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KAREN: The mighty U.S. Military readies for war - but is the economy prepared?

GEOFF: The President's own chief economist warns about risks to the economy.

KAREN: The bear market is mauling junior's college fund -- we'll show you how to bite back.

GEOFF: That and more on Wall $treet Week with FORTUNE.

Contents » Opening » Hubbard interview » War economy » Saving for college » School stocks

ANNOUNCER:

Wall $treet Week with FORTUNE is made possible in part by:

Kyocera Mita. Printers, digital copiers and color, wireless LAN solutions -- flexible document systems to help meet today's needs and tomorrow's challenges, from one company: Kyocera Mita.

And by contributions to your PBS station from viewers like you. Thank you.

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Glenn Hubbard interview

GEOFF: The top two items on President Bush's agenda are resolving the Iraq situation and pushing his economic stimulus package - and the two are related. In addition to all the Iraq news this week, White House spokesman Ari Fleischer said today "the President is going to fight for" his economic plans. Earlier today I spoke about this with Glenn Hubbard, chairman of the President's Council of Economic Advisers, from the White House. I pointed out the President has proposed a very substantial stimulus package. Today we had the strongest employment report in two years, unemployment way up, new jobs way up. In light of reports like this, I said, why do we need an economic stimulus?

» Hubbard profile » What about capital spending? » Is Hubbard leaving -- or isn't he? » Jan. 31, 2003: Krugman vs. Barro on the Bush plan

GLENN HUBBARD: Well we certainly had a better labor market report today than I think many had expected, but it's still the case that we've got relatively weak employment growth in the standards of a typical recovery. The President believes we need a much more vigorous employment recovery and we believe there's significant downside risks that make the jobs and growth package still very necessary.

GEOFF: Let me read you something. This is from Alan Greenspan who met last week with a group of senators and after that meeting The Wall Street Journal reported, "Mr. Greenspan said the U.S. economy is recovering without additional fiscal stimulus. He said Mr. Bush's proposed $670 billion of tax cuts would provide the economy with little near-term effect." Is Greenspan wrong about that?

HUBBARD: Well, let me not comment on statements I didn't hear, but I can say that we believe there's very important short-term lift from what the President is proposing, namely about a percentage point of GDP growth in 2003 and 2004. That's also the consensus of a number of studies that have been done by economists outside and by the business roundtable.

GEOFF: Glenn, what about job creation? What's your forecast on that?

HUBBARD: Well, we believe that the President's plan in 2003 would create about a half a million jobs in the second half of the year and then about 800,000, close to 900,000 jobs in 2004.

GEOFF: There's another aspect of this revealed in the budget which the President published this week which was the deficits. The budget includes the largest dollar amount deficits in the history of the country. Now this is the kind of thing that typically upsets the financial markets. No?

HUBBARD: Well, I think it's important, and the markets understand this certainly, to put these deficits in context, we believe that the key to fiscal restraint, which is what the President has spoken so eloquently about, are economic growth and spending restraint. That's what ultimately recovers the fiscal health of a country. If we wanted a balanced budget in two years, if that were the only priority for the country, we could do that, but it would mean no defense buildup, no Medicare benefit, no growth package. We have to balance these priorities.

GEOFF: Well, the other option though for balancing the budget would be not cutting taxes as you've proposed.

HUBBARD: You don't tax your way into prosperity. Ultimately what makes it possible for our economy to provide many things, many social programs, many programs generally is more rapid economic growth. And we believe the plans the President put forth have a lot of bang for the buck.

GEOFF: A lot of business people and now a lot of consumers as well seem to be almost frozen in economic terms because of uncertainty about the Iraq situation. Of course, we had the terror threat level raised today one notch. Can the President's program be effective in doing much of anything until that situation is resolved.

HUBBARD: I think it can. There are a lot of uncertainties in the environment. You mentioned geo-political risks, but frankly, as I talk to business leaders around the country, there's also an uncertainty about the economic recovery's viability. We can't sweep away real sources of uncertainty, but we can make it more attractive to spend and invest and that's what the President's plan does.

