[Fresh Ink] [Review] High Wire: The Precarious Financial Lives of American Families

[Richard Menec]

http://www.nybooks.com/articles/22080

The New York Review of Books

Volume 55, Number 18 · November 20, 2008

Trapped in the New 'You're on Your Own' World

By Robert M. Solow

High Wire: The Precarious Financial Lives of American Families by Peter 
Gosselin Basic Books, 374 pp., $26.95

1. When the Bush-Cheney administration proposed to replace Social Security 
with a system of individually accumulated, individually owned, and 
individually invested accounts, my first thought was that its goal was to 
take the Social out of Social Security. It took a few minutes longer to 
realize that it also intended to take the Security out of Social Security.

That attempt failed. In recent years, however, a mixture of public and 
private policy decisions and impersonal market developments has had the 
broad effect of shifting many financial risks from established institutions, 
including even society at large, to individuals who are unable to cope with 
them in an adequate way. Information may be impossibly difficult for 
citizens to process; or else the basic information may not be available to 
individuals or private groups. Sometimes the scale of the possible bad 
outcomes may be overwhelming. Sometimes the appropriate insurance market 
cannot function or just does not exist. The result is that individuals and 
families can be the casualties of situations that once would have been 
handled by a more centralized and more bearable allocation of risks.

The current turmoil in credit markets and the recession that is sure to 
follow are likely to drive this trend further. Banks, insurance companies, 
and other financial institutions have seen too many risks go sour. They will 
be more determined than ever to push further risks onto those needy 
borrowers who are too weak and too ignorant to bargain hard. Families, small 
businesses, and other borrowers of last resort will be under great pressure.

Peter Gosselin's excellent and thoughtful book, High Wire: The Precarious 
Financial Lives of American Families, is not the first to explore this 
territory. Two others that come to mind are Louis Uchitelle's The Disposable 
American[1] and Jacob Hacker's The Great Risk Shift.[2] Gosselin is like 
Uchitelle in combining social criticism with substantial stories of 
recognizable people who have been trapped by bad luck or bad judgment in 
this new you're-on-your-own world; he differs in covering a much broader 
variety of risks and risk-bearers than Uchitelle's focus on workers and 
job-related risks. Hacker's book also ranges over many issues, but does not 
have Gosselin's expert journalistic use of recognizable cases. (Professor 
Hacker is currently engaged in a Rockefeller Foundation-sponsored effort to 
construct a general "Index of Economic Security"-to show empirically how 
economic security varies over time and across social groups.)

Gosselin, who works in the Washington bureau of the Los Angeles Times, does 
a fine job of connecting the stories he tells to general ideas and to 
economy- wide statistical markers, some developed for his particular 
purpose. He has produced a readable and valuable book. In this connection it 
cheers me up to see how he has profited from a stay at the Urban Institute, 
a leading non- ideological research center in Washington. (I am on the board 
of the Urban Institute, but our paths never crossed there, though we are 
acquainted.)

2. A grasp of the basic principles of insurance will provide indispensable 
background for understanding both the scope of Gosselin's argument and also 
the possible remedies for the failure of social arrangements that he 
highlights. So I include a brief primer on that subject, using the 
relatively straightforward example of fire insurance.

Imagine a population of a million similar families, living in a million more 
or less similar houses. From long experience it is known that the chance 
that any given family will suffer a severe fire in any given year is about 
one in ten thousand. In other words, we can expect about a hundred fires per 
year. The same experience tells us that the average amount of damage per 
fire is $200,000. So the total damage per year is some $20 million. Serious 
house fires are rare, but when one occurs it is devastating to the unlucky 
family.

