Amit Paranjape’s Blog

The Illiterate 21st Century Consumer

Posted in Current Affairs, Financial Markets/Economics by Amit Paranjape on October 17, 2008

 

 

In the 20th century, illiteracy was something that was thought to be primarily confined to the developing world. Literacy was very simplistically defined as the ability to read and write. By this definition, nearly 100% of the developed world and an ever growing percentage of the developing world would be termed ‘literate’. In the developing world, it is often repeated over and over that one of the primary root causes of all the social, political and economic problems is lack of literacy. However, now that we are turning ‘literate’, are we really resolving these issues? I would like to argue that merely reading and writing doesn’t constitute true literacy. To be literate, one needs to really understand one’s world that we live in. Today, there are ever increasing tools of knowledge and information. Yet real knowledge is seen to be sorely lacking. This lack of basic knowledge about common things is what I would like to term as the ‘21st century global Illiteracy’. In this continuation in the series of articles on the US Financial Crisis, I explore this phenomenon.

 

 

Many of you must have seen the ‘Tonight Show with Jay Leno’. A popular segment in this well-known late night comedy talk show is ‘Jay Walking’. Here, Leno interviews regular folks who are walking by on the streets of Los Angeles. Questions are really basic like…”Who is the Vice President of the US”, or “What does ‘UN’ stand for?”, or “What is the currency of Europe?” It’s amazing the kind of answers you will hear! Many folks don’t have the faintest of clues about some extremely basic facts/questions about the world we live in.

 

This segment is really funny to watch and I really enjoy it. Now, I agree that this represents an exaggerated view of the knowledge of a ‘common man’ and I am sure a lot of editing goes into it to capture those ‘dumb’ moments. Often times though, this is not that far from the truth. It is a sad reflection of reality.

 

The modern 21st century consumer is living a dream life with all the benefits of developments in science & technology, social development, democratic governments and cultural freedom. The ongoing information technology revolution that started towards the end of the 20th century has placed any information, literally at their finger-tips. Still many are comfortably oblivious of their surroundings. This utter lack of knowledge of basic information, sciences, politics, history, economics and other disciplines is what I am terming as ‘21st century illiteracy’. No one is expecting the common man to be an expert, a PhD in any of these fields. All that is needed is some basic primary / middle school level grounding in these disciplines. Yet one rarely finds it today in many people.

 

A popular TV show that has run in different variants in many parts of the world, ‘Are you smarter than a 5th grader’ demonstrates this ignorance. Adults routinely stumble on basic primary school level questions. An interesting example that recently came to light in the US was that of the citizenship test on US history and government that is administered as part of the naturalization process for eligible foreign citizens. Apparently, nearly 70% of US adults ‘fail’ this test! Incidentally, when it comes to sports and entertainment, many of these same people excel at statistics and movie trivia.

 

Some would argue why this knowledge is even important. My response would be – Why was so much importance given to reading and writing in the 20th century? It was done so that we could understand the world around us and make informed and better decisions and choices. Are we really doing that?

 

Not just in the 20th century, but throughout the history of human civilization, mankind has progressed due to that constant desire to ask questions, and seek knowledge. “How can I master fire?”; “How can I manage cultivation?”; “What causes the planets and sun to appear to ‘move around’ the earth?”; “What causes diseases? How do we prevent them?” and on and on. Have we simply lost this desire today? Or has the current materialistic world completely taken our focus away? Or are we subscribing to these pronouncements ‘That is not my problem…Or as long as things are fine for me, why do I care!’

 

Unfortunately today, when it comes to financial markets and the global economy, things are not fine. And this is affecting each and every one of us – not just in the US, but in the entire world. How many people really understood the detailed mechanics of adjustable rate mortgages (ARMs)? How many really took time to analyze the potential risks of these instruments based on macro-economic factors? It is easy to now blame Allen Greenspan for keeping rates at historic lows and thereby contributing to very attractive rates on these ARMs at the beginning of this decade. But wasn’t the consumer simply making an assumption (if at all they understood some parts about the ARM…) that these good rates are going to stay on? Was it just wishful thinking? Yes, to some extent – most US consumers are optimistic in nature and prescribe to this ‘good times will continue’ philosophy. But being ignorant about the basics of economics was the primary culprit. There was also a ‘herd mentality’. Since ‘other people’ were taking these mortgages, why not me? How is this herd mentality different from that of illiterate village folks in a third world country?

