Capitalisn’t: Our Personal Finance Mistakes Are the Industry’s Profits

Episode Transcript

John Campbell: If you poison yourself or your kids, too bad, you should have been smarter. Well, some of the mistakes that people make in the financial context can be as destructive as that.

Bethany McLean: Today's topic takes me back to the very beginning of my career. My first job in journalism was in the personal finance section at Fortune. Back then, I think there was a pretty clear worldview, or at least it was my view: if people could just become a little more financially sophisticated, their lives would improve, so people just need to learn to save. People need to learn to invest. People need to avoid unnecessary debt. People need to start planning for retirement.

Here we are today, and if millions of people keep making the same mistakes, maybe we should ask if there's something about the environment in which those decisions are being made. That brings us to a new book written by John Campbell and Tarun Ramadorai, called Fixed: How the Financial System is Rigged Against You.

It all raises questions that go well beyond finance. How much freedom should people have to make mistakes? How much protection should society provide? At what point does consumer choice become a trap? Maybe the biggest, have we turned too many of life's risks from retirement to healthcare to education into individual financial problems, particularly in a world where, as they argue, the financial system really is stacked against ordinary households?

They argue it's a huge contributor to inequality and that financial literacy may not be the solution that we think it is. This interview was originally done as a webinar through the Stigler Center, so Luigi is not present in the interview, but you will hear his acerbic take at the end, in our usual wrap-up. I wanted to start with something really pretty basic. You guys are both economists. Why this book? What led you to write this? Let's start with John.

John: I started to get into it by asking what finance theory tells us about what people should do. How should you manage your affairs through your lifetime? Then I realized, "Well, maybe I should compare that with what people actually do. Perhaps we can study and measure the behavior of ordinary households." It quickly became apparent that a lot of the things people do are very hard to make sense of from an academic perspective. They're very different from what economists would recommend.

Now, initially I thought, "Well, these are mistakes. Maybe we can educate people out of them." The more I studied it, the more I realized that there's a toxic interaction between the mistakes people make and the response of the financial industry, where one begets the other, and the end result is a system that really doesn't meet the interests of many ordinary people.

Tarun Ramadorai: I think it's quite important to recognize that people feel these issues extremely viscerally. The first experience that most ordinary people have with the financial system is through the personal finance market. In some ways, finance is a stand-in for all these conspiracy theories that we have out there about the way that the economic system works, how it may be rigged against us. It's not just about the fact that they get mistrustful. It's also the fact that that mistrust can translate into electoral problems. It can spawn populist movements. In some sense, we have to be very, very careful and responsible about the way we manage those interactions that people have with the financial system.

John: I think, in the old days, personal finance was seen as a very down-market topic, the sort of thing that would be taught in community colleges. There's a whole industry of personal finance influencers who write books at that level. Do this, do that, do the other thing. Our perspective is very different. Our perspective is that actually the challenges of personal finance are fundamental, very intellectually demanding, and really to handle it well, you need to understand economics.

I teach a course at Harvard, which had over 300 students last fall on personal finance, and I use it as a way to teach economics. Harvard now has many more first-generation college students than we used to have. I'm very glad about that. About 20% of the students in the course are first-generation students, and they want to take their savvy back to help their families and their communities. That I find very satisfying and important because one of the themes of our book is that the system worsens inequality because you have complex financial products that are too hard for many people to manage.

Particularly less educated people, less financially sophisticated people who are often poorer, will start to make mistakes, and those mistakes will be costly, and the result actually worsens the inequality of wealth. As well as worsening the sense that we live in a system that's rigged against ordinary people and favors the rich, and that has all the political consequences that Tarun referred to.

Bethany: If the system is broken for households, who is it working for? Who's benefiting the most from the fact that the system is broken for households?

Tarun: The decisions that households are asked to make are fully as sophisticated as the decisions that corporations are asked to make. A mortgage refinancing problem is actually a very complicated problem to solve appropriately. Now, given that it's such a complicated problem, households find it very hard to make the right decision. Sometimes what they want is not exactly the same as what they need. In fact, you can be very, very far away from what they need.

The problem, of course, is that in capitalist systems, you don't necessarily make a lot of money by persuading people that what they want isn't what they need. Corporations run into this gap, and then they provide products and services that cater to the demands that people express rather than the demands that people should actually have. Now, in the short run, this generates profits. It also, sadly, generates these bizarre, inequitable cross-subsidies.

