Paul Solman Answered Your Questions on Recent Economic Turmoil

PAUL SOLMAN: Yes.

JEFFREY BROWN: And, you know, we've done several segments where we bring on personal finance experts, and usually what they always say is, "Well, don't panic." Of course.

PAUL SOLMAN: Well, you don't want to really go on the NewsHour with Jim Lehrer, and say to --

JEFFREY BROWN: And say "Panic."

PAUL SOLMAN: -- the millions of --

JEFFREY BROWN: We discourage that.

[Laughter.]

PAUL SOLMAN: "Yeah, hey, you all should be panicking, the situation is out of hand, move to New Zealand." I mean, you know --

JEFFREY BROWN: Yeah, of course.

But, OK, M.J. Gerard, from Potter Valley, Calif., "What is a prudent individual to do, considering the current economic climate?" I'll just read a couple of these --

PAUL SOLMAN: Yeah, sure.

JEFFREY BROWN: Colin McCullough from Rockwell City, Iowa, "With the market volatility, should one maintain a substantial position in the market, or pull back on an uptick in the market, if a pullback -- to where?"

Fred from Seattle, "I want to invest $25,000 in a college fund for my 1-year-old. I'm afraid that this is a bad time to start such an investment, but at the same time, I don't want to wait too long."

Well, that's -- there are more, but -- what do you -- you know, I'm not putting you in the position of financial analyst or advisor, and certainly we don't want you held responsible for what you advise --

PAUL SOLMAN: Everyone should panic and move to New Zealand, that's my advice.

JEFFREY BROWN: OK, but help people think about a time like this.

PAUL SOLMAN: Yeah, you know, I mean, of course, you might tell people that, not only have we talked about the Red Sox a lot over the years, we've talked about this very issue, with regards to your own finances. And, I suppose, mine as well -- that part I don't remember.

There's no answer, you know, to this, because -- not only because I would be terribly scared, and am, when people ask me for advice, you know, fellow employees of ours, for example.

You know, terribly scared that I say something and then, you know, it doesn't work out in some proximate period of time -- that is to say before they die -- and they hold me responsible. You know, I mean, what do I know?

And the reason I don't know anything is because -- even though I understand the system as well as most people, or better than most, I can't tell you what's going to happen, what's going to happen is going to be determined by how people like you, me, and the people who are writing to this very Insider Forum are going to do.

I mean, if everybody -- if I were really to say, to put it starkly -- "Hey, everybody ought to sell stocks," and, by the way, somebody could edit that very clip that I just said, and make it into that on the Internet, already -- but if I were to say that, and mean it, and --

JEFFREY BROWN: And everybody did it?

PAUL SOLMAN: Yeah, it's sheer grandiosity to think that anybody would think that I was other than a lunatic, or --

JEFFREY BROWN: Right.

PAUL SOLMAN: -- but if they were to do it, the future, at least in the short run, would actually change, you know?

So, I can't -- you can't tell people what they ought to do. As a general rule of thumb, the people who come on our show say what? They say, "Let's -- you should diversify." What does that mean? Don't put all your eggs in one basket, that is all your investment eggs in one basket.

Have different kind of investments, so that if one goes up, the other goes down -- you hope you have -- I mean. I guess I should put it the other way -- if one goes down, the other one is likely to go up. You don't -- because you're trying not to take risk if you can avoid it, unless, of course, you love doing so.

So, what's a mutual fund? A mutual fund is a diversified group of stocks. So you don't just get the IBM stock your rich Aunt Marie left you in her will, never trade out of IBM, and then you're completely subject to the fluctuations of that one particular company.

If, however, you have a mutual fund, then some companies go up, some companies go down, and in general your -- the performance of your fund, and of your investment, mirrors the performance that is the prosperity of the stock market, as a whole, right?

Now, that doesn't mean that stocks, as a whole, won't go down, as they've certainly been doing lately. So, then there's a further level of diversification, and that diversification is across asset classes, and assets class is stocks, another one is bonds, and other one is real estate.

