The Death of the Middle Class, Myth #1: No one can afford to save any more

Elizabeth Warren starts her talk off with the falling national savings rate. The savings rate has indeed fallen; in fact, it has become nonexistent. But Warren, like many commentators, implies that this is because families are too strapped to save. In fact, it's because of the two successive bubbles in the stock and housing markets. Families responded to the run up in their net worth by saving less. If you look at assets, rather than savings rates, people in the boomer generation--the generation that is in its prime savings years now--look pretty much like their parents.

Now, you could argue that this was foolish, and I in fact agree with you; Boomers need more savings than their parents, and they shouldn't have been so confident in massive paper gains. But that's not the same thing as saying that they were forced to forgo saving in order to provide for their kids, which is essentially what Elizabeth Warren argues. The asset model is a standard explanation that pretty much any economist in the country could give you; either Elizabeth Warren didn't ask any, or she ignored what they said. Even if you think this explanation is wrong, I think you need to explain why your model is a better fit.

Comments

Elizabeth Warren (like her gen-X counterpart Anya Kamenetz) is a hack who makes her money by telling her readers what they want to hear: That their middle-class lives are really tough. That their lack of savings are somebody else's fault. That what with all the granite countertops, SUVs, cell phones, internet connections, and daily Starbucks lattes that the poor, put-upon middle class has to have nowadays, somebody should really be giving her readers some money so that they can afford it all.

Elizabeth Warren was smart enough not to talk to an economist, because she knew what the economist would have to say would not be what her readers wanted to hear.

Posted by David Wright | May 7, 2008 5:02 PM

you didn't even link to her, or her work, for further reference?
http://clusty.com/search?input-form=clusty-simple&v%3Asources=webplus&query=Elizabeth+Warren+

I've called you vapid & hateful, before, but, I Sincerely hope that this was, simply, hasty posting sans proofing..

Posted by Mark E Hoffer | May 7, 2008 5:05 PM

It seems to me that the idea that the middle class can't afford to save is self-evidently false. Incomes vary widely, yet just about everybody manages to get by. If a family of four can get by on $40,000 per year, then a family of four making $50,000 per year can afford to save $7-8k per year (after taxes). If they aren't, it's not because they can't--it's because they've decided to spend that money on unnecessary expenditures.

Posted by Brandon Berg | May 7, 2008 5:17 PM

I imagine if they were to adopt the median living standards of a family in 1985, they would save a significant amount of money. Lemme know when the Ford Focus becomes the best selling four door sedan, and the median home size shrinks, cable and satellite t.v. subscriptions drop significantly, etc., etc., while the saving rate remain stagnant, and then Warren might have a point.

Posted by Will Allen | May 7, 2008 5:31 PM

Also, Spencer, if that really was the issue, problem solved; the movement of women into the workforce has pretty much plateaued.

Posted by Megan McArdle | May 7, 2008 5:43 PM

Perhaps I am overly skeptical of government competence, but I often wonder if the methods they use to measure savings capture the changing nature of our savings today.

For example, if the savings rate were to just count net inflow to FDIC insured accounts, it would count me as zero or slightly negative.

Yet I have 8% of my income going into a 401k. I also have a growing portolio (well not this year) where my dividends & gains are reinvested. Do these investments count as savings?

Oh, and who the heck is Spencer?

Posted by Keith | May 7, 2008 5:59 PM

My wife and I live in DC, and our combined income last year was just above $100K. We saved last year, after taxes, between the two of us, nearly $40,000.

No, I am not making that up.

How did we do it? We live way, WAY beneath our means. We paid off our cars way before the terms of the agreement a couple of years ago, she cooks at home and does a fantastic job (better than most restaurants), we live in a cheap two-bedroom apartment, and our biggest entertainment extravagance is the monthly DirecTV bill.

We plan to move to the Midwest in less than a year, where we actually will be able to afford a single-family home. And both of us should have no problem finding jobs.

I've said we should write a book, but I'm afraid American society wouldn't be interested in reading our secret, because sacrifice and future-oriented thinking over several years' hard work isn't The Fast, Secret, New Way YOU Can Get Rich!

Posted by Michael | May 7, 2008 6:08 PM

I'm a philosopher, not an economist (though these are not mutually exclusive in principle, they are in my case). But I blame the cost of college education. My husband and I were paying off our own student loans into our 40's, when we should have been saving toward our children's college educations. So now we are taking out more loans to cover theirs. We will probably never have any significant savings, but with luck, our kids won't get stuck on the same wheel.

