This past week, Wells Fargo was ordered to pay over $200 million to customers they ripped off by nefarious transaction processing. It is pretty simple, actually, and not limited to Wells Fargo. Instead of processing debit card and check transactions on a first-come basis, the bank decided to process transactions descending by value, thereby racking up the maximum possible number of overdraft fees (in some cases over $300 per day). The judge in the case lambasted Wells Fargo for this practice, which isn't illegal except for when it is done surreptitiously. $200M is far from a paltry sum, but compared to the haul these banks generate from the larger pool of fees, it is a drop in the bucket.
This case illustrates a singular problem with modern day corporate finance: the focus on short-term profits over long-term viability. Rather than developing shareholder equity through traditional means (e.g., growing the pool of commercial and consumer customers), banks are increasingly relying on short-term revenue generating schemes that simply transfer wealth from their customers to their shareholders. The recently-passed financial reform bill and the creation of a first-of-it's-kind consumer financial protection agency are, at the very least, calling into question the permanency of these revenue sources, and as of today (August 15), banks are required to have customers "opt-in" to overdraft programs.
Even without legislative intervention, I find it hard to imagine a situation where banks continue to "innovate" ways to charge the hell out of customers. First, according to a FDIC report in 2008, the majority of overdraft fees are paid by those who can least afford it. This makes sense, as poorer customers are more likely to maintain low balances. This also means that, in general, poor customers are more likely to rack up other sorts of "account maintenance" fees (e.g., minimum balance requirements, late payments), implying that the fee business relies disproportionally on low-income accounts. This is not a good business strategy for any company targeting consumers... you can only get blood from a stone for so long.
Second, while fees have skyrocketed in recent years, the real cost of conducting financial transactions has plummeted due to technological innovation and low interest rates. This has allowed online-only banks and credit unions to realistically compete with national banks***.
Finally, and most important, by engaging in usurious practices and having that knowledge made public, big banks are less likely to find themselves competitive in the consumer-banking marketplace (and potentially the commercial marketplace, depending on how far public image considerations go). A recent example is the "move your money" campaign that garnered national attention a few months ago. Banks are, in effect, sacrificing reputation and long-term growth prospects for short-term profits, and as they rely on a dwindling customer base for revenue generation, there is no way this is sustainable in the long run.
Now, banks are claiming that they will have to find new sources of "revenue" to replace that lost by regulations. There is no doubt they will try to do this, and I say to them: good luck.
***Fidelity and Etrade both offer consumer banking services that refund all ATM fees (they do not have branches, and I imagine it is cheaper for them to pay the fees than it is to support the ATM infrastructure necessary for a national bank). They will charge fees if combined-account minimums are not reached. Other banks (Capital One) do not charge foreign transaction fees. Credit unions rarely have account maintenance fees on their basic checking accounts (go to http://www.money-rates.com/ ).
Disclaimer: technically, I am a Wells Fargo customer. I opened a checking account to take advantage of their "two-for-one" season pass to Winter Park and Copper, and plan on closing the account as soon as possible. I have a checking account, a savings account, and a mortgage with my university credit union, and a checking account with Fidelity. Although I occasionally overdraw my credit union account, I have a free line of credit that activates in those circumstances. Most banks offer this if your credit is not horrible.
Sunday, August 15, 2010
Friday, August 6, 2010
Are jobless benefits to blame for unemployment?
This is my first post, but why not start out with a complicated issue?
Relatively bad employment numbers came out Friday, and in celebration, CNBC posted this poll, asking people whether the jobless, enabled by repeated extensions of unemployment insurance (UI), are responsible for the current employment crisis. Last time I checked, a majority believed the answer to be yes, essentially echoing the views of John Kyl and other Republican lawmakers. The poll is not scientific, and certainly not objective. Public opinion polls are relatively meaningless when it comes to such a complex issue; what bothers me is that there is an abundance of excellent research into this claim, and none of it is ever mentioned in the public debate.
It seems that everyone (myself included) either knows someone or has heard stories about those who take advantage of UI. After being laid off, the suspect (lets call him George Costanza) makes a cursory effort to find work to secure benefits as long as possible. Meanwhile, our tax dollars are subsidizing George's lavish lifestyle of beer and volleyball. It makes sense that UI will, at the very least, create a "reservation wage," or salary level below which staying unemployed is a better option than taking a job. It also makes sense that an increase in the amount of UI paid (usually some percentage of previous wages up to some cap) will tend to increase the duration of unemployment. In other words, common sense suggests there is significant moral hazard associated with UI.
