Michael Sheradden’s Compounding Interest

Two decades ago an obscure academic revolutionized thinking about poverty. Now his insights might just save the middle class.
July 11, 2012 |
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In 1991, a professor of social work at Washington University named Michael Sherraden published a book called Assets and the Poor. Sherraden was neither a big name nor a natural self-promoter, the book was published by an obscure academic press, and his topic was not earth-shattering—he proposed a new approach to ameliorating poverty by helping poor families save for the future, as an alternative to programs that simply provided enough income for day-to-day sustenance. But the book caught on quickly in Washington. In a city susceptible to intellectual fads, what’s even more remarkable is that Assets and the Poor sparked the emergence of something that has lasted, and that has come to be known over the ensuing twenty years as the asset movement. Its adherents grew to include dozens of academics, policy entrepreneurs in nonprofits and foundations, mayors, governors, and members of Congress. The story of Sherraden’s book shines an unusually clear light on an often obscure part of the policymaking process. Everyone knows how a bill becomes a law. But how does an idea become a cause?

It started in 1991, when William Raspberry, then a columnist for the Washington Post, latched on to the ideas in Sherraden’s book. According to Bob Friedman of the Corporation for Enterprise, Raspberry’s column led Jack Kemp, then secretary of housing and urban development under President George H. W. Bush, to seek out the book, and “wave his dog-eared copy around at speeches.” The converging enthusiasm of Raspberry, a liberal columnist; Kemp, a free-market conservative with an unusual interest in poverty and race; Friedman, an innovator working to develop self-employment opportunities as an anti-poverty strategy; and Will Marshall of the Progressive Policy Institute, the moderate Democratic think tank that had published Sherraden’s early work, showed the broad appeal of the idea.

Sherraden made four points: First, poverty was characterized not just by a lack of income, but by a lack of assets, such as small amounts of savings that could cushion a financial setback. (Disparities in wealth by race were, and still are, far wider than disparities of income.) Second, poor people, with help and encouragement, could save and would be far better off if they did. Third, the existing safety net contained significant traps, in the form of asset limits that prohibited recipients from saving much or even owning a reliable car without losing food stamps or other benefits. Finally, he demonstrated that government programs to encourage assets were not new, but were overwhelmingly tilted toward the middle class and above, in the form of the home mortgage interest deduction, Individual Retirement Accounts, and dozens of other policies.

These four themes resonated on different parts of the political spectrum. Kemp and a handful of creative conservatives saw the possibility of “empowerment,” or what would later be called “the ownership society,” to bring more people into the world of capitalism, as owners and investors. For many Democratic politicians—particularly with the party’s likely nominee, Bill Clinton, promising to “end welfare as we know it”—any kind of new idea about poverty reduction was welcome, especially one that treated poor people as capable of making their own way out of the cycle of poverty. Liberal antipoverty advocates worried, to be sure, that the focus on assets would distract attention from the pressing need to repair the income-maintenance safety net. But most agreed that asset limits had created a trap. And by revealing the enormous subsidies for assets provided to better-off Americans, Sherraden gave liberals a comfortable universalist language. Providing similar incentives to the poor, they argued, was not a targeted program like welfare, but simply a matter of providing the same things to everyone.

Sherraden’s ideas had broad implications for policy, but they were distilled into a specific proposal, the Individual Development Account. Modeled on Individual Retirement Accounts, IDAs would help low-income families save by using public or philanthropic dollars to match small savings in accounts that could later be used for homeownership, self-employment, or education.
Enthusiastic politicians from both parties introduced IDA legislation in the House and Senate in the early 1990s. The Assets for Independence Act created a very small demonstration program, funded at $25 million a year, in 1998. President Clinton called for a $500 billion program in his 1999 State of the Union address. Although nothing of this scale was enacted, Ray Boshara, who crafted the original legislation while working for Representative Tony Hall, chair of the House Select Committee on Hunger, says that at the time “the politics were way ahead of the practice”—that is, the political enthusiasm for IDAs as a policy far outpaced any actual experience with designing or implementing them. If something as expensive as Clinton’s proposal had been enacted, it might well have been a disaster.

Instead, patient development of Sherraden’s ideas came from philanthropic foundations. Benita Melton of the Charles Stewart Mott Foundation, which along with the Ford Foundation was an early and central promoter of asset policies, notes that there is a classic model for the role of organized philanthropy in American social policy: Foundations are, in effect, “the research and development arm for government.” They support policy development, demonstration projects, research to test results, and refinements of policy design, which government then picks up and takes to scale.
In recent decades, this classic model has atrophied as government, driven by ideology, has shown little interest in objective information about what works. The Obama administration, however, through its Social Innovation Fund and other initiatives, has taken a renewed interest in the social sector and the innovations it has tested. The role of foundations in developing the field of asset policy is an example of the classic model at its best.

Twelve foundations, coming to asset policy for different reasons, much like the political supporters, backed the American Dream Demonstration project. Running from 1997 to 2002, the project established IDAs with matched savings for 2,364 people through community organizations. The ADD, one of the most thoroughly evaluated social experiments of recent years, proved Sherraden’s core insight that the poor could save. On average, participants saved $228 a year, which, with the match, led to total savings averaging $1,543.

Nonetheless, two-thirds of participants took some money out of their accounts for purposes other than homeownership, education, or launching a business, surrendering some of the matching funds. One lesson of the experiment, Boshara says, was that families “need unrestricted assets also, to make the accounts work.” When all the funds were restricted to a specified purpose, they were of no use to families facing emergencies. But without some restrictions, families would never build up the funds needed to pay for a first home or other large assets. Political considerations also argued for some limits on how much families could drain their accounts for any purpose, since the programs that subsidize assets for the middle class are for restricted purposes, such as homeownership or retirement.

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.

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