Financial Literacy, a Mid Term Exam.

Canada's Finance Minister Jim Flaherty proposes a task force to make recommendations toward improving financial literacy [National Post May 21]. An editorial in the National Post [May 23] strongly emphasizes the need for improved financial literacy. So lets do a short mid term exam.

Imagine a lender with a pool of outstanding loans of $300 each repaid at $369 14 days later. Imagine the lender is so efficient that the loan pool is always fully loaned out.
Question 1. What is the gross annualized rate of return on the loan pool. This would yield its gross revenue from which it would have to deduct all of its operating costs including bad debts, cost of capital, and all other expenses. Is the answer a)23%, b)600%, or c)21,653%?

Question 2. What is the annualized rate of interest cost to the borrowers who from time to time have loans from that pool? Is the answer a)23%, b)600% or c)21,653%?

25 marks if you made the same choice for both questions. You correctly realized that the annualized interest cost to the borrower is the same as the annualized interest rate that the lender earns. Your answer to question 2 should therefore be the same as your answer to question 1.

Another 75 marks if you chose c for both.

On this scale of grading the financial press, the Federal Government, and the Province of BC receive a score of 25% for choosing b for both questions. That is how they describe the payday loan on which this example is based.

The correct answer is c) or 21,653% and a financial tutorial follows. But first note how this explains a headline in the National Post May 19 "Payday Lenders Keen on Canada".

I have no quarrel with the payday loan industry except for transparency and disclosure. Undoubtedly they have high costs and expenses. However they are understandably unwilling to express their lending terms in the normal form for borrowing and lending transactions i.e. the equivalent annualized rate.

I do have a quarrel with the financial press and with government agencies who both failed the mid term exam and are seemingly reluctant to confess the deficiencies in their own financial literacy. They have done little to encourage transparency with respect to the cost of borrowing in general and payday loans in particular.

You will probably read more bafflegab about such loans being short term and non renewable. Think of it as get on the bus Gus. If you hop on a bus traveling 20km/hr and hop off after only 5 minutes or after a few kilometers you were still traveling at 20km/hr as long as you were on the bus.

Now for the tutorial.
1. Take a pocket financial calculator.
2. Enter -300 as PV for present value, negative because firm pays out cash.
3. Enter 369 as FV for future value.
4. Enter n as 1 for 1 period.
5. Request calculate i. result is 23% which is the % for the period which is 2 weeks.
6. Enter n=26 to say continue at this rate for 26 periods to equal 1 year.
7. Request calculate FV and the result is 65,261. If you gasp in astonishment then welcome to the power of compound interest.
8. Enter n=1. For now the calculator is holding in memory a PV=300 and a FV=65261.
9. Request calculate i. result is 21653% This is the equilibrating interest rate which describes the annual rate of interest reflected in a present value of 300 and a future value of 65,261 over a 1 year time horizon under the terms of the loan. This is the correct "annualized rate of interest".

For those of you who do not have a financial calculator you can use most spreadsheets such as Excel with its built in formulas and arrive at the same conclusion.

For those with only a pocket calculator it is somewhat tedious but here are the steps.

The formula to work with is PV(1+i)**26= FV
The 1+i is 1.23 as the rate per 2 week period is .23 (23%) and the expression must be raised to the 26th power for the 26 such periods in the year.

Enter 1.23 and save it to memory.
Now enter 300 multiply it by the saved 1.23.
The first time you do this you naturally get 369. Now hit multiply and memory recall and = and you get 453.87. Continue doing that for another 24 tedious times and you end up with 65,261 which is the future value.

Now use the same formula with the known PV and known FV and a time period of 1 for one year. It looks like
300(1+i)1=65261
Simplify to
(1+i)=217.53
i=216.53 which is the decimal equivalent of 21653%. Remember 50% is equal to .5 so you must move the decimal right 2 places when moving from a decimal equivalent to a percent.

I would be delighted to serve on the Finance Ministers proposed "task force on financial literacy, which would issue recommendations toward a national strategy toward improving Canadians' understanding of broader financial matters". However it scarcely needs a likely high cost task force tackling a convoluted assignment of "toward", "improving", "understanding", "broader", "matters". Just jump to one obvious conclusion "teach the use of financial calculators in high school".

