The Gates Foundation has just pledged $500 million to a cause that seems quite different from typical problems like disease, famine or illiteracy. That $500 million is going to help poor people learn to save money.
“We think really that poverty stops where savings starts,” Chris De Noose of the World Savings Bank Institute told the L.A. Times.
The new Freakonomics Radio podcast (download/subscribe at iTunes, get the RSS feed or listen live via the link in box at right) explores an idea that the Gates Foundation may want to look into: Prize-Linked Savings (PLS). In a nutshell, PLS is a kind of savings account that pools some of the interest from all depositors and pays out a big lottery prize every month or so. It combines the thrill of the lottery with the safety of a savings account. It’s sometimes called a “no-lose lottery,” since a depositor is automatically entered into the lottery but can’t lose the original money she deposits.
And while PLS might play well in the poorest parts of Africa and Asia, there’s a group of researchers who feel that PLS is very badly needed right here in the U.S.
Peter Tufano is a Harvard Business School professor who specializes in consumer finance. He recently helped conduct a survey in several countries, including the U.S., which asked people if they could come up with $2,000 in 30 days if they had to. It turns out that nearly half of Americans couldn’t – “which means,” Tufano says in the podcast, “that they stand only one emergency or crisis away from really quite dire circumstances. This isn’t picked up in the national economic statistics.”
The facts are simple. Americans have a low savings rate; and Americans love to play the lottery. Last year, we spent more than $58 billion on lottery tickets, or roughly $200 per person. As entertainment goes, the lottery is pretty cheap – a dollar and a dream and all that. But as an investment, it offers a dreadful return. States typically withhold about 40 percent of the ticket money from the prize pool for overhead costs and, often, education funds. That’s a far worse return than casino gambling or horse race betting. Which is why the lottery is sometimes called “a tax on stupid people.”
That’s why people like Tufano and University of Maryland economist Melissa Kearney are interested in bringing PLS plans to the U.S. (Here’s their paper on the topic, well worth a read.) PLS accounts have been successful in other parts of the world for years. In the podcast, you’ll hear from Tufano and Kearney, as well as from the folks who started a successful PLS program in South Africa – and the folks who got that program shut down.
Why? Because the National Lotteries Board of South Africa sued the bank that offered the PLS. It turns out that the biggest obstacle to offering a lottery payout with a savings account is … the state-run lottery.
And that may be the biggest barrier to making PLS happen in the U.S.: it is, for the most part and in most states, illegal.
There is, however, one exception already – in Michigan, where the “Save to Win” program has been offered among several credit unions, and recently paid out its first $100,000 prize (to an 87-year-old woman who had deposited $75). You’ll hear about the Michigan program in the podcast as well.
Melissa Kearney sums up the argument best:
“So we know Americans like gambling. They always have, the majority of them do it, and they’re going to keep doing it. And so what we do is take seriously the idea that people want some small chance of winning a large sum of money. That market, that asset is missing from the American landscape. Low-wealth individuals, the only asset available to them that gives them some chance of accumulating a large amount of money is the state lottery. In fact, a recent national survey of a thousand adults, one in five American adults said their greatest chance of accumulating hundreds of thousands of dollars is through the lottery. That number jumps to forty percent for folks making less than twenty-five thousand dollars a year. So a lot of Americans think the lottery is their only chance at winning big sums of money, why don’t we take that appetite for gambling, for a product like this and attach it to a savings vehicle that offers some positive return? It’s a win-win situation.”
Except, of course, for state lotteries.
Stephen J. DUBNER: There’s something Peter Tufano wants to know about you: If you had to, could you come up with $2,000 in 30 days? That’s the question he asked a whole bunch of people in 13 countries, including the U.S.
Peter TUFANO: Why $2,000? Cause an auto transmission is about $1,500. Most estimates of what everyday emergencies are about are in that order of magnitude, if you were to have a sick or ailing relative on the other side of the country and you had to buy a full price plane tickets, it could easily be that amount. And then why this language “come up with” as opposed to “save”? Because we wanted to see if people had access to resources between savings and credit, and friends and family. About half of Americans are not able to come up with $2,000 in 30 days, which means that they stand only one emergency or crisis away from really quite dire circumstances. This isn’t picked up in the national economic statistics; this is picked up at a much more local level, at a much more intimate level of what happens inside families. It’s this lack of savings as it were that motivates me.
