The Business Desk with Paul Solman

Is Long-Term Care Insurance a Good Idea?

Fri, 25 May 2012 10:25:37 -0500

Registered nurse Susan Eager pays a house call visit to a patient in Denver, Colo. Photo by John Moore/Getty Images.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Friday's query:

Name: Nancy

Question: What happens to long-term care insurance in the new health care? I have paid for long-term care for over 10 years. My Board Certified Elder Law Attorney told me it was my "best decision." Was it?

Paul Solman: I don't know if there's anything in the new law that pertains to long-term care insurance. But I'm wary of it, and have never bought any for my wife or myself. Here's my reasoning.

We're in our late 60s, just a hair ahead of the Baby Boom. If we live a long time, so will tens of millions of our contemporaries, I'm guessing. If we need long-term care, they probably will, too. But if insurance companies are flooded with claimants, they figure to be strained to honor their obligations. That suggests, at least to me, that they will be forced to stint on payments, impose all sorts of restrictions, or maybe fail to pay entirely.

My choice, then, has been to self insure. My wife and I have saved since the 1970s for the purpose of financing our old age. And since our four parents lived to an average age of 89, and two of them needed long-term care, we've saved assiduously.

In general, my answer to a question like yours, Nancy, would depend upon your age and your savings. Given your situation, I would ask your attorney to review the terms of the long-term care policy and the financial health of the company that issued it.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Do You Get Back All Your Money From a U.S. Bond?

Thu, 24 May 2012 18:25:57 -0500

A trader works at the New York Stock Exchange. Photo by Scott Eells/Bloomberg via Getty Images.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Thursday's query:

Name: Sam Katz

Question: Even though government bond prices fluctuate daily, wouldn't you get back your original investment if held to maturity plus interest along the way?

Paul Solman: Strictly speaking, yes, but suppose the interest rate on a government bond is weirdly low when you buy it? Then, if you're bond doesn't mature for a decade, say, you'll be getting back a lot less than you would have had you put your money elsewhere.

It's simple to understand but sometimes hard to remember: An interest rate is determined by several factors. One is impatience -- how much will you pay to use someone else's money right now? (This is sometimes called "the time value of money".) In addition, any interest rate is influenced by two risks. The first risk is default. The second is inflation.

So let's take the three factors one at a time. The historical cost of impatience? A reasonable guess is in the vicinity of 2 percent per year. Default risk? Well, even for the United States, it's greater than zero, wouldn't you say, Sam, given all the talk about debt ceilings, downgrades and the like? Finally, inflation. It has been running at 2-3 percent per year of late.

To lend your money for a decade, then, wouldn't you suppose the United States should have to be paying you something like 4-6 percent in interest? Which, it just so happens, is the range in which the U.S. 10-year bond has fluctuated for more than a century?

And yet, as I write (let me go to Bloomberg.com for a moment), the United States would have to pay less than 1.8 percent a year to borrow for a decade.

Why so low? you well might ask. The answer would appear to be: because pretty much every other investment in the world looks like an even worse bet.

But your question is whether or not you get back your "original investment." Sure. But how much would that investment be worth if inflation accelerates in the meantime? What if the United States flirts with default and interest rates are driven sky high? Will you be content to get 1.8 percent a year while your fellow Americans can buy a US. bond that pays its usual 4-6 percent? Or, as happened in the early '80s, more than 10 percent? In Warren Buffet's February letter to shareholders, he quoted a comment made by professional investor Shelby Cullom Davis long ago: "Bonds promoted as offering risk-free returns are now priced to deliver return-free risk."

I must admit, and often do, that more than half the assets my wife and I hold for retirement are invested in a way to protect against inflation: in TIPS (Treasury Inflation-Protected Securities). At least that covers us if inflation spikes. But if the global economy becomes more secure and other investments seem less risky, our TIPS may lose value compared to what they're worth today. In other words, even they appear to be a risky investment.

A few months ago, my rightly revered friend Andy Tobias, a longtime TIPS enthusiast, wrote that not only had he exited bonds, but, "I'm even out of the TIPS that have appreciated so nicely -- because they have appreciated so nicely. When first suggested, they yielded a ridiculously good 4.25 percent above inflation. Today, depending on their maturity, they yield little or nothing above inflation (and, because they sell at a premium, may actually carry a small negative yield). Going forward, they may not hedge inflation as well as stocks or real estate."

But, Tobias notwithstanding, I continue to ask myself: What's safer than TIPS? I still don't have a good answer. Meanwhile, Vanguard's TIPS mutual fund (and ours), VAIPX, has appreciated by nearly 1.5 percent since Andy wrote the above, while it also yielded an interest rate that matches inflation and gets reinvested in the fund, in effect buying us more shares.