GEOFF: Glenn Hubbard, thanks so much for being here.

HUBBARD: Thank you.

GEOFF: Karen?

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War economy discussion

KAREN: Well, President Bush told Iraq the game is over, pushing the U.S. closer to a confrontation in the Gulf. Frank Gaffney, president of the Center for Security Policy, says there is no alternative now to war. Robert Hormats, vice-chairman of Goldman Sachs International, warns we may be well-prepared militarily, but not so well-prepared economically. Robert joins us from New York.

Gentlemen, welcome.

Bob, let me start with you. What do you think about the comments we just heard from Mr. Hubbard about the economic stimulus program?

ROBERT HORMATS: Well, I think the economic stimulus program has some very positive elements, like accelerating the 2004 and 2006 tax cuts, trying to put them in relatively soon; accelerating the marriage penalty elimination; credit for children. Various things of that sort are quite positive and do provide near-term stimulus.

On the other hand, eliminating the tax on dividends, I think, does not provide very much short-term stimulus. It does not provide, to use Glenn Hubbard's words, much bang for the buck. And that tends to be a problem down the road, because it will widen the budget deficit down in the future years when we won't need the stimulus, but doesn't help in the current year when we do need the stimulus.

KAREN: You've also said we are not prepared economically for war with Iraq. Could you tell me what you mean by that?

HORMATS: Well, we're very well-prepared militarily, and I agree with Frank, if we have to go to war, we're very well-prepared for that war. But economically we're not.

We've got a weak economy. The state and local governments that are in the front line in the war against terrorism, are in difficult financial straits. We're very dependent on imported oil, very vulnerable. There are a lot of problems in the economy that are going to make it more difficult for us to deal with the war.

We have the resources to fight the war, but economically, if the war does not go as well as anticipated; if the aftermath of the war, the occupation of Iraq, presents problems; if there's more disruption of oil; the economy will be in much worse shape as a result.

KAREN: Frank, you've written very succinctly that there is no alternative to war. Please elaborate.

GAFFNEY: I've felt for a long time, that given the nature of Saddam Hussein, Karen, war was inevitable.

It was a question of whether it was going to be on his terms and in a timing of his choice, or whether it was going to be under circumstances that we determined. My sense is that President Bush sees it the same way, and that he has in fact made the decision internally that this business of liberating Iraq is going to have to be the tool used to disarm the Iraqi regime, rather than relying upon some U.N. process, inspections or some other deus ex machina, if you will.

KAREN: Is the inevitable response to all the sabre rattling some retaliation of terrorism on U.S. soil?

GAFFNEY: I'm sorry to say that today's raising of the alert is just another reminder that terrorism on our soil is, I believe, another thing that is almost certain to happen. I don't think it is going to happen to a greater degree if we liberate Iraq. In fact, I think that that action may well -- by eliminating one of the remaining safe havens in which terrorists operate, get financial support, training and logistical assistance and the like -- may actually reduce the likelihood of terror. But I still think the likelihood is high.

And this is one of the reasons that I would say about the economic package, war is unfortunately a come-as-you-are affair. We may not be ready economically and it may be that we're not prepared in terms of our homeland security either, but those are facts of life that have to be dealt with, and I think that is what President Bush is trying to do through a combination of defense here and offense overseas.

KAREN: Bob Hormats, what do you think the reaction of the financial markets would be to another act of terrorism here in the United States?

HORMATS: Well, it would be very harmful. It would harm confidence for several reasons.

One, because Americans believe that we've made considerable progress in preparing ourselves for another act of terrorism, and a lot of work has been done to avert another act of terrorism. Another act would demonstrate additional vulnerability.

It could be very disruptive economically. It certainly could be very disruptive to confidence, which would make consumers and corporations even more reluctant to make big commitments to spend or to invest.

And of course you have to deal with the immediate problem of the area that was affected adversely by terrorism.

It would be psychologically harmful and economically harmful, both.

KAREN: Can we expect the same type of economic stimulus post-World War II from a potential war with Iraq now?

