The Federal Government’s Propaganda to Spend

The U.S. federal government should be looking for solutions to the savings problem, not exacerbating it.

The U.S Treasury Department reported today that it has so far sent about $50 billion in “stimulus checks,” returning some tax money to all but upper-income taxpayers. Judging by the media’s response to  how these checks have been spent, we should be disappointed that too much of this money will go to pay off debts or even be saved.  From the time this stimulus package has been conceived, the government has worked hard to convince us that the patriotic thing to do would to be to blow the entire check as soon as it arrives.

This is sad. Election cycles are short, and it is clear that our politicians are more interested in short term fixes to the economy, increasing the chances that they will stay in office, rather than encouraging people to use what was their money to begin with to pay of some of some of their debts or to enhance their all-too-often-meager savings. Spending all of the money now may indeed help avert a recession in the short run, but the savings crisis is not going away anytime soon and when the U.S. does actually fall on very hard times (potentially much harder than we have now), it will only be people’s ability to draw on their savings that will allow them to keep purchasing the things they need and to allow the economy to avoid an even more staggering meltdown.

Savings creates our abilty to consume in the future, regardless of the highs and lows of the economy. A government planning for the long term security of its people would not ignore this.

Can High Gas Prices Increase Savings?

Not anytime soon. But if people believe these prices will last for a long time they may indeed increase our savings. I believe that part of the reason many Americans have reckless spending habits can be tied to a lack of free time, a related increase in stress, and the use of money in an attempt to ameliorate this condition. Some social critics, such as Juliet Shor, have also made this observation, laying the blame at the feet of greedy corporations. I’ve never found that arguement persuasive.

I think the more interesting research that speaks to this issue comes out of the interface between economics and psychology. It is in that research we find stark differences between what people believe will make them happy and what actually does make them happy. One, of many, examples of this difference has become known as the The Commuting Paradox. Here’s the basic idea. People believe that big houses will make them happy, so they go out to the suburbs where the price per square foot of house is lower and they buy a larger house. The big house does not make them happy. But now they have a long commute to work. Long commutes create stress, reduce the amount of time you have to spend with friends and family and in so doing reduce overall happiness.

And I believe the added stress and decreased happiness associated with the long-commute lifestyle is a progenitur of overspending. Yes, the house (at least on a per square foot basis) was cheaper. But the gas is more expensive, eating out is more expensive (who has time to cook), and many of the services we buy to help us manage our time can be very expensive. Those who have this lifestyle start with a serious financial disadvantage to those who walk to their jobs or have a very short commute. And not only are they poorer for it, they aren’t as happy as well.

What if gas prices went up to $5 a gallon and remained there, or even increased, over subsequent years? Over time, people would begin to make different choices about where they lived, choosing to live closer to work (often a city) and to forgoing the 30 mile commute. The housing stock, along with local zoning regulations that govern housing density, would gradually adjust to meet this new demand. A shorter commute, in addition to increasing personal happiness, would drive down stress-induced spending.

So, keep on going gas prices! You are a savior in disguise.

Surpassing the Jones’

Robert Frank, an economist whose books and editorials I’ve often enjoyed, recently published an editorial in the New York Times entitled “The Invisible Hand is Shaking.” It is a lucid piece, describing why it is necessary to tax gasoline in order to require consumers to pay the entire social costs of gasoline (production costs + pollution costs).  This is a typical example of what economists call an “externality,” which in a nutshell means that that the the market price of a particular item does not reflect its true cost to society. In such cases economists, regardless of their personal political leanings, advocate taxation as a way to bring price and social costs into balance and thereby enhance economic efficiency — almost always the holy grail of economic analysis.

My own background as a business school academic, and one who often teaches and does research in marketing, suggests that economists view externalities far too narrowly. Almost everything we buy and consume involves some amount externality, distortions between the market price and the total social costs. In some cases these externalities are generated from pollution or environmental degradation of some kind, but often they exist just because they affect the enjoyment of others consumption. What?

