Buy $3 Trillion in Stocks. What Could Go Wrong?
(Corrects second paragraph to delete reference to Josh Barro.)
Of the five economic proposals Jesse Myerson lists in Rolling Stone, one stands out, though not in a positive sense: that the U.S. start a sovereign wealth fund. It's a proposal that would prove problematic for capital markets, pose thorny conflicts of interest, and offer vast opportunities for cronyism and graft.
The idea has drawn some support from economists, as well as from bloggers such as Dylan Matthews. Although Myerson didn’t offer specifics about creating such a fund, Matthews suggested it could start with the holdings of the Social Security and Medicare trust funds, which now own about $3 trillion in government bonds.
According to the World Federation of Exchanges, the market value of all publicly listed companies is about $63 trillion, about $23 trillion of which is listed on U.S. stock exchanges. If a U.S. sovereign wealth fund tried to buy a market-weighted index, it would wind up with more than 4 percent of every publicly traded company in the world. If the fund wanted to avoid foreign entanglements, it would own more than 11 percent of the U.S. stock market, becoming the largest shareholder of nine of the 10 biggest corporations. For perspective, Vanguard Group Inc., the mutual-fund behemoth, is the biggest shareholder in Apple Inc. and Exxon Mobil Corp., the world’s two most valuable companies, and it only owns about 5 percent of each.
How should a U.S. sovereign wealth fund act as a shareholder? Should it resemble the big mutual funds that are often reluctant to eject incumbent managers and directors, or should it take a more activist position in the manner of California’s public-employee retirement system? How should the U.S. government influence decisions about where companies should invest, how they should deploy their corporate cash hoards, or whom they should hire?
Miles Kimball, an economist at the University of Michigan who favors establishing a sovereign wealth fund, says that voting decisions should be outsourced to “pension fund managers with broadly diversified portfolios,” but that raises more questions than answers. Dalton Conley, a sociology professor at New York University, says such a fund should be “controlled by the American people and should be directed to socially responsible investments,” with the fund’s board elected every year by a simple majority vote. It's hard to imagine how this process could be insulated from special interests when so much money is on the line.
As for how the fund should invest, some suggest it could do better than a typical index fund if it turned over hundreds of billions or trillions of dollars to private-equity firms and hedge funds in an effort to mimic pension plans and university endowments.
That would be an enormous boon to the alternative-investment industry, which charges large fees on assets under management, but it would almost certainly be a bad deal for regular Americans. If anything, the federal government’s private-equity and hedge-fund allocations would probably depress returns for the pension funds run by states and municipalities, as those strategies do best when there isn’t a lot of competition.
As if that weren’t bad enough, opportunities for cronyism would abound and would be difficult to keep in check. Who would be in charge of hiring and evaluating the fund’s money managers? This is a challenge for every institutional investor. The problem would be magnified in a fund as large as the one some have proposed.
It may sound clever, but a U.S. sovereign wealth fund would be more trouble than it's worth.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)