HORMATS: Probably not. One of the problems with modern wars is that they don't, economically, provide very much stimulus. They're relatively short. They're not like the big mobilizations of World War II or World War I or even, to a degree, the Vietnam War.

But they do deal with and concern people with respect to confidence. Confidence if the war goes well, which I expect it will, that will boost confidence, and if oil prices go down, that will help.

But there are a lot of risks. One risk is that we're anticipating a big decline in oil prices just as we saw after the Gulf War. The problem now is that oil is affected by other factors. Venezuela has cut way back. There's a lot of disruption to its oil facilities. If there's disruption to Iraqi oil facilities, that will deprive the world of 2 million barrels a day. If there's disruption elsewhere in the Gulf, more oil would be displaced, so these are the kinds of risks that could make a war very disruptive to the economy.

And then the aftermath of the war. The American people have not been prepared for the fact that we will probably have to occupy that country for a number of years with large numbers of troops: for peacekeeping; to find all these weapons of mass destruction; to avoid instability. We had to occupy Bosnia, a small country, with at first 60,000 people; now it's only 20,000. That's a very small country. Iraq is a bigger country, much more difficult.

GAFFNEY: Can I get a word in edgewise here?

KAREN: Yes, what do you say about that, Frank?

GAFFNEY: I would just disagree on one point, and it's a fundamental point, I think.

The war we're in already is a global war. It is a war that has the potential, and, I think, the probability of being as long-lived as the Cold War. It is not going to begin or end with Iraq. The liberation of Iraq may, in fact, make the kind of occupation that Bob has talked about and its costs much less than we think.

But I believe the American economy, and certainly the American people, ought to be being mobilized now for a much more demanding and difficult and dangerous war. And I think, ironically, that will probably be the principal effect of the next -- I hope it's not -- but possibly catastrophic attack on us, is to propel us onto a different footing, a wartime footing of the kind we really haven't seen since World War II, with potentially offsetting economic effects to the kinds of downturn effects that Bob described.

KAREN: How are we going to pay for this, Frank?

GAFFNEY: Well, the way we're going to pay for it is the way we always pay for these things. I think we're going to pay for it principally in the short term through deficit spending, and over the longer term through economic growth. I think we will, in fact, if we are successful in this global war, create conditions that will be conducive to a vastly more prosperous future.

But the alternative is a very dim one, indeed. And I don't think we really have any choice but to take this war on as we must.

HORMATS: I agree we don't have a choice, but I would say two things.

One, we probably will have to spend more on homeland defense, which troubles me a great deal, because the state and local governments, which are the front line on the homeland defense area, have really gotten into very deep difficulty financially, and the federal government is really not helping them out very much.

GAFFNEY: Agreed.

HORMATS: The second part of the problem is, we will have to spend more money, but the risk is that the uncertainty that Americans really are not used to with respect to their own security could be a negative. We could get a lot of physical stimulus that Frank suggests we might need to bolster our home and defense capabilities, but there's that measure of uncertainty for investors and consumers that could work in the opposite direction, and that's the negative risk.

GAFFNEY: That's for sure.

KAREN: And that's going to have to be the last word. Bob Hormats, Frank Gaffney, thank you for joining us.

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Saving for college

GEOFF: It's a message of economic uncertainty above all, and in an economy like that, one of the toughest questions many people face is: How are you going to pay for college - your child's or grandchild's or maybe even your own?

There are more ways than ever to do it, but some are confusing, and making the wrong choice can be an expensive mistake. We'll sort out your options, identifying the best and the worst ways to pay for college, and we've even found some education stocks that have been performing like financial geniuses.

And speaking of smart, America's richest universities really do manage their money much better than most people or institutions.

Over the three years ending mid-2002, the S&P dropped over 9 percent but the largest university endowments earned a total return of more than 5 1/2 percent. The major reason was wise diversification.

For example, last year America's biggest university endowment fund, Harvard's, lost money on stocks but earned 32 percent on foreign bonds and 10 percent. on hedge funds.

Unfortunately, Harvard won't invest your money for you, so how are you going to pay for one of these, no matter who it's for? The cost is getting to be staggering. Today's 5-year-old will need over $100,000 to attend a public university, $300,000 to $400,000 for a top-ranked private school.

