Why Not Equity?

Why Not Equity?
(AP Photo/Richard Drew)
Why Not Equity?
(AP Photo/Richard Drew)
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The traditional, and somewhat unimaginative, official response to financial crises is for the Federal Reserve Bank to lower interest rates. The theory – and it’s more like a knee-jerk reaction – is that cheaper abundant debt will solve the problem. So, while the stock market tanks, eroding confidence along with equity wealth, including corporate balance sheets and 401(k)s, the response is to offer cheaper debt. There’s a better way.

Why not equity? As part of its mandate to stabilize the economy, what the government, via the Fed, should be doing is targeting the real culprit in the crisis, shrinking equity wealth. It should do this by buying American stocks. Lots of them. The substantial incremental demand provided by government intervention will drive stock prices higher, thus restoring real wealth and balance sheet equity. Corporations and individuals will regain confidence, optimism and the equity wherewithal to increase their economic activity. Improving the general tone of the market now, aborting a meltdown and recession, may obviate the need for targeted – and very expensive -- bailouts later.

Raising stock prices will also immediately lower the cost of capital. Increased economic activity will occur quickly as lower capital costs mean more investments meet or exceed their hurdle rate. And the wealth effect of higher stock prices will foment consumer demand and entrepreneurial “animal spirits,” not to mention a happier electorate. The psychological impact of knowing the U.S. government is supporting the stock market would be immense.

Don’t be dissuaded by ideological nitpicks about the government owning stocks; it can buy index funds (to avoid favoritism) and forego voting rights. These are mere details.

The prospect of the federal government becoming a regular buyer of U.S. equities, particularly leaning against the wind in a bear market, would also instill confidence and lower risk premiums in the U.S. equity markets, increasing their attractiveness to foreign and domestic investors. The ability to buy equities, not just debt, will put another tool at the Fed’s disposal in fulfilling its mandate to temper financial meltdowns.

The United States government -- that’s us -- will own this appreciating asset instead of a sterile debt instrument. Ibbotson Associates, a leading asset and data research firm, calculates that long term returns on U.S. equities, in almost any time period, are around 10% per annum, more than twice that of bonds. Lower the cost of government along with capital? A twofer! Many other countries, through their sovereign wealth funds, invest in equities. Why not U.S.?

And what will the federal government do with is newfound wealth-creating assets? Generally, long-term investments are made to fund retirement. Think corporate and state pension plans, IRAs and 401(k)s, etc. Social Security unlike most sovereign wealth funds, is the only major component of our retirement complex which does not own equities.

No wonder returns have been so anemic. Investing in stock index funds as a financial management tool could be the start of creating a third leg of Social Security, government-funded individual retirement accounts, funded with stock not cash. Perhaps we should take a page out of Andrew Yang’s playbook, but alter it slightly: give every American $12,000 per year, but in stock, not cash. Or maybe a portion is allocated to state employee retirement systems to bolster their solvency. Probably, we’d need minimum holding periods -- say, 10 years -- so the windfall doesn’t get flipped and the wonderful benefit of compounding has time to work its magic.

John W. Childs is the founder of J.W. Childs Associates, a private equity firm.

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