We could be in for a wild ride!
As the 2020 elections approach, the stock buyback debates are heating up, and predictions say the Democrats may potentially gain control of both the Congress and the Senate.
So how did a practice that was considered stock manipulation and was generally illegal prior to 1982 gain such favor? Once again, greed.
Since 2009 net corporate stock buybacks have accounted for 90% of the net demand for stocks. And the nearly $5 trillion spent on buybacks since 2009 has artificially inflated earnings per share. In the last several years stock buybacks have soared from approximately $ 400 billion in 2012 to $806 billion in 2018, with significantly higher levels predicted for 2019.
As noted in the chart above, since the financial crisis there’s basically been only one buyer of stocks, and it’s not the average individual who was burned by the crash after the 2008 market plummeted and they lost their investments. As Tyler Durden notes in his article in ZeroHedge, “there has been only one buyer of stock: the companies themselves, who have engaged in the greatest debt-funded buyback spree in history.”
So, what does all this mean? Most people believe the stock market shows public confidence and public buying. However, the reality is very different. It may all be an illusion, yet another Ponzi scheme. This corporate buyback trend is especially dangerous, as many of these purchases since 2009 until today are debt funded!
The debate appears to be divided along political lines with Republicans (primarily), claiming buybacks improve U.S. economic performance overall as it gives shareholders the opportunity to reinvest their distributions back into the economy.
In a recent New York Times op-ed, Joshua Bolton, Chief Executive of Business Roundtable and Ken Bertsch, executive director of the Council for Institutional Investors praised buybacks. They claimed that many of the largest buyback purchasers also spend the most on R&D.
“It is a myth,” they say, “that buybacks and dividends displace investments that companies would otherwise make to grow or develop innovations.” Their argument is that individuals can use their dividends and buyback distribution to buy goods and to reinvest in other ventures. However, a highly disproportionate allotment of the gains from distributions to shareholders go to the richest households. In 2016 just 10 percent of U.S. households possessed 84 percent of all U.S.-held corporate shares .
The banning of stock buybacks because of the manipulation of the stock market has become a real political issue for some Democrats who claim buybacks damage the economy. They equate the practice to the looting of a corporation and that piling buybacks on top of dividends is a major determinant of employment, instability and insecurity. They contend that buybacks take away from a company investing in research and development and their employees.
As I have discussed in the past, stock buybacks manipulate the stock market through two different functions – one is the open market buying by corporations which drive up the market because of the price-insensitive buying, and the other one is through the artificially increased earnings-per-share (“EPS”) by virtue of the fewer number of shares outstanding. Because the market is typically judged on a multiple of EPS, the so-called “Price-Earnings-Ratio,” then higher earnings per share will typically translate into higher prices being paid by the market for stocks.
As discussed, since 2009 90% of the net buying activity in the stock market has been related to stock buybacks. Also, a startling commentary regarding that statistic is that since 2014 total buybacks have accounted for a huge 120% of the net demand for stocks, which would imply that, without the buybacks, there would have been net selling in the stock market over the past five years.
Another staggering statistic relates to the referenced impact on earnings-per-share which was caused by the stock buybacks. This indicates that from September 2011 through September 2018 total corporate sales increased only 53% per share, while earnings-per-share increased 380%!
Senator Tammy Baldwin (D-WI), in a staff report on the economic benefits of the Reward Work Act says, “Corporate profits should be shared with the workers who actually create them. It’s just wrong for big corporations to pocket massive, permanent tax breaks and reward the wealth of top executives with more stock buybacks, while closing facilities and laying off workers… The explosion of corporate stock buybacks is driving wealth inequality….” Sen Baldwin’s legislation also gives corporate workers a voice by “providing them a seat at the table on corporate boards ….”
Many would agree with her claims.
William Lazonick, professor of economics at the University of Massachusetts Lowell, president of the Academic Industry Research Network and author of Profits without Prosperity, whom I have quoted several times before in articles on buybacks says, “For over three decades, I have studied the financialization of the business corporation. I can only describe what I have seen as ‘the looting of the American corporation.’ Aggressive shareholders and many executives only have an interest in taking money out of a corporation, instead of investing in it. Workers and taxpayers are at the back of the line when it comes to deciding how to spend a company’s profits. Top priority has gone to stock buybacks that give manipulative boosts to the company’s stock price. These unwarranted distributions to shareholders stifle investment in innovation, and they drive inequality by keeping wages low and work unstable while enriching the wealthiest.”
A further analysis by Professor Lazonick, Emre Gomeç, of the Academic-Industry Research Network, and Drucker Institute Director Rick Wartzman, who tabulated total business commitments for both buybacks and employee compensation, states it looks like “corporate America has pledged 30 times more to buying back its own shares than to investing in its workforces.”
Professor Lazonick claims buybacks “fueled the rising income inequality gap at the expense of much-needed corporate investment in research, development, and workers.”
“The issue is what are they not doing when they do stock buybacks,” he told The American Prospect. “What they’re not doing is keeping people employed longer, paying them more, and giving them more benefits. There’s a direct connection between the decline of those norms and the rise of buybacks and the legitimized ideology of ‘Shareholder First.’”
If the Democrats gain the House and Senate majority in the 2020 elections and they curtail buybacks, some supporters are concerned this will lead to an all-out recession. New restrictions on them could slash demand for stocks, virtually ensuring a stock market crash.
As stock buybacks have fueled much of the gains in the bull market of the past decade, some forecasts predict it’s nearly inevitable that Wall Street’s addiction to share buybacks will cause a stock market crash.
Regardless of where you stand on the buyback issue, it is one that we need to be more concerned with and one we need to demand more accountability on. Hurry up and wait to see what happens is not an option.
Richard Bowen is widely known as the Citigroup whistleblower. As Business Chief Underwriter for Citigroup during the housing bubble financial crisis meltdown, he repeatedly warned Citi executive management and the board about fraudulent behavior within the organization. The company certified poor mortgages as quality mortgages and sold them to Fannie Mae, Freddie Mac and other investors.
