The lack of financial literacy is a drawback to the functioning of the free market economy. A minister has said that there are still over 2,000 institutions and agencies collecting deposits from the public paying higher than sustainable interest rates. This is despite so many people having burnt their fingers in deposits with the Golden Key, Sakvithi and the Danduwan Mudalali and other dicey deposit takers.

A sucker, they say, is born every minute. We might think this lack of financial literacy is peculiar to developing countries. But here is what one writer in the London Economist wrote a few months ago. ‘Everybody wants it. Nobody understands it. People just won’t talk about it. And that is what leads you to the sub-prime. Take the greed and the financial misrepresentation out of it and the root of this crisis is massive levels of financial illiteracy" (Economist 5th April 2008 page 75).

You would be surprised to learn how many bank managers invested and lost money in the Gold Quest pyramid fraud. I happened to meet the German who minted the medallions and over a discussion he told me that there was nothing wrong in the multi-level marketing scheme for which he was minting the medallions. His point was that the world is full of suckers and that if one firm doesn’t get them someone else would.

A Survey in USA found that four out of ten American credit card holders do not pay the full amount due every month on their cards despite the punitive interest rates that follow. Nearly a third said they had no idea what the interest rate on their credit card was. If one scrutinizes the list of persons who have invested in Golden Key, one would find even bankers and a retired central banker though he was not of any high rank.

Household finances

My wife has done a course in home economics while studying at St Bridget’s Convent and I thought her good management of the household budget had something to do with the knowledge she must have gathered there. One of her practices is to put money into separate envelopes for various purposes - petrol for example - and we try to keep to limit ourselves to the sum allocated. But I have noticed that many office girls spend without any budgeting and end up borrowing money or taking salary advances. How does one teach elementary prudential economics to housewives who are generally in charge of household expenses?

Despite so many bank branches being opened across the country, many people in the rural areas still do not have bank accounts - not even savings accounts. Many of them do not understand why this puts them at a disadvantage in the occupation they are engaged in. Today there are ATMs and there can be 24 hour banking if people use electronic banking. Even business people do not utilize their cash to their best advantage. A former Malaysian Chinese boss used to tell me that money should not be allowed to go to sleep and that it must be invested even overnight.

Financial bubbles

Consider those American borrowers who kept on borrowing and investing in property expecting house prices to keep on rising. They would borrow and buy one house and then sell it at a profit and pay back the bank loan. They would then borrow again and buy or build another house and do the same. There is something called gearing and leverage - high sounding terms for simple concepts. If you leverage too much in this way and increase your debt too high in relation to your own funds or equity, the risk becomes very high. Often borrowers did not even realize that their monthly payments would rise if interest rates went up since most mortgage lending was on adjustable interest rates.

Our businessmen often have to pay higher monthly installments to banks as they jack up their interest rates. The business borrowers have no strategy to deal with this risk. Our financial market lacks instruments to hedge such risks. It is the same with the stock market. Short selling is absent even in the safe mode of stock lending. This is because the Central Depository where shares are held on behalf of investors lacks flexibility. There is much talk of introducing derivatives. But even currency risk cannot be covered since there is no free access to forward exchange markets.

When the Japanese opened up their financial sector in the 1970s & 1980s they realized that they lacked the expertise in the trading of the new fangled financial instruments and invited foreign stockbrokers and Fund Managers to come in. It is not difficult to write a derivatives contract as Asantha de Mel found out.  But to assess the underlying risks of the price movements in question and the trading of such contracts requires expertise as those involved in trading in commodity or financial markets know.

Each time a foreign stockbroker set up shop here, it had to close down because of the failure of the regulators to liberalize. Unless there is liberalization of capital account transactions it would hardly be profitable for a foreign stockbroker to set up here.

Financial reporting must accord with economics

The Central Bank always reports that the Treasury bills and bond auctions are oversubscribed by adding the total offers, even those at very high unacceptable rates. Then it proceeds to reject those high offers. This is misleading. If the CB announces its demand earlier and if it can take up such quantity at a given interest rate, if at that rate there is over-supply then the issue can be said to be oversubscribed. Of course the market is not quite free because the captive funds don’t quote but are allocated a quota of securities on offer by the CB. Shouldn’t the CB press releases explain clearly what is involved? In other countries the Minutes of the Monetary Policy Committee of the Monetary Authority are published. These even include the names of those who voted for a particular decision, say, to raise or reduce policy interest rates.

If the universities had taught anything about the financial crises of the past, the US   mortgage borrowers would have known that the housing bubble cannot go on forever. Bubbles are nothing new in financial history since the days of the South Sea Bubble and the Tulip mania of Holland. In 1929 the stockbrokers in USA disregarded rules about permissible leverage and extended unlimited credit to their clients who kept on buying and selling shares during the bull run. When the boom petered out the clients defaulted and the stockbrokers got into financial difficulties. It is this stock market crash that preceded the Great Depression of the 1930s.

Boom and bust, bubbles and crashes are due to the ‘madness of crowds’ a phenomenon that cannot be abolished in a free market system where economic decisions are decentralized.  Of course the centralization of decisions in a central planning agency has even bigger problems. What is required is for the Central Bank to act prudently and check expansion in time by tightening credit when commodity or asset markets over-heat.  It is now recognized that Alan Greenspan made a mistake in not checking the boom conditions in time by raising interest rates. He persisted with low interest rates for too long and permitted the bubble to gather strength until it developed its own momentum. The inevitable sudden collapse followed.

The American Congress realized the need for improving financial literacy among the people and even declared a Financial Literacy Month (April). We have still to realize the importance of financial literacy. We have social movements for protecting the environment, climate change etc but no one has taken the initiative to promote financial literacy here. In some American schools even children are taught about money and how to handle it. We do not generally have the western habit of parents giving pocket money to their children. My mother would have thought it a crazy idea perhaps from the devil himself to tempt children. But there is a need to teach children how to handle money.

The American children’s book "Rich Dad, poor Dad" is a self-help best seller. Teaching children about money may even promote entrepreneurship skills. The Economist refers to a campaign started by Jeroo Billimoria in Amsterdam called Aflatoun. She did work in India among rural communities promoting financial literacy. She runs a course in financial literacy for children through her organization- a non-profit foundation. She has extended the scope of her activity to several developing countries. An important part of her teaching is also to get the children to start saving through opening bank accounts.