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Is Spending the Way2Save?

posted 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.

Comments

Adam,

Thanks for bringing up the Way2Save program to us readers, but I think your criticisms of the program are misdirected. First, you suggest that "Absent the interest, forced savings is a loss in real purchasing power for consumers because of inflation" -- but the whole point of interest is to compensate savers for the risk-adjusted time-value of money. As you note, the three-year return on money in the Way2Save program is 6.46% APR, which is about three times the inflation rate over the past few years. (Admittedly, taxes will take a bite out of these returns, but Wachovia certainly cannot be blamed for the disincentives to save set up by our income tax.)

Second, you note that the "interest generated from Way2Save could be offset by higher prices due to interchange," which is surely correct. But again, the problem is not Wachovia's program but the credit system -- merchants who accept Visa et al. agree not to discriminate based on how a customer pays, so *all* consumers suffer the costs of the interchange system regardless of whether they are in the Way2Save program or paying cash.

Third, you suggest that "the program is structured to further Wachovia’s interest" as if it were a bad thing. But you can't really expect Wachovia to set up a program that's against their interests. And in some sense, Wachovia profiting from the use of its debit cards is irrelevant; the real question is does this program benefit Wachovia customers rather than using other methods of paying for goods. Most credit cards these days, for example, give users cash back or other incentives in order to get the merchant fees, whereas most debit cards have no benefits for users. So it seems, in any analysis, that Wachovia's customers who prefer to use a debit card anyway are getting a windfall here.

Finally, the whole thrust of the post misses an important social issue: Saving money is not just about postponing consumption but about having some insurance against the unknown future. Whether it be a job loss or fast-rising medical bills, the first place many people turn to is their savings (rather than bankruptcy) for help. When people have the insurance of savings to cushion the bumps of life, we all benefit, and thus programs like Wachovia's should be, to the extent they actually help people save, applauded.

Anonymous Skeptic makes a some excellent points that I largely agree with. My posting was apparently not as clear on these points as I had hoped. Let me address Anonymous Skeptic's points in turn:

(1) When I wrote "Absent the interest..., " the point I was trying to make was that simply transferring dollars from a checking account to a savings account isn't helpful by itself (unless you place significant value on the discipline function of keep the funds out of a DDA account). What is helpful is that the money in savings is then earning interest. But when evaluating Way2Save, we should look only at the interest earned, not the total amount in the savings account, most of which was simply transferred from a checking acount.

(2) No doubt "*all* consumers suffer the costs of the interchange system". This is something I've written a great deal about elsewhere. Interchange creates an externality for all consumers in the form of higher prices. This will reduce the direct impact on debit card users, but there will still be an impact on them.

(3) Wachovia is a for-profit institution and should be out to make money for its shareholders. There's nothing at all wrong with that per se. Wachovia needs an incentive to act. [Note, though, as per point 2, above, Wachovia's profits are coming from a 3rd party externality.] But because Wachovia's goal is its own profits, not the well-being of its depositors, we should not blithely accept that the program does benefit Wachovia's depositors. The benefit to them is uncertain.

As you suggest, the proper baseline for comparison might not be what the depositor would get if she made only cash purchases (i.e., nothing), but the rewards that depositor would receive by using a credit card instead of a debit card. Let's say the depositor could get 3% cash back (capped at $300 annually) on a single credit card (but could use multiple cards over the course of the year). That's money the depositor would earn without having to keep funds tied up in the savings account (a major assumption of the Way2Save interest earnings). Whether the depositor would do better with a cards rewards program or Way2Save will depend on the particulars of the usage, but I think that there are a lot of scenarios whereby the depositor comes out better dollar for dollar by using the rewards credit card than the Way2Save debit card. Of course, the rewards card interchange is likely higher than the debit card interchange, so we would need to adjust for higher prices again.

But see the bigger point here--rewards programs rather than anything inherent in the payment device--is what is shaping consumer choice of payment system and is often pushing consumers to use payment systems with interchange (because that's how the rewards programs are funded), even though it imposes externalities on third parties.

