Quartz #15—>How to Stabilize the Financial System and Make Money for US Taxpayers

Here is the full text of my 15th Quartz column, “How to stabilize the financial system and make money for US taxpayers” now brought home to supplysideliberal.com. It was first published on February 8, 2013. Links to all my other columns can be found here.

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© February 8, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

Note: a version of this column is also slated to be published in FS Focus, the financial services magazine of the ICAEW, an organization of accountants in the UK. In that version, the passage from “In brief, …” to the end of its paragraph was replaced with this passage, which I think you will find interesting as well:

At its inception, a US sovereign wealth fund would be established by issuing $1 trillion worth of low-interest safe Treasury bonds and investing those funds in high-expected-return risky assets. That takes those risky assets off the hands of private investors and puts safe assets in the hands of those private investors instead. Having fewer risky assets on their balance sheets overall would make those private investors readier to back private firms in taking on the additional risks involved in buying equipment, building factories, or starting up new businesses. And having more safe assets in the hands of private investors would provide good collateral for the financial arrangements those projects would need. Thus, the establishment of the sovereign wealth fund encourages investment and stimulates the economy. The Fed has plenty of tools for keeping the economy from being stimulated too much. So the mere existence of the sovereign wealth fund gives the Fed a wider range of stimulus levels to choose from. Moreover, any given level of stimulus would requires a less aggressive course of quantitative easing (QE) on the part of the Fed than it would otherwise need to pursue.

Geopolitically, the world still lives in the shadow of Sept. 11, 2001. Economically, the world still lives in the shadow of Sept. 15, 2008, the day Lehman Brothers collapsed and ushered in a deep financial crisis. The fundamental problem: big banks and other financial firms that pretended to take on huge risks without, in fact, being able to shoulder those risks. Under the guise of taking such risks, these financial firms reaped the reward during the good times. But when the risks came home to roost, only US taxpayers—the US government acting on their behalf—had the wherewithal to absorb those risks.

In the future, shouldn’t US taxpayers get some of the reward from taking on the macroeconomic risks that are too big and too pervasive for banks and financial firms to shoulder? Such risk-bearing is richly rewarded. Indeed, as George Mason University professor Tyler Cowen points out in his American Interest article, “The Inequality that Matters,” a shockingly high fraction of the wealth of the super-rich comes from finance. But more importantly, having US taxpayers rewarded for actually taking on macroeconomic risk—risk that US taxpayers end up bearing in large measure anyway—would crowd out the charade of big banks and financial firms pretending to take on that risk. And it is that pretense that brought the world to the dreadful, long-lasting economic quagmire it is in now.

In my Quartz column a little over a month ago I explained “Why the US needs its own sovereign wealth fund” primarily as a way to give the Federal Reserve more running room in monetary policy. In brief, the mere existence of a US sovereign wealth fund, one that issued through the Treasury $1 trillion worth of low-interest safe bonds and invested it in high-expected-return risky assets, would give the Federal Reserve a lot more room to maneuver.  Moreover, it would allow the Fed to pursue a less aggressive course of quantitative easing (QE) than it would otherwise need to pursue. The US fund would draw political controversy to itself, and away from the Fed, thereby preserving the independence of monetary policy that we need in order to avoid inflation in the long run.

But a US sovereign wealth fund can do more if given the independence it needs to focus on (1) making money for the US taxpayer and (2) financial stability, rather than extraneous political objectives. These two goals are consistent, since the same contrarian strategy serves both. Buying assets cheap, relative to their fundamentals, and selling assets that are expensive, relative to their fundamentals, both pushes asset prices toward their fundamentals and, by buying low and selling high, makes profits that we can use to help pay off the national debt. It takes almost inhuman fortitude to withstand the winds of investment fashion. But given appropriate compensation policies, a $1 trillion US sovereign wealth fund would be able to hire the next generation’s Warren Buffett to take care of US taxpayers’ money. They deserve no less.

Update: I discovered in a forgotten email a pdf of a version of this in print (on page 8) and a link to a version on the Economia website. I find those mostly interesting for the visuals:

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