saving – Andrew Samwick

Scrambling Your Nest Egg

February 20, 2008Andrew SamwickLeave a comment

J.W. Elphinstone reports on a growing number of people taking loans and withdrawals from their retirement accounts to cover their expenses:

Trent Charlton knew the risks when he borrowed $10,000 from his 401(k) and cut his retirement savings in half.

But Charlton, a 40-year-old account executive at an Irvine, Calif., trucking company, said he had little choice because he and his wife could not keep up with monthly expenses after American Express reduced the limits on three credit cards.

As home prices fall and banks tighten lending standards, more people are doing the same thing: raiding their retirement savings just to get by and spending their nest eggs to gas up SUVs, pay mortgages or put food on the table.

But dipping into 401(k) accounts can carry risks because defaulted loans and hardship withdrawals are taxed as income and are subject to a 10 percent penalty if the worker is under 59 1/2 years old.

That means if the trend grows, many Americans will risk coming up short on retirement savings or may have to rely on an overburdened Social Security system.

"People who take out a loan or withdrawal are adding to a looming retirement crisis over the next 30 to 40 years," said Eric Levy, a partner at global consulting firm Mercer. "And what implications will that have (for) our economy?"

Some of the nation's largest retirement plan administrators, such as Great-West Retirement Services and Fidelity Investments, are seeing double-digit spikes in hardship withdrawals and increases in loan requests, a sharp departure from levels that traditionally varied little.

Administrators say consumers are using retirement savings to pay for unmanageable mortgages, maxed-out credit cards, and costly utilities and groceries.

Charlton and his wife used the retirement money and $7,000 from savings to pay down their credit card debt. They also cut monthly expenses by pawning a diamond ring and selling camera equipment he owed money on. And he's looking for someone to take over his $550 monthly payment on a gray BMW 335i he leased last April.

Charlton said his goal is to pay off the 401(k) loan in two years. He has not decided whether he will contribute to the plan during that time.

If I may be indelicate here, Trent's problem is that he thought a $550 monthly car lease payment and maxed out credit cards were appropriate expenditures for a 40-year old worker with only $20,000 in a 401(k), even before the credit crunch hit. If that's his attitude toward money, he is going to have a lifetime of financial worries.

Read the whole thing for more about the procedures for loans and withdrawals and more information on how this trend is evolving.

In Defense of (Some) Neuroeconomics

January 18, 2008Andrew SamwickLeave a comment

Earlier this week, Alex Tabarrok was not too impressed by a recent neuroeconomics paper that examined the neural responses to typical marketing actions for consumed goods. In this case, the authors showed that telling subjects that a wine was expensive changed the way the brain processed the experience. (Here's a popular press article on the paper. Alex provides a link to the published paper.)

I saw one of the paper's authors, Antonio Rangel, present the paper at Econopalooza this month. I had a similar reaction to Alex--this is probably not the most critical use of fMRI technology to enhance our understanding of economic behavior. However, I should also point out that there are hundreds of sessions to attend at the ASSA meetings, and two of the ones I chose to attend were the ones on neuroeconomics that featured Antonio and David Laibson. They are two of the most creative and insightful researchers in our profession, and I would make similar choices about which sessions to attend given the same menu next year.

Seeing a number of papers presented, I think David's work on hyperbolic discounting provides a better illustration of how the new technology can enhance the field of economics. In several theoretical and empirical papers over the last decade, David and his co-authors have investigated the tendency of people to act as if they have very high discount rates for choices in the near future, such as a preference for $1 today versus $1.20 tomorrow, but fairly low discount rates for choices in the more distant future, such as a preference for $1.05 in 11 years versus $1 in 10 years. This introduces a time-inconsistency problem, since what I will actually do in year 10 changes when it arrives. This is a departure from the classical model of consumer behavior. (I think the most important consequence is that it makes illiquidity a feature, not a bug, of a long-term savings account like a 401(k)). David has argued his case very persuasively, and his research is having a large impact on the way academics and policy makers think about saving.

