How we see bankers. Photographer: Jan Stromme via Getty Images
How we see bankers. Photographer: Jan Stromme via Getty Images

Regulate banks all you want. Fine them and force them to be as cautious as the goblins that guard the wizard gold at J.K. Rowling's Gringotts. Even so, most people will always be suspicious of bankers because they don't understand what they do.

Annamaria Lusardi, a professor at the George Washington University School of Business, and Olivia Mitchell, a professor at the Wharton School of the University of Pennsylvania, have just published a comprehensive review of their own and others' work on financial literacy. To anyone who believes people generally understand how their debts and savings work, at least on a basic level, their article will be depressing reading.

Back in 2008, Lusardi and Mitchell designed three questions to test basic financial literacy. How basic? You be the judge:

1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 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; do not know; refuse to answer.]
2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent a year. After 1 year, would you be able to buy: [more than, exactly the same as, or less than today with the money in this account; do not know; refuse to answer.]
3. 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." [true; false; do not know; refuse to answer.]1

The same questions have since been put to various samples of the U.S. population and to statistically representative groups in other countries. Only in Germany and Switzerland did a small majority (53.2 percent and 50.1 percent, respectively) get all three questions right. In the U.S., that figure was 30.2 percent; in Japan, 27 percent; and in Italy, 24.9 percent (which may go some way toward explaining why that country is perpetually in financial trouble). In Russia, only 3.7 percent managed to answer all three questions correctly.

In general, older people are less financially literate than younger ones:

Women are less literate than men:

Education levels matter, but even about a third of university graduates (probably those trained in the liberal arts) cannot get all three answers right:

Don't even try asking most Americans about the relationship between interest rates and bond prices: Only 21 percent know what that is, according to a 2011 study. A majority of people throughout the world is stumped by compound interest and so unable to understand how mortgages and credit cards work. Of course, that doesn't stop them from taking out mortgages and maxing out credit cards -- only one-third of respondents in a 2009 U.S. study knew approximately how long it would take for a loan taken out at 20 percent to double in size.

There are some perfectly good excuses for this widespread financial illiteracy. The Japanese have a hard time answering inflation questions because they've only known deflation for much of their conscious lives. Women become more financially literate with age, because when they're younger, they often leave the money planning to their husbands. Immigrants are less savvy than the native-born, possibly because of language troubles.

Still, the net result is that banks and financial companies are selling products to innocents, who are at their mercy. The average credit card fees paid by less knowledgeable Americans are 50 percent higher than for their more literate peers, Lusardi and a collaborator have found.

Because so many people are financially ignorant, they are ripped off by payday lenders; sold homes they cannot really afford with the help of mortgages they cannot finance; bilked out of their savings by penny stock brokers; and, on the other end of the scale, by bankers offering interest rates lower than inflation. The 1 percent preys on the 70 percent of U.S. illiterates, not because they are poor but because they don't know enough to make informed decisions.

Research shows financial-education programs do not always work to change people's behavior, and that's normal: Some are thrifty, others profligate. They should all, however, know what they're letting themselves in for. Before buying any financial product, people should pass a simple government-mandated test on its properties. Lusardi and Mitchell could design the questions.

1 For the record (and not out of disrespect for Bloomberg View readers' financial literacy), the correct answers are: 1, more than $102; 2, less than today; 3, false.

To contact the author of this article: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this article: Marc champion at mchampion7@bloomberg.net.