Rebate or Bonus?

In Going Broke,I discuss Nicholas Epley’s studies of how thinking differently about a windfall influences what we do with it. In a series of laboratory studies, Epley found that money described as a “bonus” was more likely to be spent than money described as a “rebate.”

A bonus feels like extra income, whereas a rebate feels like lost income that is being restored: a reimbursement. In “Rebate Psychology,” an excellent op-ed piece in today’s NY Times, Epley points out that the proposals for an economic stimulus package fail to take advantage of his findings. If politicians are hoping to encourage spending, they would be better off describing the $600 and $1200 disbursements as bonuses, not tax rebates. Thinking about money differently can greatly influence whether we hold on to it or let it slip away.

Epley’s research is a good example of what psychologists call a framing effect, but the larger question is, should consumers spend or save their rebates? Many Americans would be better off saving their rebates or using them to pay down debt. As a result, I am glad that Epley’s framing effects have been ignored in the current proposals. Spending a “bonus” might be good for the stock market, but for many consumers, saving the tax “rebate” would be a much wiser course of action.

Moral Hazard and the Costs of Foreclosure

Today the Boston Globe reports that the City of Boston will begin pressuring mortgage companies to maintain their foreclosed, vacant properties. Many of these deteriorating buildings are in violation of city ordinances, and when safety becomes an issue, the city is forced to assume the costs of boarding buildings up or—as in the case of one home—draining a backyard pool.

The costs of maintaining foreclosed properties can be thought of as a negative externality: an expense produced by the mortgage companies’ own behavior that is borne by someone else, in this case the citizens of Boston. To the extent that we blame the foreclosure crisis on the irresponsible practices of lenders who have ventured into the risky subprime market, we can say that these costs have been unfairly unloaded onto the city. Ideally, the banks should adopt lending practices that make foreclosure less likely and factor all the costs of foreclosure—including the maintenance of vacant properties—into their business plans.

Which brings us to the concept of moral hazard: the idea that people who are shielded from the risks of their own actions behave less responsibly. Moral hazard is often applied to consumer behavior. For example, one of the arguments against supplying health insurance is that it might encourage risky behavior and the unnecessary use of healthcare services. If everyone assumed all the costs of their health-related behavior (e.g. eating, smoking, and visiting the doctor) would they behave more prudently?

The proposed responses to the foreclosure crisis also bring up issues of moral hazard. For example, would a bailout of the mortgage lenders shield them from the consequences of their unwise lending practices and inadvertently encourage that behavior? (For a discussion of these issues, see the NPR story “Subprime Bailout: Good Idea or 'Moral Hazard?”)

The question of how policies encourage or discourage prudent behavior is a constant concern. In this case, Boston City Councilor Robert Consalvo will introduce legislation that would force mortgage companies to identify who is responsible for the maintenance of empty buildings, post contact numbers, and pay a $100 annual fee for each vacant property. It is unclear whether this plan would eliminate a moral hazard in the lending industry and promote more responsible lending practices, but at very least, the City of Boston is justified in redirecting the costs of maintaining vacant foreclosed properties back to the owners.

The Prisoner's Dilemma of Tax Rebates

In a January 27th post to her blog, Elizabeth Warren likens the American consumer to a battered athlete who is being asked to go back in and do it one more time for the economy. Spend to help us win the game again. The proposed stimulus package will give the athlete a boost by putting a few hundred dollars in his or her pocket. The analogy is apt, because for millions of tapped-out consumers, spending the tax rebate will just put off debt repayment and maintain their current level of vulnerability to unexpected expenses or any other bumps in the economic road ahead.

The stimulus package highlights the Prisoner’s Dilemma of our current economy. Spending is good for the economy as a whole, but saving is good for the individual consumer. We have over-fished the waters of the consumer economy, and too many individual citizens have been sacrificed in the process. Rather than spend their rebates—which, ironically, the federal government must finance with borrowed money!—Warren recommends that consumers use the rebate to pay off some of their debts. BabyBelle, a commenter to Warren’s post, says she plans to deposit the rebate in her rainy day fund. Both of these ideas are on target. The rule should be (a), if you have debt, use the rebate to pay it down or (b), if you are debt free but have little savings, save the rebate. On the other hand, if you have no debt and plenty of savings, do whatever you want with your rebate. Unfortunately, not enough Americans fit in to this enviable category.

These recommendations may not help the economy as a whole, but generally “the economy” is defined as the stock market—the current value of the portfolios of wealthy investors. When the market starts to drop, the economy is said to be taking a down-turn, and the media and politicians begin to pay attention. But for far too long the personal financial portfolios of individual middle class and poor consumers have been going south without raising an eyebrow. It is time these consumers ignore the call to bail out the rich investors and concentrate on what is best for their personal economies. Save your rebate or use it to pay down debt. Don’t spend it.

Clinton & Singletary on the Economy

In a recent column entitled, “One Candidate and the Economy," Michelle Singletary, the personal finance columnist for the Washington Post, reports a conversation with Democratic presidential candidate Hillary Clinton. Clinton’s comments show that she is aware of the larger role of credit card and other commercial debt in the ongoing foreclosure crisis and general economic downturn. One of her most useful points is the need for financial education and improved financial literacy. Without blaming the victim, she recognizes that there is a serious problem of personal indebtedness and the need to help people get out from under.

This kind of article is not surprising from Michelle Singletary. She is one of the most level-headed personal finance advisors on the scene today. In a sea of useless financial advice, Singletary is an oasis of sound judgment.