The existence of fire insurance makes an enormous difference. If each of the 
million families pays an insurance premium of $20 a year, all damages can be 
reimbursed. Major house fires would still not be welcome events; but they 
would not be financially catastrophic. The small probability of a large loss 
is eliminated, and replaced by a small but certain cost. Insurance companies 
would have to charge a bit more than $20 per house, to cover administrative 
costs and profit. Also companies would have to build up a reserve, to allow 
for the fact that annual losses would surely fluctuate around the average of 
$20 million, with an occasional bad year. On the other side of the ledger, 
investment of the reserves, presumably in reasonably safe and liquid 
securities, would offset at least some of the costs of the system.

Nevertheless, fire insurance has its problems, two in particular. Notice, 
first, that the existence of fire insurance does nothing to diminish the 
number of fires. Insurance is a way of pooling or sharing risks, not of 
eliminating them. In fact the opposite is true: the existence of fire 
insurance probably increases the number of fires. In the absence of 
insurance, one has to expect that home owners will be very careful about 
loose matches, old soldering irons, and other such dangers. The knowledge 
that they are fully covered may lead to some carelessness, and to more 
fires. This sort of effect is called "moral hazard." (It is why subsidized 
flood insurance encourages people to live in flood plains.) Insurance 
companies have devices to discourage moral hazard. Deductibles and 
co-payments are two such devices: no fire is costless to the insuree. 
Required precautions are another device; every insured home is supposed to 
have an approved extinguisher and smoke alarms.

The second problem is different. All houses are not alike, after all. Some 
are more fire-prone than others. To take an extreme case, suppose that 90 
percent of the million homes have, for various reasons, essentially no risk 
of fire. The hundred fires per year all come from the remaining 100,000, 
each with a probability of one in one thousand. They are responsible for the 
annual damage cost of $20 million. The 900,000 fire-free home owners very 
likely know this. They are in effect subsidizing the fire-prone houses, so 
they will choose not to buy insurance. Only the fire-prone homes will be in 
the market.

This is called "adverse selection." To be viable, insurance companies will 
have to charge a premium of $200 per year, and even some of the fire-prone 
home owners may balk. You can easily imagine how the whole insurance market 
might unravel if there are houses of many degrees of fire-proneness: each 
time the rate rises, the least vulnerable, least fire-prone customers may 
drop out, leading to a still higher rate and still more dropouts. Insurance 
companies may respond by refusing coverage altogether to very fire-prone 
houses (or refusing health insurance to people who look as if they might 
actually become seriously-or expensively-sick). Modern information 
technology and data-mining techniques make it possible for insurance 
companies to pinpoint the known risks associated with individual applicants 
and quote "appropriate" rates.

Naturally, they do; but this only further undermines the insurance 
principle. Unless something drastic is done about it, adverse selection can 
lead to a situation in which precisely those who need insurance most cannot 
get it, or cannot afford it. Keep in mind that it is in the self-interest of 
the safe or healthy not to be in the same insurance pool, paying the same 
rate, as the fire- or sickness-prone, because they will be paying in more 
than the costs they incur, so that others can pay in less. In such cases, if 
adequate insurance is to be provided, there may have to be external 
regulation or direct public provision.

3. Gosselin interprets his theme broadly, and his book covers a lot of 
ground. A sample of topics will convey the scope:

(1) A marked tendency for incomes to become more subject to large 
fluctuations, especially recently, so that both poor and moderately affluent 
people are increasingly exposed to the risk of a large-like 50 percent-drop 
in income from one year to the next.

(2) The growing unwillingness of employers to support defined-benefit 
pension plans that impose on them the obligation to pay benefits based on 
previous earnings to retired employees, and the replacement of such plans by 
defined-contribution plans, 401(k) and others. These leave the retirees 
facing the possibility that their own bad investment choices or just the 
accident of retirement during a down period in the securities markets will 
reduce eventual benefits below normal expectations. This risk is on top of 
the well-known fact that many employees, out of ignorance, inattention, or 
inertia, simply fail to accept clearly favorable options when offered, and 
for the same reasons, as well as bad luck, often invest predictably badly. 
It seems inevitable that the recent volatility in equity markets will induce 
even more employers to convert pension plans to forms that leave the risks 
of stock market and bond market fluctuations squarely on the employees.