Disregarding the current crisis for the moment, what does the research suggest? First, it makes sense to consider what exactly it is that unemployment insurance is designed to accomplish. Just like any other insurance, UI is provided to protect against unforeseen events. Employers are required to pay taxes on payroll to provide a social safety net for laid off workers. Although it is easy to suggest that workers should be more responsible and have a "rainy day fund," it is rarely the case (in 2001, nearly half of newly unemployed workers reported zero liquid wealth at the time of termination).
So, what are the benefits of UI? First, these programs allow the unemployed to "smooth" their consumption over time, particularly when they are constrained in their ability to borrow. By providing a consistent flow of income, preexisting obligations can be met (think rent or mortgage payments), and a moderate standard of living can be sustained, allowing the unemployed the opportunity to find a new job without selling the family silver. Second, and related, by providing these "private" benefits, social goals are met, namely the prevention of a compounding negative economic shock. Consider an industrial plant closing in a smaller town. Hundreds of previously employed people now are faced with the grim reality of zero income. Spending in local shops drops, leading to more job losses. Mortgage payments are missed, and perhaps some homes are foreclosed on, lowering property values in surrounding neighborhoods. UI can help reduce these impacts by, at the very least, smoothing the transition to new jobs, and more likely by maintaining local consumer demand. Indeed, Mark Zandi recently testified that a $1 increase in UI benefits generates an estimated $1.64 in near-term GDP vs. approximately $0.29 per dollar if we extend the Bush tax cuts. This is because those receiving UI are generally budget constrained in their ability to save, so almost every dollar re-enters the economy immediately. In other words, UI is an effective short-term stimulus, maintaining or increasing consumer demand in our consumption-driven economy.
These are benefits. What about the disincentive to work? Well, turns out this effect is not that strong. Many research studies have looked at how the duration of unemployment spells is affected by the length of unemployment benefit payments. However, these studies need to be carefully conducted; when comparing across states or times, it is important to account for the fact that, in general, benefit extensions are associated with periods of high unemployment. Proving causation in this setting is very difficult. One recent study by David Card and Phillip Levine* found the impact of a politically-motivated extension of jobless benefits on unemployment duration was relatively small. For a 13 week extension, the average spell of unemployment increased by only one week.
Other evidence on the disincentive effect of UI is the "bunching" of workers exiting the unemployment pool at the time of benefit exhaustion, implying that they are using up all their benefits and then finding a job. Card, Chetty, and Weber** performed a statistical analysis of previous studies and also applied their model to the Austrian economy, showing that fewer than 1% of workers' re-entrance to employment coincided with benefit exhaustion. The reason for the sharp contrast with previous studies is simple: those other studies measure the duration of unemployment based on self-reporting of employment status. Workers are required to register as unemployed with the unemployment agency to receive UI benefits. After the exhaustion of benefits, they may continue to register if they want to take advantage of job search services, etc., but there is no financial payment, and so many workers simply choose to exit the unemployment system (note: continuing registration is generally required to prevent situations where a worker never tells the agency they found a job, thereby inflating unemployment numbers). Card et al. focus on the period between losing a job and starting a new job, and find that the bunching effect is very small.
Most recent empirical work suggests that the disincentive effect associated with UI is small, particularly when compared to the estimated benefits of these programs. What does this say about the current situation?
Right now, the US is experiencing one of the worst economic downturns ever . Compounding the traditional drop in employment during recessions is the fact that jobs are returning much more slowly than would be expected given GDP numbers and the rebound in equity markets (see graph, taken from Calculated Risk). The reasons for this disturbing trend are numerous, and not the point.
Unfortunately, there are not many empirical corollaries to the present situation, but when there are about 5 job seekers for every available job, it is hard to convince me jobless benefits are to blame for the unemployment rate. Shooting from the hip, I would argue that in the current economic climate, the benefits of UI are higher than normal and the efficiency costs are lower. The first point is more obvious: right now, we are suffering from a severe lack of demand in the economy, and although the stimulus package has helped save/create jobs and pumped badly needed cash into communities, UI is probably a more effective way to stimulate demand quickly and temporarily (see Zandi comments referenced above). Additionally, if benefits were to permanently lapse (there have been a few temporary lapses recently due to the political stalemate in the senate), the feared double-dip in the housing market would almost certainly materialize as a huge block of the unemployed find it impossible to continue making mortgage payments (or, for that matter, rent payments). Older unemployed with families will enter the public assistance pool and younger workers will move back in with their parents, when possible. Mortgage and credit card default rates will skyrocket, and the fragile recovery will be imperiled. Finally, by extending UI, the other programs associated with an unemployed status are utilized by workers. Although the outlook is dismal for the long-term unemployed, to collect a check they need to try to find work, something that is not necessary to qualify for welfare or other public assistance programs. Not extending UI benefits will reduce the federal deficit on the surface, but as the unemployed are absorbed into other public assistance programs, local and state governments will feel an even more significant pinch.
