Low savings and the financial crisis

David Leonhardt and Ben Stein feel that the virtual lack of savings among American households has been instrumental in creating the crisis. The net result of the past two decades of financial engineering has been a proliferation of financial instruments, promising (and delivering for some time) spectacular returns, that enticed investors and savers away from regular deposit insured savings avenues. The "wealth effect" and "irrational exuberance" generated by the sustained boom in equity and real estate markets, gave currency to an impression that asset markets can only go up. The result was a steep fall in the household savings rate, which even fell into negative territory.



Ironically, the low savings may have played a significant role in containing the ongoing crisis by limiting the runs on bank deposits. If people do not have enough savings account deposits to pull out, then there cannot be bank runs! Atleast the markets do not have to contend with a rush to pull out deposits!

Update 1
Daniel Gross highlights how institutional factors (like aggressive credit-card solicitations, ubiquitous casinos, state lotteries, and payday lenders, which "outnumber McDonald's franchises in four out of five of the nation's most populous states") and macroeconomic developments (increasing cost of goods and services, while incomes stagnate or even decline) have contributed to keeping savings down.

According to the Federal Reserve, the net worth of households and nonprofit organizations soared from $39.2 trillion at the end of 2002 to $58.7 trillion in the third quarter of 2007, a 50% increase. This came at a time when real personal savings were miniuscule: $174.9 billion in 2003 and just $57.4 billion last year.

But with consumer spending forming 70% of economic activity, Americans need to spend more at this time of economic crisis.