August 2007 Archives

Several people over the past couple of weeks have asked me what i thought about the Murdoch takeover of the Wall Street Journal. I don't have a whole lot to add that hasn't been laid out in stories and commentaries in the New York Times, Business Week, and the Wall Street Journal. Basically, I'm not concerned short-term. I don't think Murdoch spent $5 billion to ruin the reputation of the now crown jewel in his media empire. No, what worries me is when the septugenarian passes away. I don't see a management structure and dynamic sucession behind him. That's when I worry about the future of the nation's premier newspaper.

I'm skimming through a book by Carlo M. Cipolla, Between Two Cultures: An Introduction to Economic History. He has nice quote from Keynes on economics: "Keynes rightly held that 'economics is a branch of logic, a way of thinking. The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking.' "

Thanks to a reference by Andrew Samwick, economist at Dartmouth University, here's a link to a good piece on the tragic bridge collapse in Minneapolis by Stephen Flynn:

In the end, investigators may find that there are unique and extraordinary reasons why the I-35W bridge failed. But the graphic images of buckled pavement, stranded vehicles, twisted girders and heroic rescuers are a reminder that infrastructure cannot be taken for granted. The blind eye that taxpayers and our elected officials have been turning to the imperative of maintaining and upgrading the critical foundations that underpin our lives is irrational and reckless.

America's gross domestic product in 2006 was $13.2 trillion. We can afford to have world-class infrastructure. As a stepping-off point, we should insist that our elected representatives publicly acknowledge the risk of neglecting the bridges, roads and other essential hardware that goes into making a modern civilization. Then we should hold them accountable for setting priorities and for marshaling the requisite resources to repair our increasingly brittle society.

Samwick rightly adds this observation at his blog:

What I see most places I travel around the country are homes that are overbuilt to nearly the edge of the property line, and then a crumbling infrastructure across that line. Roads, power lines, sewers, schools--you name it. Almost everything used in common across that property line is stressed to the point of breaking.

Too much neglect for too lomg of the common space.

Thanks to Tyler Cowen's blog, I've recently read two intriguing articles about carbon footprints. The "Localvore's Dilemma" from the Boston Globe challenges the common notion that buying local produce is more energy-efficient and greenhouse-friendly than buying food that has been shipped long distances.

Food activists in the US and especially in Western Europe have pushed to put the term on menus and grocery-store labels.

But a gathering body of evidence suggests that local food can sometimes consume more energy -- and produce more greenhouse gases -- than food imported from great distances. Moving food by train or ship is quite efficient, pound for pound, and transportation can often be a relatively small part of the total energy "footprint" of food compared with growing, packaging, or, for that matter, cooking it. A head of lettuce grown in Vermont may have less of an energy impact than one shipped up from Chile. But grow that Vermont lettuce late in the season in a heated greenhouse and its energy impact leapfrogs the imported option. So while local food may have its benefits, helping with climate change is not always one of them.

The other article--Walking to the shops 'damages planet more than going by car'--comes from the London Times. I'm suspicious of these claims, but here goes:

Food production is now so energy-intensive that more carbon is emitted providing a person with enough calories to walk to the shops than a car would emit over the same distance. The climate could benefit if people avoided exercise, ate less and became couch potatoes. Provided, of course, they remembered to switch off the TV rather than leaving it on standby.

"The troubling fact is that taking a lot of exercise and then eating a bit more food is not good for the global atmosphere. Eating less and driving to save energy would be better."

The article reads like a parody. Still, I have no idea how to evaluate the competing claims in either article. As Tess Vigeland pointed out to me, it's much like health news. One study will tout drinking red wine because it's healthy for you. Several months later another study will trumpet the opposite result. (Still, red wine is good for the soul if not the body.)

It's at this moment that I retreat to economic fundamentalism. I can't evaluate the competing claims. And I don't believe that individuals can really make much of a difference on their own. We're facing a common risk and a common good. That's why I favor simply imposing a steep carbon tax on everyone, and then let the collective wisdom of the market sort what is energy-efficient and carbon-friendly and what isn't.

The best global warming insurance policy is a carbon tax. Everything else is secondary commentary.

Economist Greg Mankiw at Harvard has insights on carbon taxes and gasoline taxes at his blog.

I do a monthly column for the Star Tribune. The paper doesn't archive it. So, I'll try and remember to post it when it comes out. Here are the last two columns.