There are some savvy members of the population. Unfortunately, those savvy members of the population are also wealthier, more educated, have higher incomes. These are the elite of society. What you can have is a system where the mistakes of the lower-income, less well-educated, less savvy members of the population can then fatten the profits of the financial sector, but then they can pass on some of those benefits to the people who understand much better how to make the right decisions because they can then provide a more competitive product offering for someone who can unmask all of these problems that exist in the system.

It's two groups that are benefiting at the moment. One is the corporations themselves, but the other is this elite group. Now, back to this political economy perspective, this is really going to fuel all kinds of conspiracy theories if we're not careful.

John: Banks offer checking accounts, and they routinely offer overdraft protection, which what that means is if you overdraft your account, maybe inadvertently, they'll honor the debit or the check, but they'll charge you a fat fee for that. That's actually going to be very expensive short-term credit. Those overdraft fees help to subsidize "free checking accounts." The reason that you don't have to pay that much for your checking account is, in part, the overdraft fees that banks are collecting.

Now, if you are well-organized and you never overdraft, you get a great deal, but you're saving money because other people are making mistakes. Similarly, with mortgage refinancing, even a plain vanilla fixed-rate mortgage, 30-year, the standard US mortgage, you should refinance it when rates fall to save money, but the people who do that quicker and know when to do it tend to be better-off people.

Also, there's troubling evidence of racial inequity that Black and Hispanic borrowers do this systematically more slowly than White borrowers, and so they end up paying higher mortgage rates. Not because they were offered a worse mortgage rate at origination, but because they're stuck paying an old high rate that they really don't need to pay. Well, the revenue that comes in from those borrowers shows up in part in the form of lower mortgage rates upfront. I'm paying a lower mortgage rate because there are other people who are making the mistakes.

This is actually pervasive in personal finance, and it's a major theme of the book. Once you see this, you see it everywhere, and I think people should be very troubled by this.

Bethany: Let me ask a philosophical devil's advocate question. Why isn't this the way it should be? Why shouldn't the more sophisticated people take advantage of a system, even if they are profiting from the mistakes of other people? Why should it be different?

Tarun: Good for you in the short run, good for you for a little while, until it's precisely this mistrust that undercuts the entire canvas of the system that we're operating in. What happens is, when a sufficiently large number of people gets the feeling that the system is rigged against them, then sometimes there can be these explosions of electoral anger, of outrage when there's a scandal, of regulatory backlash that can go too far, constraints that can be imposed on the system that are a result of the anger that is emerging in the system rather than a forward-looking approach to these problems.

I think that's certainly one issue. I think the other issue is I think we're quite happy with the idea that we have progressive income taxation, for example. When we see regressive taxes of this type that are not necessarily what people voted for or agreed to or believed was part of the social contract, then at the very least, I think we need to expose these issues and have a public debate about them.

John: I'd make an analogy that we bring up in the book between personal finance and the pharmaceutical marketplace. 120 years ago, it was essentially unregulated. You had the beginnings of modern medicine, actually very helpful products, but you also had snake oil, and you had opiates, and you had all kinds of stuff that was very destructive of health. Society made a decision that we weren't just going to say to people, "Well, you got to research it, you got to look out for yourself, and if you poison yourself or your kids, too bad; you should have been smarter."

Well, some of the mistakes that people make in the financial context can be as destructive as that. Bethany, I know you've written a book about Enron. One of the horror stories that we tell at the beginning of the book is about an Enron employee who put all his retirement savings in Enron because he thought he knew the company; he never thought it would go bust. He ended up ruining his retirement and living in poverty in his old age. You can say he should have been smarter, but I think that actually there's a lot of interest in society in trying to create a somewhat safer society in which we still have plenty of room for choice, but we make sure that the worst and most destructive mistakes are pretty hard to make.

Tarun: I think it is true that you can make profits out of the mistakes of others, but there are also situations in which the mistakes of others impose negative externalities that eventually have the taxpayer on the hook. For example, suppose you have retirement savings issues. At some point, if there are people who have run out of retirement savings money, then the state is going to be on the hook because we're not going to be comfortable with lots of really poor, elderly people wandering around, and so we then have to impose taxation. The bill will come due at some stage. It's not clear that it will come for this generation, but it might come at some point in the future.