 

Many people today invest directly or indirectly (through pension plans) in the financial markets. Yet many do not understand basics such as valuations, Price/Earnings, Dividends, etc. Even fewer understand bonds and treasuries. On a similar note, in a completely different knowledge discipline, how many patients really understand the most basic information about the prescription drugs that they are taking? If ‘Health’ and ‘Wealth’ are the most important things to most people, then this ignorance is appalling.

 

Lack of books and other reading material contributed to some illiteracy for deprived people in the 20th century. A bright student in a remote village would find it extremely hard to learn any advanced topics due to the lack of resources. However, today there are no excuses for the 21st century consumer.

 

Even 15 years back in the US, if you wanted to get some basic grounding on some discipline and learn something new, or brush up some old stuff, you probably had to take some time off and head to the local library. There you were mostly reliant on a good librarian to find the right books/journals for you. And then you had to navigate through the big reference books (often times, on library premises) to get to what you were looking for. Compare that with today’s world. How far have we come in such a short period? Almost all of that information is now available at a click of a mouse! And ‘search’ has become so easy! And yet this 21st century illiteracy continues to thrive.

 

I find it extremely hard to understand why the same people who spend hours online on social networking sites can’t find time to learn something new about economics. Or about basics in medical sciences. Ultimately, your financial health and physical health are amongst the most important things in the world we live in…Aren’t they? I think first we need to acknowledge this 21st century illiteracy phenomenon. Then, we need to understand it and start actively addressing it. A big change is needed, first and foremost in our attitudes towards knowledge. This change is one of the primary steps to create smart, intelligent consumers who truly understand the global world they live in, and make informed choices.

 [You might want to read these related posts; 'US Financial Crisis - Who Is To Be Blamed' and 'The Clueless Global Leadership' ]

 

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The Clueless Global Financial Leadership?

Posted in Current Affairs, Financial Markets/Economics by Amit Paranjape on October 10, 2008

  

 

 Rarely has one seen the entire global leadership of the financial world, so utterly clueless. The leadership comprising of the elected officials, finance/treasury heads, central banking heads, regulatory heads, Company Board of Directors and CEOs – all seem completely lost!

 

They say one thing, do another…talk about being globally coordinated, then do things in isolation…swear by ‘free market’ principles, only to violate them the next day, they agree to vote on a plan…and then reject it, only to approve it later…,bailout one bank, but not the other. In the mean time, the markets keep tumbling…trillions of dollars worth of market cap is just vanishing in thin air!

 

Everyday, there are parallels being drawn to the ‘Great Depression’. Everyone, including the leadership is in denial…This was not supposed to happen! Over the past seven decades, we have seen a World War, a Cold War, Oil Shocks, 9-11, and on and on. Over this period mankind has survived one great crisis after another, including the possibility of M.A.D. (Mutually Assured Destruction – that doomsday scenario so commonly speculated; especially at the height of the Cold War). Even during these darkest of dark times, it felt that someone had some control. We may have not liked the direction of that control, but at least someone was affecting it.

 

This current financial mess was not supposed to happen! But it did…The modern world was supposed to have a robust system of monitoring, checks and balances. There were safety factors, reserve ratios, rate cut options, liquidity injections, and an array of other weapons in the armory of the leadership to combat such problem. The CEOs having precipitated this crisis, by amongst other things their ‘greed’ and ‘aggressive business practices’, had many options to limit the damage…but either they were embroiled in their own stubbornness, or just totally oblivious?!

 

One thing is for sure – right now ‘we the global population’ are losing this battle; and losing it badly! We had lessons learnt from the ‘Great Depression’, the 1980s crash, the Asian crisis of the 1990s, the dotcom crash and the WorldCom/Enron saga. And yet we got completely blind sighted. We have probably the most qualified US Treasury Secretary and yet he seems as lost as everyone else! Just recently we had a comprehensive Sarbanes-Oxley regulation that was supposed to force ‘companies’ to disclose their risks & exposures in a proactive fashion. European banks (which haven’t been immune to this problem) had spent years coming with BASEL II regulations to do a better job of ‘risk management’ and yet we end up with this? Has the ‘system’ failed so miserably? Or the companies creating this mess were so terrific at ‘hiding’ their actions? Or the ‘system’ was so utterly totally incompetent?

