What’s irking central bankers is not that they have bought too many stocks or bonds. Rather, it’s that they haven’t bought enough.
At least, that’s the take of Roger Farmer, a professor of economics at UCLA and a consultant to the Federal Reserve Bank of Atlanta, the Reserve Bank of Australia, the European Central Bank and the Bank of England.
“Central banks should be trading an exchange-traded fund over the whole market—not individual stocks, but every publically traded stock, fairly weighted,” says Farmer. “That is the object that should be stabilized, not Apple Computer or Toyota.”
Farmer envisions the following scenario: The stock market plunges by 30%. The central bank tells an asset management firm such as Vanguard or State Street to assemble an ETF that contains every publicly listed stock. Then the central bank makes a public announcement that it will buy the ETF in a couple of days.
“They would announce, ‘This ETF, which is trading at 70, will be trading back at 100. If you don’t make that happen, we will,’” says Farmer.
Assuming the public believes the Fed—and they likely would—“then private individuals will start buying companies that make up the ETF in anticipation of the fact that the Fed will be trading it,” he believes.
Current rules of the Fed, ECB and BoE prevent them from making such massive investments in public securities. “The inability to do that is leading to the kind of crisis we are looking at,” says Farmer.