Jordan Goodman is author of Everyone's Money Book on College. He's critical of one popular financing vehicle, state-sponsored prepaid tuition plans. Diana Cantor is executive director of the Virginia College Savings Plan and oversees that state's prepaid tuition program as well as other financing options. Welcome to both of you.

Jordan, there are a lot of ways to invest for college. You have given them grades. So why don't you briefly take us through them?

JORDAN GOODMAN: Sure. Certainly you want to start with the 529 plans. It's probably I think the best one out there. I'm going to give that an A- because the money goes in there, you don't get a deduction, but it's going to be growing tax free. It's got a lot of different choices. There's 50 different state plans to choose from, so you can move the money around as you like. In some states, in many states you get a state tax deduction as well, so you want to take a look at your own state and see. So that's really the best one.

The next one I give a B+. It's the Coverdell Educational Savings Account. It used to be called the Education IRA. It's now named after the senator from Georgia who came up with the idea. What's good about it is you can put it in any investments, it's kind of self-directed. You don't get a deduction, but you can use it for all kinds of things in addition to tuition.

Then my next one would be custodial accounts, sort of so-called uniform gifts to minors act accounts, which have been around a long time. I give them a B- because the money is taxable inside those accounts, maybe at the kid's rate, but, you know, still going to have some taxes there. You don't get a deduction for keeping it in, and once the kid turns 18, he can run off with the money if he likes.

» Goodman profile » Cantor profile » College endowments: Who saw the biggest change in 2002? » How well do colleges invest? Better than most

GEOFF: It's out of your control.

GOODMAN: The so-called Ferrari factor, you know.

And then I give a C+ to the traditional state pre-paid tuition plans, because what's been happening lately is they've been running into a real crunch, at least on an actuarial basis. And what that means is they've been assuming a lower rate of increase in state tuitions and they've been going up faster than that, and their rate of return assumptions have been too high. They're assuming 8, 9, 10 percent returns sometimes and they're only getting 3 percent, in some cases even losses. So there's a gap happening here actuarially, and some of the plans are starting to get a little nervous if they're going to actually be able to have the cash to pay out these promised plans they've had, which is whatever the cost of tuition is, we're going to cover it. I'm just getting a little nervous that they're not actually going to be able to make it in the future.

GEOFF: Well, that would be a big problem. Now, Diana, you run one of these plans, or at least you oversee one of them, among other things. Is there a danger that these pre-paid tuition plans are going to break their promise to the parents and grandparents who put money into them?

DIANA CANTOR: Well, one thing I think to keep in mind is that you need to really be very familiar with your own state's plan. Only 19 states offer these programs, but families in those states who have invested in these programs I think will find that their grade would rise significantly if they really look under their program opportunities. Also many of the states have state guarantees that back the pay outs of these programs.

GEOFF: So they are guaranteed as far as getting what you paid for.

CANTOR: Exactly. So families who have already invested in these programs would be guaranteed of receiving the defined benefit that they bargained for. For families coming in, now would be a great time, you can transfer all the risk of this investment to the state or the agency that's operating these plans. And so in today's world of insecurity, as we've been hearing, it could be a wonderful option.

GEOFF: But what happened in the state of Colorado? Isn't their plan in deep trouble?

CANTOR: Well, I think Colorado had some unique circumstances that the families in Colorado should, you know, really look into and understand what happened. They're creating some options that are very promising for their families, and I think all in all the program will work out for the families in Colorado.

GEOFF: Your top rated investment vehicle, Jordan, was 529 plans, and there's a lot of confusion about these 529 plans. You mentioned that every state has them. People don't seem to understand that you don't have to live in the state in which you invest. Is that right?

GOODMAN: Correct. Now usually the first thing you should do is to take a look at your own state, because if you get a state tax deduction then that's something, you know, that would really be a great benefit. Now if you're in Texas or Florida where there's no income tax, it doesn't make any difference. But take a look at your own state first and then take a look at some other states. And you can put in the amount up to the deduction, you know, and then you can put some money in other states as well.