DUBNER: Tufano is all about the motivation. He’s a professor at Harvard Business School; one of his specialties is consumer finance. He wants to know how many checks you write, and for what; how much you borrow, and why. And what you spend on beer, on toys -- or on lottery tickets.
ANNOUNCER: From American Public Media and WNYC, this is Freakonomics Radio. Today, America’s sad savings rate may have met its match. If you like the lottery, we’ve got a bank account for you. Here’s your host, Stephen Dubner.
DUBNER: Americans are generally terrible at saving money. Think about what Peter Tufano just said -- half our country doesn’t have enough money in the bank to survive one breakdown. And it’s not just poor people. In Tufano’s survey, only 25 percent of the people who earn between $100,000 and $150,000 a year could come up with that $2,000 in 30 days.
We are, however, excellent at spending money. Houses, cars, clothes, books, electronics -- and lottery tickets. Households that play the lottery spend on average about $1,000 a year on tickets -- that’s more than a typical household spends in grocery stores on dairy products and beer combined. This year, Americans will buy about $60 billion worth of lottery tickets.
The other day, I went to a store in Penn Station in New York called Carlton Cards. It’s pretty big. In the back are rack upon rack of greeting cards and some candy bins. But there weren’t any customers back there. All the customers were jammed up front, at the lottery counters. According to the New York State Lottery, Carlton Cards sells more lottery tickets than any other store in New York. Kirit Prajapadi is one of the managers. I asked how much lottery revenue his store does in a year.
Kirit PRAJAPADI: It’s about $8 to $9 million a year.
DUBNER: Holy crap! $8 to $9 million a year in lottery sales in one store in Penn Station.
DUBNER: OK, you see people buying tickets all day. You see winners a lot. Tell me how excited they are when they win.
PRAJAPADI: When they win, they forget about all their losses. And they get excited, like they win something. Whatever they lose, they just care about their win.
DUBNER: They give you a hug? Give you a kiss?
PRAJAPADI: Not really. Just handshake probably sometimes.
DUBNER: You probably don’t want the hug or the kiss.
PRAJAPADI: No, not really.
Melissa KEARNEY: When I was in graduate school there was a local little store by my graduate student-housing unit, and I would stop there on the way home and pick up milk and orange juice, and notice lots of people buying lottery tickets.
DUBNER: This is Melissa Kearny. She teaches economics at the University of Maryland.
KEARNEY: So I just sort of started chatting with the vendor, and he said “Oh I have people coming in and spending hundreds and thousands of dollars on lottery tickets a month, a year.” And so being a graduate student I just downloaded some data and started playing around, and was struck, regular people do spend a lot of money buying lottery tickets. So it was just sort of a passing curiosity really. I started wondering about what were they not buying in order to buy lottery tickets.
DUBNER: So let’s walk through some of the numbers in lottery gambling. In the U.S., how many people play the lottery?
KEARNEY: Half of U.S. adults surveyed said they played the lottery in the past year.
DUBNER: And would that make it the most popular form of gambling in the U.S.?
KEARNEY: Yes, by far. So two out of three American adults report gambling, and 50 percent say they’ve played lottery, and the next closest is casino, which is about one in five adults.
DUBNER: Why do so many people play the lottery? Because it’s fun! For a dollar or two, you buy the chance to dream. Big. This remarkable bargain illustrates a phenomenon -- a probabilistic oddity -- that economists call “skewness.”
KEARNEY: That’s the idea that there’s some big prize way out there that corresponds to very small odds, but there’s some potential of capturing that. And that’s what your typical money market account can’t give you. So you could have $1,500 in your money market account, and every month you might earn a dollar on it. But there’s no chance in any month that you’ll earn $100,000 or even $10,000.
DUBNER: Now, I know as an economist you’re not trained to answer this question, but as a human being, tell me, why is skewness so important to us?
KEARNEY: That’s the chance of changing your life, right? That’s the return, that’s the big-win outcome that might allow you to buy a beach house, or, you know, to send your kids to college. If it’s less far out in the distribution that might be what you need to make a down payment on a house, or buy a car, or throw your daughter the wedding you want to throw her.
DUBNER: For a lot of people, skewness has an irresistible appeal. And so, a handful of researchers like Melissa Kearney are trying to harness its power -- the unlikely chance of changing your life with a big prize -- to solve America’s low savings rate. The idea is a new financial product that combines the thrill of the lottery with the goal of, say, accumulating more than $2,000 in a savings account. So that a broken transmission doesn’t become a full-blown crisis. Here’s Kearney’s pitch.