Bethany: We have this concept of personal responsibility, but yet we've admitted in some spheres of life that actually it only goes so far. I've thought a lot about this because, in the wake of the financial crisis, I wrote a op-ed that got me all sorts of hate mail about how, "Well, if you took out a mortgage you couldn't afford, isn't that your fault?" I really thought about it after that, and I thought, "No, it really actually isn't because you were sold that product, and responsibility has to be a two-way street."

There's a section in your book entitled The Perils of Intuitive Finance, and part of what you write about is how difficult it is to save us from ourselves. I wanted you to talk a little bit more about that. You've got this great line in here: the future is a foreign country, and our future selves seem to us now as others. A deep factor complicating our ability to make the sensible trade-offs between present rewards and future benefits required for sound financial management. I was thinking of a line from Shakespeare, "Is the fault in our stars or in us?" Is the fault in our financial system or is it in us? I'd love for you to talk a little bit about that.

John: Often, people do not act like the classic rational optimizers that we learn about in economics courses. There's different aspects of that. You brought up one, which is present bias, which is favoring the present over the future. It shows up in many ways. It shows up in under-saving. It shows up in procrastinating. We put off figuring out our retirement savings plan because it's so painful. We have other things we want to do on the weekend. Those sorts of things.

There are also cognitive biases like anchoring effects. We tend to treat a 15% discount as equally valuable, whether it's on a bottle of shampoo or on an automobile. Of course, you really should be thinking in dollars. Human brains really didn't evolve to do the kind of long-term statistical analysis that is called for. We naturally do things by learning from experience. That works in many spheres of life. In finance, the experience comes in too slowly and too randomly. It's just not a good way to learn.

Then what we say is that, because people have these problems and they make mistakes, that actually perverts the energy of capitalism for a couple of reasons. One is the suppliers will supply the demands that people express. If people are attracted by shiny, eye-catching things and ignore hidden costs on the other side, well, you'll get a lot of products with the eye-catching benefits and the hidden costs. The invisible hand works, but it doesn't deliver what we would hope for.

Beyond that, something that hasn't come up yet is that people really hate to shop around in personal finance. Many people like to shop for other things, go to the mall or whatever, but almost nobody likes to shop for personal finance products. People often stick with familiar brands and have a brand loyalty. That creates branding competition. There's not the incentive to lower price and raise quality. The incentive is to spend money on branding. You can get wasteful competition where-- My favorite example is the suburb of Boston where I live is full of bank branches which are all empty. They're not centers of business. They have one employee in an ATM. They're always empty, but they're essentially billboards.

They exist because people like to feel that there's a physical bank. Then once they choose their physical bank, they're very loyal to it, even if a rival bank is offering a much better deal. There's market power. Because there's free entry, there's actually wasteful competition. Even Chicago-style economists recognize that when you have this combination of free entry and market power, capitalism may not work the way it does when we have competition to drive down prices and drive up quality.

Bethany: I love this because, of course, the world is not an economics textbook as much as some economists would like to pretend otherwise. As you think through this landscape, is there one financial product that you think we need to get right more than any other? Do we need to get the whole smorgasbord right? If you were advising somebody that there is one thing, you only have the time to understand one thing, what is the one product you need to get right?

John: I think the big problem, frankly, in the US is access to tax-favored retirement saving. You're fine if you work for a big company or a big university. I have a good retirement plan. Self-employed people or people who change jobs frequently, people who work for small businesses, have less advantageous options and more confusing options. They often have to open IRAs. That's a jungle out there once you get into IRAs.

One of the things that we recommend is the creation of a single retirement account that you carry with you through your working life and that gets opened when you first start work. There'd need to be some competition. We're not advocating public provision, but some competition to provide these. Then you carry it with you. That actually is very similar to the system they have in Australia. Which is well-regarded internationally.

Bethany: How far can consumer education go, both in our education system and employers? If we doubled the amount of financial education tomorrow, would outcomes actually improve?

Tarun: First of all, I should just say that it would be a little absurd of me as an educator to say I don't believe in the value of education. I think it's really, really important. There's no question that you definitely want a more educated citizenry. I just want to point out, and maybe this is a little bit of a straw man, but it's worth putting out there, which is that it seems all too easy as a solution for financial firms who are providing products and services in personal finance to throw a couple of million dollars into a financial education charity and then declare victory.

