How Loyalty Programs Work, and Why They May Cost You More Money in the Long Run
Loyalty programs are designed to give you perks for sticking with a particular airline or store, but because of the way your mind works when making decisions you might end up saving more money by avoiding them all together.
Psychology Today has dissected how loyalty programs work, and they've found that we're often willing to spend more money in the name of accruing more points:
Because you may pay more for some flights on that airline in order to stick with the particular carrier, you may pay more for those simple comforts than you might be willing to pay if they were just offered to you directly. That is, you might not pay $40 for the opportunity to board early if it were offered to you at check-in, but you might pay $40 more for a flight on an airline where your loyalty club membership allows you to board early.
The idea of loyalty programs is to help you develop a habits that include the companies offering them. The more you participate—meaning, the closer you get to a reward—the more you'll tend to appreciate the program and begin to form these habits.
Loyalty programs aren't inherently bad, however. So long as you don't let the draw of points lead you to spending a bunch of extra money, they can be used to your advantage without creating bad habits. For some tips, our guide to mastering airline loyalty programs is a good start.
One of the big problems during the financial crisis was a bank run in the shadow banking system when doubts emerged about the safety of deposits.
In my last column at the Fiscal Times, I talked about an approach to solving the problem that involves having deposits in the shadow system backed (insured) by high quality collateral.
But high quality collateral is not the only option. Another way to do this is through a type of insurance along the lines of what the FDIC does for the traditional banking system, along with restrictions on eligibility for the insurance. In reaction to my column, and in support of the insurance approach, Morgan Ricks of Harvard Law School emails:
I enjoyed your Fiscal Times piece and am glad you're focused on this issue.
I'm a big admirer of Gary and Andrew's work, but I would encourage you to give some more thought to whether collateral requirements for repo are likely to do the trick. Here are a few things to consider:
- Many of the short-term liabilities of the shadow banking system were and are uncollateralized (think about Lehman's reliance on unsecured commercial paper -- the default of which caused the Reserve Fund to "break the buck," igniting the run on money market funds; and Citigroup's SIVs, which financed themselves in the unsecured markets).
- Money market investors do not want to take possession of collateral and dispose of it. Even if the collateral is high quality, they don't want the interest rate risk. That's not their business. They don't want to deal with the consequences of a counterparty default. This is why, in the crisis, many money market investors stopped rolling even those repos that were fully secured by Treasuries and agencies:
- See Chris Cox's testimony on Bear Stearns (here http://www.sec.gov/news/testimony/2008/ts040308cc.htm): "For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed"
- See also FRBNY's repo task force report (here http://www.newyorkfed.org/prc/report_100517.pdf): “Discussions in the Task Force emphasized repeatedly that many Cash Investors focus primarily if not almost exclusively on counterparty concerns and that they will withdraw secured funding on the same or very similar timeframes as they would withdraw unsecured funding.”
- Even if collateral requirements reduce the likelihood of runs, how do we calibrate them -- what is the objective function? Presumably we think maturity transformation (fractional reserve banking) is a good thing -- it increases the supply of loanable funds by pooling otherwise idle cash reserves and deploying them toward productive investments. Risk constraints (such as collateral requirements) necessarily reduce this surplus -- there is a real social cost. How do we appraise the corresponding benefit? That is, how do we estimate the systemic instability associated with any given level of collateral requirements? My argument is that we can't. And by "we" I mean not just the government, but anybody.
My paper argues that we avoid these problems with an insurance regime; that financial firms outside the insurance regime should be disallowed from conducting maturity transformation (i.e., they would have to rely on term funding, not money market funding); and that we should develop functional criteria of eligibility for the insurance regime. (By the way, this is not the same thing as "extending" insurance to shadow banks.)
Anyway, these are things worth thinking about. I think the insurance approach needs more serious consideration than it has received -- it's a little lonely over here ...
Best,
Morgan Ricks
See here for nice summary of this approach and link to the underlying academic paper.
robert shumake
Knight Science Journalism Tracker » Blog Archive » Science <b>News</b>: A <b>...</b>
Science News's enterprising reporter Ron Cowen got it after he looked through the program and abstracts of the Amer. Astronomical Assoc's Division of Planetary Sciences meeting underway in Pasadena. He saw a session devoted to the birth ...
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robert shumake
Knight Science Journalism Tracker » Blog Archive » Science <b>News</b>: A <b>...</b>
Science News's enterprising reporter Ron Cowen got it after he looked through the program and abstracts of the Amer. Astronomical Assoc's Division of Planetary Sciences meeting underway in Pasadena. He saw a session devoted to the birth ...
Gates Foundation Backs ABC <b>News</b> Project - NYTimes.com
The Gates Foundation gives a $1.5 million grant to ABC News to support the network's reporting on various global health crises.