Free speech and incitement to hate

"Hang the bankers" said the protest sign at the G20 meetings in London last week.
"Kill the umpire" is said to be heard at some baseball games.
"Hate all ….[fill in the blank with whites, blacks, reds, yellows, Christians, Muslims Jews]" and you will be in serious trouble with the law.

The first 2, taken at face value, incite and advocate an illegal act.
The third one does not advocate an illegal act since hate is not illegal.

These three examples suggest an interesting test for free speech.
Speech that advocates an illegal act goes beyond the protection of free speech.

I am firmly against hanging, killing, and hate. If our society wishes to inhibit incitements to hate then they should make hate illegal. Of course that would be so impossible to enforce that it will not happen.

But now how do we deal with protests against a law that is viewed as immoral?
"Kill the bill" would not be viewed as advocating an illegal act and so would remain as valid free speech.

Update February 6 2010
An item from the February 4 2010 The Roanoke Times

"A federal judge today dismissed one of four charges that neo-Nazi leader William A. White was convicted of in December.

"'The court finds that there is no substantial evidence which would permit any rational trier of fact to find the defendant guilty,' U.S. District Judge James Turk wrote in an opinion.

"The jury verdict dismissed by Turk alleged that White had threatened Richard Warman, a human rights attorney from Canada who often brings civil actions against white supremacists.

"White, the self-proclaimed commander of the Roanoke-based American National Socialist Workers Party, wrote on his Web site that Warman should be killed. "

There it is advocating an illegal act and it is not a violation of free speech.

No to Auto Bailout, Auto Invigoration Instead

In the first 2 months of 2009 the top 10 selling cars in Canada were small cars and of the 10 only 2 were from domestic manufacturers. Cars of Japan and Korea dominate the small car market. Chinese cars are not on the North American scene.

The Canadian government is planning to use taxpayer's money to subsidize car manufacturing in Canada by the old line producers.

China has invested a large portion of its trade surplus in US Treasury bonds. With the present turmoil in the financial markets they are understandably becoming uneasy. To exchange to Yuan would drive the Yuan up and the US$ down, something neither country wishes.

The Canadian $ is somewhat low relative to the US$, the Canadian banking system is robust and stable. It would be a prudent move for China to move some of its investments to Canada.

Chrysler Canada is in financial difficulty and has threatened to shut down its Canadian operations unless it receives adequate government bailout.

Put all this together and what may emerge?

China moves some of its reserve holdings to Canada.

A Chinese car manufacturer keen on entering the North American market with their small and efficient cars buys out the Chrysler facilities. They borrow the Canadian $ from the Chinese government who are holding Canadian Treasury bills.

With imported components plus North American components and assembly in Canada, the Chinese cars qualify for auto pact free trade.

What a win win situation. Car manufacturing continues in Canada, perhaps with reduced employment and perhaps with reduced demand for North American components. No consumption or waste of Canadian taxpayer dollars. A new competitor in the market provides an invigorating shock to an ailing industry.

Gas, pollution, health, schools, parents

Some facts that seem to be related.
1. Gas prices are still high and driving, particularly for short hops, is expensive.
2. Automobiles are a source of pollution.
3. Parents are busy people.
4. "More than 80% of kids ages 11 to 17 surveyed in the Alberta study had one or more risk factors..[for Type 2 diabetes] because they were inactive….[and did not eat healthily]. [Vancouver Sun 2009-03-13].
5. Elementary schools are located to be within easy walking distance of the area they serve.
Now here is the observation that seems to me to be out of place.
I live across the street from an elementary school and twice each day there is
heavy traffic with children being dropped off or picked up. Each day I ask myself "why?".

Paper Wilting is Not Wealth Destruction

"Between 40 and 45 percent of the world's wealth has been destroyed in little less than a year and a half," Schwarzman told an audience at the Japan Society. "This is absolutely unprecedented in our lifetime." (Reuters March 11, 20090

The quote is from Stephen A. Schwarzman, chief executive of the Blackstone Group.
Blackstone describes itself as "a leading global alternative asset manager and provider of financial advisory services ..".

This is a classic example of the myopia of the financial community which sees wealth as pieces of paper that flutter between financial institutions.

