Why I'm in favor of financial illiteracy

 
I'm not a fan of mandatory investor education classes. The issue was brought up recently by former chair of FDIC, Sheila Bair, who sees early financial education as ways to stop future FTX-style disasters.

The model of finance I've been using for many years is the fairly dismal dark forest model. The financial industry is a shadowy forest full of sly foxes waiting to prey on retail investors. The list of sly foxes is long: all sorts of Samuel Bankman-Frieds, IRS scammers, internet ponzi schemers, stock con-artists, bankers hocking high-fee products, fly-by-night gold mine promoters, and shady crypto platforms. It's truly horrifying out there.

So why not implement mandatory high school financial literacy classes to upgrade the retail class's defences against this dark forest?

My first concern is that high school students can only absorb so much. Mandatory financial literacy classes will inevitably come at the expense of learning other very important things like math, writing, and science, which are at the base of so many vital disciplines.

Second, while I'm sure financial literacy classes might help a bit to protect us against the dark forest, I don't think they'll do much. The prototypical retail investor's single biggest weakness is that we are all incredibly busy people. As we rush through the dark forest we simply don't have enough time to familiarize ourselves with its many arcana. This incapacity to pay sufficient attention makes us easy pickings, no matter whether we've had a few financial literacy classes or not.  

The dark forest preys not only on our rushed lives, but also our need to keep up with the Joneses, our precarious and stressful financial situations, and our worries for loved ones. I'm just not convinced that a few years of high-school financial literacy classes will release us from these eternal and very-exploitable emotions.

Luckily, we have two other major defences against the dark forest: the competitive market and the government.

The government can make the dark forest safer by flushing out bad actors and pushing fraudsters to the nether regions, then nudging us retail investors towards the parts made safe. It does so by regulation, standard investor protections, licensing requirements, and through law enforcement and the court system.

As for the market, its competitive nature gives rise to a class of trained and experienced financial professionals who are generally equipped to lead retail investors through the dark forest.

If we get these two defences right, then we can afford ourselves a great luxury: a retail investor class that gets to remain relatively ignorant of finance while being safe in its ignorance. This ignorance is a thing of beauty. Instead of folks having to waste time and energy learning about the forest's fox population, its patois, and its dangerous pathways, they can focus on their own very busy lives, families, studies, hobbies, and careers. That's what we want them to do. We don't want a world where the average person needs to give up an hour or two each week slogging through financial literacy 101. We want them to blithely use financial products and take for granted they will be safe, and then get on with more important things.

Alas, if we get these two defences wrong, then we get disasters like Sam Bankman-Fried's FTX, which destroyed the financial lives of thousands of innocent retail investors. 

What happened with FTX? In the case of FTX's offshore exchange, there was a complete absence of government regulation. Not so FTX's US arm. Alas, FTX-US operated under a bare-bones regulatory framework courtesy of state licensing boards, which are simply not appropriate for overseeing a trading venue like FTX, and are more equipped for watching over remittance companies like Western Union. (See my article Let's stop regulating crypto exchanges like Western Union.) This was the dark forest at its darkest.

To see how see this first line of defence can be properly deployed, take a look at what happened in Japan when FTX collapsed. FTX's Japanese customers were made 100% whole a few months after the debacle. (American ones are still waiting). That's because Japan got things right and forced FTX Japan to adopt appropriate regulation, effectively preventing the sly fox Bankman-Fried from preying on Japanese citizens. (See my article Six reasons why FTX Japan survived while the rest of FTX burned.) 

The second defence against predators like Sam Bankman-Fried, a market-supplied legion of trained and experience financial professionals, was lacking, too, since stuff like dogecoin and dogwifhat is outside the ambit of the financial professional class, and deservedly so. Had seasoned institutional investors and other financial professionals been operating in the sector, they would have used their training to suss out the FTX fraud much earlier, guiding folks away to safer exchanges.

The two defences entirely lacking, the result was a wave of innocent retail investors left free to venture into into the dark forest. But mandatory financial literacy classes don't fix this. Government regulation and elite financial professionals do.