Lottery Loopholes and Deadly Doctors

There’s something Peter Tufano wants to know about you: “If you had to, could you come up with $2000 in 30 days?” That’s the question he asked a whole bunch of people in 13 countries, including the U.S.

Peter TUFANO: Why $2000? Because an auto transmission is about fifteen hundred. Most estimates of what everyday emergencies are about are in order of that magnitude. If you were to have a sick or ailing relative on the other side of the country and you had to buy a full-price plane ticket, it could easily be that amount. And then why this language “come up with” as opposed to “save?”  Because we wanted to see if people had access to resources between savings and credit and friends and family. And about half of Americans are not able to come up with $2,000 in 30 days, which means that they stand only one emergency or crisis away from really quite dire circumstances.

Tufano has spent more than three decades in academia — first at Harvard and now at Oxford’s Said Business School —  trying to figure out why consumers do what they do. He wants to know how many checks you write, and for what. How much you borrow, and why.  And especially this: why Americans are so bad at saving money. Our personal savings rate has been plunging for more than 20 years, and actually went negative in 2006. The Great Recession shocked it back into the positive — it’s been at about 5 percent since 2008 — but now it’s started to fall again. Think about what Tufano just said: half of us don’t have access to enough money to survive one breakdown.  And it’s not just people who don’t earn a lot of money. Tufano found that more than 20 percent of the households earning more than $150,000 a year couldn’t up with that $2,000 in 30 days.  Americans are, however, pretty good at spending money. For example: this year, we’ll spend about $60 billion – that’s about $520 per household — on something that isn’t very practical.

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Melissa Kearney is an economist at the University of Maryland. When she was in grad school, she used to stop at a little store in the evening to get her milk and orange juice, and she noticed that a lot of people were buying lottery tickets.

Melissa KEARNEY: And so I just sort of started chatting with the vendor, and he said “Oh, I have people coming in and spending hundreds, thousands of dollars on lottery tickets a month, a year.”’ And so being a graduate student I just downloaded some data and started playing around, and was struck, in particular people do spend a lot of money buying lottery tickets. 

DUBNER: So let’s walk through some of the numbers in lottery gambling. In the U.S., how many people play the lottery?

KEARNEY: You know, half of U.S. adults surveyed say they played the lottery at some point in the past year. 

DUBNER: And would that make it the most popular form of gambling in the U.S.?

KEARNEY: Yes, by far. So two out of three American adults report gambling, and 50 percent say they’ve played the lottery. The next closest is casino, which is about one in five adults.

And why do so many people play the lottery? Because it’s fun. For a dollar or two, you buy the chance to dream. To dream big. This remarkable bargain illustrates a phenomenon — a probabilistic oddity — that economists call “skewness.”

KEARNEY: That’s the idea that there’s some big prize way out there that corresponds to very small odds, but there’s some potential of capturing that. And that’s what your typical money market account can’t give you. So you could have $1,500 in your money market account, and every month you might earn a dollar on it. But there’s no chance in every  month that you’ll earn $100,000, or even $10,000.

DUBNER: Now, I know as an economist you’re not trained to answer this question, but as a human being tell me, why is skewness so important to us?

KEARNEY: That’s the chance of changing your life, right? That’s the return, that’s the big-win outcome that might allow you to buy a beach house, or to send your kids to college. Or you know, if it’s less far out in the distribution that might be what you need to make a down payment on a house, or buy a car, or throw your daughter the wedding you want to throw her.

For a lot of people, skewness has an irresistible appeal. And so a handful of researchers, like Melissa Kearney, are trying to harness its power — the unlikely chance of changing your life with a big prize — to solve America’s low savings rate. The idea is a new financial product that combines the thrill of the lottery with the goal of  maybe accumulating more than $2,000 in a savings account, so that a broken transmission doesn’t become a full-blown crisis. Here’s Kearney’s pitch:

KEARNEY: So we know Americans like gambling. They always have, the majority of them do it, and they’re going to keep doing it. And so what we do is take seriously the idea that people want some small chance of winning a large sum of money.  That market, that asset is missing from the American landscape. Low-wealth individuals — the only asset available to them that gives them some chance of accumulating a large amount of money is the state lottery. And in fact, a recent national survey of a thousand adults, one in five American adults said their greatest chance of accumulating hundreds of thousands of dollars was through the lottery. That number jumps to 40 percent for folks making less than $25,000 dollars a year. So a lot of Americans think the lottery is their only chance at winning big sums of money, why don’t we take that appetite for gambling, for a product like this, and attach it to a savings vehicle that offers some positive return?  It’s a win-win situation.