ABC <b>News</b> and Facebook team up for election coverage - Lost Remote
ABC News is also partnering with Yahoo! News to do election polling, with results posted on both sites. In addition, the network will be doing daily 15-minute webcasts beginning October 25th at 6:45 am, the idea being that the webcast ...
robert shumake
How Loyalty Programs Work, and Why They May Cost You More Money in the Long Run
Loyalty programs are designed to give you perks for sticking with a particular airline or store, but because of the way your mind works when making decisions you might end up saving more money by avoiding them all together.
Psychology Today has dissected how loyalty programs work, and they've found that we're often willing to spend more money in the name of accruing more points:
Because you may pay more for some flights on that airline in order to stick with the particular carrier, you may pay more for those simple comforts than you might be willing to pay if they were just offered to you directly. That is, you might not pay $40 for the opportunity to board early if it were offered to you at check-in, but you might pay $40 more for a flight on an airline where your loyalty club membership allows you to board early.
The idea of loyalty programs is to help you develop a habits that include the companies offering them. The more you participate—meaning, the closer you get to a reward—the more you'll tend to appreciate the program and begin to form these habits.
Loyalty programs aren't inherently bad, however. So long as you don't let the draw of points lead you to spending a bunch of extra money, they can be used to your advantage without creating bad habits. For some tips, our guide to mastering airline loyalty programs is a good start.
One of the big problems during the financial crisis was a bank run in the shadow banking system when doubts emerged about the safety of deposits.
In my last column at the Fiscal Times, I talked about an approach to solving the problem that involves having deposits in the shadow system backed (insured) by high quality collateral.
But high quality collateral is not the only option. Another way to do this is through a type of insurance along the lines of what the FDIC does for the traditional banking system, along with restrictions on eligibility for the insurance. In reaction to my column, and in support of the insurance approach, Morgan Ricks of Harvard Law School emails:
I enjoyed your Fiscal Times piece and am glad you're focused on this issue.
I'm a big admirer of Gary and Andrew's work, but I would encourage you to give some more thought to whether collateral requirements for repo are likely to do the trick. Here are a few things to consider:
- Many of the short-term liabilities of the shadow banking system were and are uncollateralized (think about Lehman's reliance on unsecured commercial paper -- the default of which caused the Reserve Fund to "break the buck," igniting the run on money market funds; and Citigroup's SIVs, which financed themselves in the unsecured markets).
- Money market investors do not want to take possession of collateral and dispose of it. Even if the collateral is high quality, they don't want the interest rate risk. That's not their business. They don't want to deal with the consequences of a counterparty default. This is why, in the crisis, many money market investors stopped rolling even those repos that were fully secured by Treasuries and agencies:
- See Chris Cox's testimony on Bear Stearns (here http://www.sec.gov/news/testimony/2008/ts040308cc.htm): "For the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed"
- See also FRBNY's repo task force report (here http://www.newyorkfed.org/prc/report_100517.pdf): “Discussions in the Task Force emphasized repeatedly that many Cash Investors focus primarily if not almost exclusively on counterparty concerns and that they will withdraw secured funding on the same or very similar timeframes as they would withdraw unsecured funding.”
- Even if collateral requirements reduce the likelihood of runs, how do we calibrate them -- what is the objective function? Presumably we think maturity transformation (fractional reserve banking) is a good thing -- it increases the supply of loanable funds by pooling otherwise idle cash reserves and deploying them toward productive investments. Risk constraints (such as collateral requirements) necessarily reduce this surplus -- there is a real social cost. How do we appraise the corresponding benefit? That is, how do we estimate the systemic instability associated with any given level of collateral requirements? My argument is that we can't. And by "we" I mean not just the government, but anybody.
My paper argues that we avoid these problems with an insurance regime; that financial firms outside the insurance regime should be disallowed from conducting maturity transformation (i.e., they would have to rely on term funding, not money market funding); and that we should develop functional criteria of eligibility for the insurance regime. (By the way, this is not the same thing as "extending" insurance to shadow banks.)
Anyway, these are things worth thinking about. I think the insurance approach needs more serious consideration than it has received -- it's a little lonely over here ...
Best,
Morgan Ricks
See here for nice summary of this approach and link to the underlying academic paper.
robert shumake
Knight Science Journalism Tracker » Blog Archive » Science <b>News</b>: A <b>...</b>
Science News's enterprising reporter Ron Cowen got it after he looked through the program and abstracts of the Amer. Astronomical Assoc's Division of Planetary Sciences meeting underway in Pasadena. He saw a session devoted to the birth ...
Gates Foundation Backs ABC <b>News</b> Project - NYTimes.com
The Gates Foundation gives a $1.5 million grant to ABC News to support the network's reporting on various global health crises.
ABC <b>News</b> and Facebook team up for election coverage - Lost Remote
ABC News is also partnering with Yahoo! News to do election polling, with results posted on both sites. In addition, the network will be doing daily 15-minute webcasts beginning October 25th at 6:45 am, the idea being that the webcast ...
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