My reaction is: what a bunch of reckless, irresponsible hooey. The paper engages in a bunch of wild guesswork calculated to three significant digits. Austin summarizes
There are two problems with this. The first is that I don't know my "probability of an emergency," and as nearly as I can tell neither does the author.Even with borrowing costs as high as 18% APR (typical of some credit cards but much higher than a home equity loan) and a liquidity premium as low as 2% (well below the expected spread between equity and cash holdings) the probability of an emergency must exceed 21% to justify an EF.
The first thing you need in any sane analysis is real-world data on emergencies. What sort of emergencies actually occur to real people, how often, and how much they cost. Without that data, there's just no point in doing an analysis. And I'd wager that "emergencies" are skewed and have fat tails, and that analysis should show that it takes a jillion skabillion years to gather enough data to get an accurate estimate of the kurtosis parameter.
I've lost my job twice in twenty years. If I'm reading my old statistics book correctly, that is consistent with an emergency rate of 31% per year (that is, P > 0.05 of seeing only two emergencies even though the actual rate is 31% per year).
Of course, if anyone took action based on his paper and it didn't turn out well, he could always always say it was not him, it was the reader, who made the assumptions about X.
The second big problem is the huge, huge, huge assumption that you can always get a loan when you need one. I'd be curious to know what my chances of being able to get a loan equal to six months' salary were in late 2008. That's higher than my credit card limits. I don't think there's anything close to certainty on being able to get a HELOC. Plus, the probability of to get a large loan is surely less than 100% if you have substantial debt, even if that debt is a mortgage in good standing.
Hatcher talks about silly stuff like "whether the household that saves for the event of an emergency has more net worth at the end of the life cycle." Why should anyone care about that? If the emergency hits and you don't have any cash and you can't get a loan, the negative psychological value of being up Economist's Creek without a paddle exceed the warm feelings of being able to say "But the economist assured me that the chances of that happening were small! And I take comfort that pool of grasshoppers I'm belong to will collectively have a higher net worth at the end of our life cycles then the pool of ants will!"
This sounds like the LTCM guys saying after their world crashed in ruins, "but our calculations showed that was a ten-sigma event!" It's stuff like this that makes me distrust economists.
Treating "debt" as the exact equivalent of "cash" is an example of the insanity that swept over our country during the last couple of decades. I think William J. Bernstein put it well in a different context. He was critiquing the economists' concept of "consumption smoothing" in the cases where it leads to the notion that it's fine to overspend now, because your spreadsheet predicts you'll make it up later:
Always remember Pascal's Wager: the imperative to avoid the worst-case scenario. The consequences of oversaving pale next to those of undersaving.