This win-win situation has already worked in many other countries. It’s called Prize-Linked Savings, or PLS. Here’s how it works. People deposit money in a bank, or maybe buy a government bond, and instead of receiving the going rate of interest, they’ll get a smidge less, maybe a quarter of a percentage point less. And all those smidges are then gathered up into a prize pool, and cash prizes are distributed from that pool, just like lottery winnings, maybe once a month, to a few lucky winners. And the losers – well, there are no losers really. Everyone keeps his original savings. So you could call a PLS plan a “no-lose lottery.” It’s the kind of idea that can really catch fire.

Robert KEIP: My name is Robert Keip.  I worked at First National Bank for 11 years, where I headed up the investment product house, and our focus was trying to look at ways of growing the funding base of the bank.

DUBNER: First National Bank is in South Africa. In 2005, it started what would turn out to be a phenomenally successful PLS program. It was born out of South Africa’s financial problems, as the country struggled to put the apartheid era behind it. Millions of Black South Africans did not use banks, for anything. Robert Keip wanted to find a way to get some of them in the door.

KEIP: Now in South Africa, because so much of the population is unbanked, so much of the savings are literally sitting under mattresses. Now, this has got a double effect: the one that it really does do badly at is that it removes that funding from the mainstream banking environment so it can’t be harnessed to lend out and fund economic growth because retail funding tends to come in  from consumers and then get lent out to businesses who can then create jobs, so that was the one problem. And the second problem was really that these people with the money under mattresses were excluded from the banking system, and by being excluded by the banking system you miss out on so many benefits that really help with people’s individual development. For example, developing credit records, being less exposed to money being lost of stolen on the way home.

But Keip’s bank had a problem. Interest rates at the time weren’t keeping up with inflation, so putting your money in a plain old savings account might actually erode its value. Keip’s job was to make it worthwhile for customers to deposit new money. So instead of simply offering an account with a scrawny interest rate, he would offer an account with practically no interest at all, but it came with the chance for a really big payday.

KEIP: So what we did, we literally pooled all of these little point-two-five percents of interest.  And then what we did, we paid out that interest in lump sums to a few people.  So we paid out 150 people a month in lump sum prizes. So the first prize would be a million Rand, which is an enormous amount of money in South Africa. And then there were three prizes of 100,000 Rand. And then we went down to 20,000 Rand, and a few prizes of a 1,000 Rand.

DUBNER: So let’s say I live in South Africa. I take the money I’m earning and put it under my mattress or maybe buy some high-risk equities. You’re offering me the security of a bank account and the excitement of a chance to win a million Rand. And what did you call this idea?

 KEIP: We called it the “Million a Month Account.”

 DUBNER: MAMA.

 KEIP: And MAMA became the trivial name for it.

 DUBNER: And you’re the man who gave birth to MAMA.

 KEIP: Yes.

 DUBNER: How successful was MAMA?

 KEIP: Hugely. Probably too successful for its own good.

MAMA attracted more than a million new customers to Keip’s bank. Other banks in South Africa took note — and complained to regulators. And then Keip’s bank heard from someone else: the South African National Lottery.

KEIP: Well, we engaged with them before we launched. We wrote to them and got their opinion on the product. The wrote us a letter back saying they didn’t think it was a lottery — they thought it fell into a promotional competition part of the legislation — and that we just comply with the rules of promotional competition. And we launched and nothing was heard from them for six or so months, and then they contacted us to say actually they don’t like what we’re doing and they think that it’s a lottery now.

 DUBNER: So when you were starting out and there was very little money in your coffers, they thought that it wasn’t a lottery, but then after it got going for a while, and you had, how much: a couple hundred million dollars?

 KEIP: About $200 million dollars, but more importantly it was over a million customers that we had brought in.

 DUBNER: And the National Lotteries Board changed its mind then. It thought: Oh, that thing that we said a little while ago was not a lottery, now looks a lot like a lottery.

 KEIP: Yes.

 DUBNER: And what did they do then?

 KEIP: Well, we first engaged with them and tried to discuss it, but it was very clear that they were in no position or not wanting to even try to discuss what the issues were. And so they took us to court to have us closed down.

In court, the South African National Lottery argued that First National Bank’s PLS program infringed upon the lottery’s domain, and it noted that PLS customers were surrendering their rightful interest payment on their savings. Hmm. As opposed, that is, to surrendering the entire price of a lottery ticket. Anyway, the court sided with the Lottery, and the PLS program was shut down. Robert Keip stands by the program’s success. He says that 20 percent of the PLS accounts were opened by people who were previously unbanked. In 2009, after First National Bank’s PLS program was shut down, Keip was invited to Washington to talk to federal banking officials about its success.

Now, a bank in the U.S. can’t set up a no-lose lottery either. Why not? Because the only legal lotteries here are those that are run by the states themselves. Nice monopoly if you can get it, right? State lotteries generate billions in revenues, and so, while most statehouses might like to help their citizens save more money, they may not be willing to pit their own lotteries against a rival lottery run by a bank. But in 2009, the same year that MAMA was shut down in South Africa, Peter Tufano and some colleagues found a legal loophole in Michigan that let them set up a PLS plan there with some credit unions. Here’s Dave Adams, CEO of the Michigan Credit Union League.

