Friday, September 11, 2009

Just because you’re rich doesn’t mean you’re smart

By: Felix Salmon

A tweet from Joe Weisenthal yesterday, on the subject of Annie Leibovitz, is I think revealing of a particularly American mindset: call it the Wealth Corollary of the Efficient Market Hypothesis. In a nutshell, it says that if you’ve made lots of money, you must be pretty smart.

I think there’s a pretty good case to be made that the EMH(WC) is responsible for a lot of the rules surrounding the limitations on who is and who is not allowed to invest in hedge funds, and also for many of the obsequious interviews with rich individuals frequently featured in the financial media.

“If she’s rich, smart and has access to good advisers,” said Joe, “it’s on her to take such a huge decision [borrowing $24 million from Art Capital Group] seriously.”

That’s fair, as far as it goes, but the only evidence that Joe had of Leibovitz being a smart person with access to good advisers was that she had lots of money. The problem is that it’s far too easy for people to simply assume, on the grounds of wealth alone, that therefore there must also be some degree of financial sophistication.

The annals of finance are full of people taking advantage of the financially-illiterate, and while it’s certainly possible to take advantage of the financially-illiterate poor (lotteries, numbers games, payday lending, overdraft fees, etc) it’s equally lucrative to take advantage of the financially-illiterate rich, both through outright fraud and through hidden and/or excessive money-management fees. Or, in the case of Art Capital Group, getting Leibovitz to take out a loan with punitive default provisions, in the full and certain knowledge that she would be forced to default.

The fallacy embedded in the EMH(WC) can be hard for financial journalists to grok, because we have such a high financial-sophistication-to-wealth ratio. (More thanks to a low denominator than to a high numerator, it must be said.) If a financial journalist became wealthy, there’s a good chance they would be qualified to look after their money reasonably well. But that doesn’t mean for a minute that the same is true of photographers, say, or baseball stars like Lenny Dykstra, or pop stars like Michael Jackson, or any number of other people who have struck it rich in the sports/media/entertainment business. Annie Leibovitz was ill-advised for many years, and would have been much better off taking simple off-the-peg advice from her client American Express. But they were smart enough not to go down that road:

Because of her credit issues, Leibovitz was forced to deal almost exclusively in cash. In 1987, American Express offered her a plum ad campaign. Ironically, Leibovitz’s application for a card had been denied many times.

The American Dream is fundamentally meritocratic: if you’re smart and work hard, you can be massively successful. But the reality is different: some people are massively successful, and some non-negligible proportion of those people is not smart at all, especially not when it comes to finances. Having lots of money, sometimes, just makes it that much easier not to ever worry or think about matters financial. And that, in turn, makes it much more likely that you’ll end up being taken advantage of.

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