Although this is conjecture, my belief is that the efficiency costs of UI are lower during an economic downturn (the disincentive to find a job is lower). Generally, UI provides a fraction of normal income, meaning that families will supplement UI with savings or loans in the expectation that work will come soon. As workers are unemployed for longer and longer , savings are diminished. In many cases, UI will cease to cover a pre-unemployment standard of living, and so the incentive to find a job should increase as the duration of unemployment increases. Second, uncertainty about the possibility of UI extensions increases the opportunity cost of turning down a job; if you can't count on an extension and jobs are scarce, the tradeoff between remaining unemployed and taking a low-wage job is shifted to the latter.
So, is UI to blame for the unemployment rate? Sure, without benefits the official rate would be lower, but that would be due to the fact that there is little incentive to call yourself unemployed if you aren't benefiting financially. In all actuality, the real unemployment rate would probably be higher as the stimulating benefits of UI are lost. With deficit hawks making a political comeback, the extension of jobless benefits will continue to be debated, but the evidence is pretty clear: there are benefits associated with UI, and the potential risks of removing assistance from millions of unemployed are enormous. Until the private sector begins hiring in earnest, jobless benefits should be extended.
*David Card and Phillip B. Levine, “Extended benefits and the duration of UI spells: evidence from the New Jersey extended benefit program,” Journal of Public Economics 78 (2000): 107‐138.
**David Card, Raj Chetty and Andrea Weber, "The Spike at Benefit Exhaustion: Leaving the Unemployment System or Starting a New Job?," American Economic Review 97 (2007): 113-118.
Relatively bad employment numbers came out Friday, and in celebration, CNBC posted this poll, asking people whether the jobless, enabled by repeated extensions of unemployment insurance (UI), are responsible for the current employment crisis. Last time I checked, a majority believed the answer to be yes, essentially echoing the views of John Kyl and other Republican lawmakers. The poll is not scientific, and certainly not objective. Public opinion polls are relatively meaningless when it comes to such a complex issue; what bothers me is that there is an abundance of excellent research into this claim, and none of it is ever mentioned in the public debate.
It seems that everyone (myself included) either knows someone or has heard stories about those who take advantage of UI. After being laid off, the suspect (lets call him George Costanza) makes a cursory effort to find work to secure benefits as long as possible. Meanwhile, our tax dollars are subsidizing George's lavish lifestyle of beer and volleyball. It makes sense that UI will, at the very least, create a "reservation wage," or salary level below which staying unemployed is a better option than taking a job. It also makes sense that an increase in the amount of UI paid (usually some percentage of previous wages up to some cap) will tend to increase the duration of unemployment. In other words, common sense suggests there is significant moral hazard associated with UI.
Disregarding the current crisis for the moment, what does the research suggest? First, it makes sense to consider what exactly it is that unemployment insurance is designed to accomplish. Just like any other insurance, UI is provided to protect against unforeseen events. Employers are required to pay taxes on payroll to provide a social safety net for laid off workers. Although it is easy to suggest that workers should be more responsible and have a "rainy day fund," it is rarely the case (in 2001, nearly half of newly unemployed workers reported zero liquid wealth at the time of termination).
So, what are the benefits of UI? First, these programs allow the unemployed to "smooth" their consumption over time, particularly when they are constrained in their ability to borrow. By providing a consistent flow of income, preexisting obligations can be met (think rent or mortgage payments), and a moderate standard of living can be sustained, allowing the unemployed the opportunity to find a new job without selling the family silver. Second, and related, by providing these "private" benefits, social goals are met, namely the prevention of a compounding negative economic shock. Consider an industrial plant closing in a smaller town. Hundreds of previously employed people now are faced with the grim reality of zero income. Spending in local shops drops, leading to more job losses. Mortgage payments are missed, and perhaps some homes are foreclosed on, lowering property values in surrounding neighborhoods. UI can help reduce these impacts by, at the very least, smoothing the transition to new jobs, and more likely by maintaining local consumer demand. Indeed, Mark Zandi recently testified that a $1 increase in UI benefits generates an estimated $1.64 in near-term GDP vs. approximately $0.29 per dollar if we extend the Bush tax cuts. This is because those receiving UI are generally budget constrained in their ability to save, so almost every dollar re-enters the economy immediately. In other words, UI is an effective short-term stimulus, maintaining or increasing consumer demand in our consumption-driven economy.
