Keep the change is good for you, great for Bank of America

Readers have been interested in Bank of America’s Keep the Change program, which began in 2005, as a vehicle for boosting savings, and possibly charitable donations. There’s no charity option yet, but what about the savings benefits to participants? A 2008 Peter Tufano and Daniel Schneider paper has some answers.

Bank of America attributes 1.8 million new savings accounts to the Keep the Change program…and as of April 2007, its 4.3 million program participants had saved approximately $400 million collectively or about $93 on average – a steady rise from average savings of $30 in April 2006 and $67 in October of 2006.

How much has KTC benefited BofA?

Bank reports indicate that the program is a valuable customer acquisition tool, bringing in 1.8 million new savings accounts and 1.3 million new checking accounts over 19 months of program operation…The program has the potential to increase debit card use, can reduce bank costs associated with processing paper checks, and generate incremental interchange revenues from each debit card transaction…While the deposits generated by Keep the Change pale relative to Bank of America’s total assets of $1.46 trillion, the funds currently earn an interest rate of just 0.20 percent in the bank’s regular savings account permitting the bank to profit from the net interest margin.

Assorted links

1) The New Yorker interview with Richard Thaler.

2) London’s mayor wants to start a recycling bank program that gives people shopping vouchers for their recyclables.

3) Another plug this past weekend for the automatic tax return. California says it costs $2.59 to process a paper return, but only 34 cents to process its version of the automatic tax return, ReadyReturn. The makers of Turbo Tax have been trying to end the program, most recently this fall.

4) Calorie postings at Starbucks led to lower calorie consumption by six percent–except around the holidays. Hat tip: Farnam Street.

5) Will Obama mention the automatic IRA in his State of the Union speech Wednesday?

Why can’t “keep the change” send it to a charity instead?

Keep the Change is a Bank of America program that takes a debit card purchase, rounds it up to the nearest whole dollar and deposits the difference in the consumer’s saving account. Moving some spare change to your savings account every day probably isn’t going to guarantee a comfortable retirement, and so the program may not seem all that appealing to people. “I don’t use the program now because the incremental savings isn’t great enough to change my behavior,” writes reader Kate Barasz. How can Bank of America get customers like Kate to participate?

More than a few readers with similar thoughts have written in to ask: Why can’t Bank of America offer the option to send this spare change to a charity of the consumer’s choice instead? That would increase its popularity, readers say. Of course, sending the money, even in these small amounts, would move it out of the bank’s capital base. Given how pitiful interest rates are these days on savings accounts and how conservative lending standards have become, every penny that stays in house is likely to make banks a nice return. Bottom line: Good idea; don’t look for it anytime soon.

What do Kenyan farmers and American workers have in common?

1) They both pay a price for their procrastination. American workers pay when it comes to planning and saving for their retirements; Kenyan farmers pay when it comes to planning and purchasing fertilizer for their harvests.

2) They both love free shipping.

In a working paper titled “Nudging Farmers to Use Fertilizer: Theory and Experimental Evidence from Kenya,” three economists from MIT, Harvard, and the University of California-Santa Cruz weigh in on a contentious policymaking debate with some interesting findings. Many policymakers consider fertilizer subsidies to be a standard tool for boosting agricultural productivity and economic growth in developing countries. Many economists criticize these subsidies as inefficient mechanisms, which are instead used to line politicians’ pockets and keep them in power. If Kenyan farmers behaved like econs, the economists’ argument goes, they would be able to figure out the exact amount of fertilizer necessary for generating more crops and more profits, all without the need for any subsidies. After all, it’s hardly a secret that fertilizer yields more crops, and since it can be bought and sold in almost any amount, farmers should easily be able to purchase the exact amount necessary for their plot of land.

But it turns out that most farmers behave like humans–71 percent of them according to the paper–by thinking they’ll buy fertilizer, which they’ll absolutely, positively buy…tomorrow. They overestimate their patience and planning talents, waiting until the last possible moment to buy fertilizer and ending up with not much of any. It is possible, authors Esther Duflo, Michael Kremer, and Jonathan Robinson say, that large subsidies could spur fertilizer purchases, but it is also possible that these subsidies could lead to wasted purchases, extra transaction costs, and fertilizer overuse among impatient buyers. (The consequences of saving too much seem less damaging than buying or using too much fertilizer.)

What if there was a commitment strategy that could help farmers use fertilizer more efficiently and boost crop yields?

Working with a non-government organization called International Child Support, the economists developed a plan to offer small, limited-time discounts right after the harvest when farmers have extra money from recent sales. The simplest form of the discount wasn’t much of a discount. Farmers were offered a voucher allowing them to pay full price for the fertilizer and get free delivery at a date of their choosing. But free delivery is a powerful incentive for a farmer who typically has to spend time and money going to town to purchase fertilizer. Farmers were also given the option to commit to these discounts before the harvest. The program could have offered discounts at different points during the harvest season, but the economists thought that earlier discounts would not need to be as big as later discounts in order to spur purchases. They tested the idea against a standard 50 percent subsidy and simple reminders about the importance of fertilizer (without discounts). Neither performed as well as the nudge. Simply offering free delivery early in the season increased actual fertilizer use by 46 to 60 percent, a bigger boost than with a half-off subsidy offered later in the season.