But if I was nervous before reading Andy's post, which I just came upon recently, I'm even more nervous, post-post.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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If Greece Were a Binge Drinker

Wed, 23 May 2012 11:55:27 -0500

A Greek flag flies next to a statue of Socrates in Athens. IMF chief Christine Lagarde on Wednesday warned of the risk of "contamination" if Greece quits the euro and said the eurozone might therefore see the value of paying more to keep Greece in. Photo by Aris Messinis/AFP/Getty Images.

A pair of responses to my austerity/stimulus post of a few days ago illustrate the current conflict in economic ideology quite nicely.

tedmc writes on behalf of austerity:

"Doesn't the medicine of austerity arrive only after the binge? It is the 'binge' that puts the death spiral into action. Ie: group A gets [government benefits] provided by funds removed from group B -- and the promises that more is available...just vote for it. If you don't binge you don't wake up with a hangover. Now you have the hung over brother (ie: Greece) asking their more prudent brother (Germany) for just one more drink (stimulus) to get over the shakes. If they don't give them the money, Greece cries that Germany is cold hearted and evil. What is needed is tough love and the courage to say 'No. No more stimulus, No more free lunch. Nothing in life is free.'"

In contrast, consider the comment from Invisible Backhand, who defines his/her role as "Exposing Cafe Hayek, Don Boudreaux and Russ Roberts for all their Koch funded propaganda":

"Austerity is not about growth, it's about making the bondholders whole. The campaign to convince the little people it's to their benefit is just advertising funded by the rich and their paid lackeys."

Let me respond to "Invisible Backhand" first, if only because the moniker is so memorable.

Dear Invisible:

Austerity is surely about "making the bondholders whole." You do see their POV, don't you? Suppose you had loaned money to a friend from Greece? Would you not expect to be repaid? Would you do nothing but shrug? I don't know you, so the answer might be forgive and forget, but you can understand how such compassion, universally practiced, might undermine the lending process, can't you?

Futhermore, the "campaign to convince the little people it's to their benefit" is not just "advertising." It's the genuine conviction of many, like "tedmc" above, who may legitimately fear a total and devastating end to all lending if bondholders are wiped out. Any country with a budget deficit must borrow to close it. The only alternative is to print more money, at the risk of disastrous inflation. But if the country can no longer borrow, the budget will have to be cut and those most dependent upon it -- those living closest to the bone -- will suffer. Their health and education will suffer. Therefore, the human capital of their country won't develop. Economic growth will be stunted.

On to "tedmc."

Dear ted:

While your inebriation analogy will be odious to some, let's run with it. Greece is the binge drinker. But it could only afford the hooch because "Grosse bruder" loaned it the money. Greece became an alcoholic and will now suffer the shakes if forced onto the wagon. Are you telling us that Germany bears no responsibility for Greece's dependency?

More to the point, is it in Germany's national interest to see Greece crumble? Should it not be worried about Portugal, Spain and Italy -- the other prominent members of the AU (Alcoholics Unanimous)? If they all go cold turkey, will German exports not take a hit? Worse, will extremist parties not make further headway in Europe? And what happens to the ideal of a trading bloc, united both economically and -- do not forget -- politically? Does no one remember World War II? World War I? The Franco-Prussian War? Napoleon? The Thirty Years War?

Dear emailers (and the rest of you):

Binges do tend to beget austerity. But it's not at all obvious that they should. Economics is the discipline of weighing costs against benefits, not some moral exercise. Because its actors are human beings, uncertainty rules. Economic policy is thus the process of weighing costs against benefits, never being sure of the outcomes. There are rarely simple answers. There are almost never sure ones.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Does It Ever Make Sense to Dip Into Your 401(k)?

Tue, 22 May 2012 11:56:35 -0500

Creative Commons photo by Flickr user Thomas Hawk.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page.

Tuesday's question comes from an in-house NewsHour staffer who wishes to remain "Anonymous," not to be confused with the author of "Primary Colors."

Question: If an emergency situation arises, does it ever make sense to pull money from a retirement fund such as a 401(k) rather than going into credit card debt to keep from going into the red? The fear of short-sightedness is paralyzing.

Paul Solman: As far as I can tell (and readers, please let me know if I'm missing something), the answer is: It absolutely makes sense. I can think of only one situation in which it wouldn't, sketched below. The important thing to know is that you don't "pull" money out of a 401(k). You borrow it, penalty free -- up to $50,000 or half the value of the account, whichever is lower.

"Uh-oh," you might be saying. "Don't all calculations in economics depend upon the ultimate cost? So don't I have to compare the cost of the 401(k) loan to the cost of borrowing on a credit card?"

Yes, all calculations do depend upon cost, but no, in this case, you don't need to compare. That's because when you borrow from a 401(k), as I myself once did years ago for a down payment on our new house before we'd gotten the money from selling the old one, you pay back the interest to yourself. That is, the loan repayments go right back into the 401(k) itself. So the net cost is zero.