Marketers have known for a long time that what you consume impacts how I feel about what I consume. For example, I drive a Toyota with about 100K miles on it. Seems fine to me — that is until one of my friends recently bought a brand new Subaru Outback. Now my ride seems a bit shabby. Maybe I should take the millions I’m making on the book and go buy a new car. Or I could spend it on a flat screen TV, which everyone seems to have except for me. 

Let’s face it, this kind of thinking affects everyone. The enjoyment I get from the things I currently have are subject to others’ buying decisions — just like the air I breath is affected by others’ decisions to consume gasoline. Robert Frank makes similar sounding arguments in his books, but this kind of thinking has not found its way into mainstream economic analysis. The implications are enormous. Once you acknowledge that almost all consumption generates externalities taxing consumption becomes fair game, a reasonable thing to do in light of the analysis. In a future post I’ll talk about why I think taxing consumption would an exceptionally good public policy for increasing savings.  But for right now you should probably stop reading this and go get yourself a gourmet coffee from Starbucks or that ultra-cool local coffee shop near you. Everyone else is doing it.

Venus, Mars and Savings

In the fine tradition of lazy Summer vacations, usthrift blog takes a break from policy today to talk about more important things — like the mysterious differences between men and women.  But, don’t despair — it’s in the context of savings!

In his bestselling book Men are From Mars, Women are From Venus, psychotherapist John Gray uses extended metaphors and hyperbole to describe some basic psychological differences between men and women.  When men face a problem they tend to “retreat to the cave” where they sort out their problems in solitude. Women “go to the well” where they find other women and emotional support. Women and men bring different emotional and psychological tool kits to try to fix the tough problems that life throws at them.  And in our modern world of houses and running water, rather than caves and wells, how to invest your hard-earned money is one of the more important and persistent problems many people face.  How well you handle it will have enormous consequences for your financial well-being and even more basic than that, your happiness.  And chances are, if you are woman, you go about this task with considerably more effectiveness than men — even if you don’t realize it.

                Men have two psychological characteristics that play havoc on their ability to invest money.  First, they are overconfident in their own ability. This is not a characteristic confined to finance. They are overconfident in their ability with regards to almost anything. Evolutionary psychologists, those who study how our thinking patterns have evolved over time, have speculated that this tendency towards overconfidence arose because of the tasks men performed in early human societies. Men hunted, and when hunting it improves your survival chances if you are very confident when face-to-face with a wild animal.  Today we each face the market rather than wild animals. But, unlike the hunt, men’s overconfidence often dooms them in this situation. They tend to trade stocks more actively because they are convinced they know what the next hot stock will be, what is likely to go up and what is likely to go down. In so doing they incur all of the transaction costs associated with trading (commissions, taxes, bid-ask spreads) but do not pick stocks any better than the woman in the office next to theirs.  That woman will typically be less confident in her own abilities, including finance, trade stocks less often and in so doing generate risk-adjusted returns that are superior to her male counterpart.  Even in the more sedate world of mutual fund investing, women seem to have a better ability to pick good funds because they concentrate on the fees a fund charges rather than what fund happens to be hot at any given moment.  And so we have what amounts to a stark paradox in investing: Men think they know what they are doing but often don’t and women think they don’t know what they are doing but often do.

                We all know the stories about the guy who won’t stop to ask for directions and the woman who changes her mind at the drop of a hat. When similar situations occur in our own lives we look to these stories to convince ourselves that what we are observing is just normal behavior. These gender-specific stereotypes exist partially because there is some kernel of truth buried in a perhaps-humorous story.  Men are, in fact, stubborn and protective of their belief that they are knowledgeable about a particular subject, in this case how to get somewhere.  Women do, in fact, change their minds more often than men.  But the interesting part of this tendency to change their minds is why it occurs. It happens because women are better than men at listening to the thoughts and advice of others and changing their own views in light of those thoughts. If you never listen to anyone else, it’s pretty clear you aren’t going to change your mind very often. That is true whether you think you know where you are going, and can’t bear the thought that someone at the gas station will tell you that you were wrong, or whether you are facing a decision about how to plan for your financial well-being in retirement. Women are more likely to listen to and act on financial advice than men. If a company has a retirement planning seminar for their employees we can be very confident of two things. Women will think they need the seminar more than men will. Women will be more likely to use in the information obtained in the seminar to make better financial decisions.

