Saturday, January 2, 2010

Bank of Dad sets interest rate policy tomorrow

As an "economist" by training, (in quotes because I've never been a practicing economist,) I find dealing with my kids and money uniquely difficult: I want to encourage them to understand the semi-reality that is modern finance, and I want to properly educate them (read "train") about personal finance and their own behavior.

My son justed turned seven. He received a check from my father-in-law. He knows the check isn't money. He knows it can be exchanged for money at the bank, only if his grandfather actually has the money. His almost 10 year old sister reminds him, however,that the money isn't worth anything unless someone else is willing to give him something for the "worthless piece of paper", her own words that make me very proud!

My kids also have a very complicated spreadsheet we manipulate together that computes their allowances (fixed base-line plus age based component,) allocates the allowance between spendable cash paid in specie, charitable contributions they then select, and their savings at the Bank of Dad. Why the Bank of Dad? I don't see how, even under reasonable interest rate environments, parents can encourage children to save. Their discount rates are too high. (That's my view. Others could simply say they don't understand discounting. I disagree with that, as we shall see.) In the current environment, its hard to see why anyone saves...but then again, that is the point!

Last year the Bank of Dad paid 25% annually compounded weekly. Quite fairly, the kids argued that I cannot change interest rates more than once a year. They did not want me to arbitrarily move rates to manipulate short term behavior. Ironic that a six and nine year old figure that out!

We also agreed that the BofD is only required to pay the guaranteed rate on balances below $100.

For this year, I think I'll keep rates on deposits constant. However, I may issue some risky securities. My other thought is to allow them to have non-dollar deposits. There's a reasonable chance we'll go to Israel next year, and on vacation we typically give fixed per diem allowances to avoid the "can I have" syndrome. Seems completely logical to offer them the ability to manage their future currency risk.

Teaching them about the use of credit works equally well. They rarely carry cash. They know unplanned, spontaneous purchases have a higher cost. How? I charge them small fees. Running into Rite Aid to pick up medicine, and someone wants that $0.99 candy? Well, it's going to cost $1.20 or $1.25 after sales tax and the fee to borrow money from Dad for a few hours. No, that is NOT usury. That is a transaction fee combined with an interest free loan...just ask BofA!

Bottom line: I certainly fit many of the stereotypes of this article!


  1. Does the Bank of Dad run fractional reserves?

  2. Terence asks an important question, which I will address more fully in a later post on how to solve the banking crisis!

    The Bank of Dad, as far as the children are concerned, maintains 100% reserves. However, the kids clearly face sovereign risk...Mom and Dad could go broke. In the discussions of risky securities, I have considered allowing the kids to take each other's credit risk, thereby holding real default risk, (or at least cash flow timing risk, as they might have to wait for future allowances to pay off the loans.) However, given current rates on deposits at BofD, the value probably isn't there.

  3. This is something that surprised me now that I live in Wisconsin. Most kids do not have any money. And they don't get stuff except on birthdays and Christmas. Which means that while kids are not learning about money, they are learning a huge deal about delayed gratification and the art of understanding what you want vs what you need. I am thinking maybe this is more important. I don't know. It's a huge cultural shift from living in major cities where kids do not have significant wants that go unmet.


  4. This is awesome. When I was 15, my Dad loaned me $4 K to buy a commercial lawn mower and gave me 24 months interest fee to pay him back. I already had a nice book of business and took on several additional lawns once I got that mower. I paid him back in one season of mowing. Taught me to hate debt before I ever got my hands on a credit card.