Dave ADAMS: You know, banking can actually be pretty boring. It’s not like we go to social events and talk about how much we’re saving or talk about a great new feature on our checking account. So what people want and need is a fun way to save, and in Michigan we’ve come up with what with what we think will accomplish that. It’s a program called Save to Win.

 And what it is, is using a lottery concept, so that for every $25 that someone puts in to these one-year certificates of deposit, they are going to get a chance at cash prizes. And the cash prizes are given out every month by participating credit unions ranging from fifty dollars to five hundred dollars. And then there’s a grand prize at the end of the year, an opportunity to win a $100,000 grand prize. 

So even with a sputtering economy and unappetizing interest rates, a handful of credit unions in Michigan opened 16,000 new savings accounts. Who were these new customers? More than 60 percent of them had spent money on the lottery or gambling in the previous six months, and 46 percent of them currently had no savings account. One new customer was Billie June Smith. She’s 88-years-old — says she was never very good at saving money, much preferred to play the lottery. But when she learned about her credit union’s Save to Win plan, she started buying $25 certificates of deposit, and she was the first Grand Prize winner.

DUBNER: So you put $75 of your own money into a credit union savings account. And as a result, you were entered into a lottery for which you won $100,000.

 Bille June SMITH: Right.

 DUBNER: Well, that sounds like a pretty good deal to me.  What do you think?

 SMITH: Well, it is! It has helped me a lot.

 DUBNER: Now, tell me what you’ve done with the money, Billie.

 SMITH: Well, my place is a double-wide, and I had bought that way back when I retired.  And we have removed the siding and put new siding on it. We done it ourselves. My daughter and her husband live with me now. And  I’ve had to replace the furnace just a month ago. And I’ve put in water softener. And I have put my  money aside for the taxes. And I do have another savings that I don’t touch for just so long.  And I can add to it then.

Now, what about all the Save to Win customers in Michigan who didn’t win? Well, they’re on their way to their own reward: passing Peter Tufano’s test. They’ll have money in the bank when a transmission conks out or when they need to fly across the country to visit a sick relative. Timothy Flacke is executive director of the Doorways to Dreams Fund, which Tufano co-founded, and which tries to bring new financial ideas, like PLS, to low and moderate income consumers. Last year, Flacke says, was a pretty good one …

Timothy FLACKE: So in 2011, Nebraska, North Carolina and Washington state all have passed bills that explicitly authorize Prize-Linked Savings or savings promotion raffles for credit unions. A number of other states have introduced bills or were looking at bills. So we view all of that as very positive.

The PLS idea is making headway outside of credit unions, too, like a new for-profit program called SaveUp, which rewards customers at thousands of banks for depositing money or paying down debt, and in Alabama, where one foundation is offering a $20,000 prize to encourage low-income families to invest their tax refund rather than spend it.

I know what you’re thinking. You’re thinking: wow, this PLS idea sounds great! An interesting, fiscally responsible, even fun way to encourage people to save more money. So what’s stopping it from going big-time? Coming up on Freakonomics Radio, we’ll hear from some people who do not want it to go big-time. State lottery commissioners, to be precise. And we brought the idea to someone at the U.S. Treasury Department. He doesn’t like it so much either.

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The biggest lottery in the United States is run by New York State. Gordon Medenica, the state lottery director, says that 75 percent of New Yorkers play, generating nearly $8 billion in annual sales. But in order to get there, New York — like most states that have a lottery — had to rewrite its existing laws that prohibit gambling.

Gordon MEDENICA: New York first began in 1967, and it was the second state after New Hampshire to come in.

DUBNER: What was the original impetus? Was it a budget shortfall essentially? Did the state feel we need money? We can void this ban on gambling in the state and come up with a way to do it?

MEDENICA: I think was both a desire to raise money, and also I think it was a recognition that playing was going on anyway. And it was an attempt to tax and regulate an activity that they knew was very common among citizens. And whether you go back to the numbers games that existed in urban areas, and quite frankly still exist, or those kinds of activities, and even sports betting today, which of course, technically is illegal but we all know is a huge business, and I think it was a recognition on the part of lawmakers that, much like prohibition, better to tax and regulate than to ostensibly call something illegal and pretend it doesn’t go on.

State governments do more than tax and regulate their lotteries. They take a big cut for themselves. Now in gambling circles, the commission taken by whoever operates the game is known as the “rake.” With state lotteries, the rake can be as high as 60 percent. That means that as little as 40 percent of the money taken in from ticket sales ends up in the pool that pays the winners. The rest of the money usually goes to education and to cover overhead, marketing, sales commissions. Now, compare the lottery’s rake to the slot machines in a casino: they pay out more than 90 percent. Meaning a rake of 10 percent. Meaning the state lotteries are — how to put this politely? — extremely aggressive.