                So, are women just better investors than men? Yes, they are. Women bring an emotional and psychological tool kit that is better adapted to decision making in modern financial markets.  They listen, consider alternatives carefully, change their minds when necessary and generally lack the hubris that leads men astray.

How the Presidential Candidates Address the Savings Problem

One question that I’m frequently asked is how the current presidential candidates address the savings problem. Here is a short version of what they are proposing.

Barack Obama and Hillary Clinton both support a savings match program for lower income Americans. Relative to the hopelessly complicated Savers Credit Program currently in place these cash matching programs have shown some promise of increasing savings rates among the poor. Clinton’s program is a little more generous than Obama’s, the federal government matches dollar-for-dollar up to $1000 for families earning under $60,000 while Obama’s program offers a 50% match for the first $1000 of savings and caps the income eligibility at $75,000. But, either plan would probably increase savings among lower income Americans. Obama also supports a federally mandated small-business IRA plan, one that looks  similar to the “Automatic IRA” forwarded by Mark Iwry (Brookings Institute) and David John (Heritage Foundation). In this plan small businesses would be required to allow their employees access to a government-sponsored defined contribution retirement savings plan. It is unclear whether the government would manage the assets or if it would negotiate with private companies to manage those funds. Clinton takes this one step further with her “American Retirement Account” plan, essentially allowing all Americans to contribute up to $5000 on a tax-deferred basis in this new type of IRA, regardless of their employement situation or whether their current employer offers a tax-deferred plan of their own.

Obama’s plan would put some burden on small business owners while Clinton’s would not.  What I do like about Obama’s plan is that successful savers often do so through employer-sponsored plans and people who work for small businesses do indeed often face a situation in which their employer offers no retirement plan. It is directed at an obvious gap in the system. Clinton’s is certainly more generous in the federal dollars spent, either directly or via tax credits.  Finally, it is difficult to say with certainty which plan would spur more savings because, as of this writing, Clinton provides considerably more detail about her plan than Obama.

John McCain offers two proposals directly aimed at increasing savings. First, he supports partial-privitization of social security.  My belief is that partial-privitization would benefit poorer families much more than wealthier families (for a future post). He also supports decreasing taxes on capital gains and dividends. This is a tricky one. Increasing the returns to savings is certainly a good incentive to save more. And there is ample evidence from academic economists that decreasing taxes on investement returns is a good thing for the economy at large. However, tax cuts without matching spending cuts will increase the budget deficit. Buget deficits implicity tax our future income whether we like it or not.  That is certainly true for any of the candidate’s plans, not just McCain’s.

So, the candidates are putting out a few proposals, some well-developed and others less well-developed. I’ll stay tuned for anything new that hits the radar screen.

The SEC Should Act on Fee Disclosure Regulations for Financial Services

One clear lesson rising from the ashes of the sub-prime mortgage mess is that it is difficult to change the rules of the game once all interested parties think they know them. The Bush Administration’s narrowly focused bailout of some borrowers has been widely criticized as catering to business interests at the expense of cash-strapped homeowners. The government’s unfortunate task in these kinds of situations is to decide who loses money, homeowners or the multitude of businesses and individual investors that knowingly or unknowingly hold low-quality mortgage-backed securities.

