Savings

One of the fundamental determinants for achieving economic security is the manner in which families access financial services. Unfortunately, millions of households manage their money without a connection to a basic bank account. These unbanked families fend for themselves in a complex and expensive marketplace of products and services. The subsequent drain of savings and resources makes the path toward economic security all the more arduous. There ought to be another way. People should be able to access high-quality and low-cost financial products as a matter of course.

Earlier this year, the $21.7 billion Global Fund to Fight AIDS, Tuberculosis, and Malaria was forced to retract or suspend millions of dollars in aid after rampant corruption was discovered. An audit of a modest portion of selected programs found staggering percentages of money misspent or unaccounted for: 67 percent in Mauritania; 36 percent in Mali; and 30 percent in Djibouti. There were also serious concerns involving millions of dollars sent to Zambia.

As fashion designers have New York Fashion Week to debut the hottest fashions for the year, financial services policy makers have America Saves Week (going on now from February 20-27) to showcase the hottest trends in personal savings. This year’s theme is “Make Savings Automatic.” Consumers are encouraged to set up auto-payments into a savings product.

This measure creates a California Banking Development District program, a proven way to connect lower-income unbanked Californians with the financial products and services they need to enter the financial mainstream and begin to build savings and assets. It identifies specific “Banking Development Districts” where financial institutions will receive incentives such as state deposits to develop enhanced and expanded products and services for lower-income consumers.

Peter Orszag takes to the pages of the Financial Times to herald an innovative idea to increase savings. Given the enduring popularity of lotteries, he suggests we can make savings more attractive by linking it to prizes.

The allure of lotteries, he argues, can be used to help raise the national savings rate, which over the long term is an important precondition for sustained economic growth. That’s a pretty big lift. As the former head of Obama’s White House budget shop, Orszag knows that most of the work will be done by the balance sheets of the public sector and business, but he is right that households will need to be part of this shift as well. Higher household savings, especially among low to middle income families, can contribute to increasing national savings and also, importantly, provide a “much-needed cushion against the vagaries of life.”

My friend and colleague at the New America Foundation, Steve Clemons, doesn’t like the idea one bit. He thinks it is small bore gimmick that will undercut the revenue raised by existing lotteries and take attention away from addressing our macroeconomic imbalances.

To be honest, I didn’t care for the idea either when I first heard of it. I don’t buy lottery tickets and I’m not a gambler myself (even though I don’t begrudge others from partaking if it is harmless). Gambling is not appealing to me because the house almost always wins and people often end up parting with money they can ill afford to lose. And I’ve never liked the idea of creating state-run lottery franchises as a way to extract resources from the public to pay for things (like schools) that should be priorities on their own. Still, lotteries sure are popular.

Peter Tufano of the Harvard Business School (and soon to become Dean of Oxford University's Business School) has been leading the way thinking about how to take the popularity for lotteries and put it to good use. In his conception, the principle investment is protected but the prospect of hitting the jackpot gets people to set aside money that might otherwise be earmarked for consumption. While this is a relatively new idea for the US, prized-linked savings lotteries have thrived for years in the United Kingdom, Latin America, and the Middle East. Since 2009, the Doorways to Dreams (D2D) Fund, the Filene Research Institute, and the Michigan Credit Union League have piloted the concept. They offered a share certificate that earns interest, is principal protected, and enters the saver into drawings for small monthly prizes and a large jackpot. When last I checked, more than 10,000 certificates with $4.67 million in savings have been opened since the start of the project and more than 300 account holders have won $22,000 in small, monthly prizes. There are updated figures available but the point is that the pilot has shown there is demand for this product and it can work in the marketplace.

I’ll agree that this idea is not the golden ticket. It will not solve the macroeconomic challenges of rebalancing global trade or transform the US from a nation of consumers into savers. Perhaps Orszag overplays his hand by linking these issues in his op-ed. But prized-linked savings lotteries are a way to make savings more attractive and begin the process. This will be a welcomed development since many  families on the lower end of the economic ladder can’t take advantage to the various saving incentives offered up in the tax code and miss out on opportunities if their employers don’t offer savings plans. That’s why we should be looking for mechanism, opportunities, and incentives to get these families saving more over time.

The Great Recession has functioned like a large wrecking ball. One object of destruction has been the housing market. Price declines, loan defaults, and an unprecedented level of foreclosures have created a mess and left the housing finance system in shambles. This past Friday, the Obama Administration released its report on “Reforming America’s Housing Finance Market,” which was designed to start the rebuilding process.

Much of the initial anticipation has been focused on the fate of the two firms that stood in the middle of the housing finance system: Fannie Mae and Freddie Mac. With roots that extend back to the 1930s, these firms pursued a range of practices that increased the availability and accessible of mortgage financing. But their main business became underwriting the securitization of mortgages, which were packaged, sliced, and sold to investors around the world. Although they were created by the government, they were publicly traded companies that raised money in the capital markets and in turn sought to deliver profits for their investors who were comforted by the belief that the firms would have access to federal support if times got tough. The popping of the housing bubble brought on the tough times as the value of the mortgage-backed securities plummeted.