(3) The erosion of employer-provided health insurance, and the occasional 
tendency of insurance companies to welsh on expected benefits, either by 
appealing to small print in the contract or simply by stonewalling.

(4) The failure of the federal government to produce an organized plan for 
the resettling of the victims of post-Katrina New Orleans, leaving many 
former inhabitants with the Hobson's choice of either trying to rebuild in 
the absence of any assurance that enough of their neighbors will do the 
same, so as to render the old neighborhood livable, or else abandoning their 
property and moving elsewhere.

That is quite an assortment of contingencies, and there are others. What 
they have in common is that individuals have difficulty coping with 
situations that combine high uncertainty and large potential loss. Neither 
collective protection nor private insurance on affordable terms is available 
to them. This striking variety of circumstances adds interest and importance 
to High Wire, especially by showing, with some drama, that the shifting of 
risks from institutions to individuals occurs up and down the income scale, 
affecting the apparently solid middle class as well as the poor.

This expository advantage comes at some cost, however. Different 
circumstances implicate different aspects of the insurance principle. 
Gosselin's agenda does not permit him to discuss them all in any depth, or 
to show how they are related through the general properties of insurance. I 
will try here to sketch a few of the complexities in the hope of helping 
readers to see that the issues emphasized by Gosselin's account are really 
quite central to major matters of social policy.

4. Start with the most general and most complex indicator of risk: the 
year-to-year volatility of personal incomes. Gosselin's statistical analysis 
confirms what others have found. Although precise results may differ 
according to the source of the data, the time period, the definition of 
income, and the population studied, the general conclusion has to be that 
ordinary people are now more likely to experience large fluctuations in 
earnings than they were three or four decades ago. There is an element of 
paradox here: during the very same period-from the mid-1990s to the 
present-year-to-year fluctuations in national income have become noticeably 
milder, a fact that has come to be called the Great Moderation. So the 
aggregate economy has become more stable while individual fortunes have 
become less stable.

There is no arithmetic difficulty in this: your total calorie intake per day 
could become more uniform even while the daily contributions from meat, 
fish, fruits, and vegetables were coming to vary more erratically. That 
would only require determination about your consumption of calories. But it 
is natural to wonder why the economy has evolved in this particular way. 
There are many possible explanations, and many of them can be true. Rapid 
technological change may be eliminating long-tenure jobs and the continuity 
of income that they bring. The general shift in employment away from the 
production of material goods and toward the production of services tends to 
stabilize aggregate employment and income, because the demand for services 
is less vulnerable to the business cycle than the demand for goods; but job 
shifts and job destruction within the service sector may have become more 
frequent. More broadly, as an economy gets richer, and necessities form a 
smaller portion of expenditure, the whims of fad, fashion, and minor changes 
in tastes can lead to erratic fluctuations in the market value of particular 
skills and occupations, and thus to volatility of individual earnings. 
Whatever the underlying explanation, the fact remains.

Statistical volatility is an abstract fact. Gosselin humanizes it by 
choosing as his basic indicator the chance that a person or family will 
experience a year-to-year drop in income of more than 50 percent. Sure 
enough, this probability almost doubled between the decades of the 1970s and 
the 2000s, from one in twenty to about one in eleven. (The probability of a 
50+ percent rise in income also increased from about one in nine to one in 
seven. Volatility works both ways, but it is the bad surprises that hurt.)

Then Gosselin does an interesting thing. What sorts of contingencies would 
lead to such a drastic and sudden reduction in a family's income? The 
obvious suspects are major unemployment, illness, retirement or disability, 
divorce or separation, death of a spouse, even birth of a child leading to 
one parent's withdrawal from a job. Adding all these together, Gosselin 
finds that their combined incidence was somewhat lower in the decade between 
1994 and 2003 than it had been between 1974 and 1983. If one of them 
happens, however, the chance that it leads to a 50 percent drop in income 
was much higher in the later period than in the earlier one. So it is the 
financial risk that has jumped, not the generic hard luck. This sounds 
suspiciously like the tearing of a safety net. Welcome to the world of 
Individual Responsibility-the approach to economic security that has been 
advocated by government and the private sector in recent years.