Financial instability is nothing new. A great scholar into the dynamics of financial booms and busts was the late economist Hyman Minsky. (He died in 1996.) I remember Minsky striding through the annual meetings of the American Economics Association, piles of paper tucked under arm, enthusiastically expounding his ideas and theories to (mostly) small audiences. Minsky was well known, but it seemed that many mainstream economists treated him as something of an anachronism. His model of financial instability was too crude, he pessimism too ingrained, his ideas too informed by psychology, his obsession with disequilbrium and bad lending decisions discordant in an environment that emphasized equilibrium and market efficiency. But Minsky did have an appreciative audience on Wall Street, especially among economists with a global outlook and investment bankers that cut deals in all corners of the globe.

Minsky was a leading scholar into the relationship between the business cycle and the credit cycle. Good economic times fueled optimism among borrowers and lenders. Gradually, both borrowing and lending became increasingly speculative until it reached the "Ponzi" stage. At that point there was no chance of borrowers being able to repay their debts and lenders weren't going to get their money back. Charles Dickens aptly captured the Ponzi moment: Credit is a system whereby a person who cannot pay gets another person who cannot pay to guarantee that he can pay.

George Magnus, senior economic advisor at UBS Investment Research, describes the Minsky typology this way:

The essential characteristic of economic stability from Minsky’s point of view is that debt becomes increasingly easy to validate. In other words, it encourages leverage and, sooner or later, new and more ambitious debt structures. Minsky called these financial structures hedge, speculative and Ponzi (so-called after Carlo Ponzi who created and was ruined by a pyramid finance scheme in Boston in 1920). The more the economy moves from hedge finance towards Ponzi finance, the greater the susceptibility to instability.

Ponzi structures have to raise ever greater amounts of debt to finance all
commitments and may not be able to repay principal or even debt service
without so doing. The more inflationary an economy is, the greater the risk that rising interest rates will turn speculative structures into Ponzi structures, that these structures will ‘evaporate’ and that asset values will collapse with serious deflationary consequences and damaging implications for the economy.

So, are we at a Minsky Moment? It certainly seems so. But will the current credit squeeze will turn into a full-blown credit crunch? I don't think so. (And I believe that's the message of the stock market rally.)

One reason for sketicism is that corporate balance sheets are flush with cash. Anotjher factor is that the strength of the global economy. There appears to be ample liquidity sloshing around the global financial system. I also think the Fed is right to let the Darwinian process of the market hammer banks and Wall Street lenders.

That said, the risk of a credit crunch is real. e is very real. And if it gets much worse I wouldn't be surprised to see the Fed abandon its tough stance and cut its benchmark interest rate. I bet that's what Minsky would be calling for right now.

George Magnus had written two reports based on the Minsky model. The first (March) goes into detail. Download file The second (July) updates the first report. Download file.

Federal Reserve Board chairman Ben Barnanke is trying to hold the line. Although I disagree with much of the current commentary disparaging Alan Grenspan and his supposedly nefarious "Greenspan put"--the notion that the former Fed chairman would bail out investors whenever turmoil theatened--it's clear that Bernanke would like Darwinian market processes to discipline profligate investors. In others words, he wants Wall Street to remember that risk is a four letter word.

Bernanke was a leading scholar of credit during his previous academic tenure at Princeton University. What did he think about credit crunches back then? "The Credit Crunch", a 1991 paper co-authored with Cara S. Lown, economist at the Federal Reserve Boad of New York, gives a hint. The research paper looked at the impact of financial distress and credit crunch (or what the scholars argue should be more accurately called a capital crunch) on the economy in the early 1990s.

Like now, the financial mantra in the latter part of the 1980s was borrow, borrow, borrow. Deal mania was in full swing and much of the takever activity was financed by junk bonds. Shopping mall developers borrowed huge sums of money; so did homeowners. When the debt started to go bad, lenders retreated. A school of thought argued that a "credit crunch" was behind the 1990-91 recession. It's a perspective I agree with.

But not Bernanke. In essence, the paper finds compelling evidence of a bank-centered credit crunch around the time of the 1990-91 recession. But the scholars seem to take every opportunity to minimize the results on the real economy. "What is out overall assessment of the macroeconomic effect of the credit crunch in the banking sector?," ask the scholars. "We cannot be certain, but the pieces of evidence that we have turned up are not consistent with a large role for the credit crunch."