The farmland, forests, mines, factories, homes, minerals, office towers, warehouses, etc. still exist. Yes the prices attached to these assets have changed. Yes the composition of the ownership is continually changing with some winners and some losers. The flutter of paper is largely a zero sum game.

The losers in the flutter of paper seek bailout money from us taxpayers while the winners in the zero sum game are understandably maintaining a low profile.

Income Tax Complexity a Modest Solution

Each year I have a rising sense of frustration and outrage at our tax system.

I now must buy a software package and spend a minimum of 1 day preparing my tax return. Without the tax software I would find it impossible to do it myself. That is true for most folks. They hire someone.

There seems to be no automatic factor governing the year by year increase in complexity and therefore in cost and in frustration and outrage.

A modest proposal. Just imagine that in a fit of sanity the House of Commons adopted a house rule requiring all MP's to submit a letter confirming that they had prepared their own tax return without any assistance from either software or people. Surely they are all bright enough to do that. If they have difficulties with that task they might seriously work toward simplification.

My son had a more radical suggestion: that a special session of the House be held each year for the MP's to prepare their tax returns in one massive weeping and wailing session. It would play well on TV.

Some of our representatives might feel that this was not a good use of their time, that they have more important things to do.

Don't we all.

Democracy and Yes to Single Transferable Vote

An election will soon be held in the Province of British Columbia. If the Liberal government carries through with its promise it will again hold a referendum on the adoption of a single transferable vote instead of the present first past the post.

Here is a good source of information
http://en.wikipedia.org/wiki/BC-STV
"BC-STV is a proposed voting system recommended by the Citizens' Assembly on Electoral Reform for use in British Columbia. A member of the Single Transferable Vote family of voting systems, BC-STV was supported by 57.69%[1] of the voters in a referendum in 2005 but the government had decided to not be bound by a vote of less than 60% in favour. However, because of the strong majority support for BC-STV, the government has promised to re-run the referendum in 2009"

The rerun is May 12, 2009.

I want to link this to the particularly suitable mechanism of the Citizens' Assembly on Electoral Reform that was used in BC to produce the recommendation that was submitted to the last referendum. They were randomly selected, they met over an extended period of time, they consulted extensively with experts in the field and they overwhelmingly endorsed their recommendations which formed the basis for the referendum,

The mechanism fits almost precisely, and more thoroughly the new and well researched method of Deliberative Polling.

Here is the source and the reference.
http://cdd.stanford.edu/

Deliberative Polling®: Toward a Better-Informed Democracy
"The Process

"Deliberative Polling® is an attempt to use television and public opinion research in a new and constructive way. A random, representative sample is first polled on the targeted issues. After this baseline poll, members of the sample are invited to gather at a single place for a weekend in order to discuss the issues. Carefully balanced briefing materials are sent to the participants and are also made publicly available. The participants engage in dialogue with competing experts and political leaders based on questions they develop in small group discussions with trained moderators. Parts of the weekend events are broadcast on television, either live or in taped and edited form. After the deliberations, the sample is again asked the original questions. The resulting changes in opinion represent the conclusions the public would reach, if people had opportunity to become more informed and more engaged by the issues. "

For "neutral" information from the Provincial Government:
http://www.gov.bc.ca/referendum_info/first_past_the_post_bc_stv/

For information on the "pro" side see:
http://stv.ca/join

For the "anti" side see:
http://www.nostv.org/

For me the process and the conclusions are compelling and fully warrant support for electoral reform in the May 12, 2009 referendum.

An important aspect for me is that with broader representation in the legislature and yes, the possibility of coalition governments our government will be dragged kicking away from the adversarial "majority" and "opposition" mode of operation. See my earlier post on the role of party #2 [Opposition Or Team 2
January 10 2008]. If proposed legislation is indeed good and worthwhile then reasonable MLA's will vote for it. If a majority cannot be persuaded to pass the legislation, then it will fail. But that failure need not lead to an immediate election. We must move away from the "confidence vote" idea. The governing coalition carries through its term of office, accomplishes what it can and then an election is held. Reasonably simple and reasonably straightforward.