There is a market-based way to deal with these bad episodes. Careful, 
foresighted individuals and families can save some or all of their favorable 
windfalls-those increases that are 50 percent, or greater or smaller 
ones-and use them, and borrow if necessary, to smooth over the bad patches. 
This hap-pens, to a statistically visible extent. Family spending on 
consumption is in fact less volatile than family income. So families do 
smooth the income peaks and valleys on their own. No doubt the sequence of 
saving and borrowing is at work, but borrowing is costly, and there may be 
other mechanisms operating, like contributions from extended family or 
charities. All but the most affluent families must pay a much higher 
interest rate when they borrow than the interest they earn when they save, 
so income smoothing is not as easy as it sounds, and is certainly expensive.

Now instead, imagine constructing a sort of income insurance policy. We do 
have unemployment insurance, but it typically replaces only half or less of 
wages and expires after twenty-six weeks. (Another thirteen weeks have been 
tacked on temporarily as a response to the current slowdown or recession.) 
At least in fantasy one can imagine a broader policy to insure incomes that 
collects regular income- related premiums from policyholders and promises in 
return to replace a substantial part of any shortfall from some defined 
average income that would have to be determined for each policyholder 
separately.

But it is hard to imagine a private insurance company offering such a policy 
on anything like workable terms. The standard difficulties besetting any 
insurance scheme would be much too acute. The moral hazard problem-the 
danger that individuals would use the insurance as a way to take frequent 
holidays from work-could perhaps be partially controlled. For example, 
limiting insurance benefits to the replacement of only a small fraction of 
the shortfall from "average" income is analogous to a large co-payment or 
deductible; but if the replacement fraction is very small, the risk 
reduction conferred by insurance is also very small. Alternatively it might 
be possible for the insurance company to require valid certification that 
the reported income shortfall is not voluntary; the analogy is then to an 
outside medical examination in disability insurance. Even so, moral hazard 
surely does not disappear.

The adverse selection problem for private income insurance seems an order of 
magnitude tougher. Most individuals know more about their own income 
prospects than any insurance company could ever find out. Inevitably the 
insurance rolls would be filled with potential losers and risk-takers. Those 
with conservative temperaments and relatively secure jobs and those who can 
pretty safely look forward to stable or rising income with increasing 
experience and seniority would be sensibly inclined to avoid the stiff 
insurance premium and protect themselves against stepping on broken glass 
and other bad luck by saving up for the rare and unpredictable rainy day. It 
is hard to see how a universal private market for income insurance could 
survive.

But-and this is where the argument has really been leading-why does it have 
to be private? Gosselin is aware, though many have forgotten, that the idea 
of "social insurance" would once have seemed far more natural than it does 
today. Think again about the contrast between Roosevelt's Social Security 
and the Bush-Cheney "Ownership Society." It is not just a matter of this or 
that piece of legislation. The thought underlying social insurance is that 
life is a gamble, especially economic life. There will be winners and 
serious losers. The losers are singled out by bad luck, or occasional bad 
judgment, or even the wrong personal idiosyncrasy at the wrong time. In any 
case, we are in a sense all better off if we share the risk of losing and 
convert the small risk of damaging loss into a small, universal, and certain 
cost. This may have been a more natural frame of mind in the Great 
Depression of the 1930s than during the Great Moderation, when income growth 
was strong and inflation was relatively stable.

The irony is that the very fact of the Great Moderation makes social 
insurance more easily practical. When the national income is stable and 
secure, the allocation of a small fraction of it to the stabilization or 
near stabilization of individual incomes is at worst a minor burden and a 
widely shared burden. The otherwise difficult problem of adverse selection 
is essentially nullified because the insurance pool is not self-selected, 
but is by definition the whole society; the social insurance premium takes 
the form of a tax. (It is probably a good idea for benefits under an income 
insurance scheme to be part of taxable income: the more "normal" the 
better.)