There is one situation in which borrowing on a credit card would be (financially) preferable to borrowing from your retirement account: immediately before filing for bankruptcy. If you can cancel any of the credit card debt in bankruptcy -- and you can often cancel most of it -- you will have borrowed more than you will ever repay. i.e., free money. But let it be clear: Making Sen$e does not recommend this strategy.

By the way, not only is the fear of short-sightedness paralyzing; the cost of regret is real and worth taking into account in cost/benefit calculations. But in this case, once you realize that a 401(k) loan is much better than more credit card debt, there should be self-satisfaction instead of regret. Self-satisfaction is a benefit, not a cost. Thus borrowing from your 401(k) should be even more attractive, in economic terms.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Is It Better to Save or to Spend?

Mon, 21 May 2012 17:13:05 -0500

Banner protesting austerity measures in Brussels, Belgium. Photo by Morgan Till/PBS NewsHour.

Restricted as this page usually is to questions (and answers), its posts can, I realize, seem more than a bit off the news. This is especially true when the economic world is roiling, as it so often has been of late.

So let today's post be a meditation on the roil and in particular, the center-stage question facing the U.S. and Europe, one that has prompted occasionally heated exchanges on my Twitter.

The quandary is obvious: stimulus or austerity? In economic jargon, Keynesian or the Austrian School? In plainer terms, save or spend? But which is the right answer?

Each side is championed these days, as it was in the last Great Downturn, by Democrats on the one hand, and Republicans on the other -- and abroad, by their political equivalents.

This cartoon from the conservative Chicago Tribune in 1934 illustrates the Republican point of view in reaction to the spending of the New Deal.

Obama a "socialist"? Note that the Roosevelt administration (in the runaway wagon) is supposedly "communist", following the script of the man at the lower left. That's Leon Trotsky, once a leader of the Soviet Union and its Red Army. By 1934, he had long since been exiled by Stalin and was living in France, but the symbolic value of his image apparently remained vivid enough for the average American. (Or maybe the Trib hadn't kept up with times.)

Caricature assassination aside, the essence of New Deal Keynesian spending is simple and seemingly sensible: that there's nothing worse than idle resources and the very worst resource to idle are human beings, for reasons both political and economic. The political cost of idle hands is screamingly obvious: an unemployed, disaffected, meaner citizenry. (See Benjamin Friedman's major book of 2005, "The Moral Consequences of Economic Growth," for the damages of contraction. Or glance at Germany after the Great Depression of the early '30s.)

When citizens lose their jobs, they can't afford to keep spending. When consumer spending stalls, businesses see no reason to make new investments -- "Who will buy?", the song from "Oliver!", springs to the mind's ear. Businesses slow their spending, too.

The quick fix for this problem -- for decades -- has been lowering short-term interest rates to make borrowing cheaper and thus kick start spending. But it doesn't work if interest rates are at zero, as they are now. You can't have a negative interest rate.

Unless you give people money, that is. And that's the argument for stimulus. Absent the consumer and business, there's only one Big Spender left, argue the Keynesian Democrats: government, the spender of last resort. It can give people money by cutting their taxes and hoping they'll spend. And/or, it can give people money by hiring them, as Franklin D. Roosevelt did in the "Trotskyist" New Deal.

So what's not to love? The inefficiency of government planning, says the free market devotee. How so? Let us count the ways.

1) "Central planners" in government can't possibly know what people really want, and how much they want of it. That's information distributed so widely that only a price system can reveal it, as consumers and businesses, in the aggregate, reveal their preferences by what they're willing to pay. Who knows if that new road is really worth the price? Or even filling those potholes?

2) Government spending is rife with inefficiency because it lacks what the market so providentially provides: a profit motive to keep costs down. Why not pay workers whatever they ask, since they're the voters who will keep you in office?

3) Even if government spending were justifiable, now is the wrong time to splurge, since it will only add to our budget deficit, thus hobbling future generations.

What, then, is the policy that flows from this critique? Don't spend but save. Pay down the debts of the manic past. Cut inefficient government spending and endure the inevitable austerity.

Let the economy renew itself via the all-knowing market. (Or at least, more knowing than a bunch of economic "technocrats.")

This exchange between market champion Russell Roberts of George Mason University and Britain's famed biographer of Keynes, Robert Skidelsky, captures the conflict.

RUSS ROBERTS: Capitalist economies have slowdowns, contractions, slumps, recessions, and depressions. [And bounce] back fairly quickly without government intervention.

ROBERT SKIDELSKY: [But] there were terrific sufferings. I mean, people, whole communities were uprooted. ... I don't think we can take risks of the kind I think you're implying. I think the political downsides of taking those risks are going to be too great. And, in Germany, they were absolutely horrendous in the early '30s.