So, if you diversify your investments across asset classes -- a terms that's used as asset allocation -- you allocate a certain part of your funds to one class of assets like stocks, another like bonds, and so forth, then you're diversified with -- across markets, not just within markets, right?

JEFFREY BROWN: Mmm hmm.

PAUL SOLMAN: And then there's the further issue of diversification across currencies.

I mean, I can't tell you the number of people who have bemoaned to me in the last few months  the fact that, when their friend said they should diversify into Swiss francs, they didn't do it. And how do you diversify into Swiss francs?

Well, you can actually buy the actual francs on the market, you could buy bonds that are denominated in Swiss francs, which is the same as holding Swiss francs, because if the currency goes up, those bonds are worth more, I mean, if Swiss francs go up.

So, that's a further level of diversification that you can engage in.

Now, you ask the question which is behind all of the questions you were reading there, which is, "So, what exactly should I do? Which mutual fund? Which assets, which currencies?"

And there I have to respond with the oldest dodge in the world, but it's true -- which is, the current price of all of those assets, each of those assets, is the collective best guess at this moment in time as to what they're worth.

And if I knew what they were going to be worth, well, I would be a -- I would be out of some mythology, I wouldn't be a real human being.

JEFFREY BROWN: Right. And you probably wouldn't be still working for the NewsHour.

PAUL SOLMAN: Well, no, I suppose, you know, if I was actually, if I had that kind of Olympian, God-like sight of what was goinsg to happen in the world --

JEFFREY BROWN: Right.

PAUL SOLMAN: I mean, like I said, I wouldn't be a human being, so I certainly wouldn't be working for the NewsHour. I guess I would, you know, it would be like --

JEFFREY BROWN: That's what I meant --

PAUL SOLMAN: Jim Carrey in Bruce Almighty, you know, that's what it would be like.

JEFFREY BROWN: All right, let's move to the -- there's some questions about the Fed, and regulation, here.

Ron Roads from La Cantas --

PAUL SOLMAN: Let me -- let me say something, though --

JEFFREY BROWN: All right.

JEFFREY BROWN: Mmm hmm. In what ways?

PAUL SOLMAN: Well, because the extent to which your assets are significantly allocated in stocks, for example.

The reason stocks -- is the extent to which you are taking a lot of risk that the investment industry has a vested interest in suggesting to you that you're not taking.

So, why does a stock pay more than other investments? Like, why does this pay more than bonds? Stocks, on average -- let's not get into how, quite, this works. It's dividends and the rise in the price of stocks, but if you look over a period of 60 or 70 years, it gains 10 percent a year, or something like that.

Whereas bonds, you know, the money you led to the government, you know, the interest rate's 4 percent, 5 percent, 3 percent, whatever -- something considerably more modest.

So, why -- why do stocks pay that much more? By the way, there's a great puzzle in economics -- but the basic answer is -- because stocks are riskier. You're taking more risks and you're getting compensated for the risk.

Well, folks, it follows --

JEFFREY BROWN: Risk goes both ways, right?

PAUL SOLMAN: Night as day. For every incremental reward you get in your investments, you're taking that much more risk. And so, you -- there's this story that's been out there, a phrase that's been out there, particularly in the last 10, 15, 20 years -- "Stocks in the long run." Stocks in the long run have always gone up 10 percent, so they'll go down, they'll go up, but on average, they'll go up. And they'll go up by that amount.

Well, that's with a very short history of one particular country of which that's true. It's actually true across countries in the West -- Europe and so forth.

On the other hand, if you owned stocks in Imperial Russia, before the Revolution of 1917, 1918 -- well, you can forget about it, that market was over.

Cuba, and so forth -- there are radical events that can happen -- not likely to happen in the United States, that can wipe the whole -- make the history completely irrelevant.

And so it's -- it's risky to be, to have a lot of your assets in stocks. But, the investment community makes money selling stocks, and has a vested interest in convincing you that in the long run it will be safe, that you're going to forego profits by investing in safer things, more conservative, you'll miss the boat.

And, as a consequence, the one thing that I can say is that people ought to look at their total investment portfolio with a view to how much risk they really are comfortable with.