Can neuroeconomics help him make the case? In this article in Science, he and his co-authors show:

When humans are offered the choice between rewards available at different points in time, the relative values of the options are discounted according to their expected delays until delivery. Using functional magnetic resonance imaging, we examined the neural correlates of time discounting while subjects made a series of choices between monetary reward options that varied by delay to delivery. We demonstrate that two separate systems are involved in such decisions. Parts of the limbic system associated with the midbrain dopamine system, including paralimbic cortex, are preferentially activated by decisions involving immediately available rewards. In contrast, regions of the lateral prefrontal cortex and posterior parietal cortex are engaged uniformly by intertemporal choices irrespective of delay. Furthermore, the relative engagement of the two systems is directly associated with subjects’ choices, with greater relative fronto-parietal activity when subjects choose longer term options.

The research shows that two different neural systems, which evolved for very different purposes in the human brain, deal with the two decisions. When a part of the brain is activated during a particular decision, we can infer that the decision is similar to other choices or behaviors that activate that part of the brain. The more primitive part of the brain is activated with the near-term choice. This is what gives Laibson's argument credibility. We have already learned from observation of individual choices that behavior departed from the classical model. Without the brain imaging, there could have been a number of competing theories for why this is so, many of which would not cause us to dramatically rethink the underlying model. With the brain imaging, we give substantially greater weight to the theories like Laibson's that are predicated on different decision frameworks for different types of intertemporal choices.

Economic Challenges

July 4, 2007Andrew SamwickLeave a comment

The trip to Hawaii wasn't all vacation. The impetus for the trip was an invitation to make a presentation to a financial audience on "Economic Challenges: What Have We Learned? What Do We Face?" Here are the slides.

In a nutshell:

I identified three challenges to the U.S. economy that I think are fundamental: low and declining saving in all sectors of the economy, a declining labor force, and a dwindling labor income tax base. In all cases, the challenges make us less capable of absorbing additional pressures, whether unforeseen events in the near term or emerging pressures from population aging and the growth of health care costs persistently in excess of the economy's growth (and their interaction through the government's entitlement programs).

My prognosis:

Absent more prudent behavior, prices—exchange rates and interest rates—will simply change to equilibrate imbalances. The dollar has started to depreciate, but to me, the biggest mystery in the economy is how the U.S. long-term interest rate can stay so low. I cannot see it remaining that way for long, and its rise will take the stock market and (what's left of) the housing market with it. (This is a fascinating chart that didn't make it into the presentation.)

But I’ve been saying this for a while. As an economist, I’m happy to be right, but usually even happier to be wrong.

Enjoy!

Optimal Saving?

January 30, 2007Andrew SamwickLeave a comment

Some students of mine referred me to an article by Damon Darlin in Saturday's New York Times which merits a Voxy for posing the question:

Could it be possible that you are saving too much for your retirement?

That's a fascinating question, and the article goes on to quote some of the economists who have done very interesting research on it, including Karl Scholz of Wisconsin and Larry Kotlikoff of Boston University. Here's the crux of the matter:

Nevertheless, a small band of economists from universities, research institutions and the government are clearly expressing the blasphemy that many Americans could be saving less than they are being told to by the financial services industry — and spending more — while they are younger. The negative savings rate, they say, is wildly distorted.

According to them, the financial industry, with its ostensibly objective online calculators, overstates how much money someone will need in retirement. Some, in fact, contend that financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.

The more realistic amount could be as little as half the typical recommendation made by Fidelity, Vanguard or any number of other financial institutions.

Here are the excerpts from the researchers:

The economists answer that people would get more out of their money by using it when they are younger. “There is risk in saving too much,” Mr. Kotlikoff said. “You could end up squandering your youth rather than your money.”

Mr. Scholz said he and his co-authors of a study, “Are Americans Saving ‘Optimally’ for Retirement?” found oversaving across all economic and education levels and most ethnic or racial groups as well. (It found that Hispanics tended to save less.) Those who were not saving enough were usually missing their target by only a small amount.

