Learning the ABCs of Finance, and Why It Won't Help

Taking a course in managing money won't teach you the reality of a playing field that isn't level.

They're popping corks over at the Finance Ministry. The Ministerial Committee for Legislation, which vets proposed laws, smiled on the bill for "financial education" - a treasury-led endeavor to teach people how to manage their finances.

Teaching people how to manage their money is a good thing, especially given the vast advances in the money market, services, technology and labor in the last 20 years. The world is a very complicated place and the risks to the unwary and uneducated are greater than ever.

But the wild enthusiasm for financial education is worrying; it reflects a perception that the individual, the saver, the taxpayer, is the main party responsible for his fate. If only he learns the rules of the game better, he can play to win.

That isn't how it works. The biggest problem isn't that the people are ignorant, it's that the rules of the game ensure that most will lose, unless they have the right connections.

Here are some of the things that could be taught in the financial education course, and here's what you can do with that knowledge.

What you will learn: Your ability to sustain your standard of living after retirement depends directly on how much you set aside each month, and on the profits your pension fund (or other long-term saving plan ) achieves over decades, minus management fees. The difference of a few percentage points in annual returns, or management fees, accrue like compound interest into differences of hundreds of percentage points over, say, 40 years of saving money. And those returns depend on the talents of the people managing your pension portfolio and the securities they pick.

What you can do about it: Very little. You can't predict who will turn out to manage investments well. Most investment gurus are more like comets than stars - maybe they do amazingly well one year or over 10, but that's no promise they'll continue to do so. So what will determine the portfolio's returns is how well the market does and the scale of management fees.

Now, how well the market does depends on economic growth - and on the organized, serial gouging by the big men and women in the capital market, be they investment managers or corporate owners. The stronger and more corrupt the clique, the bigger its share of the economic pie, at the expense of millions of savers.

In recent years, Israel's economy has become especially swinish; vast chunks of profits have been going straight to a very few people, through insider transactions, tender offers, inflated salaries, leverage, pyramid structures and "haircuts" - defaults.

The public doesn't get it yet, because the low interest rates have been pushing asset prices high. The regulators haven't done anything about it because the forces they'd have to battle are clever and enormously stronger.

What you will learn: Haircuts are a perfectly legal move in which a company that borrowed money from the public through bond offerings defaults in part. It admits that it can't repay the principal, not in full at least, and interest.

Maybe it can only repay 80% of the loans, or maybe just 10%; in any case, it's a haircut and the arrangement hashed out with creditors will always be horribly complicated. The deal will include issuing a host of new securities that won't mature for a long time; the upshot is that the bewildered investor doesn't know if he's been gently trimmed or been given a buzz cut.

Rules for the rich

With little choice, institutional investors accept arrangements baldly tilted in favor of company owners, and learnedly explain that it's the best alternative.

What you can do about it: Nothing. The capital market is a highly concentrated place, and many of the biggest borrowers also control our pension funds. A gang of 20 bankers, businessmen and managers control most of the public's assets, assuring that most institutional investors managing the public's money won't buck at gouging. They will shy away from demanding fairer market conditions concerning, for example, interest rates, securities, collateral to back corporate debt, and tighter regulation of insider transactions and executive pay.

Prime Minister Benjamin Netanyahu and Finance Minister Yuval Steinitz have put off implementing many recommendations by the economic concentration committee by six years; Israel's fat cats will have plenty more time to lap up the cream before somebody kicks the bowl. Since many of the cats are actually in sorry financial straits, they'll be more aggressive and gluttonous than ever.

What you will learn: The Israeli system of business groups controlling financial institutions and conglomerates winds up giving a handful of people, with a combined worth of a few billion shekels, control over hundreds of billions of shekels belonging to the public. Some of the people at the top of this heap are effectively bankrupt, yet they get to appoint the managers and directors of financial institutions that may each control as much as NIS 300 billion in assets.

In other words, a small group of people has vast power to allocate resources, which has wound up creating the opposite of a meritocracy. The result is a clannish culture where what counts isn't talent and integrity, it's who you know.

What you can do about it: Nothing. The media doesn't like to go there and tends to applaud the existing structure, or distracts us from that structure with other topics, because the media is part of the clan. Unless the people kick up a fuss, there's little chance the politicians or regulators will lift a finger; they depend on the clans too.

What you will learn: You'll learn the difference between a pension plan where you set aside money each month throughout your adult life, and a "noncontributory" plan where the taxpayer does. In contributory pension plans, you set aside real money that gets invested in the capital market (yes, that bastion of organized gouging ). In noncontributory pension plans, no money is set aside. Somebody makes a note of the growing actuarial liability each month.

Pension Questions

Usually a noncontributory pension is better (for you ) because it's based on your last salary, which is typically your highest ever. Normal pensions are a function of your average monthly income. Also, noncontributory pensions don't depend on the vagaries of the markets.

What you can do about it: If you don't have a noncontributory pension - nothing. Don't even take this course. It's too depressing. The state's actuarial liabilities to its pensioners have doubled in a decade. Most of the increase was because of the best-paid employees in the land, headed by defense employees, where the actuarial liability has mushroomed to NIS 250 billion.

The bad news is that you don't have a noncontributory pension.

The worse news is that you're paying those noncontributory pensions, and your children and their children will be paying them out of their taxes, which means less money will be available for minutiae like education, health care and welfare.

At this point you probably want to stalk out of the financial education course, slamming the door behind you.

Sit tight. We're not done.

What you will learn: The poorest and weakest pay banks the highest interest, because in interest, the deciding factor is risk. But unlike the rich and powerful, the smallest borrowers actually have to repay the banks, so the risk is low and the cost of borrowing is enormous.

What you can do about it: Nothing. The Bank of Israel doesn't want to introduce real competition into the Israeli banking system. It knows full well that the banks have giant hidden unemployment - their manpower is bloated. Banks can't fire employees because of the unions. If true competition develops, bank profits could suffer. So instead of forcing the banks to compete and shore up the stability of the system by other means, the central bank prefers to nudge the banks about competition, no more.

Two kinds of businesses

What you will learn: The business sector consists of two main kinds of businesses. Some rely on talent, competitive edge, innovation, efficiency, commitment, modesty, economy and vision. The others rely on protectionism, a lack of competition, monopolistic power and cronyism.

What you can do about it: Nothing. The uncompetitive monopolistic monsters will always control the public debate. Any attempt to introduce competition and fairer rules to create a truly free, advanced economy will be dubbed antibusiness and be crushed.

What you will learn: A high-ranking minister and lawyer by trade can accept envelopes stuffed with cash, innocent of documentation or explanation, from his friends and associates if the money is designated "for political purposes." The minister may engage directly in weighty economic affairs that concern those friends and still be found immaculate by the courts and press.

What you can do about it: Go nuts. Rage. Scream. It won't help you, though. If you get caught with hundreds of thousands in cash, or in a grave conflict of interest, you'll be finished even before charges are filed. Of course, if you belong to one of the clans, you'll be okay. Of course, if you do, you don't need this short guide to financial management, and TheMarker isn't the newspaper for you.