This perspective informs their judgment of the implications of a credit crunch for monetary policy, "We argue that a credit crunch does not seriously affect the Federal Reserve's capacity to stabilize the economy but that it may make indicators of monetary policy more difficult to read," they write.

The discussant to the paper is Benjamin Friedman, economist at Harvard University. Friedman argues that the paper finds strong empirical evidence for a credit crunch. He believes the authors downplay their results too much. He also thinks they don't take the popular notion that lenders ration credit in trbulent times seriously enough.

"By contrast, the credit crunch of the 1990s resulted from the impact on bank balance sheets of the credit excesses of the 1980s, and just as banks were not alone in participating in those excesses, they are not alone in suffering the consequences. The same problems that have impaired some banks' capital have also shrunk the 'surpluses' of insurance companies, have caused profitability problems for finance companies, and have led to the collapse of the junk-bond market. In short, all other things have not been equal, and Bernanke and Lown's inference that credit demand has been weak does not follow from the pervasiveness of the slowdown in credit extensions among bank and nonbank lenders."

Today, we aren't facing a combination of a capital crunch and weak demand. This is a credit squeeze that risks turning into a credit crunch.

Mike Mandel of Business Week has a good post on the political imoplications of the housing market bust:

Is the 2008 Election Over?
Back in early 2006, I wrote

When the housing boom is over, the politics will begin…Democratic politicians fail to understand that their economic attacks on the Bush Administration can't really take hold until the housing market goes south. Rising home prices are an engine of prosperity for the typical American family. Until that engine goes in reverse -- which may be starting to happen -- doom-and-gloom politics won't really resonate….
Democrats have to be ready with their own package of reforms to cushion the housing downturn, even if the measures add to the budget deficit. There's no excuse for not having made plans in advance.

Well, that time has come. It will be much easier for the Democratic nominee—whomever he/she is—to make the case that the economy is heading in the wrong direction if the housing market is in crisis.

That point is now being made by others. A Boston Globe article

The more the crisis ripples through the economy, the more it will help Democrats make the case that Republican economic policies have spurned middle- and lower-income families, some campaign watchers said.

"It's an enormous opportunity for the Democrats to criticize the failures of the Bush administration, the fallout we are seeing from laissez-faire economic policies," Alan I. Abramowitz, a political scientist at Emory University, said yesterday.

But here is the real wild card: The unemployment rate.

And if the unemployment rate starts to rise? Then the Republicans might as well kiss the White House good-bye.

There's more financial market tubulence ahead. Okay, that's a safe forecast. Still, the the Fed's dramatic cut in the discount rate is probably enough to ease up the credit crunch. The conventional mortgage market should calm down in coming weeks.

That doesn't mean there won't be trouble. I expect that less attention will be paid to subprime mortgages and more attention to leveregaed buyout deals. There's a lot of takeover debt that can't be syndicated these days. The bank are stuck with owning the paper. Credit standards had gotten far too lax in the leveraged buyout market, and we haven't seen the full extent of this fallout.

It's not surprising that home prices are down. What is a bit surprising is how resilient home prices appear to be after all the shock waves of foreclosures, short sales, subprime implosions, reverberrations in the jumbo mortgage market, and so on.

Take the Standard & Poors/Case-Shiller Home Price Index. It has a declining annual growth rate in prices of existing single family homes across the United States down for the past 18 months. The annual decline for their 10-City Composite index is 3.4%. The comparable figure for their 20-City Composite is 2.9%.

Now, let's look at their latest figures. It's for the year ending in March 2007. The biggest decline in Detroit, with a -8.4% drop. But that's more than offset by a 10% gain in Seattle.

These are one-year results through March, 2007

U.S. National Index -1.4%

Atlanta 2.0%
Boston -4.9%
Charlotte 7.4%
Chicago 1.3%
Cleveland -2.4%
Dallas 1.6%
Denver -2.0%
Detroit -8.4%
Las Vegas -1.6%
Los Angeles -1.4%
Miami 1.0%
Minneapolis -1.9%
New York -1.1%
Phoenix -3.0%
Portland 7.0%
San Diego -6.0%
San Francisco -2.3%
Seattle 10.0%
Tampa -3.0%
Washington -4.8%

Composite-10 -1.9%
Composite-20 -1.4%

Source: Standard & Poor's
Data through March 2007

The way I look at these numbers? Home prices will slide lower for a long time to come. This will be a period of stagnation in the home market.

