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Monday

I SUPPOSE I could be described as financially literate. I have a doctorate in economics; my dissertation focused on financial decision-making. I write about economics and finance, and I've worked in the financial industry, designing investment strategies. But, when I look at the balance of my brokerage account (those low-fee global-equity index funds do not seem like such a good idea at the moment) or my credit card statement (peppered with frivolous impulse purchases), I question my financial savvy.

Nonetheless, I have volunteered to provide financial-literacy training to young mothers at a local homeless shelter. This is the first time I have volunteered since school, when my guidance counsellor forced me into it. She thought the experience would look good on my college applications.

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Teaching the dismal science

I always justified not volunteering by figuring that my actual time was worth less to the charity than the monetary value of my time. But something about this project intrigued me. I thought I'd learn from the experience; it could make me a better economist. I even spent weeks fancying myself the next Suze Orman, empowering the financially downtrodden with my economic knowledge.

Contemplating how best to spend resources given significant budget restrictions is the exact question I spent years solving, but as my first session approached, I started to wonder what value my training could provide. Economics often neglects solving this problem for genuinely poor people (or as we economists like to call them, “liquidity constrained agents”).

At our orientation session, we introduced ourselves and explained why we volunteered for this particular project. I went first. I said I volunteered because I thought that learning about how these women respond to their extreme financial constraints would be interesting.

Everyone else said they thought their experiences would be helpful (most were lawyers or in human resources). I realised I was the only one who did not say I was there to help homeless women. I wondered if that made me a bad person. But (and I may be rationalising here) I found something presumptuous about the idea I could swoop in from my comfortable life and sort out these women's financial woes. I might know about economics and finance, but I know nothing of what it's like to be a homeless single mother. I genuinely hope to help these women, but expecting that I can feels naive.

I also wondered what financial literacy skills are exactly. I've read my share of academic papers on the subject. They contain several measures of financial literacy. One measure, which predictably yields appalled gasps at economics seminars, is most people do not know bond prices fall when yields increase. How could that information be useful to homeless single mothers? I never heard Ms Orman explain that one.

We went through the curriculum we would be teaching. It was much simpler than fixed income pricing. We would be focusing on budgeting, principles of saving, repairing credit scores, and basic banking. If we had time we also would discuss the difference between stocks and bonds. Not quite an economist's definition of financially literate, but if people do not know these things already, they probably should.



Tuesday

THE first session was well attended. Several young women came in and sat across from me. One, peering at me curiously, asked if I worked in a bank.

To start, the lead volunteer told the rest of us to pair off with one of the homeless women to discuss their spending habits. I was partnered with a young woman named Tina, who just moved to the shelter and is eight months pregnant. I asked her to list everything she bought that day. She recounted her spending to the very cent. After telling me she paid $5.89 on baby lotion, she looked me up and down and said, “When you don't have money you got to watch it.” We then discussed her monthly expenses, which included $125 for cell-phone and credit-card bills.

Just then the lead volunteer interrupted everyone by urging us to consider “need” versus “want” (or as we economists call them, “necessary” versus “luxury” goods). Clothes, he said, seemed like a need but were usually a want. Ivone, a shelter resident who was sitting across from me, announced with a slight Caribbean accent that she never bought clothes. “Five years ago I bought fifteen pairs of jeans at Old Navy and that is all I will ever need, so long as I don't gain weight.” She appeared to be the group's de facto leader. She just got a job a Duane Reade, a pharmacy chain in New York, and was starting to look at apartments.

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Luxury or necessity?

The lead volunteer then called a mobile phone a luxury, unless you had a job that required it. The women vigorously disagreed. How can you not have a phone when you have a child in day care? If you are walking down a dark and street in danger how else can you call someone?

I did not push the mobile-phone issue with Tina. To me it seemed a luxury; to her it was a necessity, and it is not my place to define her preferences. I did encourage her to find a cheaper plan, perhaps a pre-paid one. Tina was surprised to learn how much less women on pre-paid plans were spending, and encouraged to learn how much money she could save by switching plans.

Next we were instructed to figure out long-term goals (an apartment, a job, etc.). Tina's goal, after having her baby, was to obtain her GED (her high-school equivalency degree). She said this was important to her because it would provide a positive example for her unborn son. She also hoped it would get her a better job. That's true, I told her; having a high school diploma or equivalency can raise your lifetime income by hundreds of thousands of dollars. This excited Tina.