The one exception to this optimism involves people who enter retirement single, either because their spouse died early, they divorced, or they never married. The studies found this group did not save enough.

I think some of the confusion in the article is due to a focus in the financial planning community on how much people are saving rather than when they do it. I think typical households are forward-looking but very impatient. That they are forward-looking means that they will enter retirement largely without surprise or regret about what they can afford. That they are impatient means that they will delay most of the saving that will get them to that level of comfort until retirement is just a decade or so away.

So if you see a 50-year old with not that much in savings, how do you decide whether that's a 50-year old who is optimally waiting to save a lot over the next 10-15 years or a 50-year old who does not recognize the need to save for retirement?

Why I Don’t Like 529 Plans: Another Pecuniary Externality

January 23, 2007Andrew SamwickLeave a comment

Here's another tax-induced pecuniary externality that concerns me. The list price on college costs has been rising faster than inflation. This prompted politicians to act, and they created 529 plans to allow families to save for college in a tax-advantaged way. Austan Goolsbee has strongly and correctly criticized some of the design issues of these plans, particularly the administrative links to states and the (I think resulting) high management fees. For now, I just want to focus on how the tax advantage is distributed and its impact on future prices.

Contributions are made with after-tax dollars, sometimes with a state income tax deduction, but the returns on the portfolio compound tax-free and withdrawals are tax-free as long as they are used for college expenses. It's like a Roth IRA that way. (You can learn more here.) The benefits of the 529 plan accrue in proportion to a family's tax rate and desired amount of education expenses. Let's leave aside the almost surely positive correlation between (family) income and desired education expenses, which will reinforce the following points, and focus just on the simple fact that the tax rate increases with family income. It is more financially advantageous for a high-income family to invest a dollar in a 529 plan than it is for a low-income family to do so.

But you might say, "Okay, but doesn't the low-income family still get a benefit?" The answer depends on whether you think the supply curve for education is flat or upward sloping. Do you believe that colleges, when faced with dedicated accounts like 529 plans that will pay a penalty if they are not used on college costs, will raise their list prices? About 20 years ago, the conjecture that they would was named the "Bennett Hypothesis," after then-Secretary of Education William J. Bennett, who decried the tendency for colleges to raise tuition prices when the federal government stepped up its financial aid programs. I have little doubt that it is true.

The pecuniary externality comes in when we think about how much the tuition will go up. What drives that? I'd argue that it will be the average size of a 529 plan, as would be the case in any market responding to an increase in consumers' willingness to pay for a good. Since the tax advantage is positively related to income, even if all of the money going into 529 plans were new saving, it would be the higher income families that would have the larger-than-average 529 balances and the lower income families that would have the smaller-than-average 529 balances. (If the higher income families are simply shifting money from other accounts to 529 plans, then this strengthens the argument.)

Putting this all together, we can infer that the list price increases in college costs could outstrip the capacity of low-income families to pay them from their 529 plans. Depending on how much colleges raise their list prices and how the details of financial aid programs work out, lower income families may be worse off by the presence of 529 plans, even if they are saving through them. It is not the low-income families' own 529 plans that make them worse off--it is the high-income families' 529 plans and their greater benefits to using them. The impact of the latter on the price is the tax-induced pecuniary externality.

It's lousy public policy. But as much as I don't like these plans as a policy instrument, I have one for each of my two children. It doesn't make sense financially to leave the money on the table, given what's going to happen to list prices.

The End of Personal Saving?

April 28, 2006Andrew SamwickLeave a comment

Today's GDP report gives some very good news in the top line number--a real growth rate of 4.8 percent in the first quarter of 2006. As this is the advance report, we'll expect revisions to the number at the end of May with the preliminary report and at the end of June with the final report. But an annual growth rate of 4.8 percent is a very nice place to start.