KEARNEY: Oh yeah, it’s a lot of money they take off.

Here’s Melissa Kearney again, the Maryland economist who studies the lottery.

KEARNEY: Consumers are paying a very high price to buy this type of product.  They can’t get it from anywhere else legally.  And then they —  the lottery commissions have the mandate to increase revenues.  So they innovate, they advertise, they market. Yeah, they sort of  behave like monopolists.

DUBNER: What do we know about people who play the lottery, what for instance is the socio-economic breakdown?

KEARNEY: O.K., so this surprises a lot of people, but people throughout the socio-economic distribution play the state lotteries. So it’s roughly fifty to sixty percent of men, roughly fifty to sixty percent of women, roughly fifty to sixty percent of people across the education spectrum, so people with  high-school dropouts, high-school degrees, college graduates.n And when you look at the absolute dollars reported spending, it’s not that different across the income distribution, so it’s sort of lower income households spend about as much in dollar terms as higher income households.  The flip side of that, of course, is it winds up being a larger share of lower-income households’ total spending. 

So the people who can least afford to play the lottery buy just as many tickets as people who make a lot of money. Which is why scholars like Kearney and Peter Tufano think Prize-Linked Savings, or PLS plans, could help America’s pathetic savings rate. For a while, Tufano actually had the New York State Lottery looking into a collaboration, but Gordon Medenica, the lottery director, told us he did the math and just didn’t think a “no-lose” lottery could compete with the gigantic state lottery payouts. I asked Leo DiBenigno, the state lottery director in Florida, what he thought of the PLS plan that Michigan credit unions have been offering.

Leo DIBENIGNO: From a purely lottery perspective, I think the Florida Lottery is the only entity in Florida that can operate a lottery game. So I’ve got to say it probably sounds illegal under current Florida law.

States protect their lotteries because the lotteries bring in lots of money for the states. And look for that money to increase, potentially big-time. The Justice Department just cleared the way for state lotteries to put their games online. Gordon Medenica, New York’s lottery director, said he was thrilled with the new ruling. Who could blame him? Now, some of that money goes to education and other worthy causes. But as Leo DiBenigno admits, that’s not what motivates people to play.

DIBENIGNO: People play the lottery to win.  They like the prizes, they like the excitement, they like the fun, the possibility of winning — you know, sometimes $10, $20, $50, and sometimes many multi, multi millions of dollars. I think the funding to education is ancillary. It’s an extra bonus that the public views the lottery as a different and unique and fun way to be able to fund at least some of things that our education system needs.

The lottery has famously been called “a tax on the stupid.”  The odds are terrible because the state rakes a huge amount off the top, far more than any casino or horsetrack would dare take. And they convert your hard-earned cash into an extra schools tax. Now, you can understand why state lottery commissioners like things just the way they are. But what about the federal  officials who work on consumer protection, things like that? What about someone like the Assistant Secretary for Financial Institutions at the Treasury Department? That was the position Michael Barr held when I interviewed him about PLS programs. I asked Barr if he ever played the lottery.

Michael BARR: I haven’t really played the lottery. I think probably if I went back over my 45 years I may have bought a scratch ticket or two in my twenties.

DUBNER: Now why do you not play the lottery?

BARR: It’s a fool’s errand. As you undoubtedly know there are a handful of people who will make some money out of the lottery but most people most of the time will lose money. It’s not a great way of spending one’s scarce resources.

DUBNER: I don’t know if you’re aware of the pilot program that’s been happening up in Michigan with the credit unions where a Prized-Linked Savings program is actually under way. Are you familiar with that at all? Called the Save to Win program?

BARR: I have not actually studied that.

DUBNER: So the folks who are trying to make this happen come up against a very simple reality: which is that it’s typically illegal. That a private institution like a bank or a credit union is not allowed to run a lottery according to state law. State law typically forbids gambling in order to allow a state, let’s say, to run a lottery itself. There’s a loophole that must be written, and those loopholes have been written. Most states do have their own lotteries. But for someone else to come in and do it, it would be illegal. If you looked at the landscape and thought, “In my role in Treasury here, I would like encourage people to save more. I’d like to make it worthwhile for them to save more, and I’d like to remove barriers that prevent them from participating in projects that let them save more.” Would you be in favor of sponsoring  or trying to get rolling some legislation that would allow for a widespread deployment of Prized-Linked Savings? Do you think that’s something that Treasury should get its momentum behind?