We then discussed how much realising that goal might cost. Tina would have to pay an exam fee and would also probably need a preparatory class. Just then Ivone spoke up. “Actually,” she said, “there is a city program that provides the class, pays for a Metrocard to get to the class, pays for all your materials, and then pays for test.” She had an encyclopedic knowledge of every government program meant to help homeless women.

“Oh, you suffered abuse, great; you can qualify for this program.” I heard her say to another woman. But, Ivone cautioned, “With all this stuff going on these days you have to be careful. These programs will be the first ones cut, so don't count on them for long.”

Finally, we tackled Tina's budget. I asked Tina if she had a job. She looked at me, laughed, and said, “I am eight months pregnant.” I asked if she was receiving welfare. She hesitantly admitted she had just applied for it, but warned that it was only temporary, until she got back on her feet; she did not intend to be a “welfare mother.” Up until now she had been using credit cards to finance her spending.

I asked her if she understood what high interest-rates and late fees could do to her credit. It makes a lot more sense to just go on welfare and try to pay her debts before the baby arrives (and with it many expenses). Someday she will have a job and pay taxes; these programs exist to help people just like her. The libertarian in me never thought I would be giving this advice.

“You're right,” she said, “a bunch of people spending money they don't have is how we all got into this mess.”

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Wednesday

JUST two women came to the next session. Tina did not return, but because she was due to deliver any day, I did not take it personally. Ivone was back, along with a woman named Marguerite.

This week's topic was my area of academic expertise: saving and investment. The curriculum, given in advance, advised saving as much as possible. Surprising though it may sound, I don't fully agree.

The poor have different saving needs from the rest of us. They do not need to save much (if at all) for retirement because the state provides them with a generous pension relative to their lifetime income. They also have less incentive to save for their children's education. American universities practice nearly perfect price discrimination: having few assets entitles poor students to more financial aid. Resources are better spent on education while a child is young, ensuring he's well prepared for university in the future. The women at the shelter have little or no income and children to support. Saving might be a better idea in the future, when they have some income and are less dependent on state benefits.

We began by asking the women how they were faring since last week's session, when we encouraged them to keep tight budgets and eliminate unnecessary spending. They listed everything they spent over the past week; both said they restricted their spending to necessities. Another volunteer noted that neither woman mentioned spending money on food. “I only buy groceries once a month,” Ivone explained.

Marguerite admitted to using check-cashing services. The volunteer leader told Marguerite how high the fees for those services are, and encouraged her to open a free checking account at a reputable bank. Unfortunately, Marguerite was still overdrawn on an account in another state, and thought this prevented her from opening a new account at a different bank. She assumed check-cashing stores were her easiest alternative. We encouraged her to open a joint account with a trusted relative.

Both women had bad banking experiences in the past. They had overdrawn their accounts, bounced checks and had to pay high fees that surprised them. That, and the current financial turmoil, has rendered them distrustful of conventional banking. I could see why they preferred the transparent fees and liquidity of check-cashing stores.

To help the women understand the benefits of traditional banking, we explained compound interest. We also learned that city of New York currently offers a program called “Work Advantage,” which provides housing vouchers for up to two years. A homeless person can qualify for it after finding a stable job. In addition, if participants save 10-20% of their income in a bank account the government matches it 100%. Ivone said they match up to $6000, which means $12,000 in the bank. “And that's a down payment on a house in Atlanta,” she exclaimed.

The lead volunteer advised Ivone and Marguerite to stay away from the stockmarket. Ivone mentioned the value of her retirement account (IRA) had fallen. “I suppose that means I have some stock, but I don't want it,” she said. “All those CEOs are liars and cheats, now they're all going bankrupt.”

I suggested that in the future, if she wanted to hold equity, she should invest in index funds. That way she owns lots of different stocks and a few cheating CEOs will be cancelled out by healthier companies. This resonated with her; she wrote down “index stocks” and vowed to call her broker the next day. Everyone was quick to remind Ivone that stocks will probably decline for the foreseeable future.

