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Financial Biological Determinism

Consumer finance journalism falls into roughly three varieties.  There is the descriptive type, which explains different vehicles for spending savings:  comparing 401(k)s to IRAs, say, or advising on fixed versus adjustable rate mortgages.  There is the dire warning, which informs you about the hidden problems with some financial instrument like reverse mortgages.  Then there's the prescriptive article: how much you should save, spend, or borrow.


This latter type is a little militant. It's full of gimmicks for getting you to do the right thing: numerical savings targets, automatic payroll diversions into savings, and in the case of Dave Ramsey, using cash for discretionary purposes, and eschewing all debt (with the possible exception of the 15-year fixed-rate mortgages with a payment no more than 25% of your take-home.)

Ultimately, all these gimmicks are aimed at doing the same thing: getting you to spend a lot less than you earn.  Dave Ramsey talks a lot about "getting control of your most powerful wealth-building tool: your income", but given how low the returns on savings accounts are, it's not like saving up for a car is going to make you fabulously more wealthy than paying 7% to finance one.  What it will do is make you buy less car.  Financing a car lets you experience all the joy of ownership up front, while the pain of paying comes later.  Buying a car for cash causes you to experience all the pain up front--if you want a $50,000 car, you have to write a $50,000 check--while the fun only comes later.  In the former situation, most people are apt to consume much more than they will in the latter.

The last sort of financial advice is by far the most lucrative--it has made Suze Orman and Dave Ramsey very, very rich.  But some research suggests that it may also be the least effective.  Spending or saving is not in our financial program stars, say the researchers; it is in our genes.

In a study of identical twins, which was published in the April edition of Journal of Consumer Research, marketing professors Itamar Simonson of Stanford University and Aner Sela of the University of Florida report that individual consumer preferences -- for such products as chocolate, hybrid cars, movies and jazz -- are genetically linked. Those preferences, the authors suggest, are a reflection of individual "prudence" -- a possible genetic predisposition to living "in the mainstream" or "on the edge" or somewhere in between. Prudent people are more cost conscious and more averse to reckless spending.

"People are born with a tendency to be more or less prudent," Simonson says, "which would suggest that they are born with a tendency to be more or less frugal."
Other researchers are working to explain the biological mechanism behind frugal living. Marketing professor Scott Rick of the University of Michigan has conducted brain imaging to reveal that frugal people quite literally "feel" the pain of spending in a way that other people do not. In one study, volunteers were shown images of consumer products, followed by their prices. In frugal people, the matching of product with price activated a part of the brain called the insula, a kind of neural distress center associated with such unpleasantries as perceived mistreatment by others, social exclusion and even a foul odor.

In his paper "Tightwads and Spendthrifts," (co-authored by George Loewenstein of Carnegie Mellon University and Cynthia Cryder, now with Washington University in St. Louis), Rick argues that frugal people anticipate the pain associated with spending money, whereas spendthrifts have little reference point for such pain and, therefore, spend like there's no tomorrow. The study, also in the Journal of Consumer Research, reports that tightwads (frugal consumers) account for roughly 25 percent of the population, while spendthrifts account for another 25 percent.

(Rick's latest research includes the surprising finding that cheapskates and spendthrifts often marry each other, but the relationships rarely last).

Certainly, my consumer finance reporting has led me to believe that there are some people who simply can't handle credit, and that this seems to be more than just bad habits.  These are not the people who have a bout of depression, or job loss, or a nasty divorce that leaves them with $15-20K worth of debt that must be painfully worked off.  They're people who consider "cutting back" to be spending every dollar they make.  Unless they find a very rich spouse, or fate intervenes, they end up in bankruptcy because they simply cannot make inflow match outflow: their impulses overwhelm their ability to do arithmetic.  My amateur theory is that it's some combination of impulse control problems, and an anxiety disorder that is temporarily palliated by shopping.  But the research in this area isn't very well fleshed out.

These people are not the majority of the population, or even the majority of people who end up in serious financial trouble.  But having spoken to them, read about them, and looked at research on them, I'm convinced they are a troubling minority: access to any significant amount of credit unambiguously makes these people worse off.

But while I'm sure that spending habits are partially inherited, I also think they're socially conditioned.  Amish people and Muslims don't get into debt trouble, not because of their sterling genetic inheritance, but because they live in cultures that really frown on that sort of thing. (This has other issues for security and economic growth, which is why I take it that some of the Amish have now started using credit cards, and "Islamic finance" is its own specialty which creates synthetic debt-like structures out of equity, but as a generalization it works).

What Dave Ramsey, and to a lesser extent, Suze Orman do is provide you with an alternative social network that can help you change the norms by which you live.  Instead of competing with your current friends over how large a house you can buy, you can join mytotalmoneymakeover.com and get a new network of cyberfriends who with whom you compete to see how much debt you can pay off, or money you can save.  Or you can call into Suze's show and hear her tell you what a proud, strong woman you are for trying to take care of yourself and your family by building financial wealth.

In fact, we know of one culture that's very, very good at helping people build wealth: academia.  Of course, academics start with a solid base: if you're a tenured professor, you are definitionally good at delaying gratification.  But one thing you learn from financial reporting is that the ability to delay gratification in your career does not always translate into wise financial stewardship; there are lots and lots of doctors, lawyers, and MBAs who clearly had what it took to go through a long initiation process, and nonetheless manage to end up with no savings and a lifestyle that can't survive more than a few weeks of job loss or other financial distress.  Academia pays modestly, and yet on average, tenured professors have quite a lot of wealth built up by the time they retire.

This is often attributed to TIAA-CREF, and sure, they're great.  But having a great pension plan does not automatically make your workers wealthy--even the generous traditional defined-benefit plan will do no good if the worker spends everything they earn and arrives at retirement deeply in debt.

Academia produces wealth because academia stigmatizes conspicuous consumption.  A professor with a jaguar can explain this as a personal eccentricity.  A professor with a jaguar, a speedboat, a vacation home, a twice-yearly cruising habit, and a 5,000 square foot McMansion with a two-story atrium and a $1,000 a month heating bill, is going to get the fisheye from his colleagues.   Yet many moderately successful salesmen would regard this as simply their due for working hard and succeeding--and would be reinforced in this by all the other salesmen with similar lifestyles.  A professor's colleagues, who are apt to have a very good idea of what professors make, would be well aware that such a lifestyle represented very imprudent levels of debt and savings.  Besides, academics, like journalists, have developed sour grapes to a high art: they quickly learn to regard expensive possessions as somewhat vulgar.

I'd be willing to bet that if you looked at places where academics don't predominantly socialize with other academics--full time professors at for-profit universities, or commuter schools, for example--you might well find that those professors have built less in the way of wealth than the average for their profession.

So while the material people have to work with might be genetic, that doesn't mean that a more frugal culture couldn't produce better results.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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