Brad DeLong writes writes in favor of federal investment in equity markets in the context of various Social Security privatization proposals. After demolishing some really bad ideas, he says,
I would rather see this forced equity savings done not through private accounts but through allowing the Secretary of the Treasury to invest the Trust Fund in equities. I would rather see this done by the Treasury Secretary for three reasons: (1) if I'm wrong, then there's no great harm, while there is great harm if you cut people's benefits assuming expected stock returns will be high and they aren't; (2) there's still a lot of risk out there, and the government is better-positioned to bear that risk than individuals; (3) offer individuals the opportunity to do so and they will churn their investments, buying high and selling low. The only reason to use private accounts for this forced equity savings is the fear that having the Secretary of the Treasury control a lot of equities will magnify our corporate oversight and control problems, and I don't see this is a first-order problem.
Although attractive in the abstract, the idea that the government might try to invest in equities and thus directly enjoy some of the fruits of the very capitalism it creates a safe environment for (rather than just benefitting indirectly via taxes) is, I think, much more fraught than the economic mind instinctively recognizes. While I'd be happy if we could make it work, I don't think we are up to it in practice (and I'm certain the Bush administration is not up to it!): the problems that need surmounting are much worse than Brad suspects, and are much worse then just “magnify[ing] our corporate oversight and control problems,” although who votes the government's shares and according to what policy is no small problem.
No, the first-order problem isn't that having the feds control a lot of equities will magnify existing corporate oversight and control problems. It's that the way in which the feds choose what to hold and sell will create huge new problems.
Start with the buying end. Buying will either be mechanistic, delegated, or discretionary. If it is mechanistic, we have the wrangle over the formula, which then distorts markets unless the formula is to buy a basket consisting of the entire stock market (even this, arguably, has secondary effects on the bond market, but let's not go there).
In fact, this is the only buy/sell formula that doesn't create huge problems right off: have the feds buy a basket that represents all the shares in a multiplicity of exchanges (not just the big ones). But this isn't easy to do, especially for small-cap stocks, without distorting markets. Even here, though, a mechanistic sell policy may have some undesirable depressive effects at inconvenient times driven by demography. And while it's arguable that similar selling would be happening anyway if the funds had been in private pension funds, that may be the wrong comparison, since the funds might otherwise come out of general tax revenue, and thus spread the effects beyond the stock market.
If the feds use any formula other than whole-market, it becomes very distortionary given the sums involved. For example, if the feds just buy the S&P 500, or even just a NYSE basket, the effect of being listed in that group or that one among competing exchanges (or, worse, de-listed) is substantially magnified because it comes with an investor who can be relied upon not to sell based on market shifts, and whose buying and selling generally is predictable. Not to mention that the biggest equity gains may well be in the stocks that are not in the S&P 500 or the NYSE (think, for example, NASDAC).
If buying is delegated to fund managers, they become incredibly powerful and lack the sort of checks on performance that would be needed since the government is highly unlikely to exit an under-performing fund. I suppose one could in theory create some performance-related pay for the managers that might substitute for market discipline, but there is no real chance that politics would allow the feds to create a performance pay scheme that would have the right sort of long-term incentives. (Again, imagine the Bush administration writing the rules here…)
If the feds themselves have any discretion as to what to buy, we're in for even worse crony capitalism than we have now, with a dash of 'lemon socialism'. Imagine if campaign contributions might, or even are thought to maybe, have a chance of turning the feds into a buyer of your shares. At this point, having the Bush administration in charge is just a nightmare. And imagine the pressure to have the government buy into 'critical industries' or key local employers to prop them up or protect them from foreign takeover. (It may be that the new TRIPS and GATT regimes protect against this somewhat; it's been a very long time since I looked.) And try re-telling the Lockhead or Chrysler stories if the government has an equity buying scheme.
It's even worse on the sell side. If the formula for selling shares is anything but mechanistic, then a government sell decision will be seen as a massive vote of no-confidence. [Side issue: can the government use its information about the economy to decide what to buy and sell? Or rather, what information is it allowed to use generally?]
Then there are the macro issues: just imagine the times when Congress and local pols will be pressing the feds to buy or sell as an aspect of counter-cyclical policy…
So while it makes sense in the abstract to have the government be a direct holder of equities, the details are just swarming with devils, demons, pitfalls, and mixed metaphors.
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