BARR: One of things that I’ve learned in my role at Treasury is that picking fights that one doesn’t have to pick is not the wisest course of action, unless it’s something that’s absolutely essential to take on, and I wouldn’t have put that in the category of high priorities to wage into a discussion of state gaming law.

DUBNER: But let me — but if your job is to help American families save more and be better financial stewards generally, and we know that tens of billions of dollars are being spent on lottery tickets every year, which you called “a fool’s game,” and one alternative is to offer bank savings accounts that — whereby a customer can put in $100, enter a lottery —  maybe win, maybe not, but maybe — and keep the $100, why isn’t that something that’s worth considering even in a politically fractious environment when the potential benefit — getting people to save more — seems to be much larger than the potential downside of angering some state lottery commissioners, let’s say?

BARR: I think there are lots of ways of encouraging greater savings among all American families and I think we should continue to innovate and try new approaches. I think that the question that you posed is potentially one aspect of one way to do that. I don’t think we yet know enough from the research to say it’s the kind of thing that we think needs to happen on a wide scale in order to be effective, and I think we have a number of potential strategies to help meet the needs of American families to save that we haven’t really fully explored and that maybe raise a somewhat lower set of issues and barriers.

All right, so Treasury doesn’t like Prize-Linked Savings accounts. Lottery commissioners don’t like the idea. Maybe you don’t like it either. Maybe you think people ought to save money on their own.

But you know what? We don’t. People respond to incentives and, for a lot of us, the incentive to save — for retirement, for emergencies, for whatever — is weak. Why? Well, because the payoff is abstract, and it’s too far in the future. It’s the opposite of skewness.

Now, this dilemma doesn’t just apply to saving money. Think of a school kid, a third- or fourth-grader. “You want me to do what? To bust my butt in school for 10 more years, and then go to college, just to get some job that I probably won’t even like?” Or think about crime and punishment. If you look at the data, it turns out the death penalty, for instance, does not work as a crime deterrent. Why? Because as it’s currently practiced at least, with the punishment waiting so far out in the future, through a maze of delays and appeals, the incentive simply isn’t strong enough to stop me from doing the crime right now.

Sometimes you need stronger incentives. Or maybe some good smoke and mirrors. That’s kind of what a Prize-Linked Savings plan could offer. In a country where it’s easy to borrow your way into bankruptcy, where you can buy lottery tickets whenever you buy a loaf of bread, PLS is like a big neon billboard that turns a boring old savings account into an exaggeration of itself. “Stick some money in here,” it says, “and you just might hit a big payday.” And even if you don’t, well, your money still belongs to you.

I’ll buy that for a dollar. Wouldn’t you?

Coming up on Freakonomics Radio, if you can’t coax someone into playing smart with their money, maybe you could just teach them?

Lauren WILLIS: It’s sort of like saying, well, we should start teaching everybody to be their own doctor, teaching everyone to be their own mechanic. Not only is it inefficient, but it has this sort of culture of blaming the consumer.

America’s financial illiteracy, in a moment.

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In the mid-nineteenth century, Vienna General Hospital was considered a world-class research center. But the hospital’s maternity ward did not have such a good reputation. If you came in to have a doctor deliver your baby, you stood a 10 to15 percent chance of dying, from what was called childbed fever.

Sherwin NULAND: Childbed fever is an infection primarily of the uterus, and it spreads out through the tubes into the abdominal cavity, of women immediately after they have given birth.

That’s Sherwin Nuland. He’s a professor of medicine at Yale. He wrote a book called The Doctors’ Plague about the situation at Vienna General. In 1847, a young Hungarian-born doctor named Ignatz Semmelweis joined the staff there. He was horrified by the situation, and Semmelweis went digging in the numbers for a clue. Now, here was something strange: There were two separate maternity wards in the hospital – one staffed by doctors, who were all male, the other by midwives, who were female. The death rate in the midwives’ ward was far lower. So it seemed to be something the doctors were doing, but what? Then, a clue came in the form of a tragedy. A colleague of Semmelweis’s died after getting gangrene. He had pricked his finger with a knife while giving a lesson in autopsy.

NULAND: And Semmelweis was away on a brief vacation when this happened. But when he came back he began to study scrupulously the autopsy findings of his friend, and noted that they were just like the autopsy findings of women with childbed fever who were dying.

His conclusion? Doctors were carrying what he called “invisible cadaver particles” from the morgue into the maternity ward. Today, we’d call them bacteria. But remember, this is the mid-1800’s, pre-germ theory.

NULAND: Consider a typical morning of a student or a young doctor in training. The very first thing he would do in the morning was to go to “the dead house,” as it was often called, and to do an autopsy on one of the women who had died the day before. And when the abdomen is open, there is a sea of pus — around the uterus, around the tubes, the young doctor will put his hands in this. He then probably wipes his hands on a towel, and goes up to take on his regular duties as an obstetrician-in-training.

