Nov. 14, 2018
I read a recent analysis of our current boom—our temporary October bust was a fleeting hiccup—on Wall Street. What was fascinating about it was that it didn’t refer in any way to the actual underlying value of securities. It was entirely about the manipulation of stock prices and dividends through corporate stock buybacks. It’s chilling and instructive in ways it wasn’t meant to be.
Lyn Alden, at FedWeek, framed our current bull market perfectly, and also put into sharp perspective how tax reform is adding fuel to the fire. All of this may sound like good news to a lot of investors, but it’s not what our economy needs right now.
As part of a wave of buybacks, Sam Walsh, chief executive officer of Rio Tinto Group, in 2015 announced his mining company would spend $2 billion in a share buyback after reporting full-year profit that beat estimates as higher output and lower costs countered a slump in commodity prices. Photographer: Chris Ratcliffe/Bloomberg
Here’s what’s happening. For years, low interest rates have been setting the table for our long-term bull market. You can borrow big and invest it in stocks, earning far, far more than you would by investing in bonds or the money market. This along has created an artificial tailwind to our economic recovery, which was the point of the Fed’s action. But the bull market has become an end in itself, and stock prices have become our most misleading indicator of economic health.
What corporations have been doing is spraying gasoline on this fire by purchasing large blocks of their own shares. As Alden so succinctly explains, this is essentially a way to make free money. Corporations have a set amount of money to distribute in the form of dividends and by reducing the number of shares, they thereby increase the amount of each payment—cut a pie into three slices rather than six and you double the size of each slice. And the buybacks also increase the price of the stock by temporarily increasing the demand for it in the market. It’s perfectly legal, but essentially creates the illusion of real economic health while enriching only those who hold the stock.
What’s especially devious about all this is how corporations are using tax reform to add even more oomph to this process. Under the new lax laws, designed to repatriate cash (formerly sequestered overseas to avoid taxes), corporations can bring back enormous sums of money to spend inside the U.S. The potential impact of the reform could be wonderful: encourage spending here in the U.S. to stimulate growth. But instead of investing in research, development, new jobs and higher wages, many corporations are simply using all that largesse to increase and enlarge their buybacks. As Alden says:
Due to the corporate tax cuts passed last year, companies (especially the tech giants like Apple and Microsoft) are bringing hundreds of millions of dollars back to the United States, which they have been accumulating overseas for years. And for the most part, they are spending this cash repatriation on stock buybacks.
The full year of 2018 is on track to be the biggest year of share buybacks ever. We might hit $1 trillion by year’s end.
Before I push back against all this as yet another way we’re avoiding the reality of widening income and wealth inequality, let’s allow for how this doesn’t just help the super-wealthy. It isn’t entirely bad for much of the country. As the stock market rises, so do retirement savings. Anyone with a pension plan—all government workers and teachers—and anyone with a 401K or a SEPP, will see their investments rise in value. And while the percentage of people in the country who are saving for retirement hovers around fifty percent, most of those who need to save may be putting some money away:
What percentage of households aged 30 to 64 with per capita earnings in excess of $20,000 have either a 401(k) or IRA-style account or some entitlement to a traditional pension benefit? The answer, according to the Survey of Consumer Finances, is 89 percent. That’s nine out of ten, for those of you who don’t like percentages.
The problem is that most of those people aren’t saving much at all, no matter how they have it invested, so gains in the stock market don’t trickle down in a substantial way to the majority of the population.
How this flood of repatriated cash is being used represents the best example of why shareholder primacy is such a counter-productive philosophy in the long run. Instead of goosing stock valuations and dividends through buybacks that are nothing more than financial engineering, corporations could be using this once-in-a-lifetime windfall to bear down on the real challenge: creating genuine new value for workers, communities and the nation. The way to invest all this suddenly liquid cash is to think hard about where to use it to strengthen existing product and service lines, how to introduce new ones, train workers, create new company-wide bonus and wage structures to incentivize creativity at all levels, and—why not—build an even bigger matching contribution to any worker’s investment in a retirement account. In other words, in addition to rewarding shareholders for their investment, reward everyone the corporation depends on for its profit: workers, customers and community. That requires thinking about the coming decades, not just the next quarterly earnings reports.
It requires problem-solving, a bit of risk taking, and a lot of creative foresight. The stuff that makes your brain hurt. It’s much less painful to divide that pie into fewer slices than to figure out how to make five more pies in addition to it. It’s hard work creating new value. America used to thrive on it, half a century ago, and we still do, in pockets of creativity where we still shine—like tech—but we need to wean ourselves from this addiction to Wall Street as the measure of our success and look to the economic health of Main Street and the middle class as the most important indicator of all. Higher stock prices and dividends don’t hurt, but they aren’t nearly enough to ensure that we become, once again, the economic powerhouse the world once regarded a beacon of hope and the globe’s most vibrant example of free market capitalism.