Posted by Kalynne Pudner | May 7, 2008 6:14 PM

Keith,

Information on 401(k) and pension plans has to be reported to the Department of Labor (at least if they're over a certain size, I think), so the federal government already has the data it needs to incorporate that into it's analysis. I'd be shocked if they weren't including it.

Posted by Jeff | May 7, 2008 6:24 PM

In the absence of big asset value gains -in fact it looks like real estate asset values are shrinking-won't people need to save more in the future to keep their asset values on par with previous generations?

Michael, you say you should write a book, maybe it will be a best -seller, like "The Wealthy Barber" which was a big success in Canada some 10 or 15 years ago and had exactly that type of advice. Unfortunately the people who most needed to read it, wouldn't.

Posted by Bill | May 7, 2008 6:27 PM

Kalynne: The cost of an typical college education has indeed increased a lot in the last 25 years. But you know what has increased even more? The lifetime earnings premium of having a typical college education. If you do a back-of-the-envelope calculation of the NPV of a college education, you find that a 20-year-old would find it worthwhile to pay upwards of $300K for a college education.

I am not surprised to find that philosophy majors are atypical as regards this cost/benefit analysis. Perhaps the financial wisdom you could impart to your kids is that they should become engineers.

Posted by David Wright | May 7, 2008 6:28 PM

Don't disrespect philosophy majors. My mom was a philosophy major. She did fine because she married my dad, a successful small business owner. He started from nothing other than hard work and a clever mind. He grew up during the depression and didn't go to college.

Posted by Nelson | May 7, 2008 6:54 PM

David,

Your Premises are True, though, could it be, that you're missing the Forest, for the Trees, so to say?

I mean, if you look at Elizabeth Warren's background, you'd see her experience with Credit Card connivances http://www.thefreedictionary.com/connivance , and, potentially, see some additional Premises.

You may have heard of: "The Sub-Prime Meltdown" --Now at a Theatre near you..

LSS: Many promises, supporting recent 'Asset' valuations, are FOS

Deleveraging not only destroys Debt, but also, the then/now Fraudulent/Unsustainable previous 'Valuation'..

some might begin to suggest non-linearity.

Posted by Mark E Hoffer | May 7, 2008 6:56 PM

The fundamental mistake here is not understanding what "savings" actually are. The are highly intermediated INVESTMENTS. The bank does not pay me 1.5% interest on my account due to my good looks or their good nature (both of which are highly suspect) but because they are investing it (in the form of loans) at 10% or better.

People have caught on to this, and are choosing to invest their own money directly, cutting out the middleman (the bank), thus disintermediating the investment process, accepting higher risks inreturn for higher rewards.

I'm 42 an everyone I know is investing either businesses, property, markets, or in human capital (in the form of education).

We are better prepared for retirement BECAUSE we save less than our parents did - and invest more.

Posted by plebist | May 7, 2008 7:00 PM

Jeff (& Keith):

My understanding of how the savings numbers are run (though I'm hardly expert) is that any form of investment (a 401k, IRA, 529 funds, gold futures, etc.) is not counted as saving but as consumption. Therefore, if your gross income is $100K and you pay $30K in aggregate taxes (fed, state, local, SS, Medicare, etc.), pay $30K in mortgage, put $15K in your 401k, $5K in a 529 plan, and spend $20K on miscellaneous expenditures (car, food, entertainment, clothes, travel, healthcare, etc.), you may think your savings rate is a virtuous 20%, but officially you've saved $0.

It is one of the reasons current US savings rate calculations tend to be skewed vs. other first world countries and vs. the past - Americans, in general, now have better (more varied, accessible and productive) investment options, and so they don't keep their "savings" in the bank (or under the mattress). Most people's lay understanding of "savings" would include the 401k and 529 plan (and maybe, if it's still 2005, the mortgage), so when they hear "negative savings rates!" trumpeted in the press they immediately think people are buying new cars with the kid's college fund, and don't realize that their own savings rate may technically be 0.

Posted by Kathryn | May 7, 2008 7:14 PM

Kathryn: I'd like to agree with you, but my perusal of google finds little to agree with you. If anything, this article from the 2005 'boom times' disagrees:

"Which of these economists are right? Let's take a closer look at the saving rate.

The Bureau of Economic Analysis starts with personal income, which includes wages (from a job or self-employment), dividends, interest, rental income (if you are a landlord), and employer contributions to health and retirement plans.

From this it subtracts income tax and the employee's share of payroll taxes. The difference is disposable personal income.

From this it subtracts consumer non-investment expenditures, including retail sales, utilities, interest payments on consumer debt, and money people send to friends and relatives overseas.