KEARNEY: So we know Americans like gambling. They always have, the majority of them do it, and they’re going to keep doing it. And so what we do is take seriously the idea that people want some small chance of winning a large sum of money. That market, that asset is missing from the American landscape. Low-wealth individuals, the only asset available to them that gives them some chance of accumulating a large amount of money, is the state lottery. And in fact, a recent national survey of a thousand adults, one in five American adults said their greatest chance of accumulating hundreds of thousands of dollars is through the lottery. That number jumps to 40 percent for folks making less than $25,000 a year. So a lot of Americans think the lottery is their only chance at winning big sums of money -- why don’t we take that appetite for gambling, for a product like this and attach it to a savings vehicle that offers some positive return? It’s a win-win situation.
DUBNER: That win-win situation, and the chance to make it happen in the U.S., has generated a lot of enthusiasm among economists like Kearney and Peter Tufano, the Harvard Business School professor we heard from earlier. He’s the man who’s been researching what are called “prize-linked savings,” or PLS, all over the world.
TUFANO: I started in the UK because they have a product called “premium bonds” which has been around for about 50 years, a little bit more. And where the government offers a savings product to investors which, at first glance, would almost look perverse: give us your money, and we promise you no interest. But that’s not quite how the program works because it’s give us your money, you can take your money out at any time, and each month we’re going to basically take the interest pool and we’re going to lottery it off so that one lucky person will become a millionaire and literally every month someone in Britain gets a knock on their door from Mr. Million who tells them they’ve won the million pound prize. There are over 100,000 other people in the UK who have found out they’ve won smaller prizes.
This was an intriguing concept and so the research that I’ve done tried to understand: Well was this more like gambling or savings? Bottom line: it’s both. Then this travel took me to South Africa where I met Robert Keip, and he was creating a product call MAMA, the Million a Month account, and I think in a word or in a phrase he described the entire economics and in some sense the value proposition for savers quite simply: Everything to gain, nothing to lose. It’s a savings account where you can take your money out when you’d like. You always have access to your principal and it will never go down in value, you may come out with a little bit of interest, a little bit of payment, but you might come out with a remarkably large payment. But you can only go up and you can never go down. And then, in respect to the extensive work on behavioral economics and behavioral finance, the logic of this product is quite obvious. People have what we call loss aversion, they much prefer to protect against losses than to worry about gains, they tend to misestimate small probabilities, but when you put it all together, in very plain English, people would rather have a small chance at a life-changing payout, than an almost certainty of a pittance.
So I can be guaranteed in this interest-rate environment to put my money away and maybe be able to buy a coffee with the amount of interest that comes off my $100 account. Whereas, I’m willing to say I’ll give up that interest but there’s some possibility, remote as it might be, that I might be able to have a life-changing payout -- an amount that would allow me to buy a car, or a house, or even more. So this preference for highly skewed payoffs or, you know, the kind of payoffs that are usually present in gambling or lottery products when combined with savings turned out to be tremendously effective around the world, but it was completely absent for legal reasons in the United States.
DUBNER: So, what are those “legal reasons?” As Tufano discovered, state law typically prohibits something like a Prize-Linked Savings account because it’s a lottery and, according to state laws, the only legal lottery is a lottery that is run by the state itself. Nice monopoly if you can get it, right?! You can hardly blame them for keeping lotteries to themselves. They generate billions in revenues. And so, while most states might like to help their citizens save more money, they may not be willing to pit their own lotteries against ones that might be run by, say, a bank.
DUBNER: Peter Tufano’s research into prize-linked savings programs around the world convinced him that the idea could help Americans, particularly low-income Americans, increase their frighteningly low savings rate. The lottery aspect made it illegal in most states -- but, in Michigan, there was a loophole. Last year, Tufano got a group of credit unions to pilot the idea. Here’s Dave Adams, CEO of the Michigan Credit Union League.
ADAMS: You know banking can actually be pretty boring. It’s not like we go to social events and talk about how much we’re saving and talk about a great new feature on our checking account. Banking services are pretty mundane. So what people want and need is a fun way to save, and in Michigan we’ve come up with what with what we think will accomplish that. It’s a program called Save to Win.
