July/August 2012 Michael Sherradden’s Compounding Interest

Two decades ago an obscure academic revolutionized thinking about poverty. Now his insights might just save the middle class.

By Mark Schmitt

Armed with insights from the ADD, asset proponents added another policy to their arsenal: children’s savings accounts (CSAs), sometimes known as “baby bonds.” The Labour government in the United Kingdom launched these accounts in 2005. By seeding an account at birth, modestly matching contributions, and compounding interest for eighteen years or more, a CSA could give a young adult a base of capital for college, training, or, later, starting a family. CSAs never quite caught fire in the U.S., although a leading presidential candidate in 2008, Hillary Clinton, embraced them until she got tangled in confusion about whether she was proposing to seed the accounts with $5,000 or $500, after which she avoided the issue. Boshara, who’s now a senior advisor with the St. Louis Fed, observes that CSAs were “a solution in search of a problem,” lacking clarity about whether they were intended to address child poverty, educational opportunity, middle-class anxiety, or dependence on government.

The alliances that the asset movement had built with some conservatives, from Kemp onward, became more complicated in the 2000s. A major supporter was Republican Senator Rick Santorum, who in his 2005 book, It Takes a Family, heralded his partnership with two more liberal senators on the ASPIRE Act, a significant expansion of IDAs. Other conservative initiatives of that era would have provided modest tax incentives for savings to the middle class, and huge benefits to the better-off. These proposals exacerbated the wariness of traditional anti-poverty liberals that asset policy might weaken the safety net rather than strengthen it, and put the asset movement in a tough spot. Since then, asset supporters have had to move carefully to take advantage of the interest from conservatives, while avoiding being drawn into a vision of the “ownership society” that would mean shifting the security of social insurance to individual accounts, or the creation of more tax-subsidized accounts that shelter savings that would occur anyway.

Starting in the mid-2000s, the emerging field of behavioral economics, embraced by Obama administration officials such as Cass Sunstein, began to influence the asset movement and helped proponents understand why, in ADD and other experiments, it was often the more modest innovations rather than big financial incentives that encouraged people to save. These insights led Reid Cramer, who succeeded Boshara as director of the Assets Program at the New America Foundation, to say recently that “the accounts themselves might be as important as the match,” simply by creating an opportunity and expectation of saving. With an account in place, small changes could be leveraged to significantly increase savings.

For example, the ADD evaluations showed that the biggest contributions to IDAs often occurred in April, when families received income tax refunds, usually through the Earned Income Tax Credit. This led asset supporters to persuade the IRS to allow the option of a “split refund,” in which part of the refund would arrive as cash and the rest would go directly into a savings account. Such innovations, together with simple, affordable banking options, help low-income workers escape the costly racket of check-cashing shops and accumulate the small but unrestricted savings that can help them get through an emergency.

The financial crisis, and particularly the meltdown of subprime lending that began in 2007, posed a sharp challenge to the asset movement. The most widely used purpose for IDAs was homeownership, and the asset movement enjoyed a close partnership with public and private efforts to promote it. Yet the crisis revealed that homeownership with a mortgage could be a trap of its own rather than an asset that led to greater security and independence, as it had been for the generations after World War II. Today, supporters of the asset-building movement argue that financial deregulation, and the explosion of predatory lending it led to, was the main reason homeownership turned out to be such a bad deal for so many Americans. They also stress the importance of financial counseling and education, which are now central to the best asset-development programs.

The Community Advantage Program, designed by the North Carolina organization Self-Help, for example, underwrote mortgages for 46,000 low-income households, and worked closely with those families to ensure that they were not buying more home than they could afford and that they could handle the payments into the future. The result has been a delinquency rate of just 9 percent, lower than on most other forms of mortgages, including non-subprime borrowers with adjustable-rate mortgages. The overwhelming majority of borrowers participating in the program made it through the financial crisis safely, accumulating significant equity in their homes and winding up with a higher net worth than demographically similar families who rented their housing.

The most recent innovation in asset policy draws all the threads together and connects them to education. “Kindergarten to College” (K2C) initiatives in San Francisco and several other cities will seed an account for every school-age child with $50, match up to $100 in savings, and encourage families to sign up for automatic deposit into the account. Here the cash incentives are more modest than the two-to-one match in the original IDAs, but simply by creating an account, and bringing every child’s family into the economic mainstream, all the insights of behavioral economics can be used to nudge people to save. These accounts also have an important aspirational effect in motivating students to study hard and to think about the future. (See Dana Goldstein, “The ‘Assets Effect’ ”.)

Most asset advocates agree that it’s time to move beyond local demonstration projects into the realm of national politics. The practice is now way ahead of the politics. Over two decades, the asset movement has shown how much can be done when the power of an idea is combined with networks of social entrepreneurs, funders, local officials, and careful social science research. Most of Sherraden’s insights are no longer just thoughts in a book. We now know from experience that people at any level of income can save; that lifting asset limits makes sense; and that well-designed programs coupled with financial education can make homeownership work. The next step is to move back into the how-a-bill-becomes-a-law part of the political process, armed with knowledge and success.

[Return to The Future of Success in America]

Mark Schmitt is a senior fellow at the Roosevelt Institute.


  • Rabbler on July 26, 2012 11:32 AM:

    So how many have actually purchased a home solely with money saved via this approach? What kind of matching is reasonably going to be available on a large scale in a future with cutbacks being faced across the board? Is turning $228 into $1543 annually even remotely possible? What powerful interests are going to quietly accept that participants funds can not used to pay debts owed to them? If, conceding a lot, large numbers of the poor save enough to put a down on a house what is that going to do to the price of houses? What % of entrepreneurial attempts collapse early on in strong economy? The cost of education is going to level off?

    Is this just another attempt to sell an American Dream, now on life support, to those who statistically barely had a chance even when things were good? Is this cosmetic surgery on a system with cancer?

  • Joseph on October 22, 2012 2:07 AM:

    Well, ok, they saved the $1543 within 5 years. Now what? What they going to purchase with those money? Fayetteville dentist.