Federal Reserve Chair Janet Yellen recently gave an interesting speech, “The Importance of Asset-Building for Low and Middle Income Households.”
She noted how few assets poor people have:
The median net worth reported by the bottom fifth of households by income was only $6,400 in 2013. Among this group, representing about 25 million American households, many families had no wealth or had negative net worth. The next fifth of households by income had median net worth of just $27,900.
But even those numbers are in a sense overstated, since much of the “net worth” is in home equity, thus not easily available, as she points out:
Home equity accounts for the lion’s share of wealth . . . for lower and middle-income families, financial assets, including 401(k) plans and pensions, are still a very small share of their assets.
This matters because,
. . . for many lower-income families without assets, the definition of a financial crisis is a month or two without a paycheck, or the advent of a sudden illness or some other unexpected expense. . . . According to the Board’s recent Survey of Household Economics and Decisionmaking, an unexpected expense of just $400 would prompt the majority of households to borrow money, sell something, or simply not pay at all.
This brings to mind several thoughts.
I’m delighted any time I spy a broad consensus across the economic spectrum. The American Institute’s Charles Murray bemoaning “Fishtown” (in his 2012 book Coming Apart) might make the same comment. The idea that all households should be saving, building assets for retirement and for a rainy day, is not just held among curmudgeonly conservatives.
But, if we want to understand the predicament of low-income households, and if we want to understand the decision-making that in part gives rise to that predicament—rather than echo the usual liberal idea that poor people are like children, buffeted by events and needing the benevolent direction of the self-appointed aristocracy—then it seems a bit superficial to leave out the role of the government.
These stark numbers leave the present value of social security, Medicare, and the income-contingent value of government programs out of “assets” and risk-planning picture. Those provide substantial resources.
Households that find the prospect of social security and Medicare reassurance against the prospect of old age don’t save as much. Households that can, or already do, rely on food stamps, unemployment, disability, Medicaid, rent and housing subsidies, and so forth, in times of need, are somewhat protected against income shocks, and in turn have less incentive to save in precaution against such shocks.
To be sure, their lives are tremendously difficult. But not nearly as difficult as they would be if those people risked dying in the gutter. And that fact surely colors their decisions to some extent. Moreover, many government programs feature asset tests. If you save up any money, you can lose health benefits, tuition benefits, and a variety of other help. The result is a strong disincentive to saving.
But we agree, more saving would be good. Or do we agree? As I look across the broad Keynesian policy consensus, I hear cacophony on that subject. Harvard’s Larry Summers is worrying about a “savings glut” leading to “secular stagnation.” More saving, in his view, would be a terrible thing for the economy as a whole. House of Debt by Chicago Booth’s Amir Sufi and Princeton’s Atif Mian links housing values to the economy through spending, not asset-building. The authors want people to spend housing equity; in their view, the major problem of the recession was that people with less housing equity stopped spending.
The Fed itself has been promoting exactly the opposite of “asset-building” on a macroeconomic level. It wants spending, lots of spending, and now. Negative 2 percent real interest rates for five years are not exactly a clarion call to get people to save more.
So, does the Fed really want more saving, or more spending? Or, somehow, more of both? Or for people to save more and the economy to save less somehow? Budget constraints are a cruel reality ignored in Keynesian economics.
Perhaps this is why Ms. Yellen chooses to use the word “asset-building” not “saving,” which is Keynesian poison. But I’m hard pressed to know how one can do the former without the latter.
More common sense from Ms. Yellen:
The housing market is improving and housing will remain an important channel for asset-building for lower and middle income families. But one of the lessons of the crisis, which will not be news to many of you, is the importance of diversification and especially of possessing savings and other liquid financial assets to fall back in times of economic distress. . . .
A larger lesson from the financial crisis, of course, is how important it is to promote asset-building, including saving for a rainy day, as protection from the ups and downs of the economy.
Which leads to the natural question, why should housing remain “an important channel for asset-building?” As opposed to, say, investment in stock index funds? Why should federal policy so strongly promote and subsidize this idea? Owner-occupied housing is a lousy asset. Yale’s Bob Shiller, hardly a right-winger, has been loudly producing facts on this point for two decades. The average rate of return is awful; housing is horribly illiquid—when you need $400, housing equity is not a big help; housing is full of idiosyncratic risk. You may live in a high-priced house that seems a great investment in retrospect. But our average low-income household in trouble “built assets” in houses in places such as Detroit.
The best thing financial policy and “consumer financial protection” could do is allow low-income households to rent, and invest their savings in a nice, balanced, passive mutual fund instead. Obviously, Ms. Yellen isn’t going to stand up and say that. But we can ask the question.
I am more dubious about the last part of this interesting speech:
The Federal Reserve’s mission is to promote a healthy economy and strong financial system, and that is why we have promoted and will continue to promote asset-building. One way we do this is through the Community Development programs at each of our 12 Reserve Banks, and through the Federal Reserve Board’s Division of Consumer and Community Affairs in Washington. As a research institution, and a convener of stakeholders involved in community development, I believe the Fed can help you in carrying out your mission, to encourage families to take the small steps that over time can lead to the accumulation of considerable assets.
I thought the Fed’s missions were price stability, employment, and financial regulation, period. Is “promoting asset-building” really the Fed’s job? Is the Federal Reserve now a “convener of stakeholders involved in community development”? I didn’t see that in the Federal Reserve Act. I thought the Fed was a central bank.
Perhaps Ms. Yellen is just being nice. But what happens if the Fed takes this seriously? If anyone wants to get serious about “promoting asset-building,” the horrendous disincentives to asset-building in Federal social programs are the obvious place to start. We’re not going to get serious about asset-building without that. But since this step is so political, and so absolutely not the Federal Reserve’s job, it seems foolish to get involved at all.
The Fed is in danger of mission creep, which will not long be tolerated from a politically independent central bank. A lot of Republican congresspeople might take objection to the idea of the Fed even saying it is a “convener of stakeholders involved in community development”—or more generally a completely independent agency entitled to do anything it wants to “promote a healthy economy.” I wish for the day I hear any Fed official say, “Here is a terrible problem, and I think our federal government should do something about it, but it’s not the Fed’s job.”
John H. Cochrane is AQR Capital Management Distinguished Service Professor of Finance at Chicago Booth.