It seems a little glib to just offer that as a solution. I know that this has been very popular. The FT has a financial literacy charity. The Times has just started one. People are very, very excited about this project. A great project and an important one. Let me offer you at least a few reasons why this is not necessarily the be-all and end-all of the solution. Financial education, there's a question about when it should be delivered and how it should be delivered. There's very little understanding of the point at which the delivery should occur.

Imagine that you were to teach students in high school or even in college about how to conduct their financial affairs. There are two problems immediately. One is a textbook treatment of this stuff or however interactive you make the class is not quite the same as a context-specific education, which is very difficult to deliver. At the point at which you're actually taking out a mortgage, do you really remember the lessons that were given to you?

How long ago were those lessons given to you, and how quickly has the financial sector evolved since then? Are the product offerings that you were taught about the same as the ones that you're seeing in front of you? Functionally, they may be the same, but how much have you retained over that period of time? Does that mean you have to take an ongoing financial education class every year? It's not clear exactly how far that's going to go.

Problems of obsolescence and problems of context dependence. I think an analogy that we have in the book is you don't necessarily want to teach people how to drive by asking them to read a manual. You have to have some practical education. It's very hard to see how you might do that. That's the first thing. The second thing I should just point out is, we're individuals, we have our wits about us when we have financial education, but corporations are spending an enormous amount of resources trying to figure out exactly how we make decisions and then trying to move in there.

It feels like a real unfair competition between David armed with the slingshot of education and Goliath standing on the other end. Now, I understand that's a little bit of an unfortunate story because David beat Goliath in that particular story, [chuckles] but I just worry a little bit that the odds are stacked against David, brave and plucky, though he may be in this particular circumstance. I think that's important.

I think the third thing is education would work much better if we were to simplify the financial system so that we give it a real chance to work. Imagine that we were to educate people about the principles, and the principles were exactly what they saw in front of them, with a suite of simpler products that they were facing at the point of making the decisions. At that point, the education is matching the environment in which you're making the decisions, and you're giving education a chance to really succeed. I think education on its own is insufficient as a solution.

Bethany: I wanted to come back to this notion of the government because there are a few tensions in your book that I want to explore. You guys don't want the government to take over. You actually write explicitly, for instance, that you're against imposing a broad fiduciary duty on the whole financial system, but yet you do advocate for a lot more government involvement. John, how do you think about that balance? What should the role of the government be here?

John: A lot of consumer financial protection came in after the financial crisis in '08/'09, the Dodd-Frank Act in this country, and similar developments in the UK and elsewhere. The big focus was on financial stability. There was also a sense that big banks had behaved badly. We needed a regulator who would, after the fact, come in and name and shame those things. Classic example being Wells Fargo and the cross-selling scandal.

Now, there's been an understandable backlash against that because business people really want the rules of the game to be defined upfront, and then they play by the rules. They don't want to be given a vague duty to be nice to your customers and have a regulator who can come in after the fact and define what that means. Now, our view is that the right way to do regulation is for the consumer regulators to define upfront the characteristics of products that must be offered, simple products that must be sold.

Now, we're not having the government set the price. We're not having the government provide the products. The government simply defines the units, the terms of the product, and the units in which prices must be quoted. It would make shopping a great deal easier, and it would restore the ability of capitalism to deliver high-quality products at low prices. We make an analogy. If you have a headache and you want an over-the-counter remedy, you walk into the pharmacy, and there's a shelf called painkillers. You have, part of it is, let's say, ibuprofen. You have the brand name. You have Advil. You also have the generic, the pharmacy brand.

The active ingredient is the same. The dosage is the same. You take two pills either way. The shelf tells you the price in standard units, the price per pill. Then you decide. Maybe you like the brand. Maybe you like to save money. It's very easy to shop. We think that shopping for these basic financial products should be much more like that. Whether it's simple transactions accounts, whether it's retirement accounts, whether it's insurance policies, we think there's a role for government to define terms, define units, and mandate that a firm that's active in a segment, let's say banking, it can offer all kinds of other accounts, but it must offer this type of account.