And that doesn't always jive with the little pie chart that some of our viewers, listeners may have seen in their pension fund reports about, you know, are you a this-risky person? Are you that risky? And so forth.

One ought to look at it more fully, and what I'd recommended is, if you have -- if you really have assets, I mean, substantial assets on which you're hoping to live, in the fairly proximate future, I'd go talk to a financial planner, and try to learn to understand this stuff, to see how much risk you're really taking, and do you want to do it.

JEFFREY BROWN: OK.

PAUL SOLMAN: There's one other thing I guess I would say here. There is a class of investments that's extremely safe, and by the way, as a result, extremely low-paying, OK? They're called TIPS -- they're Treasury Inflation Protected Securities, acronym is TIPS. They're issued by the Federal government, they do not protect you against the dollar going down, because they're denominated in dollars.

But they do protect you against inflation -- they're inflation-protected, that's why they're called that -- and so you get the underlying -- as a return you get the underlying Consumer Price Index, plus a premium. And that premium varies, depending on how popular these instruments are, these dead IOUs of the government.

Right now, they're unbelievably popular because they are considered so safe. They protect you against inflation, and they're [from] the U.S. government, right?

So, right now the premium is, I don't know, a percent -- a percent and a half -- and for very short-term TIPS, it's actually a negative premium.

You can ask me how that works, and I could explain it, but you're actually getting less than the Consumer Price Index, because these things are so popular that they've been bid up in price.

The -- but TIPS are -- have a, they've done very well, because people are so much more zealous in pursuing them, and so the value of TIPS you hold goes up in price -- that's how bonds work, if more people want them, the ones with the high interest rates, they buy them, right? And they pay more money for them.

But the TIPS also guarantee you, even now, the Consumer Price Index plus a percent, if you're lending the money to the government for more than, I don't know, a few years.

So, it's something people should at least be aware of, and do not seems to be.

From Ron Rhoades in Lecanto, Fla., "Does the Federal Reserve possess enough tools to protect against a major collapse in the functioning of our financial institutions?"

From Cam --

PAUL SOLMAN: What was it? Just take them one at a time --

JEFFREY BROWN: Oh, OK.

PAUL SOLMAN: There are too -- it'll be too hard --

JEFFREY BROWN: OK.

PAUL SOLMAN: -- I won't remember them.

JEFFREY BROWN: The Federal Reserve.

PAUL SOLMAN: I would -- presumably, the answer is yes. There is, though, one caveat after that answer, which is if the Federal Reserve itself looks like it's panicking, will it thereby restore confidence in others? I mean --

JEFFREY BROWN: When we talk about the tools of the Federal Reserve, though, what do we mean?

PAUL SOLMAN: Well, we mean -- the Federal Reserve's basic thing, is the Federal Reserve can print money.

JEFFREY BROWN: Right.

PAUL SOLMAN: Print is -- somebody took me to task for that, or somebody took somebody who was on the show to task for -- "They can't really print money, can they?" You know, the mint prints the money.

But, remember the amount of dollars and coins that are out there is a small percentage of the money supply, and really, you know, most of the money supply is in your banking account, that's not -- you know, your checking, your savings account, and so forth -- that dwarfs the amount of money, cash that actually changes hands in the economy.

So, that's what you really mean by money.

Liquidity -- that stuff is totally liquid, right? You go to the bank, and not only could you take the money, but even if there were a bank run, the government would guarantee you up to $100,000 in every bank you had money deposited in.

So, that's real money. And the Fed can create it. The Fed can create it by literally depositing more money in banks. And then the banks lend out that money to other people, and that's -- so that's how the Fed so-called "prints" money.

That's one tool. The other tool is, the Fed can lend the money, and set the rate at which banks lend money to each other, but it can lend money to banks, and in the current crisis, what the Fed has been doing -- unprecedented in certain respects, is the Fed has been lending money to banks using as collateral for that lending -- you know, they don't just lend money to the banks because they're a good guy, kind of thing -- the collateral is our IOUs that the bank hasn't otherwise be able to get rid of, hasn't been able to sell.

