Just think: If more people were financially literate, there might never have been a mortgage crisis in the US, or a Swiss franc lending crisis in Hungary and other Central and Eastern European (CEE) countries.
While everyone certainly has their fair share of blame with respect to the recent crisis -- governments could have regulated better and financial institutions could have done better risk management -- ultimate responsibility for financial decisions still rests with the individuals that make financial decisions at the micro level. Hence, the theme of this article is that financial literacy, and therefore financial education, must be the root of averting future financial crises.
Financial literacy is not just required for entering into loans and mortgages but also for other basic life decisions, such as how much to save for retirement, buying appropriate types and levels of insurance, making appropriate investments, etc.
The US Financial Literacy and Education Commission defines financial literacy as “the ability to make informed judgments and to take effective actions regarding the current and future use and management of money.” It is of importance to virtually all parts of the economy -- households, businesses, farmers, etc.
Let’s look at some of the symptoms of financial illiteracy in Central Europe today:
The vast number of households that have taken Swiss franc loans in various Central European countries betrays a lack of awareness of financial risks.
Huge segments of the population are underinsured.
Huge segments of the population do not save for retirement, lacking an understanding of the power of compound interest.
People, like lemmings, tend to buy stocks when markets are rising and sell in down markets.
Many households in Central Europe invested the vast majority of savings into housing, often believing housing could not go down. The diversification of portfolios, and of asset classes, is vital.
The lack of financial literacy, sometimes even among owners of companies, surprises me. I have had long discussions, for example, with a number of CEOs of major companies who look at equity as free money, cheaper than debt.
Financial literacy may be likened to a vaccination: If a certain percentage of the population is vaccinated, a disease like polio cannot spread and may therefore be eradicated. Might financial education help achieve a similar result, eradicating, or at least diminishing, the down cycle in recessions?
Do we have the level of confidence in financial regulators that they will get regulations right? And do we have confidence in financial institutions to get their risk management right? Without wishing to take anything away from such efforts, are we not missing part of the equation, namely getting people to make their own financial decisions in an informed and professional manner? I would argue that financial literacy needs to be part of the answer. The best protection is an informed consumer.
So how might we promote financial literacy? While I encourage individuals to research on the web and read extensively, there are also a number of government-sponsored programs afoot:
Many governments, such as in the US, the UK and Australia, have programs in place to promote financial literacy (although I am not aware of any such programs in Central Europe).
The Organization for Economic Cooperation and Development (OECD) has extensively researched best practices with respect to financial literacy in its member countries.
A number of US states have made courses covering financial literacy available in schools.
Australia mandated that its schools must provide a curriculum of financial education, established a Financial Literacy Foundation and financed the training of 2,000 teachers to teach financial literacy.
In short, at the micro level, financial literacy can make the difference between a family prospering or being financially wiped out. At the macro level, it can make the difference between the growth or diminution of the middle class. Possibly the rich get richer and the poor get poorer, as the saying goes, because of financial literacy, or lack thereof.
Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on mergers & acquisitions. He is the author of “Business Exit Planning,” published by John Wiley & Sons.