Semmelweis ordered every medical attendant who entered the doctors’ ward to submerge his hands in a chlorine wash before seeing patients. Within six months, the death rate of women in the doctors’ ward had plummeted.

NULAND: And that was it. It was as simple as that.

It was a stellar piece of medical detective work. Semmelweis not only found the cause of death, but he figured out how to prevent it. So you know the rest of the story. It became standard procedure for doctors to disinfect their hands and they stopped passing germs along to patients, right? Well, not exactly.

Michael LANGBERG: Doctors are human.  

Michael Langberg is the chief medical officer at Cedars-Sinai Medical Center in Los Angeles. He’s been trying to get his doctors to do a better job washing their hands. It hasn’t been easy.

LANGBERG: So there’s something in the human condition that somehow disconnects what is really good evidence from personal choice and habit. And I don’t know why that is. I’m not a psychiatrist; my field is internal medicine. I just have the observation. Physicians are no different. What’s disturbing about physicians is since they’re human, you would expect them to have the same rate as everybody else if not even greater rates, if not a hundred percent, than other healthcare providers. And at Cedars Sinai, I regret to report that they’re the lowest rate.

So even at an excellent hospital like Cedars-Sinai in Los Angeles, it’s the doctors who have the lowest rate of hand hygiene. Now, isn’t that bizarre? With most problems in society, we subscribe to the belief that education is the answer. Especially, when you’re talking about risky behaviors like drunk driving or risky sex or whatnot. But here, the doctors are the most educated people in the hospital — and the worst at washing their hands. So how is a hospital like Cedars-Sinai supposed to solve that problem? We’ll tell you about that later. But first, let’s take a look at another problem, another instance of where knowing the right thing is not always connected to doing the right thing. Yep, we’re gonna talk about money.

Austan GOOLSBEE: Hi, I’m Austan Goolsbee. I’m a professor at the University of Chicago Booth School of Business. And I’m the former chair of the Council of Economic Advisors.

DUBNER: Which means that you worked as an economist in the White House bending the president’s ear.

GOOLSBEE: Something like that.

 DUBNER: Something like that. Just give me for a second your view of how important financial literacy is to a well-functioning society.

 GOOLSBEE: So just for your own sake, you know, your own retirement, or your own making sure that you can send your kid to college and this sort of thing, you’ve got to at least know the basics of how to save money, if you’re going to invest the money, where are you putting it, that you’re not taking crazy risks that you don’t understand and things like that. But then, you know, we saw through the 2000s as we in some ways ripped up the rules of the road and took away some of the restrictions that financial institutions had in offering financial products to consumers, there were a lot of people with limited financial literacy who got into extremely complicated mortgages. And those mortgages blew up, and the magnification of those explosions essentially caused the financial crisis and the worst recession of most any of our lifetimes.

Wow. That’s quite a claim. That financial illiteracy — individuals not knowing what they were doing with their personal finances — helped cause the Great Recession. So how bad off are we? Annamaria Lusardi is a professor of economics at the George Washington University School of Business. She’s originally from Italy but has spent the past ten years looking into America’s financial literacy. On a scale of one to ten, she says:

Annamaria LUSARDI: I describe it as a four, if I have to give a number. I would describe it as insufficient and deeply insufficient in a sense. 

Now, the good news is that other countries aren’t necessarily better than us. The bad news is that Lusardi isn’t guessing how bad we are; she knows it from the data she’s collected. It began with a survey, administered by the National Institutes of Health and the University of Michigan, called the Health and Retirement Study. Lusardi and a colleague were allowed to stick in a few questions designed to see what people knew about money.

LUSARDI: So there were only three. And they were very simple. There was one simple question about can people do a two percent calculation?

Here’s the actual question. See if you know the answer. Suppose you had $100 in a savings account and the interest rate was two percent per year. After five years, how much do you think you would have in the account if you left the money to grow: more than $102, exactly $102, less than $102?

LUSARDI: You know, we wanted to test interest compounding, but we end up really asking people, you know, how much do you get on your savings account if you invest, you know, a hundred dollar and the interest rate is 2 percent?

The answer is: more than $102. That’s the miracle of compound interest. All right, here’s the second question. Imagine that the interest rate on your savings account was one percent per year and inflation was two percent per year. After one year, would you be able to buy more than, exactly the same as, or less than today with the money in this account? The answer is: less than today. That’s what inflation does. And here’s the third question. Do you think that the following statement is true or false? Buying a single company stock usually provides a safer return than a stock mutual fund. The answer is: false. A single stock is more volatile than a mutual fund. O.K., how’d you do? Did you ace ‘em? Turns out that only fifty percent of respondents got both of the first two questions right, and only a third of the people got all three answers right. And no offense, but these are pretty basic questions.