A reasonable set of forecasts by George Magnus, senior economic adviser at UBS Investment Bank in London. It's dated August 10. (I had set it aside and just got to it. The points he makes hold up well.)

(1) Losses will continue to mount and surface. This is particularly true in the
sub-prime and Atl-A mortgage markets, as noted by our US Mortgage Research Head, Laurie Goodman. Losses will build (to around 12% in the
sub-prime market) as the riskier 2006 'vintages' are scrutinized. Also,
given the geographic and institutional dispersion of MBS and other credit
positions, losses are likely to emerge sporadically and over time, rather
than in one cathartic event.

(2) Market volatility will remain elevated. Insofar as high volatility typically
persists, this is a fairly straightforward conclusion. But also, given the slow
recognition of losses (as discussed above), adverse surprises are likely to
shock markets episodically over the coming weeks, if not for longer.

(3) Central banks and regulators will act. Already central banks have
demonstrated their willingness to provide liquidity, as needed. But equally,
financial regulators of all stripes and locations will move to identify
problem areas. This is likely to result in increased disclosure of losses, even if the process may be lengthy.

(4) Credit conditions will not revert to the status quo ante. Even when
market conditions stabilize, easy credit conditions will not resume. This is
particularly true in challenged markets such as sub-prime or undocumented
mortgage lending, but will probably be the case other areas of credit as
well. In the US housing market, the ongoing adjustment of excess
inventories and associated downward pressure on house prices make it
improbable for lenders to offer, for example, 100% financing. Equally,
borrowers will not be able to rely on equity gains to collateralize
expenditures as they have to date.

(5) Economic activity to slow. The world economy was probably already at a growth inflection point at mid-2007, but consensus forecasts are likely to
be shaved should tighter credit conditions persist. We and our regional
teams will closely monitor financial conditions and the possible impact on
activity in the weeks ahead before making determinations about the
magnitude of the real economy effects from today's financial market
dislocations.

The New York Times has a story delving into the question, how could so many smart people buy so much bad debt. The article makes clear that the warning signs of impending financial trouble were multiple and obvious. Still, we're supposed to believe that hedge fund buccaneers, private equity money managers, and other top financial talent didn't understand the market.

"Buyers didn't fully understand what they were getting," said Rajiv Sobti, a portfolio manager at Proxima Alfa Investments, a New York hedge fund. In Wall Street parlance, Mr. Sobti added, "They were sold, not bought. The actual buyers were often not mortgage specialists, but generalists who looked at these bonds as a way of earning higher yields."

I don't buy it. Almost all Wall Street money mavens sport advanced degrees. They earn millions of dollars a year in bonuses. They work long hours, with plenty of analytical firepower on call, from supercomputers to Phds. No, what was at work was the time-honored greater fool theory.

Sure, the subprime stuff was risky and valuations dubious. But so much money was being made that the best-and-brightest convinced themselves that they'd always be able to find a greater fool to unload their bets on when the time came. Yet, as financial history has shown again and again, when the turmoil strikes the "fools" disappear.

The Washington Post has a story on how textbook brilliant Wall Street rocket scientists lacking street smarts blew it. Here's what I take is the main theme of For Wall Street's Math Brains, Miscalculations Complex Formulas Used by 'Quant' Funds Didn't Add Up in Market Downturn.

As elegant as the models are, they cannot predict unpredictable events, or human panic, some traders say. Further, some say, too many quant funds are full of myopic brainiacs, overly reliant on their tools.

"They are very smart in front of a textbook but not smart enough to understand very elementary things in reality," he said.

I don't buy it. No model works at all times in all markets. Even young quant jocks would be well acquainted with the history and mistakes from the 1998 blow-up of the famous hedge fund, Long-Term Capital Management. (A good book on the LTCM debacle is When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein.) Basically, more and more of these market neutral quant funds made huge sums of money following the same strategy, such as shorting growth and playing the carry trade. In the story, hedge fund maven Cliff Asness gets it right:

"I occasionally hear broad statements like, 'This just shows computer models don't always work,' " Clifford S. Asness, founding principal of the quant-fund firm AQR Capital Management, wrote to his clients after the sell-off. "That's true, of course, they don't, nothing always works. However, this isn't about models, this is about a strategy getting too crowded, as other successful strategies both quantitative and non-quantitative have gotten many times in the past, and then suffering when too many try to get out the same door."

