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The stock market’s recent slide to new lows has a lot to do with the lack of confidence in the recent actions initiated by the Obama administration. The stimulus bill, bank plan and mortgage relief plan have been met with skepticism and in some cases disdain

While some of the money used in these plans falls into the category of investment and will eventually be paid back, a considerable amount has no payback potential. In this second category are the tax cuts, extended unemployment benefits, payments to states to fund current operations, and payments under the mortgage relief plan. These expenditures will result in a permanent increase in the national debt, which is now over $10 trillion, with no direct means for repayment.

While estimates vary considerably, there is a high likelihood that the fiscal spending needed to pull the U.S. out of this recession could permanently add $1 trillion to the national debt. To me it seems we need one more plan.

The Obama administration should announce a plan to purchase between $500 billion and $1 trillion of U.S. equities through a sovereign wealth fund, the social security trust fund or some other vehicle. Why?

  1. Stocks are cheap - especially for an investor with a long-term focus – and the U.S. government’s investment horizon is indefinite. If stocks recover to their previous high within five years, this would represent roughly a doubling of the investment – or about 15% compounded annual returns.
  2. This plan could be self funded from day one. The Wilshire 5000 Index, which represents all publically traded U.S. companies, has a current yield of 2.91%, which would roughly cover the 2.92% interest on the issuance of 10-year Treasury Bonds.

The Wilshire 5000 Index had a value of about $10 trillion at the end of January 2009. An investment equal to 5% to 10% of U.S. equities would not be excessive in relation to the stock market or national debt. Even a smaller program could do a lot of good.

The program would be easy to implement using a passively-managed indexed approach. This would keep management expenses low and allow easy implementation. In addition, it would not distort the market by favoring companies or sectors. The government would give a handful of managers a time frame for deploying the money – say six months. Essentially, the managers’ primary decision would involve the timing of the purchases.

In the same way that corporate buyback programs can trigger increases in stock prices, the announcement of this program could have an immediate positive affect on the overall market and economy. It would represent a vote of confidence in our economic system, it would provide support for a market that is dominated by fear and panic, but most importantly, it would offer the highest potential returns of any fiscal initiative. (Hong Kong successfully implemented a similar program following a market crash in 1989, which was triggered by the Tiananmen Square aftermath.)

Is the plan socialistic? Somewhat, in the sense that the government will have direct ownership of U.S. equities. But on the other hand, if there are provisions that the U.S. will be a silent investor - with no control or voting power - then it simply represents an opportunity for taxpayers to benefit from an eventual market recovery. In doing so, it would also provide a means for eventually paying down the incremental bailout debt.

Source: Why a U.S. Sovereign Wealth Fund Should Be Created