PAUL SOLMAN: Is that not true?

RUSS ROBERTS: Well, my claim is that, in our attempts to engineer our economy from the top down, we have actually made, in many many cases, the world less secure, workers less secure, and lowered our prosperity, and hurt people.

PAUL SOLMAN: Because, otherwise, the system would have adjusted?

RUSS ROBERTS: Would have done better.

Watch: Keynes vs. Hayek: Late Economists' Hip-Hop Legacy

That was two-and-a-half years ago. In much of the world, Austrian austerity has more or less prevailed. In much of the world, global politics seem to be proving Skidelsky prophetic. Economics, remember, is the discipline that weighs costs against benefits and insists that there is no such thing as a free lunch. I'm not sure I agree with the latter statement -- what else is technological growth if not a free meal of some sort? But as to costs and benefits and the tradeoffs they inevitably dictate, there can be little question. And it's awfully hard for those of us with jobs to blame the unemployed for insisting that the tradeoffs ought not to come at their expense.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Why Not Raise Taxes Instead of Interest Rates to Reduce the Deficit?

Fri, 18 May 2012 10:41:47 -0500

Image by Spark Studio via Getty Images.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Friday's query:

Name: Phil Webb

Question: When the economy starts to get better and inflation starts to raise its ugly head, the usual cure is to raise interest rates to take money out of the economy and cool things off. Why not raise taxes instead, which could be used to reduce/eliminate the deficit, which would help the economy so you could raise taxes even more in what appears to be a positive feedback loop?

Paul Solman: Why not indeed?

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Aren't We All Better Off if Fannie, Freddie Forgive and Forget?

Thu, 17 May 2012 13:48:11 -0500

Fannie Mae headquarters in Washington, D.C. Photo by Flickr user futureatlas.com via a Creative Commons license.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Thursday's query:

Name: Barbara Seijas

Question: Wouldn't the pools of investors and Freddie Mac be better off if the principal of mortgages were reduced, rather than leaving foreclosed homes left to rot?

Paul Solman: This question came over the transom long ago. Recently, there was some news to justify an answer to it. As Annie Lowrey reported on April 10 in the New York Times:

The overseer of Fannie Mae and Freddie Mac on Tuesday opened the door to forgiving some mortgage debt of homeowners who owe more than their houses are worth, as the Obama administration has recently urged.

The acting director of the Federal Housing Finance Agency, Edward J. DeMarco, said that in some circumstances it might make economic sense for the government-run companies to reduce borrowers' mortgages, taking a hit to modify the loan but also making it less likely that a homeowner will default.

But in his speech at the Brookings Institution, Mr. DeMarco described as limited the benefits from principal reduction, saying it would hardly be a magic bullet for struggling homeowners and noting that it might carry significant costs for taxpayers. His comments left doubt about whether he would change his long-held stance against principal reduction.

"This is not about some huge difference-making program that will rescue the housing market," he said. "It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."

In a new analysis cited by Mr. DeMarco, the F.H.F.A. found that reducing mortgage principal for about 691,000 eligible underwater homeowners would reduce Fannie and Freddie's losses by about $1.7 billion, compared with doing another form of loan modification. But the Treasury Department would pay out $3.8 billion in incentives for the principal reductions, meaning a $2.1 billion net loss for the taxpayer.

Now emailer Barbara Seijas might point out to regulator DeMarco that the net loss for the taxpayer will be a lot more than $2.1 billion if houses are left to rot, as some likely will be without principal reduction.

DeMarco might even concede the point, but he would surely add that principal reduction is a slippery slope. If you get a break on your principal, why shouldn't I? Are we really prepared to reward bad decisions (taking out a loan you can no longer afford) at the expense of those of us who only borrowed as much as we could repay? Would large-scale principal reduction create a "moral hazard" problem that encouraged profligate borrowing (and lending) by holding out the prospect of future principal reductions during downturns?

On the other hand, wouldn't all Americans be better off if houses weren't rotting? See our story on Cleveland for this side of the argument.

Watch: Raze the Roof: Cleveland Levels Vacant Homes to Revive Neighborhoods

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Why Isn't There a Single World Currency?

Wed, 16 May 2012 14:24:32 -0500

A pile of money from around the world -- currencies of the U.S. (dollar), U.K. (pound), and Europe (euro). Creative Commons photo courtesy flickr user Images_of_Money.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Wednesday's query:

Name: Joseph St. Amand

Question: As we are reminded daily, we are all part of the same Earth. That place we call home is a small part in the "global" diversity system. Why then do the economists maintain separate dollar/currency values by region or countries when everyone should be playing on a level/moral playing field?