 

The current scenario is more like a global pandemic – the kind of massive epidemics that use to ravage cities prior to the 20th century. So called ‘experts’ and doctors use to try various things, but to little avail. Often times, their ad hoc methods (in those days, detailed causes of many of these problems were not known…) creating more damage.

  

How did this happen? That is going to be a multi-trillion dollar question! But who knows where the ‘Dollar’ will be after all this is over? And where will be the Euro and the Yen be? It might be safe idea to now refer to everything in gm/kg of Gold (Ounces/Pounds for those who prefer not to use the metric system). ‘Experts’ and ‘Pundits’ of the modern capitalist system have discussed ad nauseam the current problem and the only thing I can gather is that they are as confused as the leadership and everyone else.

 

Maybe some day, we will know what happened! Clearly that day is nowhere near! Till that day, all we can do is wait and wonder…what exactly happened? And why?

 

[You might want to read these related posts, 'The Illiterate 21st Century Consumer' and 'US Financial Crisis - Who Is To Be Blamed' ]

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US Financial Crisis – The Role of the Consumer (PART 2)

Posted in Current Affairs, Financial Markets/Economics by Amit Paranjape on October 8, 2008

 

US Financial Crisis – The Role of the American Consumer  PART 2

 

Thanks for all the feedback on the first article (US Financial Crisis – Who Is To Be Blamed) in this series. This issue has definitely touched a nerve with many more people than I had anticipated! The response rate has been terrific. In this second part, I am going to summarize some of the points of view that I received from readers and then continue further discussions on the role of the American consumer. Once again to clarify, I am not saying the American consumer is the only cause of the current financial crisis; I am simply highlighting their role in it, which I think is often understated.

 

 

The across the board feedback that I have received represents two distinct streams of thoughts. The first one is centered on how the system was the primary culprit in this whole mess. The system refers to the Banks, Fannie Mae & Freddie Mac, Government Regulators, etc. The second stream takes a more fundamental stand around the level of debt (or ‘leveraging ratio’). It argues that fundamentally, debt is not a bad thing. Companies routinely take large amounts of debt. The primary issue is deciding what levels are the right levels. What is the equilibrium point?

 

I agree with both these streams of thoughts. I have literally seen hundreds of articles and dozens of commentators on CNBC, CNN blaming the ‘system’ and talking about that ‘poor main street consumer’. That really led me to further elaborate on the role of this ‘poor’ consumer. It is amazing to note how the US media becomes totally populist (and in a sense the global media as well, that always looks at the US media for ‘best practices’) and quickly sides with the ‘main street consumer’ when things go wrong. I guess this is not a whole lot different from the electoral politics. What ever happened to true and objective journalism? I would never know.

 

I agree the consumer didn’t really play a primary role in the complicated CDOs and other exotic interbank instruments that were traded between financial institutions. These bets proved horribly wrong, in cases of some institutions such as Lehman Brothers, Bear Stearns and Merrill Lynch. A lot has been written about this and I will not elaborate further. These bets did play a huge role in the current mess. However, the end consumer was still an important catalyst creating a bottom level source for these hierarchical instruments. (I am using the term ‘hierarchical’ to highlight the fact that some of these instruments can be better explained as 2nd order/3rd order/4th order aggregated debt instruments). At the end of the day, many of these instruments in a sense were aggregations of end consumer debt.

 

Many blame the ‘system’ for grossly easing up credit. How was the ‘poor’ consumer going to figure this out? Majority of these ‘poor consumers’ are what I am terming as ‘21st century Illiterates’. I will explain this concept in detail at a later point in this article.

 

When it comes to the right debt ‘equilibrium’ there are many different schools of thoughts and theories. I am not an economist, and hence I wouldn’t add a new one to this list! Some argue that the strong growth of the US economy in the 1980s and 1990s hinged on high debt driven consumer spending. Maybe that was partially true. But clearly, it was operating on a thin edge, with minimum margin for error. When it was a little overdone, coupled with rising government deficits (as happened in the current decade) this quickly tipped the economy cart over the equilibrium knife-edge. And when it comes to this whole debate around deficit led spending driving economic growth, I am a little confused. Isn’t China the fastest growing country in the world today? They have achieved double digit growth for many years running. And they have one of the highest savings rate in the world?