Nanny Rules vs. Relevant Information: the Case of Interest

Various levels of government have expressed various levels of concern over the cost of consumer debt.

In the area of credit card interest some have proposed caps on the interest rate that credit card companies can charge.

The latest, in British Columbia is to regulate the payday loan industry to a maximum of 23% on short term loans of, for example 2 weeks.

These are examples of nanny rules to protect individuals from making stupid decisions.

In my view a preferable role of government is simply to ensure that accurate and relevant information is provided to consumers.

Take the payday loan as an example.

If the loan company says "you pay 23%" a reasonable individual may think it a little high but not unreasonable relative to credit card interest of about 24%..

The startling truth of the matter is that the real annualized rate of interest on a 14 day payday loan with a 23% fee is 21,653% while a credit card at 2% per month is 26.8% annualized.

As an aside the press reports the annualized payday rate as simply 26*23%=600% but that ignores the aspect of compounding. If the individual borrowed $100 and rolled over the loan each 2 week period then at the end of the year the debt would be $21,753. Now that might give pause to the wisdom of borrowing at what is an annualized rate of 21,654%. And the converse is that if the payday loan company lends $100 and continually rolls over its cash flow into extending or new loans then at the end of the year it will have $21,753.

So what should be the role of a non nanny government.

They should insure that the effective annualized rate of interest is quoted prominently in all contracts and in all advertisements.

If someone wants to buy money at a price of 21,654% interest rate then who is the government to pretend that their cap on fees at that rate has somehow given them some protection from a stupid move.

The illustration is copied from elsewhere and the specific numbers do not relate to my calculation. The general impression from the illustration is fair.

All this suggests a topic for a future blog. Why We Need to See Financial Calculators in Schools as Well As Scientific Calculators.

Price fixing by bureaucrats

"The Heart and Stroke Foundation’s Annual Report on Canadians’ Health reveals startling discrepancies between the cost and accessibility of basic healthy food within provinces and across the country. Depending on where you live, some Canadians are often paying more than double to almost six times the price for the same basic healthy food." [http://www.heartandstroke.com/site/apps/nlnet/content2.aspx?c=ikIQLcMWJtE&b=4955951&ct=6715269].

I certainly don't want to denigrate the good work which the Foundation does.

It rankles however to see findings in a survey that:
86% of the respondents believe that the government should "Regulate the price of nutritious foods to ensure they are equally affordable in all regions of Canada".

It boggles my mind how some government functionaries would go about deciding what the price should be. Worse, if they do regulate prices and set them too low then obviously the distributors and retailers will simply stop stocking them. Next I suppose would be a bureaucracy that also sets minimum stocking levels.

Madness feeds on madness.

Auditors Don't Do That

Brian Hunt is wrong when he says that auditors provide assurance that financial statements of an organization "..are a fair presentation of its operational results, cash flows and financial position". ( Canada Must Aim for Public Accounting Excellence We Need Common Audit Standards. Financial Post February 10, 2008). But he should know since he is President and CEO of The Institute of Chartered Accountants of Ontario and a FCA. Perhaps he just forgot to add the phrase "in accordance with Canadian generally accepted accounting principles". CA's used to say that the financial statements were fair. They just don't do that anymore. Perhaps the auditors feel that GAAP somehow guarantees that the statements are fair in some absolute sense. If so, then the qualifier is not necessary. The situation is rather like the referee surveying the scene at the end of a boxing match. One contestant lies bloodied, bruised, and concussed on the mat and the referee declares "it was a fair fight".
This may seem a rather arcane quibble on my part. However the entire global economy is in turmoil as a result of banks, insurance companies, brokers, etc finding themselves in deep financial distress while their financial statements were saying .. . Well what exactly were they saying? Did they fairly reflect the underlying economic and financial reality? I think not.
At one time auditors said that the statements were "true and correct".
Later they changed their tune to "present fairly.." (without any qualifying phrase).
Now we have "present fairly…" following the rules of the game.

Nanny State. Seat belts and cell phones

Our nanny states makes it illegal to drive without seat belts in place. It allegedly protects me from myself while I am quite capable of doing that myself. I have consitently used seat belts since at least 1962 well before they were even standard equipment. Fair enough to require seat belts for children because their parents may not have enough common sense to protect their own children.