These are benefits. What about the disincentive to work? Well, turns out this effect is not that strong. Many research studies have looked at how the duration of unemployment spells is affected by the length of unemployment benefit payments. However, these studies need to be carefully conducted; when comparing across states or times, it is important to account for the fact that, in general, benefit extensions are associated with periods of high unemployment. Proving causation in this setting is very difficult. One recent study by David Card and Phillip Levine* found the impact of a politically-motivated extension of jobless benefits on unemployment duration was relatively small. For a 13 week extension, the average spell of unemployment increased by only one week.
Other evidence on the disincentive effect of UI is the "bunching" of workers exiting the unemployment pool at the time of benefit exhaustion, implying that they are using up all their benefits and then finding a job. Card, Chetty, and Weber** performed a statistical analysis of previous studies and also applied their model to the Austrian economy, showing that fewer than 1% of workers' re-entrance to employment coincided with benefit exhaustion. The reason for the sharp contrast with previous studies is simple: those other studies measure the duration of unemployment based on self-reporting of employment status. Workers are required to register as unemployed with the unemployment agency to receive UI benefits. After the exhaustion of benefits, they may continue to register if they want to take advantage of job search services, etc., but there is no financial payment, and so many workers simply choose to exit the unemployment system (note: continuing registration is generally required to prevent situations where a worker never tells the agency they found a job, thereby inflating unemployment numbers). Card et al. focus on the period between losing a job and starting a new job, and find that the bunching effect is very small.
Most recent empirical work suggests that the disincentive effect associated with UI is small, particularly when compared to the estimated benefits of these programs. What does this say about the current situation?
Right now, the US is experiencing one of the worst economic downturns ever . Compounding the traditional drop in employment during recessions is the fact that jobs are returning much more slowly than would be expected given GDP numbers and the rebound in equity markets (see graph, taken from Calculated Risk). The reasons for this disturbing trend are numerous, and not the point.Unfortunately, there are not many empirical corollaries to the present situation, but when there are about 5 job seekers for every available job, it is hard to convince me jobless benefits are to blame for the unemployment rate. Shooting from the hip, I would argue that in the current economic climate, the benefits of UI are higher than normal and the efficiency costs are lower. The first point is more obvious: right now, we are suffering from a severe lack of demand in the economy, and although the stimulus package has helped save/create jobs and pumped badly needed cash into communities, UI is probably a more effective way to stimulate demand quickly and temporarily (see Zandi comments referenced above). Additionally, if benefits were to permanently lapse (there have been a few temporary lapses recently due to the political stalemate in the senate), the feared double-dip in the housing market would almost certainly materialize as a huge block of the unemployed find it impossible to continue making mortgage payments (or, for that matter, rent payments). Older unemployed with families will enter the public assistance pool and younger workers will move back in with their parents, when possible. Mortgage and credit card default rates will skyrocket, and the fragile recovery will be imperiled. Finally, by extending UI, the other programs associated with an unemployed status are utilized by workers. Although the outlook is dismal for the long-term unemployed, to collect a check they need to try to find work, something that is not necessary to qualify for welfare or other public assistance programs. Not extending UI benefits will reduce the federal deficit on the surface, but as the unemployed are absorbed into other public assistance programs, local and state governments will feel an even more significant pinch.
Although this is conjecture, my belief is that the efficiency costs of UI are lower during an economic downturn (the disincentive to find a job is lower). Generally, UI provides a fraction of normal income, meaning that families will supplement UI with savings or loans in the expectation that work will come soon. As workers are unemployed for longer and longer , savings are diminished. In many cases, UI will cease to cover a pre-unemployment standard of living, and so the incentive to find a job should increase as the duration of unemployment increases. Second, uncertainty about the possibility of UI extensions increases the opportunity cost of turning down a job; if you can't count on an extension and jobs are scarce, the tradeoff between remaining unemployed and taking a low-wage job is shifted to the latter.
So, is UI to blame for the unemployment rate? Sure, without benefits the official rate would be lower, but that would be due to the fact that there is little incentive to call yourself unemployed if you aren't benefiting financially. In all actuality, the real unemployment rate would probably be higher as the stimulating benefits of UI are lost. With deficit hawks making a political comeback, the extension of jobless benefits will continue to be debated, but the evidence is pretty clear: there are benefits associated with UI, and the potential risks of removing assistance from millions of unemployed are enormous. Until the private sector begins hiring in earnest, jobless benefits should be extended.
*David Card and Phillip B. Levine, “Extended benefits and the duration of UI spells: evidence from the New Jersey extended benefit program,” Journal of Public Economics 78 (2000): 107‐138.
**David Card, Raj Chetty and Andrea Weber, "The Spike at Benefit Exhaustion: Leaving the Unemployment System or Starting a New Job?," American Economic Review 97 (2007): 113-118.
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