Bethany: Tarun, another tension in the book is between people's right to choose and people's need to be told what to choose. You write, for instance, "The recently popular light touch, nudge approach to financial regulation is also inadequate and needs to be supplanted by a more muscular regulation, not so much a nudge as a vigorous shove." You also write later in the book, "It may seem counterintuitive to suggest that consumers are best served by financial products that reduce their right to choose." How do you think broadly about this tension between being told what to do and being able to do what you want to do?

Tarun: You're approaching this from the demand side, but there's also a supply side telling of this particular story, which is the demand side is, if you do this, you're constraining my right to choose. The supply side is, if you do this, you're constraining our ability to innovate because you're having a chilling effect on the way that we can do this by templating the kinds of products and services that should be out there.

I think one instructive example of areas of the market economy where we're quite happy to do that happen to do with utilities. For example, let's take water, electricity, these are essentials that you need for your house. You don't really want a lot of product innovation, except maybe there's a pricing innovation that you want, but maybe some of those pricing innovations can be painful. You want the maximum number of people to have these products. Availability is very, very important. Safety is extremely important.

Civil aviation is another classic characterization of this, which is maybe people can go much faster transatlantically than they do right now. I think we as a society have decided that we really want to be safe. When we get on a plane, we want it to get to the destination very, very safely. It's actually been a great success story in large measure. I think what we need to start doing is to think about large areas of personal finance in the same way that we think about utilities, rather than thinking about these things as being the high-flying, highly innovative ability to choose and so on and so forth.

Now, nobody is saying that we shouldn't allow customization of financial products to suit people's economic circumstances. That's absolutely critical. It's very important, and it's something that we do believe is at the heart of this. There are some changes that we're proposing. The types of units in which you quote things, the ease of comparability, the removal of features that seem completely supernumerary, except from the perspective of extracting rents from people.

These are the kinds of things that we think should be perfectly acceptable to most without necessarily constraining your right to choose. In fact, what we're saying is we're allowing you to choose anything that you want to do, and we're encouraging you to shop. What we want you to choose on is things that are quite important for the final functioning of the product and the suitability of that product for your personal circumstances, rather than features that are completely irrelevant.

Bethany: There are so many great questions in the Q&A. I want to ask every single one of these, so I'm going to try to get to them all. The first one, topic of great interest to me, is about private credit making its way into individuals via inclusion in products like target-date 401(k) plans. This risk will be invisible to most investors. Do you guys think this is a good idea or a bad idea? I thought I'd start with John, but Turan, if you feel more like this is your area, just stick your hand up. John, okay.

John: Let me take private credit and private equity together. The argument for is that private assets are an important component of wealth. Finance theory suggests that the right starting point for investing is to try to have a little of everything in the proportions in which it exists. If privately owned firms are a bigger part of the economy, then there is a case for including them in the retirement portfolio. The counterarguments come from the way in which this can be done, because you don't just directly buy private firms. What you do is you buy into private equity or private credit funds.

Now, these funds are run by private equity firms, which charge very high fees. The fee is likely to erode much of the gain. Second concern is adverse selection. The private equity funds have big institutional clients with deep pockets and long-term business relationships. Those investors are likely to get the best private assets. Worst private assets are likely to be dumped into the private equity and private credit funds that are offered in 401(k) plans. There's a cynical saying that one person's democratization of finance is another person's liquidity option. [chuckles] "I can sell this junk, finally. I can give it to the 401(k) investors."

The third concern is that because private assets are not marked to market reliably, their valuations are smoothed, and this tends to hide the risks. If individuals are choosing how much to allocate to private assets, they're likely to over-allocate because they're not going to understand the risk. It's going to look like a great deal, high return, low risk, and people will overdo it. I believe this has happened even with university endowments, which are very sophisticated institutional investors. If they get it wrong, I think the 401(k) investors are also likely to get it wrong.

When I add up the counterarguments, I find that they outweigh the positive argument, but certainly there are things to be said on both sides.

Bethany: I'm going to steal that line about the democratization of finance being someone's liquidity event. I think that's marvelous. Of course, we've gotten questions about AI. You guys have a pretty pro-technology slant in the book, but let's get to AI specifically. Do you think it can help improve personal finance education, and how do you see it overall as affecting personal finance? Do you think it's a short-term or long-term good deal for the public? Tarun?

