Bankruptcy

Is Spending the Way2Save?

By Adam Levitin

Financial institutions have begun to offer programs that appeal to consumers? desire for assistance with disciplining their saving and spending decisions. These programs draw on the insight of behavioral economics and cognitive psychology that default rules have a powerful effect in shaping consumer behavior. For example, Richard Thaler and Shlomo Benartzi have proposed requiring people to opt-out, rather than opt-in to employer-sponsored savings plans in order to overcome bounded rationality and encourage higher savings rates.

The first financial institution I know of that offered a savings assistance program was Bank of America?s Keep the Change program, which has been well-critiqued around the web. Now Wachovia has a new program called Way2Save. On the surface the program looks great. But when probed, it isn?t clear whether consumers end up with meaningful savings?increased purchasing power. With all of these programs the question that we need to ask is how much does it cost you to save?

Way2Save automatically transfers $1 from the consumer?s checking to savings account every time the consumer makes a purchase with a Wachovia Visa CheckCard (a signature-based debit card), on-line bill payment, or automatic debit. The savings account will yield 5% on these transfers in the first year, matched by a 5% annual bonus (capped at $300) and 2% with 2% matching (capped at $300) in the second and third years (rates are not specified thereafter). Consumers can also choose to transfer an additional $100 a month to their Way2Save savings account. Way2Save savings accounts can provide fee-free overdraft protection for checking accounts, and funds will not be transferred from checking to savings if it would create an overdraft on the checking account.

So let?s put some numbers on this. Wachovia assumes the typical consumer will annually make 276 CheckCard transactions, 36 on-line payment, and 12 transfers into the Way2Save account of $25/month. Wachovia also assumes that the consumer will never withdraw any funds from the savings account. If so, the Way2Save savings account will have $671 at the end of the first year ($59 of which is earned interest and bonus), $1328 after the second year ($104 of which is earned interest and bonus), and $1997 after the third year ($161 of which is earned interest and bonuses).

Looks great, no? I doubt one could find a 1, 2-, or 3-year CD with this ROI, especially as it does not need to be funded in full, up-front. (One could do a discounted present value analysis and then recalculate the APR, which would be higher.) After the first year, one should be able to find a higher yield than Way2Save offers, even with the bonus, but still this is (presumably) an FDIC-insured account with 3-year APR of 6.46%!

Well, there are some downsides. Savings is itself a consumption decision, and the basic calculus is that by spending later rather than now, real purchasing power will be increased (because of compound interest and the like). So when considering real purchasing power, we have to discount the returns for inflation and taxes on the interest earned. Putting those points aside, however, it is still not clear that Way2Save actually results in increased consumer purchasing power.

What do I mean by this? Way2Save provides three ways to save?through debit card purchases, through on-line bill payments, and through transfers from checking. The first two categories are very strange. They link saving with spending?one of the ways to ?save? is to make more purchases. Counterintuitive, no? Let?s focus just on the debit card transactions. Why is Wachovia linking saving with making Visa CheckCard purchases?

The CheckCard transactions are not free. Wachovia receives an interchange fee, set by Visa, on every CheckCard transaction. These fees are paid by the merchant?s bank, which passes them on (plus its own spread) to the merchant. Visa?s debit interchange schedule is complicated, but assuming an average transaction amount of $25, we can look at a low fee of 23.75¢ (.55%+10¢) and a high fee of .72.5¢ (1.9% +25¢) So for 276 transactions, that means Wachovia is receiving at least $65.55, and quite possibly as high as $200.10 (and more if the average transaction is larger). Not surprisingly Wachovia?s yield on CheckCard transactions of any size over $1 is always more than the consumer receives on the Way2Save account.

The $65-$200 Wachovia receives annually from these 276 CheckCard transactions is ultimately paid by merchants, who pass along at least part of this cost to consumers in the form of higher prices. We don?t know how much they will pass along (and it will surely vary by merchant and depend on the relative levels of different payment systems used to make purchases from the merchant), but some and quite possibly all of the interest the consumer earns from the forced savings will be offset by higher prices from merchants.

It?s clear that Wachovia benefits from Way2Save?lower reserve requirements on savings accounts than on checking and increased debit interchange income. No wonder Wachovia is willing to be so generous.

It?s not clear whether the consumer benefits in the end with Way2Save. Absent the interest, forced savings is a loss in real purchasing power for consumers because of inflation, and the interest generated from Way2Save could be offset by higher prices due to interchange. Let me be clear?Way2Save could be a net benefit to consumer. We just don?t know. All we do know is that the program is structured to further Wachovia?s interest, but those interests might well diverge from those of Wachovia's depositors.

We could easily structure a program to encourage savings without such a potential conflict. One way to do this would be to uncouple saving from spending. Why not simply have automatic transfers to savings of 1% of the checking account balance every month (with the same overdraft protection rules)? Wachovia might not offer the same yield, but it would not only remove an externality imposed on merchants from the savings, but it might result in higher net purchasing power for Wachovia?s depositors.

Full post as published by Credit Slips on February 12, 2008 (boomark / email).