And what it is, is using a lottery concept, so if someone saves, so that for every $25 that someone puts in to these one-year certificates of deposit, they are going to get a chance at cash prizes. And the cash prizes are given out every month by participating credit unions ranging from $50 to $500. And there’s a grand prize at the end of the year, an opportunity to win a $100,000 grand prize. So Save to Win gives people what they need, which is they need to save more, while giving them what they want, which is a fun way to do it: a game of chance that makes it interesting to save.
DUBNER: Something that you will want to talk about at a party, say “Hey, I won a hundred grand!” So you’re making savings sexy by introducing a lottery element.
ADAMS: I think so, I don’t know so far as to say that it’s sexy, but it’s certainly far better than talking about the point-five percent that I’m getting on my savings account at the bank. So now you’re getting a competitive interest rate. You’re doing what you know you need to do, which is be more responsible in the way that you save and plan for the future. But you’re getting a chance at these cash prizes including a chance at a $100,000 cash prize. And the odds of winning are much better than what you would see if you were buying lotto tickets.
DUBNER: Even with a sputtering economy and low interest rates, a handful of credit unions in Michigan opened 15,000 new savings accounts. Save to Win surveyed some of these customers. More than 60 percent of them had spent money on the lottery or gambling in the previous six months. Fifty-five percent had had no savings plan. Save to Win was beating its goals, and reaching the customers it was supposed to reach. It makes you wonder what would happen if a program like this took over an entire country.
Robert KEIP: Well, my name is Robert Keip. I worked at First National Bank for 11 years, where I headed up the Investment Product House, which was a business unit that really focused on retail deposits, both consumer and corporate deposits. And our focus was trying to look at ways of growing the funding base of the bank.
DUBNER: First National Bank, or FNB, is in South Africa. In 2005, it started what would turn out to be a phenomenally successful prize-linked savings program. It was born out of South Africa’s financial problems, as the country struggled to put the apartheid era behind it. Millions and millions of black South Africans did not use banks, for anything. Robert Keip wanted to find a way to get some of them in the door.
KEIP: Now in South Africa, because so much of the population is unbanked, so much of the savings are literally sitting under mattresses. Now, this has got a double effect: the one that really does really do badly is that it removes that funding from the mainstream banking environment so it can’t be harnessed to lend out and fund economic growth because retail funding tends to come from consumers and then get lent out to businesses who can then create jobs. That was the one problem. The second problem was really that these people with the money without bank accounts were really excluded from the banking system and by being excluded by the banking system you miss out on so many benefits that really help with people’s individual development. For example, developing credit records, not being exposed to money being stolen or lost on the way home.
DUBNER: But Keip’s bank had a problem. Interest rates at the time weren’t keeping up with inflation, so putting your money in a plain old savings account might actually erode its value. Keip’s job was to make it worthwhile for customers to deposit new money. So instead of simply offering an account with a scrawny interest rate, he’d offer an account with practically no interest at all -- but: it came with the chance for a really big payday.
KEIP: So what we did, we literally pooled all of these little point-two-five percents of interest. And then what we did is we paid out that interest in lump sums to a few people. So we paid out 150 people a month in lump sum prizes. So the first prize would be a million rand, which is an enormous amount of money in South Africa. And then there were three prizes of $100,000 rand. And then we went down to 20,000 rand, and a few prizes of a $1,000 rand. So really what we did is collected the little bits of interest that would be paid on all these little accounts and then paid it out randomly to a few select lucky winners.
DUBNER: So let’s say I live in South Africa. I take the money I’m earning and put it under my mattress or maybe buy some high-risk equities. You’re offering me the security of a bank account and the excitement of a chance to win a million rand. And what did you call this idea?
KEIP: We called it the “Million a Month Account.”
KEIP: And MAMA became the trivial name for it.
DUBNER: And you’re the man who gave birth to MAMA.
DUBNER: And how successful was MAMA?
KEIP: Hugely. Probably too successful for its own good.
DUBNER: MAMA attracted more than a million new customers to Keip’s bank. Other banks in South Africa took note -- and they complained to regulators. And then the Keip’s bank heard from someone else: the South African National Lottery.
KEIP: Well, we engaged with them before we launched. We wrote to them and asked them opinion on the product. They wrote us a letter back saying that they didn’t think it was a lottery; they thought it fell into a promotional competition part of the legislation -- and that we just comply with the requirements of promotional competition. And we launched and nothing was heard from them for six or so months, then they contacted us to say actually they don’t like what we’re doing -- that it’s a lottery now.