Now the contrast.

Other people using cell phones while they drive are a clear danger to me and to the public in general. The statistics are compelling. Clearly a case for a law forbidding cell phones while driving. Even hands free. Yet politicians in our jurisdiction are reluctant to do the right thing.

Yes there are other distractions to drivers. However this is one that is relatively easy to enforce. The evidence is in the cell phone log.

The 3 jobs of political party leaders.

Interesting item in the National Post Friday January 30, 2009 by L. Ian MacDonald
He cites Brian Mulroney as saying that a party leader has only 3 jobs: unite the party, fill the campaign coffers and win the election. That seems to be accepted by all our political leaders and explains the Canadian political scene succinctly. No mention of governing well.

[http://network.nationalpost.com/np/blogs/fullcomment/archive/2009/01/30/l-ian-macdonald-ignatieff-s-got-game.aspx]

Returning Not = Not Taking

"In Defense of Harper's Budget" in the National Post of February 4, 2009 Ezra Levant uses some unfortunate phrasing. He refers to the reduction in the GST tax as "…back into consumers' pocket". It is unfortunate in that it subtly supports the view that governments are entitled to all my wealth and that when they are generous they give some of it back.
More precisely the government stopped taking as much as before out of consumer's pockets. Yes, this reduced GST tax did reduce overall taxation. Perhaps this can be called part of a "stimulus package". More correctly it is a reduction in the drag of the government on the economy.

This is not the first time I find this subtle phrasing. Here are 2 examples from the Vancouver Sun from some time ago.

Kane: "...spending more than a quarter of a billion dollars on the B.C. homeowner grant."

Cernetig: "...and hand out another $733 million in tax relief, much of it to homeowners."

Both use wording consistent with the general idea that the government is entitled to everything and sometimes give some of it back.

Telling it like it is would say "the government is reducing the tax burden on homeowners".

Nanny State Credit Card Interest Rate

Many holders of credit cards are complaining to the government about the exorbitant interest rate charged on credit cards.

Solution 1 is for the government to act as nanny "..stronger regulation to prevent banks from charging unfair credit card interest rates and transaction fees" [ Jack Layton, National Post http://www.financialpost.com/story.html?id=1217475 ]

Solution 2 is for the government to act as a source of information "..pay off your credit card each month and avoid interest". Further information "if you only buy on your card what you can pay for next month then you have taken an advance step to avoid the problem".

I view Solution 2 as preferable.
Do we really need a nanny government?

Special thanks to Professor Louigi Karl McBalfour

God and happiness

An atheist group in the UK is sponsoring advertisements on the buses reading:
"There's probably no God. Now stop worrying and enjoy your life."

I like it.

My suggestion is that the opposing view runs some ads reading"
"There probably is a God. So be good."

Who can argue with that?

Of course the secular humanists may propose:
"It doesn't matter if there is a God or not, best to be good, stop worrying, and enjoy your life".

Of course, go for the best of both worlds.

Next will be from the field of positive psychology who may come up with:
"Just be good, stop worrying, enjoy life and it will add to your happiness."

Yes, I aspire to happiness. Perhaps you do as well.

Oposition Or Team 2

January 10 2008
In Canada we have this disfunctional heritage of calling the second most numberous party in our parliament "the opposition".

They take it literally

They seem to believe their job is to oppose everything.

In my view they should be the constructive critic and work toward extablishing themselves as the party with better ideas.

So, solution is Party 1 , Party 2 , Party 3 etc.

The current Party 3 , the NDP, is so fixed on the role of opposition that they have announced that they will work to defeat the budget which will be announced on Tuesday. They are prepared now to say they will vote against in tomorrow, without having read it.

So much for expecting our politicians to be constructive.

February 17, 2009
Addendum.
Today our leader of team Michael Ignatieff said "I'm in this business to win a majority Liberal government.."

What I wish he had said is " As leader of team 2 my job is to be a constructive participant in making parliament work for the benefit of the people of Canada. When an election is called my job will be to win a majority government. When I built a solid track record as number 2 then the electorate will promote me to number 1 without hesitation".

Comments & Ideas

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Often I am frustrated at not being able to rant at someone or to throw out my good ideas.
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