For housing, the bureau counts rent for renters or mortgage interest, property taxes and insurance for owners. It does not subtract down payments or principal payments on a house.

What's left is personal savings.

"It's the amount of money out of your income that you don't spend and don't pay in taxes. It's what you can put in the bank or stock market," says Shoven.

The saving rate is personal savings expressed as a percentage of disposable personal income."

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2005/08/07/BUG5JE423K1.DTL

Posted by Klug | May 7, 2008 8:06 PM

Kalynne, while I appreciate that you want to do as much for your children as possible, you might consider asking them to contribute to their college educations. By your report, you and your husband had to pay off your own student loans... so you paid for your educations, right? And yet you feel it necessary to pay for your children's educations as well.

Of course, I know very well that tightening guidelines about loans and grants make it harder for the students to get the necessary funding. There were changes in the law in between the time my sisters went to college and the time I went to college that meant it was much harder for my brother and I to afford college. Only the advice from my parents to apply for scholarships even if I felt underqualified for them kept me from greater debt, and I managed to get out in four years without once calling on my parents for money.*

I don't want to pick on you, just to challenge the assumption that you, as a parent, are solely responsible for two sets of college educations, your own and your children's. It may take them longer to work their way through college but it might be the most valuable thing they've ever done. (IOW, please don't take offense; if you want to do this for your children, go ahead. I just don't understand why even asking the student to contribute has become such a horrifying idea.)

*I did get chewed out for this once when I revealed at the semester break that my loan paperwork had gotten screwed up and I'd run out of food money, but honestly it hadn't occurred to me that the check would take as long as it did to come...

Posted by B. Durbin | May 7, 2008 8:34 PM

Well, fair enough, I'm wrong. Thanks for the link.

However, the treatment of investment income does skew things for a country that saves by investment rather than putting cash into the bank (or post office, or the mattress).

Lets say I put that same $20K into the 401k and 529 accounts this year. Say I also sell stock which has seen $20K in long-term appreciation. The $20K realized capital gain isn't included in my income. The $3K capital gains tax I pay on it, however, is deducted. So is my expenditure of the remaining $17K when I buy a new boat. I still have put $20K away in savings, but officially I've saved nothing.

Posted by Kathryn | May 7, 2008 8:53 PM

Great link Klug, Thanks.

It seems the answer is that my 401k contributions and my reinvested dividends count, but the reinvested capital gains do not.

It is also interesting to note that the employer contribution to health care (~15% of my pay for a family plan) counts as income so my 8% 401k only counts as 7% savings.

I also found the following from the Klug's link (a couple posts up) to be interesting:

According to Lonski's calculations, real (inflation-adjusted) net worth per U.S. worker is very close to the record high set in the first quarter of 2000, just before the stock market crashed.

This article was written in Aug 2005, pretty close to the peak for many housing markets. Perhaps net worth is a decent indicator for when speculative bubbles pop?

Posted by Keith | May 7, 2008 9:02 PM

Kalynne:
You failed to mention here, as you do in the sidebar of your blog, that you have a PhD in philosophy and nine children. While I applaud your attempt to singlehandedly save western civilization from both intellectual and demographic ruin, these are clearly factors in your inability to pay off your student loans before you turned 40.

If this is what you want in life, that's great, but you can't cite your personal experience as evidence of how rising tuition costs have made it impossible for most people to save, partly because your personal experience is extremely atypical, and partly because you could have saved money if you'd made different choices.

Also, trying to pay for college for nine children is crazy, especially if it means you can't save for your own retirement. Paying their tuition isn't going to do them any good if you end up financially dependent on them in your old age.

Posted by Brandon Berg | May 7, 2008 9:17 PM

Kathyrn and Keith:

Sorry to be the bearer of bad news. I really wish it weren't so.

That being said (and apropos of the discussion above), it's worth mentioning that college tuition (not such a small expense) counts as consumption as opposed to investment. Interesting.

Posted by Klug | May 7, 2008 9:23 PM

Kathryn/Keith:
There's a good reason for the treatment of capital gains. Let's say you buy $20,000 worth of stock at an IPO. That's $20k worth of investment. Later you sell it for $40k and by $40k worth of another company at IPO.

How much has the country's capital stock increased as a result of these transactions? You initially invested $20k, then the company created $20k worth of capital, presumably by reinvesting earnings, and then you invested $40k in another company, for a total of $80k.

But if we count reinvested capital gains, we end up with $120k. First your $20k, then the $20k generated by the company, then $40k from the person who bought your stock, and finally another $40k when you buy the other stock.