Shoud I retire at 62 or wait until I reach full retirement age? It's a question we get all the time.

To intelligently explore that questions, Bud Hebeler at www.analyzenow.com offers two Social Security programs on his website. One if for singles and the other is for married couples.

The former president of Boeing Aerospace Company has just revised and simplified the program for married couples. The program includes the Medicare Part B deductions, a simple guide to the taxable part of Social Security, and survivor's benefits.

It's a nice tool for thinking through a common--but complex--question.

I also really like his new book, "Getting Started in a Financially Secure Retirement." (Full disclosure: he very kindly compliments the quality of my financial advice.) Anyway, his book is geared toward helping individuals and families achieving their financial goals, not lining the pocket of the mutual fund industry and other financial advisors.

Check it out (and then let me know what you think.) It's a worthwhile addition to any bookshelf.

One of my favorite blogs is the ongoing discussion between University of Chicao economist and Nobel laureate Gary Becker and University of Chicago law school professor Richard Posner. The debates are always iluminating. In a recent post at Becker-Posner has Becker arguing in favor of the Fed intervening during a financial crisis and Posner dissenting. I'm sympathetic to Becker's position.

Still, I liked this paragraph about hedge funds and taxes in the Posner posting.

The losses sustained by hedge funds in the bursting of the subprime bubble lend a note of irony to opponents of taxing them comparably to other investment companies. They argue that hedge funds play an essential role in bringing market values into phase with the underlying real economic values. It now seems that a number of hedge funds were caught up in a speculative frenzy, and that far from bringing about convergence between market and real values they enlarged the wedge between them.

The housing market is nowhere near bottom. The Wall Street Journal had a good story on the meltdown in the condominium market on Saturday.

For the nation's real-estate lenders, the other shoe may be about to drop: condominiums.

Already plagued by rising home-loan defaults and foreclosures among overstretched consumers, major markets across the country -- including parts of Florida, California and Washington, D.C. -- are seeing rising foreclosures and bankruptcies of entire condo projects

Today, the New York Times had a story predicting that median home prices would drop for the first time since the government started collecting price data in the 1950s.

Economists say the decline, which could be foreshadowed in a widely followed government price index to be released this week, will probably be modest — from 1 percent to 2 percent — but could continue in 2008 and 2009.

And Martin Fridson, a superb Wall Street analyst and publisher of the Leverage World newsletter, has some ominous thoughts about the upcoming adjustable rate mortgage reset.

Under the direst ARM-reset scenarios, a flood of homeowners who took out mortgages with low, “teaser” interest rates will be forced to sell their homes when their monthly payments reset higher. Because more people stretched to buy homes as the housing market peaked in late 2005, some expect the ARM risk to be most acute this autumn, when the loans trip their two-year reset provisions.

About $800 billion of ARMs are scheduled to reset over the next couple years, including almost $200 billion in the remaining months this year, according to one frequently cited Wall Street estimate. At least one industry source pegs a higher number, almost $1.5 trillion for the calendar year 2007. Whatever the number may be... have the potential to pinch household wealth and weaken consumer spending, which would have negative ramifications for the U.S. economy and the high yield market as a whole.

That's bad enough. But a parting thought from a conversation with Chris Thornberg, founding partner of Los Angeles-based Beacon Economics, emphasized just how long it will take for the housing market to emerge from its financial woes.

The broader, contextual problem for the real estate market is that home prices are still too high compared with income levels, Thornberg opined. For instance, the average home price in Los Angeles County was recently about 11.1x the average annual income in the area, up almost threefold from a 4.1x ratio at the turn of the decade. Such levels are not sustainable, he said.

They are especially not sustainable if the unemployment rate rises from it current 4.6%. If the unemployment rate goes higher, the housing markets spirals lower.

Throughout U.S. history, there has been a deep suspicion of banks, especially big banks. A common refrain from the days of Thomas Jefferson and Andrew Jackson is that too much bank power would hurt the poor. Concerns about income distribution did lead to tough restrictions on interstate bank branches.

But these restrictions relaxed considerably once financial deregulation took hold beginning in the 1970s. Banks have gotten bigger and bigger (think Bank of America, Citigroup, and Wells Fargo), and the day of the $1 trillion bank aren't far off.

