How to stabilize the financial system and make money for US taxpayers

Who’s really taking the risk? The US taxpayer.
Who’s really taking the risk? The US taxpayer.
Image: AP Photo/Julie Jacobson
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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.