I was surprised Ivone even had an individual retirement account (IRA). She explained that she was once a paralegal assistant in a large law firm and earned $50,000 a year. She is bright and capable, and I wondered how she ended up in a shelter. Another volunteer mentioned that Oprah Winfrey, a talk-show host, often says that most people are just two paychecks away from homelessness. That sounds a little extreme, but Ivone's situation shows how vulnerable many people are.

I wondered why Ivone did not make a hardship withdrawal earlier. She seems determined to keep money in the IRA. Given the income shocks Ivone is prone to, I would think the lack of liquidity in a retirement account cancels out any tax benefit.

I wonder if we over-promote retirement savings. It does not make sense for everyone, particularly people with low income. Ivone ran up large credit-card debts and ended up in a homeless shelter while maintaining an IRA. She can probably expect the state or even her children to provide for her in old age; retirement is not her most pressing financial concern. She seems to be getting back on her feet: she has a job and is trying to improve her credit (bad credit makes it difficult to find an apartment).

The lead volunteer reminded Ivone that saving now is good for her children because it sets a positive example and she can use that money to pay for their university. I disagree with the second point, but kept quiet. Ensuring a better future for her children seems motivation enough.

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Thursday

MANY more women showed up for the third session than the second (we provided pizza). This time I was partnered with a woman named Chrystal. The curriculum was timely—banking and credit.

We explained compound interest again. Most of the women had bank accounts at some point, so they were familiar with the concept. Chrystal once had a CD (a certificate of deposit—essentially, a fixed-term loan to a bank that offers a higher rate of interest but less liquidity than a standard savings account), and maintains a custodial account for her son, from which he will not be able to withdraw until he turns 18. Although she can withdraw the money freely, she has not, even in her current financial straits. “He'll need that money when he's older, but I hope he doesn't blow it all like I did when I turned 18.”

Chrystal once had a one-year CD and tried to withdraw from it early. She was shocked to learn that doing so incurred a high penalty. I explained that CDs pay higher interest rates precisely because they count on having the money for a known period of time. “Banks lend out most of the money you give them to other people, so the longer they know you won't be asking for it the more valuable it becomes to them,” I explained.

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Incentivisation, with extra cheese

“Is that how all those banks got into trouble?” she asked. “All these people asked for their money back and the banks did not have it?”

“Sort of,” I hedged. “It really started when some of the people they lent money to did not pay it back.” I then explained securitisation to Chrystal.

“Really?! That's crazy!” she said when she learned about mortgage-backed securities. I told her that securitisation was not all bad. It meant more people got mortgages, which was good, but it also meant some people got loans they should never have been offered. Chrystal shook her head in disbelief. I reminded her that her savings will be safe whatever happens because the government insures bank accounts.

She asked if the government also insured stocks. I said no, then explained that when you buy stock, you are buying a piece of a company.

The discussion then moved to credit—specifically, how to repair a bad personal credit-rating. Unpaid credit-card debt was a universal affliction amongst the women. All had outstanding debt that kept their credit ratings low, which made renting an apartment impossible. Some had even had potential employers run credit checks on them.

Collection agents had already bought many of the women's debts, which will harm their credit ratings for seven years, regardless of whether they pay it. Once the debt is six years old (in the state of New York) the collection agency can no longer sue for it—unless you make a payment, of any size, during those six years. In that case the statute of limitations resets from the time of the last payment.

If you are poor and jobless, once your debt is sold to collection, there seems to be little incentive to repay it (assuming you believe you won't be taken to court). Once a new debt is sent to collection, your credit remains poor for seven years. So paying off newer debt not yet sent to collection is the quickest way to repair your credit.

The volunteers encouraged the women to call their debtors and negotiate with them. Chrystal has quite a bit of experience with this, and seemed adept at negotiating payment options. She asked if debt consolidators were all just thugs.

I explained to her that they pay all her debts and then she just pays them. Another volunteer explained to Chrystal how the consolidators make their money. They often renegotiate your debt: by offering to pay in full now, they might end up paying less than is ultimately due. The volunteer encouraged Chrystal to negotiate on her own behalf, rather than leaving it to collection agents.

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Friday

THE final session initially drew just two women: Ivone (whose attendance was now perfect), and a first-timer named Patrice. The topic was insurance. One of the volunteers felt strongly that because the women were single mothers, they should have life insurance. She explained that means someone will receive a payment upon the insured's death.