Tarun: Certainly, it can do things like provide scenarios or give you role-playing situations, or you could talk to a chatbot in the way that you might talk to a financial advisor, or in fact, you could even upload details of your personal situation in private mode. Please note, [chuckles] very important to do that. Then ask, "What are the five questions I should ask my financial advisor?" There's no problem in holding people accountable by using the technology that we have at our disposal to do that.

I think that can actually be quite a helpful way of trying to level the playing field. That having been said, I think it's quite important to recognize that imagine that we already have a non-level playing field where firms have an edge over individuals in the way that they're doing business. If anything, it's actually going to increase faster the advantage available to the private sector over individuals, while AI and machine learning technology in general can help you customize things, scale financial products in a way that really allows you to do a very individualized solution per person, and then do that at a high scale, maybe at a lower cost than you're used to.

The thing that you have to be very careful about is maybe the AI is also able to do better price discrimination because it understands who you are much, much faster and then does personalized pricing that can really take advantage of your weaknesses or understand exactly who you are. Maybe it identifies the fact that you're not someone who shops very much, offers you a terrible deal. There's plenty of these dystopian scenarios that you can get in this circumstance.

I think we have to be very careful. This is a Promethean technology. It's like it's come down off of the mountain. Some of it is wonderful, but fire can be used for cooking, and it can also be used for things that are not quite cooking.

Bethany: Yes, the dystopian possibilities are quite terrifying. John, a question for you. If you had the ability to simplify one consumer financial product, just one, which one would it be?

John: Here's something that would be very easy to do, and I think would make a noticeable difference. I want to bring up the institution of points in the mortgage market. What are points? Well, if you need a little extra money to cover your clothing costs, you can borrow a little more. You can get the lender to cover those costs. What they're going to do is increase your mortgage rate. They're not going to increase your official debt. They're just going to change your mortgage rate. They're going to raise it. If you have a little extra cash, you can bring along to the closing, you can lower your mortgage rate. This is called points.

It is unbelievably confusing and different from textbook finance. In textbook finance, there is an interest rate. You're always told, "Look at the APR, shop for the APR. There is an interest rate." Then, if you borrow more, that increases the debt, but the interest rate comes from the marketplace. Once we have points, we have a confusing menu of interest rates. There's evidence that people mess this up, and people who are short of money and need to borrow a little extra take the points. They raise their mortgage rate.

Now, the key to understand is that you still have the right to refinance. You're promising to pay a higher rate, but if you refinance, you needn't do that for very long, and it can be a good deal. If you don't know to refinance, then you're going to get a bad deal. This is an area where a lot of confusion arises, and it would be really very, very simple to reform. This is not a major makeover of the US mortgage system. It's a small, easy reform. It's not the biggest thing, but it would be a good step towards simplification.

Bethany: There are so many good questions in here, but I'm sensitive to time. I think, Tarun, and I'm going to ask you a last question, which is, are you guys asking the financial system to do too much? How much does education help? How much do your reforms help when, fundamentally, wages aren't keeping pace with the cost of living?

Tarun: I think one important thing to recognize is that people have this tendency to believe that personal finance is a little bit of a sideshow, that there are so many other household expenses that we have to deal with. The evidence that is accumulating, and we tried to do a very simple calculation in our household finance policy report. I chaired a committee for the Indian government in 2017, but then there are other attempts to do this.

It seems like the kinds of numbers that we're talking about, from accumulating a bunch of mistakes that people commonly make in the management of financial products, can add up to multiple percentages of gross income. Really, we're talking about 5% to 10% of gross income of household budgets that can be improved by managing your mortgage better, managing your retirement savings better, thinking about your unsecured debt, taking insurance so that you don't have to get into a debt trap at the point at which you get hit by a catastrophe of some type.

If you just add all of this stuff up, it's really accounting for a pretty significantly chunky bit of what we might think of as helping with the cost of living crisis. I think that's quite important. I think the other thing to recognize is that, if you were to just think about the fact that the people at the very top end earn higher rates of return on their savings and pay lower rates on debt, and if you just take the differential between the top end and the bottom end, that on its own is such an important factor accelerating the growth of inequality that we've seen that it just seems worthwhile trying to fix that problem on its own.

Again, back to the initial theme of our conversation, this is something where we'd like to get out of the personal finance box and then really put this right front and center and say, "This is a deeply important issue for us all to think about in society."