It is easy to be sympathetic to affected homeowners. In many cases, even if one could argue that they should have understood the implications of the variable rate and other exotic mortgages they were signing, they clearly did not. And it is difficult to blame them. Mortgage financing is about as clear as mud to the average family looking to purchase a home. This lack of transparency leads to poor decision-making. Poor decision-making leads to public angst and the aftermath of government bailouts. Much like the Enron-era accounting scandals, it is too late to save some people from financial distress. But we can look closely at the harsh lessons of this crisis with an eye toward creating reasonable protections for people who enter the increasingly complex market for financial services. Are there other sectors of the financial markets that suffer from the same staggering opaqueness as the mortgage market? You bet.

Most people have almost no idea how much money they are being charged by the mutual funds contained within their company-sponsored retirement plans. The regulations governing mutual funds, set by the U.S. Securities and Exchange Commission, foster this ignorance. The General Accounting Office has recommended changing disclosure laws to require investment management companies to tell investors how much, in dollars, they are being charged. Under pressure from financial industry lobbyists, that information has not been revealed. The result is tepid price competition in the mutual fund industry, and a slow but steady drain on the retirement savings of millions of Americans — even though most are completely unaware of it.

The market for annuities, a popular product among those preparing to retire, can also be very confusing. Its mystery is shrouded by complicated insurance speak that may be well intentioned but is not accessible to most retirees. Some retirees fork over a substantial proportion of their life savings to these products, sold on the merit of apparent safety, without understanding the risks macroeconomic events can pose. For example, the holder of a simple fixed-payout life annuity could see the real earning power of his or her steady monthly payments plummet if inflation suddenly lurched upward and remained at that higher level for a few years. If the problem were widespread would there be calls for some kind of government bailout? Who could doubt it?

Mutual funds and annuities are just examples of perfectly good investment products sold by many well-intentioned companies that, due to woefully inadequate disclosure laws, can be abused by some institutions that market them. The creativity and flexibility of our financial markets have outstripped the creativity and flexibility of those charged with ensuring that consumers and investors who make reasonably diligent efforts to understand the products and services they are being offered can do so.

We need bold reform in financial disclosure regulation. The costs of the financial products and services many Americans purchase should be made absolutely apparent, even to those without any financial background whatsoever. It would increase individuals’ ability to understand these marketplaces, to shop around, and ultimately encourage healthy competition in both price and service quality. Perhaps more importantly, it would lead some people whose bewilderment about financial matters keeps them from entering financial markets that might be beneficial to them to enter those markets. Commercial law requires price transparency when we go, for example, to the grocery store to purchase a gallon of milk. The stakes in financial markets are much higher than they are at the grocery store, and yet financial institutions aren’t required to divulge their prices to you. Americans of all economic strata are being asked to shoulder an increasing portion of the burden of their own economic well-being in retirement. And most of us are not going about the task very effectively. The seeds of a future government bailout should be obvious. Government regulatory agencies need to learn the lessons of the subprime lending crisis and act now to stem the rampant disparity between what we know and what we ought to know before we enter the ubiquitous financial marketplaces. The hard-earned savings of many Americans depend on it.

About USThrift Blog

Americans save less of their income than the citizens of any country in the developed world. This has profound implications for individuals as well as the evolution of our business and political climates. This blog will speak to these issues, sometimes through my own writing and sometimes through that of others. It will be written by an academic and cite a lot of academic research but it is intended to be translational in nature — not written in the often-obfuscated language of academic research. In upcoming postings we will explore practical ways to help households save more, ways that leverage a mixture of traditional economics and psychology with the emerging field of behavioral economics.  We will comment on public policy, including the upcoming Presidential elections, and do our best to tease out the implications for household savings from the myriad of proposals being floated by the candidates.  We will talk about the role of private businesses and how they can help their employees save more.  This blog takes my recently-released book, “Whatever Happened to Thrift: Why Americans Don’t Save and What to Do About It” as a starting point but extends the discussion beyond the ideas contained in those pages. It is an unapologetic attempt to reinvent thrift as a habit of the American people.