Source: The Washington Post
Let’s recall those heady days of 2006 when home prices were rising 10, 15, even 20 percent a year, allowing millions of homeowners to refinance mortgages and collectively take out more than $300 billion in cash from the increased value of their properties. Some spent the money on furniture, appliances, cars and vacations, adding fuel to an already roaring economy. Others reinvested it in the already booming real estate and stock markets. When it finally occurred to everyone that those houses and those stocks weren’t really worth what the debt-fueled market said they were, markets crashed, banks flirted with insolvency, and the economy sank into a deep global recession.
Now, 12 years later, it’s happening again. This time, however, it’s not households using cheap debt to take cash out of their overvalued homes. Rather, it is giant corporations using cheap debt — and a one-time tax windfall — to take cash from their balance sheets and send it to shareholders in the form of increased dividends and, in particular, stock buybacks. As before, the cash-outs are helping to drive debt — corporate debt — to record levels. As before, they are adding a short-term sugar high to an already booming economy. And once again, they are diverting capital from productive long-term investment to further inflate a financial bubble — this one in corporate stocks and bonds — that, when it bursts, will send the economy into another recession.
Welcome to the Buyback Economy. Today’s economic boom is driven not by any great burst of innovation or growth in productivity. Rather, it is driven by another round of financial engineering that converts equity into debt. It sacrifices future growth for present consumption. And it redistributes even more of the nation’s wealth to corporate executives, wealthy investors and Wall Street financiers.
Corporate executives and directors are apparently bereft of ideas and the confidence to make long-term investments. Rather than using record profits, and record amounts of borrowed money, to invest in new plants and equipment, develop new products, improve service, lower prices or raise the wages and skills of their employees, they are “returning” that money to shareholders. Corporate America, in effect, has transformed itself into one giant leveraged buyout.
Consider Apple, the world’s most valuable enterprise. As a result of a $100 billion share buyback announced last month, Apple will have returned $210 billion to shareholders since 2012. How much is $210 billion? As Robin Wigglesworth of the Financial Times reminded his Twitter followers, that’s enough to buy up the bottom 480 companies of the S&P 500.
And Apple is not alone. Last year, public companies spent more than $800 billion buying back their own shares and, thanks to all the cash freed up by the recent tax bill, Goldman Sachs estimates that share buybacks will surge to $1.2 trillion this year. That comes at a time when share prices are at an all-time high — so companies are buying at the top — and when a growing global economy offers the best opportunity to expand into new products and new markets. This is nothing short of corporate malpractice.
The best recent research on the folly of buybacks is by two professors at Europe’s top business school, INSEAD. Looking at the 60 percent of companies that have bought back their stock between 2010 and 2015, Robert Ayres and Michael Olenick calculated that the firms, as a group, spent more than 100 percent of their net profits on dividends and share repurchases. They also found that the more a company spent on buybacks, relatively speaking, the less good it did for the stock price.
At the 535 firms that spent the least, relatively speaking, on stock repurchases (less than 5 percent of the company’s market value), market value grew by an average of 248 percent. These companies included Facebook, Amazon.com, Google, Netflix and Washington-based Danaher, all of which mainly used the buybacks as compensation for employees. (Amazon chief executive Jeffrey P. Bezos owns The Washington Post.)
By contrast, the 64 firms that spent the most repurchasing shares (the equivalent of 100 percent of market value) saw an average 22 percent decline in the firm’s market value. These include Sears, J.C. Penney, Hewlett-Packard, Macy’s, Xerox and Viacom, for all of which the primary purpose of the buybacks was to prop up the stock price in the face of disappointing operating results.
Corporate buybacks don’t just affect individual companies, however. At this scale, buybacks are also a factor in the performance of the overall economy.
Consider that $1.2 trillion is the equivalent of more than 6 percent of the annual output — or gross domestic product — of the United States, the world’s largest economy. It is larger than the GDP of all but the 15 largest countries in the world. And it is a sum that will likely far exceed the amount of money raised by the corporate sector’s issuing new stock, meaning that for another year, more equity capital is flowing out of publicly traded corporations than flowing in.
As the accompanying chart indicates, over the past decade, net issuance of public stock — new issues minus buybacks — has been a negative $3 trillion. This reduction in the supply of public shares in American companies, coupled with an increased global demand for them, goes a long way toward explaining why stocks are now priced at 25 times earnings, well above their historical average.
The most significant and troubling aspect of this buyback boom, however, is that despite record corporate profits and cash flow, at least a third of the shares are being repurchased with borrowed money, bringing the corporate debt to an all-time high, not only in an absolute sense but also in relation to profits, assets and the overall size of the economy.