January 9, 1997
Economic Scene: Insure Wages? Home Prices? Why Not, Book Argues
By PETER PASSELL
ost homeowners wouldn't be able to sleep if they didn't have fire insurance. But what about the much greater financial risk of losing equity if the volatile housing market heads south?
By the same token, unemployment insurance is a crucial link in guaranteeing adequate income in the event of a job loss. But for most Americans, the greater risks to their livelihoods are borne privately -- for example, the risk of living in a declining economic region or simply entering the job market in an era of stagnant wages.
"Macro Markets" (Oxford University Press), by Robert Shiller of Yale University, explores these and other gaping holes in insurance. But when the book was published in 1994, it disappeared into the ether where unread books reside. Now, thanks to TIAA-CREF, the giant pension and insurance system for colleges, it is getting a second chance at the limelight.
"Macro Markets" received TIAA-CREF's first Paul Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security last week at the annual meeting of the Allied Social Science Association in New Orleans. It was a choice that left John Biggs, the chairman of TIAA-CREF, dancing in the aisles.
"Economists have shown little interest in the institutions of insurance," he argued, "and we're delighted to support the sort of research that affects us."
This is a time of spectacular innovation, one in which it is possible to hedge against (or bet on) anything from the size of back orders in computer memory chips to changes in the price of orange-juice concentrate.
Trading in financial derivatives -- the generic term for synthetic securities that are, in essence, wagers -- now tops $50 trillion annually. And that is just another form of insurance against risk. Strikingly, though, this market has been confined to business-to-business transactions.
It has hardly touched household assets in general and human capital -- the ability to earn a living -- in particular.
One reason, notes Stephen Ross, an economist at the Yale School of Management and a judge in the Samuelson Prize competition, is "adverse selection." Those most eager to insure themselves against, say, physical disability are typically those at highest risk.
Another reason familiar to specialists is "moral hazard." Those who are insured against, say, auto theft, are more inclined to leave their cars unlocked, pushing premiums beyond the reach of more prudent owners.
But insurance markets for disability and auto theft do exist. Why then, Shiller asks, is there no way to insure against stagnant wages? One possibility is that few would pay enough to get an insurance company to take the other side of the bet. Another is that most people are willing to pay to protect themselves only against a sudden catastrophe rather than the less severe losses from economic change.
Still, wage and income growth is often uncorrelated between countries. There's no good reason, Shiller argues, why, say, the Taiwanese, with relatively low incomes and rapidly rising wages, wouldn't be willing to bear some of the risk of wage stagnation in Japan, which has high incomes and slowly rising wages, in return for cash premiums today from the Japanese.
Or consider the less grandiose idea of insuring against changing housing costs the way farmers and food conglomerates insure each other against changing corn prices.
Those who already own valuable houses might be prepared to forgo any profit from further appreciation in return for insurance against any fall in price. Meanwhile, renters thinking about buying might be prepared to take the other side of the bet, insuring themselves against rising house costs in return for forgoing the benefits if house prices fall.
Ross finds the Shiller approach "provocative and bold," but argues that "the issues of practicality loom large." An attempt to trade options linked to an overall index of house prices in Britain failed for lack of interest in the 1980s, he notes. It may be that the idea was never marketed well.
On the other hand, there may be insurmountable psychological barriers to getting people to pay to reduce certain kinds of risks.
Olivia Mitchell, an economist at the Wharton School of Business and another judge on the Samuelson Prize committee, offers one other caution.
While the risk of stagnant wages in a whole country might be offset by buying into the wage experiences of a larger pool of nations, she argues that most of the variation in individuals' incomes has nothing to do with overall wage trends. And those risks may be inherently uninsurable because of moral hazard: If the insurance company will replace 70 percent of any shortfall in my income next year, I think I'll take the day off.
Whatever the criticisms, everyone agrees that Shiller is plowing exceptionally fertile turf. The ideas seem -- dare one say it -- obvious. But like most profound ideas, they are only obvious after someone thought of them.
Copyright 1997 The New York Times Company