Patrice spoke up. “I don't want that, someone betting on you dying, no way! Once you have that and you live with someone—friend, boyfriend, family or whoever—they will want to kill you.”

The volunteer tried to explain to Patrice that she can choose her beneficiary (and urged her strongly to select her child), but that did not help. She wanted nobody to profit from her death. We looked at some literature that listed various insurance companies offering life insurance. AIG was at the top of the list. I advised Patrice to steer clear of that one.

Just then Chrystal and two other women arrived. We broke into smaller groups. I ended up with Chrystal, her two friends and another volunteer. I began to explain life insurance, which Chrystal believed she already had. Shortly after having her son, she received a solicitation for insurance that would protect him. I was familiar with the program and explained the policy covered her son, not her.

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“Whoa, this is too much for me. I'm leaving,” said one of Chrystal's friends as she walked out the door. Chrystal was reeling from the idea that she had insured her son's life.

The other woman, whose name I did not get, seemed high. She wore a large fuzzy hat, and kept nodding slowly. She peered at me and mumbled, “Why do I need this? Doesn't Social Security pay for it already?”

I explained that Social Security will pay her survivors a death benefit that will likely not cover the funeral, then will pay any children survivor benefits until they turn 18 (the exact amount of the latter depends on the deceased's lifetime earnings). Still, she made a good point. Social Security provides something—probably more then she makes now—and likely not significantly less than a policy she could afford. Given her present circumstances, I wondered if life insurance should be a financial priority.

Chrystal was concerned that if she got sick her son would be stuck with her health bills, and asked if life insurance could help. The other volunteer told Chrystal her son would not be liable, but if she was concerned about that she should look into health insurance. He explained other types of insurance, such as health, renters' and car. He cautioned that they would have to pay premiums to keep the policy active. The woman in the fuzzy hat mumbled something about a 401(k) and asked if insurance was like that.

I explained that the two were different: money in a 401(k) (a company sponsored retirement account) is yours. It grows (you hope) by its investments, but whatever the size the balance is always yours. An insurance policy only pays you if something happens: for instance, renters' insurance will pay you if your apartment burns down, but if not then you pay them and receive nothing.

Chrystal and the woman in the fuzzy hat thought that sounded unfair. I explained the idea was to give them security. “Suppose after you work hard, get out of here, find an apartment, and spend all this money buying furniture, and then it all burns down. Then you are left with nothing and have nowhere to go. If you have insurance you get a few thousand dollars to sort yourself out.”

The example seemed to resonate, as did the concept of financial derivatives. They each said “Ohhhh”, looked pensive, and then nodded in agreement (though the woman in the fuzzy hat was nodding continuously anyway).

Chrystal had a question about her 401(k). After she left her last job she received a letter informing her that she forfeited her plan. She assumed she lost the whole account. I asked if she made contributions to it or just her employer. She said it was both. I explained that whatever she put in their 401(k) is hers. Their employer can sometimes take back what they put in, but her money remains hers.

“So I still have that money?” Chrystal asked hopefully. I said it was, but withdrawing it before she turned 59 and six months would incur a large penalty. I mentioned that they might qualify for a hardship withdrawal now. Chrystal was reluctant; she was concerned about the state of the world in 40 years and liked having some security.

I was surprised by how many of the homeless women have 401(k)s and IRAs. One popular perception of women in Chrystal's situation is that poor impulse control drove them to homelessness, but by keeping a 401(k) in her current circumstances, it seems Chrystal's discount rate is lower than mine.

The woman in the fuzzy hat was more enthusiastic. “Hardship withdrawal, that sounds cool,” she kept repeating and asked me to write it down for her. I realised I just encouraged a woman who seemed to be on drugs to raid her 401(k).

Chrystal had more questions about insurance. She wondered why, when she insured her son, the insurer investigated his health status. I told her insurers hope they never have to pay; they wanted to make sure his probability of dying soon was low. Insurance companies often suspect the only people who buy insurance are the ones most likely to collect. The other volunteer advocated buying get life insurance while young and healthy; that way they can't deny you in the future.

Chrystal nodded, pondering adverse selection, and said she would look into it.

We then said our goodbyes. Chrystal and Ivone thanked us for our help. The woman in the fuzzy hat gazed at me, grinned, shook my hand and said, “Thanks so much; you're so nice, and have really pretty eyelashes.”