You know, when the banks invested in, for example, mortgage-backed securities, these IOUs whose collateral is a batch, a pool of mortgages, right?

JEFFREY BROWN: Right.

PAUL SOLMAN: The income coming in from those mortgages, and then there are those IOUs that are backed by those mortgages, they're mortgage-backed securities -- well, suddenly nobody wants them anymore, everybody's afraid that the mortgagors aren't going to pay off, therefore these IOUs won't pay off, and they won't be worth anything.

Banks stuck holding a whole bunch of them, right? And the bank can't raise any money to keep its business going, because everybody says, "Hey, I want one of those," "Well, I'll give it to you wholesale," "Forget it, I can't afford to touch them, because who knows how low they're going to go in value." Nobody else wants them, either.

That's the credit crunch, because if the bank can't get money, it can't then turn around and lend it out.

The Fed has come in and said, "Hey, come to Mama. Come to our window, we'll lend you money that you can then lend out at a profit, we'll lend you that money, using as collateral these securities which you couldn't get anything for because everybody was too scared of them."

That's the other tool -- the discount window, the Feds lending to banks, as well as the Fed creating money in the system.

JEFFREY BROWN: OK, let me ask you -- we only have about 5 minutes, so let me ask you a few more questions here.

Cam Mannino, Oakland, Mich., "Why aren't you and others talking about deregulation as being at the heart of the financial crisis at the moment? For instance, how did we let companies like Bear Stearns become so powerful that its fall could take down our whole economy?"

And related, from Ron in Rochester, N.H., "In your opinion, what regulatory measures would have prevented the current financial crisis?"

I think people don't quite understand -- and you were talking about risk earlier -- instruments that create risk, is anybody watching when these investment houses and others create these instruments, and should more be done?

PAUL SOLMAN: In the first place, I look at any piece we've done, you go to the Internet, YouTube, wherever you want, and we've got deregulation fingered every single time as a culprit in this.

Deregulation is a huge part of this story, it started happening in the, you know, Reagan years, that was the ideology, it's been the ideology of this country, you know, of -- pretty much officially for the last 30 years, even before it was, even in the Carter administration, there was a considerable amount of deregulation.

It's not to say that deregulation, in general, is a bad thing, it all depends on what you're deregulating and the extent to which you are doing it.

There's an eternal cat-and-mouse game, though, that goes on between government and people trying to make a buck however they can. And the problem with deregulation is, it can often let the guys who are trying to make a buck get so far ahead of the game, that they could do the kinds of stuff they've done in the last few years.

And that has been, just -- quite naturally -- to think that they were making a bunch of good bets, and to be able to borrow more and more money in order to make those bets.

It's not that Bear Stearns has become so powerful, it's that Bear Stearns got so out of hand, and was risking so much money, because so little of it was its own, so much of it was borrowed money, that when the markets went against it, we don't even yet know what bets Bear Sterns actually was making -- but when markets went against it, suddenly all of those bets that Bear Stearns had made that was, in fact, the collateral for the money they borrowed, those very bets, and they couldn't sell the bets any more, because nobody wanted to buy them, just like with the mortgage-backed securities.

Then suddenly all Bear Stearns lenders say, "Hey, give us back the money," Bear Stearns can't come up with the money. And the Fed, and them had to step in and say, "We'll guarantee Bear Stearns up to $30 billion to keep the game going."

But, deregulation, absolutely the incredibly important part of the story, what do you do about it?

There are now proposals, Barney Frank has, Chris Dodd in the Senate, have proposals, there are other proposals to the Fed, and Henry Paulson have been talking about to bail out homeowners, extend the terms so that you don't have to have these mass foreclosures, on the one hand, at the bottom of they pyramid, if you will.

And up at the top, trying to make sure that there's a market for the, you know, the securities that are out there, and to impose restrictions to have the Fed or some other Federal agency look into how do we, in the future, monitor these guys so they can't get around the rules that we traded for the banking system back in the '30s, the last time we had a major crash.