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Financial Literacy:An Issue of American Competitiveness
Global Conference 2009
Financial Literacy:
An Issue of American Competitiveness
Wednesday, April 29, 2009; 9:30 AM - 10:45 AM
Moderator:
John Bryant, Founder, Chairman and CEO, Operation HOPE;
Vice Chairman, U.S. President's Advisory Council on Financial Literacy
Speakers:
Sean Cleary, Chairman, Strategic Concepts (Pty) Ltd.
Richard Hartnack, Vice Chairman, U.S. Bancorp
Charlie Rahilly, President and CEO, Premiere Radio Networks
David S. Simon, Executive Vice President, Citigroup Inc.
Beverly Daniel Tatum, President, Spelman College
Leverage of U.S. households has increasedrapidly since 1980
Source: Moody’s Economy.com.
25
50
75
100
125
150
1952 1958 1964 1970 1977 1983 1989 1995 2002 2008
Household debts as percent of disposable personal income
Q4 2007: 139.5%
Q4 2008: 133.7%
Average, 1952–2008: 77.0%
U.S. household assets shrank by 16 percentfrom its peak in Q3 2007
0
15
30
45
60
75
90
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Other financial assets
Life insurance and pensionfundsMutual funds
Corporate equities
Credit market instruments
Deposits
Other tangible assets
Durable goods
Real estate
US$ trillions
Personal saving rate has been decliningsteadily
Source: Bureau of Economic Analysis. Note: Quarterly data.
Personal saving as a percentage of disposable personal income
-2%
0%
2%
4%
6%
8%
10%
12%
14%
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006
Surveys have shown low levels offinancial literacy
For example, a recent survey found that:
• A minority of Americans keep close track of what they spend on typical
monthly expenses. More than two in 10 keep little or no track at all.
• Four in 10 credit card holders say they do not or cannot pay the full amount
due every month on the card they use most often
– This is particularly true of younger Americans, blacks and Latinos and lower-
income Americans.
• Less than half of Americans have ever ordered their credit report.
Source: Princeton Survey Research Associates International for the National Foundation for Credit Counseling, 2007.
Recent studies have found low levelsof financial literacy
For example, Lusardi and Tufano (2008) studied a representative
sample of the US population and found that only:
• 36% of respondents performed an interest rate calculation correctly
• 35% figured out that making minimum payments equal to the
interest payment on outstanding credit card debt will never eliminate
debt
• 7% responded correctly to a question requiring an understanding of
the notion of the time value of moneySource: Annamaria Lusardi and Peter Tufano, “Debt Literacy, Financial Experience, and Overindebtedness,” working paper, September 2008.
Financial literacy programs can successfullyimprove financial skills
For example, 6–12 months after taking the FDIC’s Money Smart training,participants reported that:
• They were more likely to:
– Open deposit accounts
– Save money in a mainstream deposit product
– Use and adhere to a budget
– Have increased confidence in their financial ability
• More than half of the respondents reported that:
– Their level of savings increased
– Their debt decreased
– They were more likely to comparison-shop for financial products and servicesSource: FDIC, “A Longitudinal Evaluation of the Intermediate-term Impact of the Money Smart Financial Education Curriculum upon Consumers’ Behavior andConfidence,” April 2007.
Panelists’ slides
Sean ClearyChairman
Strategic Concepts (Pty) Ltd.
2002-2007:48% netfinancing
from foreigngovernments
Savings surplusin Asia
U.S. currentaccount
deficit ’01-07absorbed savings glut
2000dot.commarketcrash
Fed cutrates: 6.5%
to 3.5%
Al QaedaSept.11,
2001
Fed cutrates to 1%July ’03-’04
2000-2003:USG budget
surplus todeficit–war/ tax
cuts
US householdspending
exploded -mortgagefinance
Origins of the crisis
Acknowledgement: George Soros,The Crash of 2008 and What it Means
U.S. personal savings rate
Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Standard & Poor’s, MacroMarkets, Haver Analytics.
Saving rate (right axis)
Real home price (left axis)
Real home priceHistorical average = 100
Personal saving rate (%)4-quarter movingaverage
Acknowledgement: George Soros,The Crash of 2008 and What it Means
U.S. household mortgage debt
Sources: Federal Reserve Board, Haver Analytics. Note: Single-family residence.
U.S. households added more mortgage debt in the past sixyears than in the prior life of the mortgage market.
US$ billions
$5,520 billion in Q3 2001
$11,028 billion in Q3 2007
Acknowledgement: George Soros,The Crash of 2008 and What it Means
Quality of real estate-backed securities Real estate lending has been safer and safer?
Sources: RBS Greenwich Capital, Intex Solutions Inc., Commercial Mortgage Alert.
