Financially Fragile Households: Can You Come Up With Funds Needed to Cope?

Annamaria Lusardi, Daniel J. Schneider and Peter Tufano; Working Paper 17072, Financially Fragile Households, Evidence and Implications, prepared for the National Bureau for Economic Research, " a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works."

(Editor's Note: We've included some paragraphs from the working paper, as well as editing out some material during that process.)

Introduction

Economists and policymakers have focused on various elements of consumer financial behavior to gauge the overall well-being of households and of the economy. For example, the household savings rate, its converse — the rate of consumer spending, and household borrowing levels are commonly used aggregate metrics. On the micro-level, researchers have studied the distribution of wealth across the population, for example to assess households’ abilities to afford to retire. Other research examines households’ abilities to withstand financial shocks, usually by looking at their savings levels and access to credit. Yet other work examines bankruptcy filings as a metric of financial problems. Our work builds upon this large literature, but characterizes financial fragility by examining households’ abilities to access emergency funds from any source.

In particular, we study US households’ abilities to come up with $2,000 in 30 days, and we compare their coping ability with that of households in seven other industrialized countries.

Using this $2,000/30 day metric of financial fragility, we find widespread financial weakness in America: one quarter of Americans report that they certainly could not come up with the funds needed to cope with such a shock within thirty days, and an additional 19% would cope at least in part by selling or pawning possessions or taking payday loans. Adopting a broader definition of financial fragility, we find that almost half of all households report that they certainly not or could probably not come up with funds to deal with an ordinary financial shock of this size. We examine the cross-sectional distribution of financial fragility and we show that it is not just a poor person’s problem: a material fraction of the solidly middle class is pessimistic about their ability to come up with $2,000 in a month. Our work allows us to begin to characterize a "pecking order" of coping mechanisms, broadly rationalize them on the basis of direct and indirect costs, and suggest some implications of these patterns. Finally, we compare the levels of financial fragility and methods of coping across eight industrialized countries. While there exist differences in coping ability, we find a largely consistent ordering of coping methods.

We believe that a full consideration of financial fragility will enlighten public policy. In advocacy and policy circles, asset building for long horizon goals (retirement, education, small business development) has understandably been the primary focus. While the US government provides extensive direct and indirect subsidies to long-horizon savings, there is much less, if any, explicit policy related to short-term emergency savings. For example, home borrowing (and indirectly long-term savings in equity buildup) is tax advantaged through home mortgage deductions and long-term investing is advantaged through long-term capital gains rates. At the same time, income earned from emergency savings accounts receives no special treatment. To the contrary, asset limits on many social programs actively discourage low-income families from building up savings. While borrowing from family and friends is a critical element of household coping, it is virtually invisible in public policy. Finally, discussions of regulating and banning high-cost, short term borrowing schemes do not typically acknowledge their place in the pecking order of coping mechanisms.

... [the] perceived capacity to cope with an emergency is lowest in the US, UK, and Germany, all countries in which 50% of households or more would probably or certainly be unable to come up with the emergency funds. France and Portugal occupy an intermediate position; 46% of respondents in Portugal would certainly or probably be unable to come up with the funds as would 37% of those in France. The highest levels of coping capacity are found in Canada (28% certainly or probably unable), Netherlands (27.9%), and Italy (20%). In sum, we see substantial cross-national heterogeneity in perceived capacity to cope, with the United States at the upper end in terms of financial fragility.

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Financially Fragile Households: Can You Come Up With Funds Needed to Cope?

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