John: We don't claim that personal finance problems are the only problems of our society. That would be absurd. We do claim that they are first-order important. Again, to return to an earlier theme, they have contributed to a widespread distrust of institutions and of the market economy itself. We think that's really dangerous because we actually believe in the market economy and think that it has advanced prosperity in an unprecedented way in the last 50 years.

Contrary to the claim that wages aren't keeping up with the cost of living, in the big picture, that's definitely not true. There have been improvements in the standard of living. Those have been delivered by the market economy. If support withers for that market economy, things could go very badly wrong.

Bethany: I think the fundamental question, Luigi, that this book raises is does capitalism work in personal finance?

Luigi Zingales: I think, if you want, you can ask a more general question: does capitalism work? Not just in personal finance, but does it work? Yes, I think it does with the proper rules. As much as I like this book, I'm a little disappointed that they didn't go further in the criticism. For example, they dismissed completely the shift in fiduciary duty and then said, "Oh, no, we cannot have it in the financial market because that will prevent innovation," and blah, blah, blah. Maybe we need that.

I think that we are at a crossroad, in my view, because when I say technology, it's not just AI, but even the understanding of human psychology has gone so far. Companies have become so effective that, honestly, then can manipulate it and have a possible form or shape. People now wear that ring, Oura, that you can get every information about your health. Pretty soon, they're going to know when you're low on sugar because then you're more prone to buy this or to buy that.

Bethany: Oh, my God. [laughs] You just took this book and put it off on a whole wide range of conspiracy theories. I think, unfortunately, a conspiracy theory is like a broken conspiracy theory is right twice a day. I'm sorry, it's not funny, but it's funny. [laughs]

Luigi: You know why it's not a conspiracy theory? Unfortunately, we train those people. We train those people in psychology, in economics, in data analysis, so that they can take advantage of every possible form or shape of a [unintelligible 00:39:22]. Finance has always been at the front end, both in the positive and in the negative. Honestly, this book is political when it should be economic, and it's economic when it should be political. Let me explain.

He says that the problem that you're ripping off people is that eventually they're going to not trust capitalism, which is absolutely true. To me, the problem that you rip off people is that you rip off people. I don't want a system that, on average, rip off people even if they are not revolting. Then, if you really want to go, there is an economic issue. If you care about efficiency of the system, there are a lot of resources that are spent trying to rip off people better, which are completely wasted from a societal point of view.

They mentioned this vaguely in the book, but I think this should be front and center. If you're an economist, you should say, "This system doesn't work." They are political when they should be economic. On the other hand, they are economic when they should be political because, in all the solutions, they are trying to go for technical solution. I agree with most of them, so I'm not quarreling with the solution. The point is that they let it in that this solution can be parachuted from heaven.

I'm sorry to say, the financial industry is lobbying for this not to take place. The fine benefits plan are much better for individuals. One of the reasons why we don't have it is because the financial industry pushed very hard so that we don't have it. I think they're also very dismissive of a public option. They always say, "Oh, we don't want the government to do that." Clearly, we don't want the government to be a monopolist in doing that, but I'm not so sure that in some situation, adding a public option is not a bad idea.

After all, if the private sector is so efficient, it should do much better than the public option. The public option is ensuring that at least you are not ripped off in the most egregious way. Sorry, I got off the wrong side of the bed this morning.

Bethany: No, that's okay. I think it's good when you get up on the wrong side of the bed. I couldn't help wondering, though, we're recording this the day after SpaceX went public. There are headlines everywhere about the world's first trillionaire. I thought, is this even really the problem? In other words, it is a problem, but in a world where we have the world's first trillionaire and where others are not far behind that, one of the lines they write is that the financial system is an important contributor to wealth inequality, in particular, the inequality between middle class and wealthier people. I thought, "Really? Does it even matter anymore?" I think maybe I'm becoming too much of a nihilist. What do you think?

Luigi: At the end of the day, I was listening this morning, a podcast, retail investors are flocking to buy SpaceX. I think our system of disclosure, I think that there is disclosure. People know that this valuation is based on basically a dream. Now, in part, some valuation based on the dream in the past have succeeded. This is where my libertarian side said, if they waste their own money in that, it's not the worst thing in the world. This is where I would make guidelines, so you cannot invest in a 401(k) or individual stock.