Fixed-rate conduit commercial mortgage-backed security subordination (%)
AA credit rating
BBB credit rating
Acknowledgement: George Soros,
The Crash of 2008 and What it Means
Source: Inside Mortgage Finance. Note: 2007 to Q2.
Growth in credit availability
Subprime share of mortgage originations
Alt-A share of mortgage originations
Acknowledgement: George Soros,The Crash of 2008 and What it Means
Surge in securitization
Source: Lehman Brothers.
US$ billions
MBS
ABS
CMBS
CDOs
August 10
ECBintroducesfurther 61bn
U.S. Fedguarantees asmuch overnightmoney asneeded
August 16
CountrywideFinancial(largest U.S.mortgageoriginator)draws whole$11.5 bn creditline
August 17
U.S. Fed cuts50 basis pointsoff discountrate
August 6,2007
AmericanHomeMortgage filesfor bankruptcy
August 9
BNP Paribassuspends 3inv. funds($2bn): sub-primemortgageexposure;short-termcredit marketsfreeze. ECBintroduces95bn to
unfreezemarkets; U.S.Fed and Bankof Japan follow
August 13
ECB puts infurther 47.7bn
U.S. Fed andBank of Japanguaranteeliquidity
GoldmanSachs commits$3bn to propup hedge fund
September 13
Northern Rock(U.K. mortgagelender) admitstrouble
U.K .Treasuryguaranteestrigger firstBritish bankrun in 100years.
Sub-prime mortgage sector falls apart
Merrill Lynch dumping subprime mortgage bondsfor pennies on the dollar, July 30, 2008$30bn portfolio for 22c/$.$30bn portfolio for 22c/$. The surprise move may put pressure on otherinvestment banks, notably Citigroup, to do the same.
• Merrill’s 2nd write-offwas $5.7 bn, bringing itstotal subprime write-offsover year to August to$52 bn.• The company alsoissued $8.6 bn of stockMonday, dilutingshareholders by 38%.• The move could putpressure on Citigroup,which still has $22.5 bn ofsubprime assets. UBS isnext at $15.6 bn.
Treasury Acts to Shore Up Fannie Mae and Freddie Mac, July 14, 2008WASHINGTON — Alarmed by the sharply eroding confidence in the nation’stwo largest mortgage finance companies, the Bush administration on Sundayasked Congress to approve a sweeping rescue package that would giveofficials the power to inject billions of federal dollars into the beleagueredcompanies through investments and loans.
G7: Subprime Write-Offs Could Hit $400 BillionFebruary 11, 2008As if banks and brokerages had not written off enough money for the subprimemistakes, the G7 experts think the figure could go as high as $400 billion.
In 2008, bank write-offs cascaded…
…till Lehman fell—then 3 weeks of rising panic…
Oct. 3: Following US Senate, House of Rep.
votes to pass an amended $700 bn bailout ofWall St. firmsOct. 9: Paulsen punts direct liquidity input
Ireland and Greece guarantee all bank depositsFrance proposes EU-wide rescue fund.Oct. 7: Iceland speaks of national bankruptcyOct. 9: U.K. suesOct. 8: U.K. provides £50 by rescue package forbanks; £2000bn to be pumped into moneymarkets; £250bn to cover medium-term debt
Sept. 15, 2008 Lehman Brothers 20072007• Ranked #1 “Most Admired Securities Firm” by Fortune
• Achieves record net revenues, net income and earnings percommon share (diluted) for the fourth consecutive year basedon record results in all three business segments• Acts as financial advisor on largest-ever M&A transaction infinancial institutions sector: $98 billion acquisition of ABNAMRO by a consortium of the Royal Bank of Scotland,Santander and Fortis• #1 dealer on the London Stock Exchange by annual tradingvolume for the third year in a row
October 10-13: IMF injects liquidity;G7 Finance Ministers agree joint response
The big falls
• Value of global financial assets (stocks, bonds, currencies) fell
>$50 tn in 2008—about one year’s GDP
• Global stock markets lost $28.7 tn in 2008, and $6.6 tn in
Jan/Feb 2009
• Net capital flows to emerging markets may fall to $165 bn in
2009, from $470 bn in 2008 and $930 bn in 2007. Net flows to
emerging Asian economies may fall 80% from peak 2007.
• Protectionist measures to prevent a deeper fallout won’t
work—no room for denial or populism
• Asia is likely to recover strongly in 2010. South Asia’s growth
prospects still good.
• Asia suffering cyclicalcyclical slowdown - problems in developed
economies; not a structural structural economic breakdown: growth
engines in Asia unlikely to weaken
Global impacts: Asian Development Bank
• Meltdown will cost developing countries > US$180
billion by end 2009; perhaps > US$ 400 billion
within three years.