Moral hazard, however, is always with us. It is plausible that a state-run 
universal social insurance system would be better able than a private 
company to detect and prevent exploitation of the system by malingerers. 
Maybe success would depend on the creation of a norm of good citizenship; 
something like that underlies the establishment of social insurance in the 
first place. It seems to work in the Nordic countries-though not without 
strain-where the tradition of social insurance is strongest. The US has a 
long way to go. Gosselin cleverly cites the Mayflower Compact and its 
proposal to create such laws and regulations "as shall be thought most meet 
and convenient for the general good of the Colony, unto which we promise all 
due submission and obedience." That is indeed a long way from where we are 
now. Gosselin mentions that forty-one of fifty men on board signed.

5. The other important institution that has been engaged in shifting risk to 
individuals is the business firm as employer, especially the large firm. The 
main risks to think about are those connected with nonwage benefits like 
pensions and health care. (It is also important that the average length of 
job tenure has been decreasing, but that has many causes and is best dealt 
with as part of the general issue of income volatility.) Health care is a 
specialized subject unto itself, and I will not dwell on it. But there are 
some general principles underlying this whole change in the landscape that 
are implicit in Gosselin's excellent account, but need spelling out, so that 
we can understand what is possible.

The first thing to understand is that changes in pension or other benefit 
arrangements are not simply transfers between employer and worker. Pretty 
clearly it is the total cost of an hour of labor that matters to an 
employer, however it is divided between cash wages and benefits. The 
preferences of workers are not so transparent; but nonwage benefits are 
obviously very important, and it is a reasonable first approximation that 
workers, like their employers, value a dollar of wages about equally with a 
dollar of benefits. But then it is the total cost of an hour of labor that 
the fundamental forces of the labor market-whatever they are-must be 
determining. The allocation between benefits and cash wages will depend on 
other factors, like tax laws, the duration of contracts, transaction costs, 
and the like.

The point to remember is that one cannot really talk about benefits as if 
they were independent of wages. Anything that happens to one of them will 
affect the other. By the way, between December 1998 and December 2007, 
according to the Department of Labor's Employment Cost Index, wage and 
salary costs per hour in US private industry increased by 32 percent and 
hourly benefit costs, including health benefits, by 50 percent (both 
uncorrected for inflation). That tells us something about levels of 
spending, but does not speak to the question of risk-bearing. One suspects 
that most businesses, as they shift from defined-benefit to 
defined-contribution pension plans such as the 401(k), have also taken the 
opportunity to reduce their pension costs, and thus their total labor costs, 
overall. It would be interesting to have comprehensive data on that point, 
but I do not know of any.

The usual story is that US businesses have had to put heavier pressure on 
labor costs as they faced intensified competition from imports generally and 
especially those from emerging economies with low wages and negligible 
benefits. It is also thought that technological changes have had much the 
same effect: decreased demand and therefore downward pressure on the wages 
and benefits of even moderately skilled labor. There is certainly some truth 
in that kind of account.

The question, for Gosselin and his readers, is whether that is the whole 
story, or whether there is another factor: a sea change in public and 
private beliefs about the norms of the labor market, the responsibilities of 
business firms, nonprofit organizations, and governments toward the lot of 
their employees, clients, and citizens. When Ronald Reagan fired the air 
traffic controllers in 1981, was he just tending to the efficiency of the 
air transport system, or was he also sending a message to the private 
economy that the implicit rules of the game had changed and that unions 
could expect no protection, much less sympathy? If the latter, it is a 
message that could also extend to the behavior of insurance companies toward 
their policyholders, and still elsewhere. Gosselin believes that the message 
was intended and understood. If the government thinks that individuals have 
no claim on society, but should stand or fall by their own incapacities and 
mistakes, then business firms are surely not responsible for picking up the 
pieces.