Paul Solman: Ah, the dream: one world, one economy, one currency -- and, of course, one global political system. It may prove the only way to survive here on Earth, but if Europe is a leading indicator, it's not likely to happen anytime soon. Diversity means different strokes for different folks. But a common currency means a common economic policy, which is turning out to be impossible for groups of people with habits as different as those of the Germans and those of the Greeks. Remember, even here in the "United" States, we fought a devastating civil war over conflicting economic policies: some 625,000 dead, the most of any war in which America has ever been involved and 2 percent of the total population. Adjusted for the number of Americans today, that would be 6 million fatalities -- over economic policy.

I don't mean to denigrate your proposal, Joseph. The towering economist of the Great Depression, England's John Maynard Keynes, advocated a single currency for the post-War economies of the West at the 1944 Bretton Woods conference when it seemed clear the war would be won. Look up the "Bancor" for further details. Lord Keynes' American counterpart at the event, Harry Dexter White, eventually won out and there was, in effect, a "free world" currency -- the U.S. dollar, which in turn was pegged to gold. But economic imbalances in trade and money creation persuaded President Richard Nixon to cut the cord between the dollar and gold in 1971, suggesting just how hard it is to maintain a single world currency.

Watch: Nixon Ends Bretton Woods International Monetary System

Admittedly, the dollar has been the de facto currency in much of the world since, but its shifting value has pretty much reflected economic policy differences between the U.S. and other countries over the decades. Similarly, the world's other currencies have pretty much reflected their national economic policies -- chiefly, how they choose to manage their money supply and their trade. The huge exceptions were the countries of the Soviet bloc, when the Iron Curtain still hung, and of course China, which still manipulates the value of the "people's currency," the Renminbi.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Are U.S. Wages Enough to Live On?

Tue, 15 May 2012 13:23:46 -0500

A waitress carries a pizza to customers at Gino's East restaurant in Chicago. Wait staff in Illinois earn $2.13 an hour, before tips. Photo by Daniel Acker/Bloomberg via Getty Images.

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Tuesday's query:

Name: Ingrid

Question: Is it true that some workers in America get paid less than $10 per hour? Such as waiters, retail customer service, factory workers? Is it enough to survive on? Can they eat, travel, have a home and pay medical essentials etc. on $10 per hour? I watch the PBS NewsHour in Australia sometimes. You turn it on and can't turn it off. I liked the story about financial literacy on Sesame Street a lot in every way -- production, facts, laughs, in depth, experts, psychological references.

Watch: "'Sesame Street' Tells You How to Get to Sunnier Days Financially"

Paul Solman: Yes, Ingrid, some workers in America do get paid less than $10 an hour. In fact, the Federal minimum wage is $7.25 an hour, and more than 5 percent of all workers earn this amount or less -- about 4 million Americans. Eighteen states do have a higher minimum, but the highest is only $9.04 (Washington state). The federal minimum wage has reached the inflation-adjusted equivalent of today's $10 an hour once in U.S. history -- in 1968. See the first chart on this site for a graphic representation.

You ask: "Can they eat, travel, have a home and pay medical essentials etc. on $10 per hour?"

Well, I know of no deaths by starvation in America, but as to the rest, the answer is "No."

I've interviewed plenty of people in the past few years who couldn't afford their jobs because the commute was too expensive. And as to having a home, the last official government report, issued in June 2011, tallied 650,000 homeless Americans. If you meant "own a home, the number of foreclosures in the past few years has averaged close to 3 million.

Medical essentials? Depends on what one means by "essentials," I guess. But I can almost guarantee you I wouldn't be able to afford the medications my doctor considers essential to me on $10 an hour.

Put it this way: The minimum wage is now about more than 40 percent below the federal poverty line. See "Minimum Wage History" again to confirm. The numbers remind me of the old line in poker: Read 'em and weep. Very different meaning, however.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Worried About Retirement? An Excellent Free Video Tool Debuts

Mon, 14 May 2012 10:25:33 -0500

Image of "Curious Behaviors" used with permission of the Financial Security Project at Boston College.

A suggestion for those pondering retirement: a [new interactive video tool](http://fsp.bc.edu/curious/) introduced by old friend Alicia Munnell, professor of management, director of the Center for Retirement Research and head of the new Center for Financial Literacy -- all at Boston College. (We interviewed her for a pair of retirement-related pieces: "Raising the Retirement Age" and "Rethinking Retirement Benefit Calculation Could Aid Social Security."

Hosted by an amiable Boston actor named Jerry Kissel, "'Curious Behaviors That Can Ruin Your Retirement is an interactive program on behavioral impediments to retirement planning," according to the site. It's short, easy to use, cheesy at times but extremely insightful. And coming from Munnell, you can depend upon its accuracy. Highly recommended.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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The 'Safest Investment' for Americans

Fri, 11 May 2012 11:38:54 -0500

Finance professor Zvi Bodie talks to Paul Solman in 2011 about pension woes.