 

Here are some interesting statistics that I recently came across. In the 1960s and 1970s, American savings rate was in the 10-20% range. In the roaring 1980s, it was 4%. Sometime in the 1990s, it turned negative and has since then stayed negative. In 1980s it was lot more difficult to get a car loan than it is today. Today, an average consumer has 9 credit cards and $17,000 of debt. Enough has been discussed on the housing debt numbers. There was this great commercial that use to appear on American TV a few years back. If only I could get a copy of that on YouTube, it would make my points so much better! The commercial was for a debt consolidation agency and it showed a middle-aged man talking about his great mansion, his great car, his great pool, how his family enjoys a great life-style, and on and on. At the end, he asks a simple question in a really funny way, ‘How do I do all this?’ And then he answers, ‘By talking on debt!’, and continues…. ‘I am in debt up to my eye-balls…I can barely pay my finance charges! Somebody, please help me!’

 

Many Americans do blame to government for budget deficits (at least a big percentage of the voters seem to…). But no one seems to be blaming the consumer deficits? The consumer today lives in an ‘instant gratification’ society where if he likes a 60 inch LCD TV in Best Buy, he wants it right away. Even if doesn’t have the money, he can always get the ‘No interest for 12 months, followed by easy $50/month installments’ deal. How very attractive! Is such consumption, really helping the US economy grow? I am not sure. It is definitely helping the Asian economies to grow for sure! Many such examples can be given, but I will add just one more.

 

Consider this; a single engineer in her early 40s is working in a large manufacturing company in the Dallas/Forth Worth Metroplex. She has a mid-level position, earning her around 70-80K per year, a decent salary but nothing great. She wants to live the ‘American dream’. This definition of the dream itself changes from state to state, especially when it comes to housing. In Texas, in this woman’s case, it translates to a living in a 4,000 sq ft ‘house’. Well, to ‘afford’ (‘afford’ being a relative term by itself…) such a house on a 30+ year mortgage (yes, 40 yr mortgages were recently introduced, to add to the zero down mortgages already present…), she had to pick a suburb that was 40 miles from her workplace. But that shouldn’t be a problem, should it? The great American freeway system which incidentally has eliminated the need for any public transportation should get her to the workplace in comfort and in quick time! She still needs a car though…but not any car. She has to ride in style. She will not settle for anything other than a big 8 cylinder GMC Suburban (A SUV that has a rated seating capacity of 8-10, but could easily accommodate twice as many passengers, if not more in the developing world. It has a 6.5 liter V8 Gasoline engine). Of course, this SUV doesn’t come cheap either; but then there are always those zero down loans to the rescue. And I am not even going to discuss the gas mileage and the price of gas here…I think you get the idea. The recent surge in oil prices have maybe finally forced the American consumer out of these gas guzzling behemoths, but I doubt if it has altered the fundamental consumption drive highlighted in this example.

 

All the debt that this woman is taking on, what economies are they really driving? The American car companies are already in deep trouble. Chances are she might have bought a Japanese SUV. And the gas guzzling nature of this beast of a vehicle helps power other ‘not so stable economies in the world’.

 

And I haven’t even talked about ‘retirement savings’. It is an irony – discussing retirement savings and negative savings rate together!

 

What is the view of an average consumer living in Springfield (no, I am not referring to Homer Simpson…and that is not the stereotypical image of an average American consumer that I have in my mind) with regards to his debt? Does he realistically believe that he can pay it off in a decent amount of time, and then save enough money for retirement? And how much money does he really need for retirement? Most Americans I have come across frankly don’t think too much about retirement planning. Even fewer have an idea of a target for retirement savings and their estimated expenses in future. It’s one thing for a 20 something or a 30 something to carry a substantial debt and be carefree about retirement planning. But it is amazing to note the number of people in their late 40s and 50s who still carry substantial amount of debt. These people in my view have absolutely no idea of what their ideal debt leverage ratio should have been in the first place. They have already tipped the equilibrium. They are simply taking a shot in the dark as far as retirement is concerned. Do they think that social security alone would be sufficient? And with the rate the government deficits are growing, some experts predict that even social security, ‘that sacred cow’ may be sacred no more.