The GDP report also contains information on personal income and saving, and this continues to be more and more puzzling:

Personal saving -- disposable personal income less personal outlays -- was a negative $50.5 billion in the first quarter, compared with a negative $15.8 billion in the fourth. The personal saving rate -- saving as a percentage of disposable personal income -- decreased from a negative 0.2 percent in the fourth quarter to a negative 0.5 percent in the first. Saving from current income may be near zero or negative when outlays are financed by borrowing (including borrowing financed through credit cards or home equity loans), by selling investments or other assets, or by using savings from previous periods.

In a free society with a market economy, we have choices about whether to save or consume our resources today, and I don't presume to tell people which choice to make. But it's a very simple truth that we cannot consume the same resources both today and tomorrow, and so it is with an eye toward the ability to consume in the future that economists generally believe that the savings rate should be high rather than low.

I wonder how it can be that with the Baby Boom generation in the high-income and presumably high-saving part of its economic life cycle, we can possibly have negative saving rates for the population as a whole, if we are making decisions with any attention to the amount of consumption we will be able to do in the future.

Shopped Out?

August 31, 2005Andrew SamwickLeave a comment

Barry Ritholtz of The Big Picture and I are the latest installment of the Wall Street Journal's Econoblog feature. Here's the teaser:

The free-spending U.S. consumer has been fueling economic growth for years. But with prices at the pump creeping ever higher and signs of a slowing housing market starting to emerge, will the credit cards finally be put away?

Retailers like Wal-Mart have been complaining for months that costly gasoline has been keeping more price-conscious shoppers away from their stores, and with gasoline and other commodity prices marching higher in the wake of Hurricane Katrina, the squeeze is likely to get tighter. Meanwhile, workers' hourly earnings fell behind the pace of inflation in July, and personal saving levels have dwindled to 0%, leaving highly indebted consumers little financial cushion other than their homes -- which many have already leveraged heavily.

So is the long national shopping spree finally winding down?

I confess that I hadn't noticed Barry's exceptional blog until I started trading columns with him--a true embarrassment on my part after 11 months in the blogosphere. He's got excellent material on capital markets and the major economic releases, as well as a keen eye for developments in music and technology. He's got no sympathy for people who blow bubbles or don't pay attention to their data. And the graphics on his blog rival any that I've seen. Here are a couple of interesting posts, to get you started, if you are also new to his blog:

The Return of the 30 Year Bond

The Soft Prejudice of Low Expectations: The Federal Deficit

Consumer Issues and Investors

The Physics of 4 Wheel Drive and Snow

In Praise of Gene Steuerle

June 2, 2005Andrew SamwickLeave a comment

Suppose we just got rid of this thorny democratic process of reforming Social Security and appointed one person to handle the job. My nominee for the position of "Social Security Czar" is Gene Steuerle of the Urban Institute. To see why, follow this link (via Arnold Kling) to his recent testimony before the House Ways and Means Committee. Can we exhume the Voxy for Congressional testimony? Let's just call it an instant classic.

He starts as follows:

The Social Security debate could and should be part of a larger one in which we engage our fellow citizens in choosing the best direction for society as a whole as better things happen to us in the way of longer lives and new health care goods and services. How can we really take best advantage of these new opportunities? How can we spread the gains from this increased level of well-being and wealth to create a stronger nation with opportunity for all? And how should we share the costs?

Instead, the debate is upside down. Due to the ways we have designed our programs and our budgets, every year we spend greater shares of our national income in areas where needs have declined, and then claim we don’t have enough left over for areas—such as education, public safety, children, and anti-terrorism—where real needs remain and have often grown. I sometimes imagine sitting in the Ways and Means Committee room when someone from the National Institutes of Health comes in claiming to have found a cure, though expensive, for cancer. The members of committee, trapped in the logic of our current budget, find that instead of celebrating this advance, they commiserate among themselves about the increased cost for Social Security.

As a member of the baby boom generation, I remember youthful conversations among my cohort, regardless of political persuasion, that centered on what type of government we could help create to best serve society. As now scheduled, our legacy is to bequeath a government whose almost sole purpose is to finance our own consumption in retirement. Not only haven’t we come close to paying for the government transfers we are scheduled to receive, but we plan to pay for them by dwindling almost to oblivion the rest of government that would serve our children and grandchildren.