In response to our post of May 9 on the benefits of Treasury Inflation-Protected Securities, this arrived from the eminent finance guru from Boston University, FoM¢* Zvi Bodie, aka our pension Bodie-sattva. It was Zvi who convinced me to invest a significant portion of my retirement portfolio in TIPS when they first were offered back in the '90s, at that time via a new mutual fund run by TIAA-CREF.

For most Americans the safest investment is not TIPS, but Series I Savings Bonds. For the past several years the U.S. Treasury has been offering these bonds to the public at a guaranteed interest rate that is at least equal to the rate of inflation for a period of 30 years. This means that for every dollar you invest today, you have the right to take it out fully adjusted for inflation at any time over the next 30 years. So in a worst case scenario (unless the U.S. government defaults), you will have maintained the purchasing power of your money. If the U.S. Treasury raises the interest rate above the rate of inflation, you can cash in your old bond and buy a new one with no loss of accumulated interest. If you have held the old bond for over five years, there is no penalty when you cash it in. I know of no safer way to invest for a long time horizon. For people of modest income, a combination of Social Security and an annual investment of up to $10,000 per year in I Bonds should suffice to finance a comfortable retirement without any significant risk and without any special tax-deferred retirement accounts.

For example, a 30-year-old who buys $10,000 per year of I Bonds and retires at age 70 will have accumulated $400,000 of today's purchasing power. Even at today's high prices that would be enough to buy a guaranteed lifetime inflation-proof income benefit of more than $16,000 per year from a high quality insurance company. I believe that this option ought to be brought to the attention of every American by the government and trustworthy financial advisers.

*Friend of Making Sen$e

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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'The Scream': For Love or Money?

Thu, 10 May 2012 15:51:15 -0500

"The Scream," painted by Edvard Munch in 1895, sold at a record price of $119.9 million on May 2.

A few belated thoughts on the economics of art in the wake of the $120 million price fetched by Edvard Munch's "The Scream."

Claude Monet was one of the most successful businessman-artists in history. Even in the 19th century, he sold a painting for the equivalent of today's $375,000-$750,000, about what a high-price painter of today might get. In June 2008 (pre-Lehman collapse) "Le bassin aux nymphéas" (water lilies) sold at Christie's for $71 million dollars ($80 million with fees). But just a year later, a much larger "Nympheas" failed to reach the minimum bid of $30 million and was withdrawn, "drawing gasps from a packed saleroom," according to Bloomberg.

Bottom line: You could have made -- or lost -- a fortune on an artist who has always commanded the highest prices, in life and death. How sure, then, is any investment in art?

It simply isn't, though rare indeed is the collector who doesn't think about the economics of art: fair price and true value.

The concepts of price and value are not to be confused. "Value" is abstract and elusive. "Price" is here and now: whatever the market will bear at the moment. A cynic might paraphrase Oscar Wilde: An economist is someone who knows the price of everything and the value of nothing. (For the record, Wilde was defining "a cynic.")

For centuries, philosophers tended to equate value and price. Starting around the time of Adam Smith, the thinking tended to equate price with cost of production. Thus, if something's cost was low, its price should be too.

This notion persists. A year's dose of the drug Ceredase, which treats a rare genetic condition of bone deterioration, was selling for $300,000 last I looked. But since it costs a miniscule fraction of that to produce, it's been a source of great controversy, and many consider the price a gross injustice. Indeed, the same might be said of a multimillion dollar Monet, especially considering how fast he painted and how long he lived.

But economists have come to understand that a Munch or a Monet, like a drug, car or diamond, is simply worth what it will bring, and that in turn depends on the amount available (the supply) relative to what people want (the demand).

Supply, of course, is pretty simple to calculate, especially in the case of "The Scream," a one-of-a-kind. But demand is trickier. Demand has to do with how badly people want something: the amount of satisfaction it provides. But satisfaction to whom? And how can you quantify satisfaction anyway?

In the case of Ceredase, you can at least imagine some sort of consensus estimate. A human being avoids a crippling fate. We may all be able to agree, within broad limits, as to what that's worth. But how many people would agree on the value of a Munch? And how many people? Without competition, the low bidder wins.

The great Rembrandt van Rijn himself, long after he'd attained genius status, provided surprisingly little satisfaction to a surprisingly large number of people, including the most famous art arbiter of the 19th century, John Ruskin. ("Vulgarity, dullness, or impiety will indeed always express themselves through art, in brown and gray, as in Rembrandt," wrote Ruskin in purple prose.)

But if beauty truly is in the eye of the beholder, how can the value of an artwork be safely arrived at?

Sad to say, with great difficulty. Rembrandt himself provides a case in point. Perhaps his most famous etching, "Christ Preaching," is better known as the "hundred guilder print" because it once brought that lofty price (several thousand of today's dollars) at auction during his lifetime. Less well-known is the fact that the bid was Rembrandt's, part of a dogged effort to drive up the print's value and establish a new price level for his etchings. (In economic terms, he was artificially pumping up demand.)

