Fee Creep and High Interest Rates at the Bank of Dad

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When my cousin Marc and his sister started receiving allowances as kids, my aunt and uncle gave the practice a novel twist: They indexed the allowance to the price of ice cream at Baskin-Robbins.

The late 1970s was, if nothing else, a productive time to teach kids about prices. The U.S. inflation rates in 1979 and 1980 were 11.3 percent and 13.5 percent, respectively. Ice cream-pegged allowances rose by the scoop.

The ice cream index gave Marc an early preference for rules as a way to guide behavior in finance, as opposed to decision-making. He went on to earn a Ph.D. in economics from the University of Chicago, so he knows a thing or two. I’m not just saying that because of his brilliance, wit and accomplishments. I’m saying it because we were horsing around once when we were 13 or so and he twisted my arm behind my back until I started crying. The authorities ruled it an accident. But who’s to say it couldn’t happen again?

Pondering the Baskin-Robbins episode helped Marc figure out a way to help his own kids manage their money and learn about finance, circa 2004. He instituted rules by “founding” a bank just for them, the Bank of Dad, with clear rules, rates and visibility so that they could make their own decisions about saving, spending and charity. “I’m a Chicago guy," he said, referring to the University of Chicago school of economic thought. "I want rules, not discretion, to set policy,” Marc told me in a phone interview.

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Kids need banks at least as much as their parents do. More specifically, kids need really high interest rates. The prefrontal cortex, the brain region thought to govern thinking ahead, keeps developing until we're in our 20s. That makes waiting for anything, in general, and planning, in particular, a challenge for kids and teenagers. Perhaps you’ve noticed.

The Bank of Dad needed to offer an incentive much higher than the market’s to draw the deposits of customers for whom a year might as well be a geological eon. Marc offered 25 percent annual interest rates, compounded weekly. "Their discount rates are too high," he wrote on his blog in 2010, economist-speak for kids’ exclusive focus on the here and now, at the expense of their future preferences.

Marc invented the Bank of Dad on his own, but he wasn’t the first to do so. New Yorker writer David Owen launched a "Bank of Dave" when his kids were young. He wrote up the experience in his 2003 book, The First National Bank of Dad. Deposits at the Bank of Dave earned 5 percent a month, compounded monthly, for an annual rate around 70 percent. Personal finance columnist Dan Kadlec has blogged as the “Bank of Dad” at CBS.

The Bank of Dad experiment can extend as far as a parent (somehow it’s always the dad here) can responsibly take it.

Marc considered letting the kids dabble in non-dollar-denominated deposits a year before a planned family trip abroad. The complexity of exchange rates was too much for young people who only cared about prices on the spot market at the moment they wanted to buy something.

He also charges the kids an ATM-like convenience fee if they're in a store together and the kids need a few dollars and didn't bring any cash of their own. Banks tack on fees. Why shouldn’t parents? "That is a transaction fee combined with an interest-free loan ... just ask BofA!" he wrote in 2010.

David Owen opened a virtual stock market for his kids, rendering the market's prices in cents, not dollars. Virtual stock markets are tough, Owen concluded, because the pain isn’t real and the experiment can’t run long enough for the kids to generate real knowledge. “When it comes to investing, I think, kids should be allowed to begin screwing up as early as possible, because many of the truly valuable lessons take years to sink in,” he wrote.

Starting early is a theme that turns up in other lessons notoriously difficult for parents to convey. Bank of Dad or no Bank of Dad, years can go by and kids learn whatever they learn, without parental guidance. “It’s kind of like sex ed. I’m trying to get parents to begin at the very beginning,” says David Palmiter, a clinical psychologist, author and professor at Marywood University, who works with kids and families on financial questions. The main problem is not the Bank of Dad setting rates too high or low, but busy parents and easily distracted kids avoiding the topic.

My cousin Marc and Owen succeeded because the game -- it's kind of a bounded-reality game -- was set up within a healthy, functioning home. Not all are. When Ernest Thompson Seton, a nature writer who died in 1946, turned 21, his father gave him a bill for expenses accrued on his behalf since his birth, including his birth. He paid it, Margaret Atwood writes in her 2008 nonfiction work, Payback: Debt and the Shadow Side of Wealth.

Sooner or later, Banks of Dad shut down, losing their not-as-little customers to institutions backed by the Federal, not Family, Deposit Insurance Corporation. Marc’s bank stumbled when an influx of foreign capital -- presents in check form from grandparents -- overwhelmed the young depositors (the Bank of Dad guaranteed interest rates only on the first $100).

David Owen’s experiment occurred in the early 1990s. He’s had time to see the results play out now that his kids are 30 and 26. “It didn’t prevent them from being English majors,” he said of the experiment. That’s not a surprise. He concludes with an impassioned plea that the most important habit parents can instill in their kids is reading and critical thinking.

After several years, Owen’s kids no longer needed the game. It’s just as well, he said, because pin money that the teenagers brought in was straining the bank’s ability to cover interest on deposits: "It was unsustainable after they started babysitting.”

Correction: The original version of this story mislabeled average annualized monthly inflation rates as "monthly inflation rates."

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