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