Watch: The Better $120 Million Status Symbol: 'The Scream' or a Yacht?

It took several hundred years for Rembrandt's prices to firm; in 1882, a painting of his sold for $1.6 million in today's prices (as are all figures cited from here on). Rembrandts have been climbing steadily in price ever since. But for every Rembrandt, there's a Thomas Gainsborough or a Jean-Louis-Ernest Meissonier.

Gainsborough did portrait commissions in the late 1700s for the equivalent of something like $10,000. One hundred years later (1876), his "Duchess of Devonshire" sold for $1 million, and in 1921, his ubiquitously reproduced "Blue Boy" sold for more than $6 million. But in the 1930s the art market crashed and a Gainsborough went for about $200,000 (1935); another, for closer to $30,000 in 1942. In 1887, a painting by Meissonier, the French academic realist, brought the equivalent of today's $1.5 million; in 1940, one sold for $5,000.

The Salon masters have since made a comeback, as has John Singer Sargent (another spectacular boom-to-bust investment), among others. The prices of the best-known impressionists and post-impressionists, on the other hand, have gone up and up throughout the 20th century.

Art prices might seem to be especially volatile, then, especially if you believe Burton Fredericksen of the Getty Museum, who has been quoted as saying that the only artists to have maintained consistent values for the past 500 years have been Raphael and Leonardo.

The standard reason given for the volatility of value is that art collectors are both fickle and few in number, leading to a thin market and low demand. It might not require many people losing interest in an artist to depress the price.

But if art prices in general are "volatile" and "fickle," one needs to ask: compared to what?

The prices of all conceivable investments are subject to swift and sudden changes, even though millions of people own them. And the history of investment booms and busts is older and more dramatic than the volatility of the art market.

Economic historians long like to tell of so-called "tulipmania." When Rembrandt was 31 years old, for example, it reached its peak in his native Holland. At the top of this speculative craze in 1636, one tulip bulb (of a particularly colorful and sought-after virus-influenced variety, the Viceroy), sold for "two last [loads] of wheat and four of rye, four fat oxen, eight pigs, a dozen sheep, two oxheads of wine, four tons of butter, 1,000 pounds of cheese, a bed, some clothing and a silver beaker" -- tens of thousands in today's money. After the market crashed a year later, the bulb was virtually worthless.

(Incidentally, the great Dutch seascapist, Jan van Goyen, speculated on a batch of 10 bulbs, paying roughly the cash equivalent of the items above, plus a picture by Salomon van Ruysdael and another by himself, not yet painted. He died before delivering his work, bankrupted by the tulip crash. Major van Goyens and van Ruysdaels sold for something like $1,000 in today's money back then; today, they fetch $100,000-$150,000 at auction, while tulips, of course, sell for a few bucks a dozen.)

The story of tulipmania has taken some hits from scholarship in recent years, as well as from some economists who claim that bubbles are impossible, on the theory that if things are worth what the market brings, then that must be their true value.

But it's a circular argument. Most sane observers would agree that bubbles happen, and long before the dot-com or mortgage-based securities collapses, history proved the point. Consider the "South Sea bubble" of the early 1700s on which millions of British pounds were lost, including thousands by the warden of the Royal Mint, Sir Isaac Newton, a fellow who should have known that what goes up must come down.

The examples can be multiplied ad nauseam, for even the seemingly safest investments. Silver, a measure of value for millenia, rose to $50 an ounce in the late 1970s -- today's $150 or so. By the time we did a story on Warren Buffett investing in silver in 1998, the precious metal had lost a good deal of its luster, and, inflation-adjusted, more than 90 percent of its value. Gold? Oil? Look them up.

Compared to many other investments, then, art has not been especially risky. Moreover, when an art dealer utters the time-honored cliche -- "You can't hang a stock or bond on the wall" -- don't scoff. S/he may sound self-serving, but the fact is that art has a use value as uncharacteristic of other investments as volatility is typical of them.

Is "The Scream" a steal at $120 million? A scam? In art as in oil, who knows? Are we talking Rembrandt or Rossetti, Michaelangelo or Meissonier? Chardin's prices have held since the 18th century; Rosa Bonheur's "The Horse Fair" sold for the equivalent of $1.2 million in 1887, was eventually acquired by New York's Metropolitan Museum and went on to spend the first half of the 20th century in its warehouse. By 1914, a Bonheur was bringing less than $20,000 at auction.

As for oil, in Rosa Bonheur's lifetime (1822-1899) technology transformed it from worthless muck to "black gold." Advances in solar energy could turn it back into dross just as quickly.