LUSARDI: It was a surprise, in a sense that we were expecting people not to know very much, but we were surprised by how little people knew given that we were giving this interview to people who were 50 and older. So they had already engaged in probably a lot of financial transactions.

Lusardi was so struck by the sad state of our financial literacy — not just among older people but, as she discovered in later surveys, among young adults, women, and minorities — that she’s become an advocate for fixing this problem. The obvious solution, as she sees it, is to make financial literacy part of our educational curriculum. High school would probably be the best place. Because we all know that educating people about risk is the best way to solve a problem, isn’t it? Isn’t it?

WILLIS: It’s sort of like saying, well, we should start teaching everybody to be their own doctor, teaching everyone to be their own mechanic. Not only is it inefficient, but it has this sort of culture of blaming the consumer.

That’s Lauren Willis. She’s a professor at Loyola Law School, Los Angeles. She teaches contracts and consumer law. Lately, she has argued in a couple of law journals against widespread financial education. She’s come to believe that a little bit of education can give people the illusion that they’re better than they are at making financial decisions and an overconfidence that can lead to reckless behavior. She first developed this position after reading a speech by Fed Reserve Chairman Ben Bernanke about the need for financial literacy education.

Ben BERNANKE: The evidence suggests that financial counseling can improve consumers’ management of their credit. My written testimony describes a number of other studies that document the positive effects of financial education and knowledge on financial outcomes.

WILLIS: And he cited some papers that he said supported the idea that this would work. And I went and looked at those papers, hopeful that I would find something that worked, and I was appalled. They absolutely did not prove that financial literacy education was effective. They proved that people liked the classes. They take a survey and people say, “Yeah, I liked it,” at least the people that stuck around to fill out the survey. And you know, people are very polite. They would say, “Yeah, sure. I’m going to do all those things you told me to do when I get home.” But there was not real evidence that people actually change their behavior and had changed outcomes.

So we’ve got a puzzle here, don’t we? You’ve got the Fed chairman and one leading scholar saying that education is the way out of our widespread financial illiteracy, and you’ve got another scholar saying, “Hold everything! That would be a disaster!” So we decided to get these two scholars together for a chat.

Annamaria Lusardi in favor of financial education and Lauren Willis against. We began with something they agree on: there are tens of millions of financial illiterates in this fine country of ours, and that is not a good thing.

DUBNER: So, that does sound bad, the fact that you both think that Americans are quite financially illiterate. But, you know, maybe we should just think, you know, too bad for those people, those are dumb people, and that’s what evolution is for and capitalism takes care of them? So, you know, anyone who chooses to smarten up, you know, that’s a big advantage for them. What’s wrong with thinking like that?

 LUSARDI: I don’t like this kind of thinking very much, I have to say. I actually think that people are very smart, and they try to do the best of what they can do, but I think it’s very expensive to acquire financial education. And that’s why, you know, for the normal literacy we have set up school. Imagine a world where, you know, we don’t have school and people have to do the education themselves. It’s very expensive and very inefficient. And there is an externality. There is a cost to society of what other people do.

 DUBNER: So, Lauren, it sounds as though you have a lot of respect for Annamaria’s research, but what do you think when you hear her describe this new curriculum that should be taught in schools throughout the land of teaching children and then older teenagers and adults to be financially literate? You think that’s a good idea?

 WILLIS: The problem is we are just not going to commit the resources that we would need to do that. You know, we currently don’t teach people how to do math terribly well. And I actually think math makes a difference, just plain old math. There are studies that show that folks with basic math skills do better financially later in their lives. There is no evidence that people who know the difference between a stock and a bond do better later in their lives as a consequence of being taught that. It’s sort of like saying, “Well, we should start teaching everybody to be there own doctor, teaching everyone to be their own mechanic,” you know, something like that — you know, terrible inefficient to do that.

 DUBNER: So your position then is what? So if you say, Lauren, that Annamaria understands that problem quite well, but that really she’s attacking the demand side, and really it sounds like you’re identifying a big set of problems on the supply side. So, if that’s the case, what do you propose?

 WILLIS: Well, a few things. One is I think we’ve moved to a point where financial decisions are complex because there are complex products out there. It’s not just to fool people. I mean, there really are good complicated products out there and good complicated decisions that need to be made. We need to train and regulate a cadre of financial advisers, neutral financial advisers that are not going to be conflicted by also being salespeople. And so then that’s —

 DUBNER: And these, and these people are employed by whom then?

WILLIS: Well, it would have to work in a similar way to other professions. And so there would have to be some folks that were doing pro bono work as well as it simply would need to become also something that people expected to pay some kind of flat fee for to get financial advice.      

DUBNER: And Annamaria, when you hear Lauren say that your idea for educating people, for giving them more financial literacy in let’s say the school system  over the course of many years, when you hear her say that your proposal for that is just too expensive, and cumbersome, and it probably won’t work on top of that, what do you say to that?