The Kenyan farmers example may offer some ideas for banks here in the U.S., which could certainly benefit from a healthier deposit base. There are many commitment strategies for saving – Save More Tomorrow being the favorite one from Nudge. The savings nudge with the closest resemblance to the fertilizer nudge is a debit card loaded with your tax refund. Aimed at Americans without bank accounts, the card provides a way to put cash aside without paying huge check cashing fees. Perhaps some marketing campaigns for special savings accounts or certificates of deposit with slightly higher interest rates could be offered around New Years Day, when people are always trying to make commitments, or tax day, when people have a few extra dollars in their wallet.

Of course, the real lesson from this nudge may be the power of free shipping. Would Americans accept lower interest rates or commit to locking up their money for longer periods if banks offered to pay the shipping costs (up to some amount) on their DVD and book purchases for the year?

Interested readers can find a full copy of the June version of the paper can be found here. A gated copy of the August version can be found here.

Obama proposes savings nudges

In case you missed them over the weekend, the Obama administration announced ideas designed to boost saving by Americans. Readers were all over this story from the start (kindly sending the Nudge blog e-alerts). Nudgers will recognized many of the ideas, such as automatic enrollment in 401k plans, tax refunds in the form of U.S. Savings Bonds, and easy ways to move money earned through overtime and extra vacation days into retirement accounts. Read the full piece here.

Behavioral economics and standing in line outside indymac

Since the Great Depression, the U.S. government has insured bank deposits up to $100,000 per account. So why, last week, were so many people standing in line at IndyMac, the California bank that failed under the crush of bad subprime loans? Fear, uncertainty, loss aversion, a propensity for herd behavior – behavioral economists have seen this all this before. A seminal paper on herd behavior in non-market contexts (Banerjee 1992) argued that herd behavior can occur when private information is not shared publicly. Individuals with private information act, leading to information cascades as others follow their lead, with the result being a socially suboptimal outcome.

In the case of IndyMac, no one had – or has – any private inside information about the collapse of the Federal Deposit Insurance Corporation, and yet public notices about bank deposit insurance did not keep people at home. Of course, everyone in line might have simply wanted enough money to pay a mortgage and food for a month, or had assets greater than $100,000, which meant all of their money wouldn’t have been insured. But what are the odds?

The Washington Post points out an interesting distinction between how people see the failures of human institutions like IndyMac versus the physical destruction caused by natural events like hurricanes.

People are often more fearful of man-made events than they are of natural ones. “We are rather blase about nature,” said Paul Slovic, the founder of Decision Research, an Oregon nonprofit group that studies human behavior and advises governments. “We think it’s generally benign even though we get clobbered by it over and over again. That’s why after a big storm we go back and rebuild on the spot.”

He continued: “But we are quite the opposite for certain types of risk that are human-caused, particularly if they involve something new or mysterious. We react very strongly to that. . . . If people see signs of incompetence or that the system is not being regulated or controlled, that is very worrisome.”

Obama and Clinton on how to boost savings rates

Roger Lowenstein nicely distinguishes Hillary Clinton and Barack Obama’s policy and philosophical differences about how to help people save more money.

Clinton has proposed a national 401(k) under which the government would match up to the first $500 to $1,000 that a worker sets aside. The intent is to kick-start poor and middle-class people, who do not have the income to take advantage of tax deductions and whose savings rate is especially low. “The tax system is upside down when it comes to savings,” says Gene Sperling, Clinton’s economic adviser. “We give the most incentive to those who need it least.” (Only 5 to 7 percent of savings deductions go to people on the bottom half of the income ladder, Sperling says.)

The Clinton proposal mixes egalitarian values with free-market orthodoxy. It assumes that if you give people an incentive to save, they will. Indeed, economic theory holds that most folks will do the math, figure out how much they need to save for the future and act on it now. But experience has shown otherwise. Actual people (as distinct from the textbook variety) are not necessarily so responsible. Many Americans do not take advantage of 401(k)s. They also do lots of other silly things with their finances, like taking mortgages they can’t afford.

Obama’s remedy for human irrationality is to use the government to force a choice on people — but a choice in which inertia would tilt the outcome toward greater savings. Obama wants to require employers to automatically enroll workers in 401(k) plans at a savings rate of 3 percent. Employees would be free to opt out (or to choose a higher savings rate). Obama would also provide a federal match, but a smaller one than Clinton. His central idea, backed by new research but strongly at odds with traditional mainstream economics, is that changing the default option will encourage as much saving as providing a financial incentive. In other words, if people have to opt out of plans rather than in, they will end up saving more. Obama is sympathetic because it jibes with his experience as a community organizer, when he found that people did not apply for grants or programs for which they were eligible.