So finally, in terms of making long-run price predictions, we can only fall back on the words of the 20th century's greatest economist, John Maynard Keynes. "In the long run," wrote Keynes, "we are all dead." To which the art dealer might add: "But in the meantime, isn't life a lot nicer with beautiful things on the wall?"

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Hot TIPS on Where To Invest

Wed, 09 May 2012 16:03:16 -0500

Photo by Kick Images via Getty Images.

Readers of this page regularly ask about Treasury Inflation-Protected Securities (see note below), which I've long said are my own preferred investment vehicle. Do TIPS still make up more than half the family retirement portfolio, even with negative yields before factoring in the underlying interest rate, which matches inflation? The answer remains a shaky "yes," as does my reason for doing so: Even though the TIPS fund I use, Vanguard's bargain-basement VAIPX, is at its all-time high -- suggesting it's time to sell -- every other investment in the world seems even riskier.

The reason I bring up TIPS is a review by esteemed economics columnist David Warsh of books by two longtime FsOM$*, Zvi Bodie and Bob Schiller. Anyone interested in economics would do well to read Warsh's "Economics Principals" column on Sundays. And anyone interested in TIPS would do well to read Bodie's new book, co-authored by Rachelle Taqqu: "Risk Less and Prosper."

*Friends of Making Sen$e

Editor's Note: Read Paul's previous posts on TIPS:

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Is the IRS Sexist When It Comes to Child Care?

Tue, 08 May 2012 17:45:38 -0500

Photo by Subactive_Photo via Flickr Creative Commons

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Tuesday's query:

Name: JJ

Question: What's with the inequitable treatment of household employers?

I'm a working mom, and after paying yet another year's worth of nanny taxes and related expenses, I'm frustrated by what seems to be the very sexist treatment of these costs under the tax code. Paying for child care -- and related expenses such as unemployment insurance, workman's comp policy and nanny taxes -- amounts to more than 30 percent of my after-tax income.

These are very real costs of earning my income. I'm required to register with the state and federal government as a business, pay state taxes and unemployment insurance contributions quarterly, do withholding, etc. If I were any other kind of business, I could use these expenses to reduce taxable income, but as a household employer I'm limited to a measly $3,000 deduction that in my case is eliminated anyway by the alternative minimum tax.

This seems a huge and largely gender-based inequity since child care costs are the burden of working women. Is it simply that most people don't even bother to comply? Maybe compliance would go way up -- benefiting both the Treasury Department and household employees who would get Social Security -- if us working moms could deduct our true child care expenses.

Paul Solman: What an excellent point. I'd never thought of it until this email. If what you mean by non-compliance is working parents taking more than the $3,000 deduction, my guess is that they don't. And some may not take the deduction at all due to ignorance. But your logic certainly makes sense.

The closest I've come to this issue is the fact that household work, if done by the parents themselves, is not counted as part of GDP (gross domestic product, as measured by the final sales of everything in the economy in a given year).

Therefore, if you're a dad or mom who takes care of his children full time, you are making no official contribution to the country's total output. If, however, you're a parent who hires someone to do the job for you, those wages are counted as part of GDP. Makes you wonder about GDP as a measure, doesn't it? For a recent alternative yardstick, see this site, where you can download the "Report by the Commission on the Measurement of Economic Performance and Social Progress" of Nobels Amartya Sen and Joe Stiglitz. It's a fitting week to do so, as it was commissioned by Nicholas Sarkozy, the outgoing (in both senses of the word) president of France.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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Stand-Up Comedian Baratunde Thurston on 'How To Be Black'

Mon, 07 May 2012 18:14:37 -0500

By Paul Solman and Elizabeth Shell

Baratunde Thurston seemed like something of a wonder: a stand-up comedian via Sidwell Friends and Harvard. I note, however, that there is now something called The Harvard College Stand-Up Comic Society, so perhaps surprise is unwarranted. And when you read Thurston's new book, "How to Be Black," or note that he works for The Onion, you realize that he's so gregarious and funny, a stand-up career appears not just apposite but almost unavoidable.

Despite a healthy number of reviews -- 66 of them -- which generally brings a book's ratings down (or up) to Earth, Thurston's book gets a dizzying 4.8 of a possible 5 stars on Amazon. By contrast, "The Hunger Games" gets a 4.3.

Face-to-face, Thurston is just as personable as in print or on stage: a totally unpretentious, candid young man who answers all questions and bridles at none.

One more word of introduction. Our interview of Thurston grew out of the closest encounter we've had with "going viral" -- our interview with Charles Murray, author of "Coming Apart" and architect of the how-in-touch-are-you-with-white-America? quiz that more than 100,000 of you responded to. Murray and Thurston posed questions to each other -- and answered them -- in the New York Times a few months ago. It gave us the idea of interviewing Thurston about whether black America was also "coming apart." When he visited Boston, we did. Here's the result.

This entry is cross-posted on the Rundown- NewsHour's blog of news and insight.

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