GEOFF: And, Diana, does your kid have to go to school in that state to use these plans?

GOODMAN: Well, actually none of the pre-paid plans or the savings plans, Geoff, make a child go to any in state school or any other school specifically, so they're very flexible. For example, many states even offer many savings options. In Virginia we have two types of savings plans. We have one that you can get directly from the state and one in partnership with the American funds called CollegeAmerica. So families really should be looking across the country and see all the different options that the states have.

GEOFF: Jordan, we don't have much time left, but you have given us your worst ways of paying for college. Could you take us very briefly through those.

GOODMAN: Sure. I think life insurance is not a good way.

GEOFF: Don't borrow against your life insurance.

GOODMAN: Don't borrow against your life insurance, because it's really designed for your insurance and possibly your retirement needs. So that's a pretty bad way.

I think 401(k)s, a lot of people borrow against their 401(k)s, or even worse take money out of a 401(k). This is designed for the parents' retirement, not for the kid's education.

Annuities is another one. I think again it's designed for retirement. You really shouldn't take money out and have a penalty against yourself. So often parents want to do everything for their kids that they hurt their own retirement. That's not a good thing to do.

GEOFF: Right. Diana, if you had to identify one thing that people don't seem to understand about these various college investment plans, what would it be?

CANTOR: I think the one thing is to really try and understand how flexible they are. You can move your money out, you can get them back, you can use them across the country at almost any higher education institution. Do your homework just like you expect your children to be doing.

GEOFF: Jordan, what would you say?

GOODMAN: I think the confusion is that there's so many plans they don't know which one to do, and sometimes they just don't do any of them as a result. The participation could be a lot higher in these things, and you should put in more than just the state tax deduction.

The deduction is nice, but the real quality in these things is having the money growing tax free for college education. Every dollar that you put in up front is one dollar you don't have to borrow when you get to college, and people aren't saving enough.

GEOFF: Jordan, Diana, thanks so much.

GOODMAN: Thank you.

CANTOR: Thanks, Geoff.

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School stocks

KAREN: College may cost a lot of money. But there's one area of education that might make you some bucks: education stocks. For-profit colleges, universities and technical schools are scoring high in the market right now.

They jumped 26 per cent in the last 12 months. The S&P 500 lost nearly that amount.

We talked to analyst Gary Bisbee at Lehman Brothers about his favorite stocks.

» Investors rake in classroom profits

Apollo Group tops his list, up 41 per cent in the last year. Apollo caters to working adults who want to move up in their careers -- a nice niche, Gary says.

He also likes Corinthian colleges, up 62 per cent in the last year. Aging baby boomers and a growing need for healthcare workers make its healthcare training programs attractive.

Career Education also made the list, thanks to solid demand for programs such as cooking, business, and art and visual communications. Career Education is up 32 per cent in the last year.

One potential risk for the group: a recovering economy could prompt investors to take profits.

Gary does not own any of these stocks personally, and Lehman Brothers has no investment banking relationship with the companies.

GEOFF: For more on education stocks and much else, check our Web site at pbs.org.

That's our program for tonight. We want to know what you think, Write us at Wall $treet Week with FORTUNE, Owings Mills, MD, 21117 or E-mail us at WSW@PBS.ORG.

KAREN: With all the talk of war, does gold still twinkle in investor's eyes? One of the world's best money managers, Jean-Marie Eveillard, will be here next week to answer that question.

But coming up next on many of these PBS stations, NOW with Bill Moyers has an exclusive report on fighting terrorism at home.

Goodnight.

ANNOUNCER: To learn more about this program, visit PBS Online at pbs.org, America Online keyword "PBS." For a transcript of this program, send $5 to: transcripts, Wall $treet Week with FORTUNE, Maryland Public Television, Owings Mills, Maryland 21117.

Wall $treet Week with FORTUNE was made possible in part by:

Kyocera Mita. Printers, digital copiers and color, wireless lan solutions -- flexible document systems to help meet today's needs and tomorrow's challenges, from one company: Kyocera Mita.

And by contributions to your PBS station from viewers like you. Thank you.

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