Yes, it does seem to be a question of priorities. He finishes his introductory remarks with:

Social Security is only part of this problem, but it is an important part for four reasons:

It sets the standard for how long we should work and who covers the costs
associated with our longer lives and the new medical care we receive;

There are many inequities and inefficiencies in Social Security that are
independent of its size;

By default (in absence of new legislation), Social Security is designed to absorb ever-larger shares of our national income, thereby squeezing out other programs, particularly discretionary expenditures, that are not treated equally in the budget process.

A number of related employee benefit reforms would likely increase private saving, enhance the well-being of low- and average-income workers in retirement, and improve the solvency of Social Security.

He addresses each of these in turn, and makes the following recommendations (with my numbering):

Increase the early and normal retirement ages so that at any given tax rate, the system provides fewer subsidies for middle-age retirement and increased revenues, higher annual benefits in retirement, higher lifetime benefits, and a greater portion of resources to those who are truly old.
Backload benefits more to older ages, such as the last 12 years of life expectancy, so as to progressively increase benefits in later ages when they are needed more and to increase labor force incentives for individuals still in late-middle age, as defined by life expectancy.
Provide a well-designed minimum benefit to help low-income households and groups with less education and lower life expectancies, while simultaneously reducing poverty rates (relative to living standards or wages) among the elderly.
Determine family benefits for middle- and upper-income individuals in an actuarially neutral manner by applying private pension standards, making sure that benefits are shared equitably, and reducing or removing significant discrimination against single heads of household, many abandoned spouses, two-earner couples, many divorced persons, those who marry others close to their own age, some who pay significant marriage penalties for remarrying, and those who bear children earlier in life.
Provide a minimum benefit that extends to spouses and divorced persons as well as workers to provide additional protections for groups that are particularly vulnerable, and as an alternative to free and poorly targeted transfers to higher-income households.
Count all years of work history, providing an additional work incentive and removing the discrimination against those who work longer.
Ensure responsible budgetary policy by changing the default rules to guarantee the system automatically moves toward balance—say, through adjustments in the retirement ages or the rate of growth of benefits for higher-income households—whenever the Social Security trustees repeatedly report a likely long-run deficit.
Reduce the tax gaming used with retirement plans when taxpayers simultaneously report interest deductions while deferring or excluding interest and other retirement plan income from taxation.
Provide additional incentive for plans that do a better job at providing a portable benefit for all workers, such as using the FICA tax exclusion to finance increased deposits to retirement accounts and guaranteeing all workers in a qualified plan a minimum level of portable benefits.
Make clearer in the law that employers can use opt-out, not just opt-in, methods of encouraging retirement plan participation—without threat of lawsuit.
Focus retirement plan incentives more on lower-wage workers, for instance, through an increase in a modified savers credit, which should be adjusted so that it is available for employer, as well as employee, contributions and so that the credit is deposited in retirement accounts.
Provide safe harbors from lawsuits for designated types of retirement and other benefit plans offered by employers who hire or retain older workers.
Restore the earnings base for Social Security by increasing the portion of cash wages subject to Social Security tax, capping the tax-free levels of health insurance that can be provided, and dealing with tax preferences for other employee benefits.

Numbers 1 - 7 & 13 deal explicitly with Social Security. Some of them are quite similar to ideas I have expressed in various forms in earlier posts. In brief: raise retirement ages, raise the maximum taxable earnings level, remove disincentives to current work, rationalize the spousal and minimum benefits, and put future solvency on autopilot through modest changes triggered by deterioration in the system's long-term health.

Numbers 8 - 12 deal with changes to private pension plans. With the ongoing growth in defined contribution plans relative to defined benefit plans, it is becoming less clear to me that employers need to be so fundamentally involved in pension plan design. So setting up a universal, lifetime savings account for each person (to which employers could contribute if they want to and with default options that encourage at least modest saving rates) may be the way to go.

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