Bethany: Yes. I suspect it will probably work as a stock because the way Musk got Tesla to work is by creating a company where a short squeeze was an ongoing threat. SpaceX is going to be that [unintelligible 00:43:07], given the tiny portion of the float that is publicly traded. Then the idea that SpaceX has to be part—thank God the S&P 500 said no—but has to be part of all of the indexes. It just sets up a perfect condition for a short squeeze. I suspect that's the recipe to make it work as a stock and keep the Musk machine going for a little while longer. I digress.

Yes, it's interesting how much working as a journalist in business over these past whatever 30 years has changed my perspective. I've just watched the system repeatedly fail. I've also watched people repeatedly get preyed on, most acutely in the financial crisis, which, I think, really does require asking yourself that core question: whose fault was this? Was it the fault of the financial system, or was it the fault of greedy homeowners who took out mortgages that they couldn't afford?

Once you realize in that case that people were sold these mortgages by an incredibly powerful machine because the mortgage lenders could turn around and sell risky mortgages for more money to Wall Street, it just forever changed my view of things. I think I've become much more cynical than I would have been at the start of my career. I sometimes wish I could take today's mindset and go back and see things that I wrote about through a more skeptical lens.

Luigi: Me too. I think I changed my mind on this. Shortly after the financial crisis, there was a euro crisis. In Italy, banks sold very sophisticated and risky products to their depositors. Some people argue, "Oh, we should do financial literacy." They say, "What the heck, no. We should prevent banks from selling those risky products. It's much cheaper and much more effective."

To their credit, I think that they do say this in the book, that basically financial literacy is a great thing in general, but don't expect miracles. We need more. I have a mixed feeling because I think that this book reflects a transition in the profession, and they are half the way through this transition. The words are much more aggressive than the substance if you read the subtitle of the book and some of the stuff. Then, when it comes to the punch, what do you do? There is not the willingness to go all the way. That's my analysis.

Bethany: If you're just suggesting marginal changes, do you have more chance of getting something done than if you're actually really just delivering a full frontal assault on the whole system? I don't know. It's an interesting life question, right?

Luigi: I think that, actually, my view is that things that don't bend eventually break. The system is very rigid now. You think everything is impossible. I think that there will be a time where things, all of a sudden, would be possible. My fear is that, at that time, we're going to go too far inevitably because there's been too much resistance now in doing anything. The swing would be very dramatic in the opposite direction.

Bethany: Yes. One of the things that might cause it, it's going to be really interesting to see what happens with all of these semi-liquid funds that have been sold to investors. Semi-liquid is just a total oxymoron. The idea being that you can get your money out as long as the total requests don't exceed 5% of the fund's net asset value. Now you have all these private credit funds and even some private equity funds that have been sold to individuals on that basis, where the redemption requests are at 10%, 15%. People aren't able to get their money out.

If it turns out on top of that, that the assets within those funds have been mismarked, as many people have argued, and that the people running the funds have been siphoning off fees based on inflated asset values, and the people who have invested are going to be left with their money stuck in a thing where the values are plummeting, I think you might have something close to rebellion, or you might have something that raises enough of a mess inside in Washington that something gets changed. Again, even then, maybe it'll just be more at the edges than the whole scale change that I think you're advocating for.

Luigi: You see, I think that if the people losing their money are rich individuals, because this is a private equity market--

Bethany: No, no, no, they're not. That's the thing. These funds have been sold to pretty ordinary people. Not people at the bottom end of the income distribution, but people in the middle and upper middle. Again, I don't know. I think the products were in the fine print. It was probably appropriately described, but I don't think people have understood just how much the people running these funds have made and benefited from this, and just how misleading some of the marketing was.

Luigi: My big fear is that this stuff will end up into our 401(k)s. One listener wrote me an email saying, "Oh, this will not happen because there is a strict liability rule, and if you put something that is too risky, you risk too much. As a 401(k) manager, as a reason manager, will never do that, except that the Trump administration is providing a safe harbor under some condition." Really, this is a socialist government, but socialist for the rich and [unintelligible 00:48:34] individual is for the poor.

Bethany: I think that's a fair point. I think the private equity industry has gotten most of what it has wanted from all administrations, not just this one. I suspect now that they are stuck with all these companies that they can't sell, they are going to figure out a way to get private equity into 401(k)s in some form so that people's money can serve as their exit.