What has been the impact of banks on income distribution? In an intriguing paper, economists Thorsten Beck, Ross Levine, and Alexey Levkov investigate this question in Big Bad Banks? The Impact of U.S. Branch Deregulation on Income Distribution (NBER Working Paper N0. 13299, August 2007).

The scholars find that the deregulation of bank branches narrowed income inequality (relative to the national trend of widening inequality). "Deregulation tightened the distribution of income by disproportionately helping the poor, not by hurting the rich," according to their analysis. The main reason: The labor market. Deregulation increased the wages of unskilled workers relative to skilled workers and it narrowed the income gap between men and women, pushing up[ women's wages relative to men.

Will Federal Reserve Board chairman Ben Bernanke ciome under criticism for not pricking the residential real estate bubble earlier at this weekend's central banking confab in Jackson Hole, Wyoming? This article in Bloomberg "Bernanke May Hear Call for Fed Activism on Regulation" says yes. For instance, Otmar Issing, the former European Central Bank chief economist, and William White, head of the monetary and economics department at the Bank for International Settlements, have argued that when asset prices balloon--like during the dot.com boom and the residential real estate bubble--policy makers should raise interest rates.

Bernanke has resisted the notion, arguing that the primary mission of the Fed is to contain inflation and to prevent a financial collapse. He should resist the idea. The notion that a central banker would have the ability to determine when a bubble has been formed, and when it should be pricked, defies imagination. The job is hard enough.

What's more, the downside of bubbles is emphasized far too much. There is a long literature that sees many beneficial effects from bubbles. You can tap into that vein of thinking with several books, including Mike Mandel's Rational Exuberance, my Deflation: What Happens When Prices Fall, Peter Garber's Famous First Bubbles, and Daniel Gross' Pop: Why Bubbles Are Great for the Economy. Here's a link to a review I did of Gross' book for Business Week,

Are the wild gyrations in the market troubling you? Then I'd suggest picking up a copy of "Worry-Free Investing" by finance professor Zvi Bodie of Boston University (with Michael J. Clowes). It was published several years ago, but the advice remains timely. Instead of asking, "How much money will I make?" Bodie argues the fundamental financial question is "How much can I afford to lose?"

Bodie believes that most of want to sustain our standard of living throughout our lives. The way to accomplish that is to limit downside risk, and to save a substantial portion of your income every year. Stocks, he says, are too risky for most people. Instead, savers should try to lock in a long-term standard of living while taking as little risk as possible. His preferred investment in retirement savings accounts is U.S. government inflation protected securities (Tips), and Series I savings bonds for taxable accounts. Both are risk free investments that designed to protect the saver form the ravages of inflation.

I'm more convinced that equities play a major role in the average portfolio than Bodie. But I like his book partly because he makes you think through what you're doing and partly because his philosophy is in such stark contrast to so much financial advice peddled on TV, on Wall Street, and other media. If you've watched any of the business television shows you know they're incessantly hyperventilating over the latest rumors, market gossip, and fast-buck trading schemes. They're obsessed with finding the next winning stock. It's as if everyone is supposed to be a Wall Street trader or hedge fund gunslinger wannabee.

Well, most of us aren't.

Indeed, there is a great divide in the world of investing: The entrepreneur and the insurance buyer. And knowing which you are can save you from a lot of money mistakes. Entrepreneurs, whether they call Wall Street, Main Street, or dot.com home, are out to make big bucks. And they're willing to risk losing a bundle, perhaps everything, in their pursuit of a large payoff. Entrepreneurs are obsessed with their market, and they're constantly seeking an information edge on the competition. Many of these risk-takers use leverage lots of borrowed money--to magnify their potential gains and losses.

Insurance buyers periodically set aside money into the market through a tax-deferred savings plan, such as a 401(k) or 403(b). Maybe they put some additional savings into an equity mutual fund and a 529 college savings plan. In essence, their taking out an insurance policy against the risk of a lower living standard in retirement or to limit how much their children will have to borrow to attend college. The goal is to constrain the downside rather than to reach for untold riches. And Bodie has savvy advice for the insurance buyer.

Of course, which would you rather be called, an entrepreneur or an insurance buyer? Yet "insurance buyers" investing in Tips, Series I savings bonds and, yes, a low-fee equity index mutual fund will do well financially over the long haul, and still have the time to do many other things that matter, from work to family.