 LUSARDI: Actually, this is exactly what people always tell me, you know, it’s expensive to do financial education. I think it’s expensive not to do financial education. And we have just seen the consequences of that. Think of how expensive has been the cost of this financial crisis. You know, a lot of people tell me that, you know, financial education is very difficult, and I love this analogy of driving, because, you know, driving is also very difficult and look what we have done. We have put fifteen-year-olds on the road. And imagine what could happen if you put people on the road without giving them a driving license, without checking that they are able to drive. Imagine that.

DUBNER: And also, there’s the assumption that just about anybody can be taught what might look from a distance like a rather complex set of skills — driving a heavy car, right?

 LUSARDI: Yeah, and you know, we are not asking people to drive in a Formula One race.  What we are only asking you is to go slow and to be able to reach your destination, and you know, not to have accidents that can hurt you and others.  

 WILLIS: So, I think the problem actually is that the current world we live in does require people to act like they’re Formula One drivers, right?  I mean, let me just read you from the Federal Reserve Board consumer handbook on adjustable rate mortgages. “To compare two ARMs, adjustable rate mortgages, with each other, or to compare an ARM with a fixed-rate mortgage you need to know about indexes, margins, discounts, caps on rates and payments, negative amortization, payment options and recasting your loan.”  And so what we’re expecting from people is, in fact, Formula One.

So where do you come down in this debate? Is financial illiteracy something that should be fought on the demand side, through widespread education, like Annamaria Lusardi suggests? Or on the supply side, through better regulation of financial instruments and a new cadre of financial advisers, like Lauren Willis wants? It seems obvious, to me at least, that some combination of both would be much better than nothing at all. I get Willis’s argument that widespread financial education might be a massive waste of money. And sure, I can get behind her call for more transparency in financial products. But do we really want to rely upon a bunch of pro bono financial advisers to get people out of their messes? The fact is that financial illiteracy is a hard problem to solve. It  requires a fair amount of knowledge, a good bit of willpower — and it probably calls for some creativity. Like other hard problems. You remember the situation at Cedars-Sinai Medical Center, with doctors not washing their hands? Dr. Michael Langberg says their hand hygiene rate was about 65 percent …

 LANGBERG: That would mean that 35 percent of the time it wasn’t being done. And that translated to our medical staff as potential harm.

So what do you do? The doctors are the best-educated people in the hospital, so it wasn’t as if they didn’t know the danger of carrying around bacteria on their hands. Cedars-Sinai tried a bunch of ideas that seemed to make sense: they put up signs and sent out e-mails; they handed out bottles of hand sanitizer; they even awarded $10 Starbucks gift cards to doctors who did wash their hands. But none of this boosted the handwashing rate. So rather than moving forward, Cedars-Sinai took a step backward.

LANGBERG: We had an effort to prove to the physicians that, believe it or not, physicians’ hands can carry organisms. We would go to the leadership of the medical staff and ask them if they wanted to have their hands cultured, for example, and they did. And they were cultured, and some of them were pretty ugly.

That’s right. The docs were asked to lay their palms in petri dishes, which were then sent to the lab. After two days of incubation, the dishes grew a bunch of yellow bumps in the shape of a hand — bacteria. That’s when the hospital’s chief of staff made a clever and creative decision: to take a photo of one of those disgusting, bacteria-laden palmprints and make it the screen saver on the hospital’s computers. The screen saver did its job: the staff was shocked and disgusted, and the handwashing rate shot up to nearly 100 percent. Victory! But to keep the rate high, Cedars-Sinai has had to be vigilant and sometimes a little wicked.  Would you believe public shaming? That’s right. The names of doctors who failed to wash their hands were posted during departmental meetings.

LANGBERG: The first time it happened, I think subsequently other people in the room are texting the individuals to say, “Do you know that your name was up here for having been caught not doing hand hygiene?” And as much as you want to reward people for doing it, these kinds of consequences, um, actions have had a really important impact on the way in which physicians are really aware of hand hygiene.

It’s humbling, isn’t it? To think that the best-educated people in the hospital need to be tricked and shamed and even frightened into washing their hands. It shows just how hard behavior change can be — whether it’s hand-washing or something like learning how to do a better job with your personal finances. We like to think we can flick a switch, make a resolution, maybe take a course, and suddenly we start doing the right thing, the responsible thing. But it can take all kinds of incentives, all kinds of carrots and sticks, to make that happen. What if we used the kind of tricks that Cedars-Sinai used for hand-washing to try to increase our financial literacy? What if your 401(k) paperwork came with a tin of cat food — to remind you what you might be eating in old age if you don’t learn a bit more about investing?  What if your adjustable-rate mortgage application came with a picture of the future you, living in a cardboard shack on the sidewalk …