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Tuesday, June 10, 2008

I Want It Now

An email from someone I respect says to take a look at today's column by David Brooks on savings behavior since the issue of adequate saving is particularly important in an era of increasing life expectancy. In addition, Kevin Drum says:

Culture of Debt, by Kevin Drum: ....This isn't exactly what I've come to expect from David Brooks, but today he decries the fact that "the social norms and institutions that encouraged frugality and spending what you earn have been undermined" and then goes on to name names...

I doubt that I'd end up agreeing with Brooks 100% about how to address this problem, but this isn't a bad start. It's a worthwhile column to read.

Mathew Yglesias reacts similarly:

Brooks on Debt Culture, by Mathey Yglesias: Kevin Drum recommends David Brooks' column on America's seduction by the culture of debt and then says "I doubt that I'd end up agreeing with Brooks 100% about how to address this problem." I actually tend to think that Brooks (and Drum) are overstating the problem somewhat, but Brooks' proposals seem like good ideas to me...

The idea of trying to establish some kind of non-predatory mechanism that would soak up some of the demand for "payday loans" seems especially promising to me.

Here's the column:

The Great Seduction, by David Brooks, Commentary, NY Times: The people who created this country built a moral structure around money. The Puritan legacy inhibited luxury and self-indulgence. Benjamin Franklin spread a practical gospel that emphasized hard work, temperance and frugality. Millions of parents, preachers, newspaper editors and teachers expounded the message. ...

Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. ...

The deterioration of financial mores has meant two things. First, it’s meant an explosion of debt that inhibits social mobility and ruins lives. ... Second, the transformation has led to a stark financial polarization. On the one hand, there is what the report calls the investor class. It has tax-deferred savings plans, as well as an army of financial advisers. On the other hand, there is the lottery class, people with little access to 401(k)’s or financial planning but plenty of access to payday lenders, credit cards and lottery agents.

The loosening of financial inhibition has meant more options for the well-educated but more temptation and chaos for the most vulnerable. Social norms, the invisible threads that guide behavior, have deteriorated. ...

The agents of destruction are many. State governments have played a role. They aggressively hawk their lottery products, which some people call a tax on stupidity. ... Payday lenders have also played a role. ... Credit card companies have played a role. ... Fifty-six percent of students in their final year of college carry four or more credit cards.

Congress and the White House have played a role. The nation’s leaders have always had an incentive to shove costs ... onto the backs of future generations. It’s only now become respectable to do so. ...

The list could go on. But the report ... also has some recommendations. First, raise public consciousness about debt the way the anti-smoking activists did with their campaign. Second, create institutions that encourage thrift.

Foundations and churches could issue short-term loans to cut into the payday lenders’ business. Public and private programs could give the poor and middle class access to financial planners. Usury laws could be enforced and strengthened. Colleges could reduce credit card advertising on campus. KidSave accounts would encourage savings from a young age. The tax code should ... do more to encourage savings up and down the income ladder.

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

I've been wondering lately if technological change has been a factor in the fall in saving, but I'm not sure the story hangs together. Suppose that, consistent with what behavioral economists find, we play tricks on ourselves to "nudge" our choices in the direction we'll be happy with over the longer run. For example, if money "burns a hole in your pocket," then you don't bring it with you when you go out (the debit/credit card stays home too). If you don't have it, you can't spend it on immediate gratification (and regret it in the future). We sometimes do the same with food sometimes. If we want to avoid overindulging on something, we don't buy it because if it's there, we won't be able to avoid eating too much, and regret it later (I will eat as many peanut M&Ms as you put in front of me, so I have to limit how many are in the house at any one time).

The idea is that technology has made some of those tricks harder to use on ourselves. For example, if you are at home and have a computer, you can go shopping on the spur of the moment. It's a lot harder to hide your money from yourself than it used to be. Transactions costs are much lower for financial transactions, so it's not as easy as it once was to put the equivalent of a trip to the store to buy ice cream as a barrier to spending money.