DUBNER: So when you were starting out and there was very little money in your coffers, they thought that it wasn’t a lottery. But then after it got going for a while, and you had, how much? A couple hundred million dollars?
KEIP: About $200 million. By the time we closed down. But more importantly it was over a million customers that we had brought in.
DUBNER: And the National Lotteries Board changed its mind then. It thought: “Oh, that thing that we said a little while ago was not a lottery, now looks a lot like a lottery.”
DUBNER: What did they do then?
KEIP: We first engaged with them and tried to discuss it but it was very clear that they were in no position and not wanting to even try to discuss what the issues were. And so they took us to court to have us closed down.
DUBNER: Hugh Melamdowitz is the man who took MAMA to court. He’s the lawyer who represented the South African National Lottery. Melamdowitz argued that First National Bank’s MAMA program infringed upon the state lottery’s right to be the only game in town. The case went all the way up to South Africa’s Supreme Court of Appeals, and Melamdowitz won every time.
DUBNER: Hugh, you must be very good.
Hugh MELAMDOWITZ: I can’t answer that.
DUBNER: Now, when MAMA was created, about 70 percent of low-income South Africans were said to be “unbanked.” The government was eager to cut this number. MAMA made it easy to get people in the bank. All they had to do was deposit a minimum of 100 rand, or about $15, into a 32-day “call” account -- what we’d call a certificate of deposit. So, what’s wrong with that?
MELAMDOWITZ: Well I suppose it is an inducement to bank, but for the period in which your money is deposited in the bank you do not receive any interest. South Africa has a relatively high interest rate. Part of the motivation around the account was touted as being a no-cost account, which was correct, but also there was no interest earned. In South Africa on a 32-day call account your interest rate is fairly substantial. So for the days when your money wasn’t earning any interest whilst it was sitting in the bank accounts and the bank was earning substantial sums. I think the idea was that it was driven towards the unbanked hence the minimum amount of 100 rand. But realistically, substantial amounts were being deposited into accounts with the chance of affecting the million rand return.
DUBNER: Now, how successful was the savings plan run by FNB in actually drawing in money from either the previously unbanked or citizens at large. How much did they take in, in what period of time?
MELAMDOWITZ: Well there was substantial taken in, not necessarily from the unbanked. My understanding is that substantial funds came from their regular customers. And really the customers who had sufficient means that they had essentially free money sitting around that they could afford to put aside for the 32 days without effecting any return, or any real return. So my understanding is that the funds were deposited not predominantly by the unbanked, but really predominantly by the banked, and I would imagine predominantly by the more wealthy customers. The return that the bank made was fairly substantial.
DUBNER: Melamdowitz’s argument seems a bit at odds with itself. He says the bank took advantage of people by failing to give them a high interest rate -- but also that most people who bought into MAMA weren’t the unbanked, that they were wealthier customers who had, as he puts it, “free money sitting around.” Well, if they want to play the bank’s lottery instead of the national lottery, why shouldn’t they be free to choose?
But Melamdowitz was doing his job: protecting the interests of his client, the National Lottery. And it worked. MAMA was shut down.
Robert Keip, the man who created MAMA at First National Bank, stands by its success. He says the excitement of the lottery payout got people in the door so fast that the cost of acquiring a new bank customer fell from $300 to $5. But that was MAMA’s goal in the first place -- to expand banking. Keip says 20 percent of MAMA accounts were opened by people who were previously unbanked. Sure, it wasn’t the majority, but MAMA reached that level in just the first three years. And it took $200 million in deposits. Last year, after MAMA was shut down by the national lottery, Robert Keip was invited to Washington D.C. to talk to federal banking officials about the program’s success.
ANNOUNCER: On the next Freakonomics Radio, we take the idea of prize-linked savings to the lottery officials of America. They don’t like it so much. And one of the first no-lose lottery winners in America describes how winning and saving feels. That’s next time on Freakonomics Radio. Whoever thought stories about savings accounts could be so exciting?
Freakonomics Radio is a coproduction of WNYC, American Public Media and Dubner Productions. You can find more audio at FreakonomicsRadio.com. And, as always, if you want to read more about the hidden side of everything, go to the blog at nytimes.com.