 

The reason I am bringing the retirement savings topic is to further highlight the lack of foresight and long-term planning of the consumer. This again highlights the ‘illiterate’ nature of the global 21st century consumer.

 

What is causing the consumer to make these series of bad decisions/mistakes? I can think of two primary reasons. First one is the desire for ‘instant gratification’. It symbolizes the ‘Live for today, who cares about tomorrow attitude’, or the strong belief ‘Tomorrow will be better, my earnings will continue to grow no matter what happens’. I am not a psychologist and can’t claim any expertise in understanding this human nature/human values. The second reason I think is a phenomenon I will call ‘21st century global Illiteracy’. I think this is very important.

 

In the 20th century, illiteracy was something that was thought to be primarily confined to the developing world. Literacy was very simplistically defined as the ability to read and write. By this definition, nearly 100% of the developed world and an ever growing percentage of the developing world would be termed ‘literate’. In the developing world, it is often repeated over and over that the one of the primary root causes of all the social, political and economic problems is lack of literacy. However, now that we are turning ‘literate’, are we really resolving these issues? I would like to argue that merely reading and writing doesn’t constitute true literacy. To be literate, one needs to really understand one’s world that we live in. Today, there are ever increasing tools of knowledge and information. Yet most people don’t know the most basic information. This lack of knowledge is what I would like to term as the ‘21st century global Illiteracy’. In the next part of this series (Part-3), I will explore this concept further.

 

[Continue onto the 3rd part in this series: 'The Clueless Global Leadership']

 
 

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US Financial Crisis – Who Is To Be Blamed?

Posted in Current Affairs, Financial Markets/Economics by Amit Paranjape on October 4, 2008

Some thoughts on the current US Financial Crisis – Who is to be blamed?   PART-1
 
Americans have been quick to blame the ‘Greedy Wall Street Executives’ for the current crisis. Given that the elections are just around the corner, the congress members are quick to take-on a populist stand and side with the people. ‘Wall Street’ is an easy target! [These congressmen conveniently forget that the same Wall Street is often times their biggest contributer...!]. However are they the primary cause of this mess?
 
I contend that the average American consumer is the biggest culprit. Now, I doubt if any elected official would ever show the fortitude to make such a call! The reasoning is simple – The American consumer has been living beyond his/her means for a long time. Credit has become a way of life. Its not just the struggling lower middle class with incomes under $50K who are stuck in deep debt. Debt has also become a way of life in the suburbia as well.
 
Consider this – a highly paid executive couple with combined earnings of over 300K should be financially very secure, right? Wrong, in many cases! Here’s the problem. This family could live a very comfortable life, buying a nice house in a suburb for say 300K and a couple of nice cars. But in reality, they end up going for a 700K (or maybe even a 1M) mansion..buy expensive luxury cars..modify their lifestyle to resemble that of the ‘super rich’ in most other parts of the world. How do they achieve this? By taking on debt!
 
The above is just a representative example. Having lived for 13 years in the US, I have always wondered how so many people can routinely live beyond their means. Some people consider debt and deficits as good things. They spur consumption and drive growth. I am not an economist and won’t get into the economic debate here. But the first principles of common sense warn us that something is terribly wrong regarding perennial deficits and debts!
 
Why blame Wall Street? Isn’t it the consumer who wanted to buy a huge mansion instead of a decent house? Isn’t it the person who wanted to shop like crazy like there is no tomorrow? Or the person who didn’t have money for his children’s college, but still took on debt to build a fancy swimming pool in his house? Or the recently graduated college student who got her first job at a hitech company, and went and bought a 35K Audi?
 
I think its about time that America realizes that the root of the current financial crisis is the average American consumer who thrives on debt! Wall Street was merely an accessory! I am not saying that the greedy Manhattan executives don’t carry any blame..they do.  But they were like any good business – supplying the ‘products’ that the consumer ultimately wanted.

[Continue onto Part-2: 'US Financial Crisis: Role Of The American Consumer']

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