:

    if you are interested in teaching your kids about working with money responsibly, Junior Achievement has a great free site. You should check it out.

    http://studentcenter.ja.org/

  • Report this Comment On November 03, 2008, at 4:41 PM, dumererl wrote:

    Thank you for again making a donation to a very worthy organization. While I have my preference, whichever organization wins the support will further the goals of economic literacy.

    Thank you again.

  • Report this Comment On November 04, 2008, at 12:34 PM, 32susan wrote:

    when I was 18--my first job as a model-- and was paid $50 a week-- I put it in the bank at once-- I bought almost nothing-- then it was marriage, children, found a job-- money in bank-- and so on-- then divorce-- assets grew-- grew & grew & grew-- 30 years later happily married-- now I help my children-- grandchildren & a young grandchild-- I've never been happier in my life-- & 76 in a few days!!!!!!!!!!!

  • Report this Comment On November 04, 2008, at 2:04 PM, mreedpgh wrote:

    Dear Tom (and fellow Fools),

    While I commend your efforts to maintain and grow Foolanthropy, having donated to Foolanthropy myself I have strong reservations with one of the charities you have selected this year. DonorsChoose has--to me--a very sizeable overhead in comparison to most of the charities to which I donate. Take a look through their financial statements, especially their Form 990. The idea that the top five directors get $100k+ in compensation for a foundation that distributes ~$9.5M is a bit skeevy for me, as is the idea that 15-25% is skimmed right off the top of every contribution to go to the overhead. Make no mistake, I like the idea that the donations are local and for well-defined projects, but I'm skeptical about the distributions of donations.

    If this is the charity selected, I'll reserve my money to donate to a previous year's Foolanthropic choice.

    Yours,

    --Mike

  • Report this Comment On February 17, 2009, at 5:46 PM, Heart4Teaching wrote:

    Hello. As an educator of at-risk children from low-income families, I want to thank you for your support of financial literacy and your partnership with donorschoose.org. This website has allowed me to provide for my students so that they are 'equally advantaged' when they walk through my classroom door each day. I am already encouraged by the support that has been given to our project (Fiscally Savvy Students Earn Save, and Spend with Sense.) Even if our project is not funded, I know from experience that you have made a tremendous difference by funding so many other projects. Thank you. This country will survive these difficult times and have a better future by educating our youth for today and tomorrow.

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