But is it really that different? You could always order goods by phone from a catalogue, so the internet isn't all that revolutionary (or is it? - the variety of goods you can buy and information about them is much greater today than when we had to rely on the Sears catalog). If you go out, debit cards make all the money in your account accessible, but so did checks in the old days (though they weren't as widely accepted), and credit cards are nothing new. Still, transactions costs have fallen substantially making it much harder for people to erect barriers in front of themselves to prevent them from acting on the emotion of the moment and preserving longer term plans, so maybe technology has played some role in bringing about this transformation in savings behavior over the last few decades.

One other thing with regard to technology and financial innovation. Twenty years ago I couldn't go on the internet, sign up for a credit card, and then transfer money to my checking account in less than a day. Having that capability - having fast credit available from a variety of sources - could make people willing to save less. Roof starts leaking? Put it on credit - no need to save for a rainy day, the credit will be there. Time for the kids to go to college but didn't bother to save enough? There was no need, you knew that you could take out a home equity loan, etc. So, the fall in saving may also be a response to the widening credit availability brought about by financial innovation. The change in saving behavior (including the accumulation of debt) we have seen is probably too large to be explained by this alone, but I do think the security - and the temptation - that easy credit brings is a factor.

Update: In comments, Richard H. Serlin writes:

I teach one of the largest university personal finance courses in the country at the University of Arizona. I am also president and co-founder of AAA Personal Finance Education, one of the largest providers of the personal finance education course required by the government for those in bankruptcy (since the BAPCPA law of 2005). So, I am an expert on this.

The gist of Brook's article is wrong and misleading (a common occurrence for David Brooks). As Harvard bankruptcy expert Elizibeth Warren puts it:

The beauty of the Over-Consumption story is that it squares neatly with many of our own intuitions. We see the malls packed with shoppers. We receive catalogs filled with outrageously expensive gadgets. We think of that overpriced summer dress that hangs in the back of the closet or that new power drill gathering dust in the back of the garage. The conclusion seems indisputable: the “urge to splurge” is driving folks to spend, spend, spend like never before.

But is it true? Deep in the recesses of federal archives is detailed information on Americans’ spending patterns going back for more than a century. It is possible to analyze data about typical families from the early 1970s and from the early 2000s, carefully sorting spending categories and family size.12 If today’s families really are blowing their paychecks on designer clothes and restaurant meals, then the expenditure data should show that they are spending more on these frivolous items than their parents did a generation earlier. But the numbers point in a very different direction.

From: The New Economics of the Middle Class: Why Making Ends Meet Has Gotten Harder: Testimony Before Senate Finance Committee, May 10, 2007

For a more in-depth explanation I recommend her books, "The Two Income Trap" and "All Your Worth: The Ultimate Lifetime Money Plan".

Essentially, the main causes of today's debt explosion and financial distress are

1) The great increase in income insecurity and other economic insecurity for the poor and middle class over the last generation, aided by Republican shredding of government support and safety net (well explained in Yale political scientist Jacob Hacker's book, "The Great Risk Shift)

2) The 80% increase in the real, inflation adjusted, median home price since 1970.

3) The great real, inflation adjusted, increase in other large fixed costs like medical and education.

4) Stagnation or decrease in real wages for most of the poor and middle class.

5) People requiring much more education to make a middle class wage. Therefore they begin earning well much later, and due to constant Republican pressure to cut spending on education, they are forced to graduate, and start their adult career lives with far higher levels of student debt than a generation.

6) The great increase in income inequality causing what Cornell Economist Robert Frank calls an expenditure cascade (prestige fever, arms race)

I have what I think is a very nice, brief, working paper explaining this, titled, "Let's Cut the Ammunition to the Housing Arms Race Permanently."

    Posted by on Tuesday, June 10, 2008 at 06:48 PM in Economics, Financial System, Technology | Permalink  TrackBack (0)  Comments (100)


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