• World Bank expects 40 mm people to fall into
poverty as a result. ILO estimates number living on
< $1/day may rise by 40 million; < $2/day by >100
million. Grain-price increases cost developing
economies $324 billion in 2007: > 3 times aid
receipts
• Total development aid (2007): $104 billion. In
October/November 2008, U.S. and E.U. mobilized
around $3 trillion to help bail out banks in crisis
LDCs, poverty and a sobering comparison
• Use fiscal stimuli needed for employmentand restoring economic growth to rejuvenatedebilitated infrastructures and advanceenvironmentally-friendly technologies
• Toxic assets must come off balance sheetsof systemically important financialinstitutions, and they must be appropriatelyrecapitalised
• Better back-office systems needed toimprove transparency and facilitate effectiveclearing and settlement arrangements, and
• A systemic approach to financial regulationand supervision is necessary, given theconnectivity of global banking and finance
• These are necessary, but not sufficient…also need…
• A new rule-based regime: States grant privilegedtrade, financing and collective security conditions tothose that adopt a Global Charter with commitments to:
– International security
– Ecological responsibility
– Respect for dignity of every human being, protection offundamental rights, advancement of justice and human securityand promotion of socio-economic welfare.
• A new global security regime– Local collective security arrangements
– Buttressed by global rapid deployment force
• Investment in equity and the environment– Large-scale investment in health and education systems and
ecologically viable economic infrastructures in developing world
– Socially and environmentally sustainable growth depends onproper balance between personal freedom and acceptance ofresponsibilities for public good and protection of globalecosystem
Necessary responses
• Budgeting
• Evaluating the capability to afford apurchase, and subsequently, evaluatingthe best way to fund that purchase
• Building an emergency fund
• Understanding how credit works(including your FICO score)
• Understanding how credit cards work
• Understanding how interest compoundsover time (tie into savings concept)
• Understanding the basic conceptsof a mortgage
• Understanding basic insuranceneeds and products
• Awareness and understanding ofwhat programs/benefits areavailable to you through youremployer or membershiporganizations
• Having a retirement plan
• Understanding investmentvehicles
Basic financial skills
Source: President’s Council on Financial Literacy, 2008 Report to the President.
• Average U.S. household (2008) >$9,000 in credit
card debt, 115m carry month-to month balances;
2006 >$17bn in penalty fees; U.S. negative savings
rate; average credit cards/person 8.5!
• “Teaser” rates: 6 months at 4.9%/lifetime 16% or 6
months 6.9%/lifetime 14%—lower teaser 3x
• Shopping: struggle between nucleus accumbens
(NAcc), dopamine (desire) and insula—aversion
(cost); prefrontal cortex stands aside or mediates
• Merchandising aims to stimulate desire and inhibit
insula—“bargains” and plastic
Aligning institutional and personal behavior
• Safety and security; nesting, warmth—opportunity to buildwealth
• In 2000s, rising house prices but anemic real median incomegrowth—ARMs with “teasers”—Alt-A (“liar loans”) common;NINJA at extreme
• 2/28—low fixed-interest rate 2 years; much higher adjustablerate thereafter
• Originators sold off as CDOs, tranched and rated; after 2005,CDO
• At subprime collapse: 2/28 types 20% all mortgages; 60% inpoor areas: end 1997—93% all foreclosures
• Peak of boom: 55% 2/28 types sold to borrowers who wouldhave qualified for prime mortgages—tricked into dumbdecisions: insula suppressed; NAcc stimulated; oxytocinflows; dopamine effect
Subprime mortgages
David S. SimonExecutive Vice President
Citigroup Inc.
Credit The engine of economic growth for centuries
Source: 1 The Myvesta Foundation, "The History of Credit and Debt by Steve Rhode" 2 Creditcards.com.
Clay tablets,earliest record of credit
(3,000 + years ago)1
First credit card,Diners Clubissued 19502
Explosion in credit and delinquencies
Source: 1 Financial Times. 2 Moody’s Economy.com.
US household debtAs % of GDP1
0
100
200
300
400
500
600
700
800
900
1,000
00 01 02 03 04 05 06 07 08
Default
90-120 days
60-90 days
30-60 days
30 days
Household debt in delinquency or default(in US$ billions, annualized)2
Credit marketBorrow
Lend
Banks
• Customer deposits • Investors
• Interest• Repayment risk
Challenges to equilibrium:
Use of credit accelerated dramatically for customers
Risk / reward ratio changed for lenders
Borrow
The solution Three-party problem to solve
Industry
Regulators
Customers
FinancialLiteracy
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