If you count reinvested capital gains, you end up counting transfer payments, which aren't real savings.

Posted by Brandon Berg | May 8, 2008 12:19 AM

MM,

with this: "you didn't even link to her, or her work, for further reference?" Sorry, I didn't see your previous post linking to her speech/video clip...a good example of one: "hast(-il)y posting sans proofing..".

I guess I could have tried to pass it off as an attempt at Irony, but, it wouldn't be so..

Posted by Mark E Hoffer | May 8, 2008 7:39 AM

Mark - Megan is vapid and hateful because she is poking holes in Warren's argument? Are you serious?

Posted by jult52 | May 8, 2008 8:08 AM

Posted by jult52

No, that wasn't it, I was under the impression that she was discussing Warren's points without offering links to them, or her..

As opposed to her, many, posts, replete with links, about ________________________.

Like I said: "I Sincerely hope that this was, simply, hasty posting sans proofing.."

and, "Sorry, I didn't see your previous post linking to her speech/video clip...a good example of one: "hast(-il)y posting sans proofing..".

"I guess I could have tried to pass it off as an attempt at Irony, but, it wouldn't be so.."

Posted by Mark E Hoffer | May 8, 2008 8:42 AM

Brandon - that treatment of capital gains makes sense given what the savings statistics actually are: a national aggregate number for all economic activity, individual, corporate, etc. It is frequently reported, and almost always heard, however, as a reflection of individual saving habits. (Which also makes sense: everyone is the center of their own universe, so everything's all about you, personally.) That's not necessarily a problem with the measurement itself, just how it's used, but given that people seem to want or need a figure reflecting average individual activity, maybe it's just not that useful (for the purposes most people turn it to, at least).

In any event, it seems we're mostly agreed that it doesn't indicate what most people think it does.

Posted by Kathryn | May 8, 2008 11:26 AM

Kathryn:
No. In my example above, the total value of individual stock holdings is $80k, not $120k. You have $40k worth of stock, and so does the other guy.

Posted by Brandon Berg | May 8, 2008 1:22 PM

Actually, I messed up the math. If we count reinvested capital gains, then we only double-count $20k, so we'd end up with $100k, not $120k.

So yeah, you're right. What you're talking about is total private savings, which is the sum of corporate savings (retained earnings) and personal savings. IMO, this is a more significant number than personal savings, because personal and corporate savings are in many ways functionally equivalent. If a company retains earnings, it's corporate saving. If it distributes dividends and the owners reinvest them, it magically becomes personal saving.

Actually, one reason (though not the major reason) for the decline in personal savings is that corporations have been retaining more earings recently than they typically do, so the decline in the personal savings rate actually is slightly overstated (though only by a few percentage points, IIRC).

Posted by Brandon Berg | May 9, 2008 2:11 AM

Brandon,

I didn't mean to claim my experience was typical. One would hope that a Ph.D. in Philosophy -- particularly one with nine kids -- was capable of identifying and avoiding the fallacy of overgeneralization, right? Nor am I bemoaning my choices (although I assure you that "singlehandedly savi[ing] western civilization from both intellectual and demographic was never considered as one of them).

But it is the case that college students who take out their own loans are repaying those loans when they could instead be saving. And that once these students have reached the income level enabling the payoff, their income level is too high for their dependent children to qualify for loans of their own. Hence the double dilemma.

But B. Durbin, you are correct. Our children will go to Auburn, because of the faculty tuition discount (which is itself the primary reason I am teaching), unless they find some other way to pay the difference. The eldest for whom we took out the loan plans to make up this difference with his internship earnings.

Because, David, he is indeed going into engineering :)

Posted by Kalynne Pudner | May 9, 2008 12:48 PM

Brandon, I didn't mean to claim my experience is typical. One would hope that a Philosophy Ph.D. -- particularly one with nine kids! -- would be capable of avoiding the fallacy of overgeneralization, right? Nor do I regret my choices (though "singlehandedly sav[ing] western civilization from both intellectual and demographic ruin" was never one of them).
But it is still true that college students who take out their own loans will be repaying those loans instead of saving; and once they've reached an income level enabling the payoff, that income level will be too high for their own dependent children to get loans. Hence the double dilemma.

I do agree with you, B. Durbin. And our children will attend Auburn because of the faculty dependent discount (which is the primary reason I am teaching now, while I still have kids at home); if they want to go elsewhere they have to find a way to make up the difference.

The eldest for whom we have taken out the loans intends to make up the difference once he begins his internship. Because, David, he did indeed go into engineering :)

Posted by Kalynne Pudner | May 9, 2008 12:55 PM