6. Gosselin's last case study-the aftermath of Katrina in New Orleans-is 
quite different from the others, but it has something in common with them 
that is worth attention. He does not focus on the Lower Ninth Ward; it is 
not news that poor black families do not attract the attention or the 
assistance of our leaders. Instead he follows the difficulties faced by a 
couple of reasonably well-off, rising, property-owning families as they 
return to their devastated houses and deserted neighborhoods, and try to 
decide what to do next.

When they think of rebuilding, they are handicapped by penny-pinching 
authorities and incompetence. Clean-up lags, services are not restored. 
Maybe worst of all, the Army Corps of Engineers cannot or will not certify 
that the levees are sufficiently restored to protect against the 
hundred-year flood; as a result, flood insurance is unavailable, and lenders 
are unwilling to commit funds. That is poignant but not unexpected. What 
connects all this to the rest of the book is that the potential returnees 
are faced with a problem of collective action. They could perhaps pull it 
off if they knew that their neighbors were committed to the same effort, if 
there were good reason to expect that a livable neighborhood would be 
recreated.

But that seems to be beyond reach. The neighbors are scattered and 
uninformed. Many of them may be going through the same difficult decision 
process and coming up against the same stumbling blocks. There is no central 
agency or community organization offering guidance, and no centralized 
source of funds to permit and reward cooperation. The logical place to look 
was the federal government, but the administration seemed to lack the will 
or the imagination or, more likely, both. Gosselin makes a striking contrast 
with a nearby community in which a long-standing Greek Orthodox religious 
group was able to provide the needed organizational focus and access to 
resources.

The analogy to social insurance is apparent. This is another case in which 
individual action tends to unravel because the solution to the problem has 
an all-or-nothing character-what economists call increasing returns to 
scale-and because each individual's action affects other individuals' 
decisions directly, and not through prices-what economists call 
externalities. Individuals are asked to take a chance that is just too risky 
for each of them alone. Coordination at the center is required. A 
free-market economist would see this. A free-market ideologue would not.

7. The standard argument for leaving all the responsibility and decisions to 
the individual in the free market is that, in appropriate circumstances, 
that is the route, and maybe the only practical route, to economic 
"efficiency." Any interference is a "distortion," and the consequence of 
such distortion is that the economy produces less than it could. (A more 
up-to-date version is that messing with the atomistic market tends to 
cripple "innovation," but we actually know little about how that works, in 
either direction.)

One standard counterargument is that the circumstances are not always 
appropriate. The classic example is that private economic activity, for 
instance, the burning of coal or oil in furnaces or cars, may damage 
everyone's environment by emitting carbon dioxide and changing the climate. 
In those cases, and there are many, market prices give the wrong signals; 
regulation or taxation or subsidization is justified precisely to restore 
efficiency. The New Orleans story is another illustration of this point: 
perceptive government intervention could have done much to assure the 
rebuilding of the city.

But efficiency is not the issue here, at least not the main issue. The 
transfer of risk from social and private institutions to individuals 
transfers a burden, mainly from the strong to the weak. That is primarily an 
issue of equity. It will surely become more urgent in current circumstances, 
perhaps urgent enough to be seen as a central political issue. Suppose that 
the best way to relieve that burden is by sharing the risk through universal 
social insurance. The premium then has to be a tax, a tax on work or 
enterprise, or some productive activity, and such a tax is a distortion, a 
source of inefficiency, a true cost to society. What then? I know what 
Gosselin would say: a society that won't pay a small cost to preserve 
equitable and fair treatment of, among others, the sick, the old, the 
unemployed, and the victims of natural disaster is not much of a society. Is 
that a minority view?

-October 23, 2008


Email to a friend Notes [1]Knopf, 2006; reviewed in these pages by James 
Lardner, June 14, 2007.

[2]Oxford University Press, 2006; reviewed in these pages by Jeff Madrick, 
March 20, 2008.

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