Fannie Mae and Freddie Mac have become wards of the state. Their losses are being covered by all of us collectively. Although much of the federal money distributed to stabilize the banks under TARP has been paid back (without so much of a thank you note), that has not been the case with Fannie and Freddie. They have soaked up about $130 billion, and counting, to meet their obligations.

The Obama administration made it perfectly clear in their report that Fannie and Freddie will be wound down. It is certainly a good move to resist trying to put them back together again. Perhaps we should not be so surprised that the profit-maximizing structure undermined the public mission.

But what’s next for the housing finance system?

The Grey Lady recently asked in their Room for Debate feature why more people are not savings money. I guess the editors felt this was a timely topic given recent figures showed the personal savings rate dipping to 5.3% in December after reaching 7% during the troughs of the Great Recession in 2009. Both these figures stand in contrast to previous years, when the rate hovered just north of zero. The savings rate actually has come a long way.

Perhaps we are making too much of this indicator. I have some concerns about the extent to which this metric adequately captures how many families are allocating their resources since it is largely driven by the consumption patterns of the more well-to-do. But I do welcome elevating the discussion of what’s driving savings behavior and this conversation offers a good place to start. I'm particularly partial to Mike Konczal's contribution which focuses on the mortgage mess and Tyler Cowen's concise four point entry.

What is clear to me is that families respond to economic uncertainty by increasing their savings. Job loss or the threat of job loss is enough to get people to cut back on their spending. And given the onslaught of the Great Recession was largely linked to historic levels of debt, many families are still de-leveraging and focusing their efforts in getting out from under of their debt overhang. And as cheap and easy credit contracts, I expect the profile and importance of savings will continue to rise. For better or worse, savings will once again be seen as an essential ingredient in promoting economic security and seizing economic opportunity.

While there may have been some decline in savings over recent months, I suspect that this reflects a fluctuation in a longer trend of increased savings. For starters, the performance (or lack thereof) of the economy continues to generate uncertainty. It’s possible to pick out a few indicators of an economic upswing but this recovery has been stingy at best. The housing market remains a mess and the job numbers continue to disappoint. We’re hardly out of the woods. In fact, the recession has gone on for so long that there is naturally some pent-up demand for some spending. The belts have been tightened but people still have to eat. And yet, people may start to eat differently. I suspect that there will be a growing appetite for a more sustainable mix of spending and saving.

Throughout 2010, the Center for Financial Services Innovation (CFSI) engaged in a marketplace-wide research effort to understand how impending changes – in demographics, the macroeconomic environment, regulation and legislation, technology, cultural paradigms, and institutional dynamics – will affect the structure of the financial services industry.

For most of the last 200 years, the story of global incomes has been one of the rich getting richer and the poor staying poor -- or "divergence, big time," as Harvard Kennedy School professor Lant Pritchett put it in a 1997 article. Pritchett argued that in 1870, the world's richest country was probably about nine times as rich as the poorest country. By 1990, that gap had increased to a 45-fold difference.

Just like fighting crime, fighting poverty takes a strong team. Medicaid, SNAP (or, food stamps), and TANF all provide a distinct and necessary role in making sure that low-income families can meet their most basic needs like food and medical care. Too often though, due to complexity and lack of coordination, people don't receive the assistance they need and the result ends up resembling the safety-net equivalent of this:

One of the factors that has contributed to the disunity of the group is the treatment of the Earned Income Tax Credit in determining the eligibility for other safety-net programs. Since EITC provides benefits in the form of cash, its a versatile member of the team. So versatile, that it could compromise access to other members of the team. If you have Batman, do you really also need the Green Lantern? This takes the form of counting the EITC against either or both the income and resource limit that means tested programs have in place. For TANF, EITC counts toward the resource limit in the month after it's received. For SNAP, it's 12 months. For SSI, it's 9 months.

However, thanks to a policy change that took place at the end of last year, some harmony will be restored among the team. EITC, as well as any additional value of a recipients tax refund, will be disregarded as income completely and as an asset for 12 months when calculating program eligibility. There are several significant benefits to this change, and, as noted to state agencies administering TANF, simplicity is chief among them. Tax refunds aren't itemized. There is no way to distinguish between EITC and any other portion of the refund. Producing the necessary tax documentation to make this distinction adds to an already burdensome verification process. The process from determining eligibility and benefit size for means tested programs can be considerable, around $1 billion a year for food stamps alone. Often this cost is absorbed by the states, who are also not having an easy time. Where states have eliminated asset tests entirely, and consequently the need to verify a participant's asset holdings, cost savings have followed. Oklahoma, for instance, saved $1 million a year when it eliminated its asset test for Medicaid and Virginia estimates that it will save around $250,000 a year by doing the same to its TANF program. Treating different parts of the tax refund differently also muddies the waters for recipients as to what portion of their refund they can retain and which they are required to spend down. While EITC could be disregarded as as a resource for as long as a year, the Child Tax Credit, which is also claimed by millions of EITC recipients, could count as soon as the month after it is received. Disregarding the entirety of the refund neutralizes this problem for both case workers and program participants.