(4) To the extent Way2Save helps people save, that's great. But we should not encourage people to save in a way that creates an externality (see point 2). And, my main point in the post was that it isn't clear whether there are real net savings in light of the higher prices encouraged by Way2Save's debit card component. It will likely play out different for each depositor. Bottom line is we don't know and that should make us skeptical because Wachovia's interest is not encouraging savings but making a profit (point 3).

The Way2Save program, without really scratching the surface, seems more useful than harmful to me. Even of no interest is paid on the "savings" account, it's money that might be ill spent otherwise, depending on the participating customer. I WOULD, however, have some cynicism about big business- like the banks mentioned- being totally honest with their customers about matters such as making the Way2Save proceeds available at the customers' request, or immediately refunding the proceeds to named beneficiaries of those customers. Do we ask the government to oversee these programs at taxpayer expense? I don't have the answers- just questions for now...

The inflation from the Fed rate drops has not began yet (except perhaps with food and gas). So at the moment this looks good for year one (unless the rate is "adjusted" which is conspicuously undefined as to criteria for such). Also how ofter is the interest compounded and added to the account? There's no running total on my account yet.

Rather than commit to a recurring fee I just go to the gas station and fill my tank $1.00 at a time with the card. Thus I maintain control over deposits. Also there is about a quarter gallon of gas in the hose if the previous customer didn't lift up the hose to dump it in his tank. This makes my fill-ups in the $50 dollar a barrel era range. So I get free gas which pays for what I'd really like to be getting from the Way2Save program. Timewise it isn't that bad if there's three or four gas stations at one intersection. But the pumps must have three hoses rather than the one hose versions. Also, since the $1 fillups are for 87 octane and I'm getting quarter gallons of 89 and 91 octane its a higher grade (89 when averaged) thanks to the incentive provided by Wachovia.

Side note - Look at platinum, and the fact that South Africa, where 80% of the worlds platinum comes from ran out of electricity, and it can't be repaired for 5 years, and consider that a car cannot be built without platinum (catalytic converter), and that the mines will be shutting and/or coming up very short very soon, and consider whether the $2,000 an ounce price will soon be going up considerably (detaching from the gold track which has no industrial use of relevance). So my Way to Save may seek more fertile returns.

One thing that you left out of your review is any advice to consumers on how to make the Way2Save program more lucrative to themselves.

I agree with you that the debit transactions are not the best way to structure spending. The Way2Save program moves $1 over to savings per debit transaction, and that dollar will earn a higher interest rate and get a 5% bonus at the end of the year. That's a 5 cent reward; the higher interest rate isn't going to earn you a huge amount compared to putting that $1 into a different form of savings, but let's assume that every debit transaction is going to yield an extra 6 cents in rewards/extra interest.

If you pay with a credit card instead, you can earn rewards ranging up to 5% back on some types of transactions. There are plenty of different cards that offer at least 1% back on any transaction. At 1% back, we earn 6 cents on any transaction of $6.00 or more. So using the Way2Save debit card only makes sense for very small transactions.

On the other hand, you are allowed to set up recurring monthly deposits of up to $100/month into Way2Save. This would give you $1200 in contributions over the first year, yielding $60 from the year end match, plus you're earning the 5% or better APY during that time. Seems like a good deal from where I stand--I already planned on having more than $1200 in savings, so by moving it into Way2Save $100 at a time, I can earn a much better return on it.

The other method of funding the account can also make sense. You also get a $1 transfer (5 cent year end bonus) for each online billpay/withdrawal. If you pay bills that you were going to anyway, this costs you nothing. You don't even need to use Wachovia's site to set up the billpays. If I go to my CC website, and set up a payment to be taken out of my Wachovia checking, I still get the $1 transfer.

The last issue is of course the stability of Wachovia. I definitely wouldn't put in money that exceeded the FDIC protection, just in case. On the other hand, I just opened a five figure CD with them because they were offering such good rates. If they do go under, I might have limited access to my funds for a few days while FDIC sorts things out, but that's not a big deal as long as I have accounts elsewhere that I can access.

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