Stock buybacks do nothing for most of us

Posted on July 23, 2016September 25, 2019 by j.giglio

Economic inequality in the United States is at historic levels. In the wake of the Great Recession, the issue has captured the attention of the American public, but there is little consensus about its causes. One of the causes is clearly the rise in corporate stock buybacks and short-term thinking.

In the 1980s, the top 1 percent of Americans accounted for 10 percent of the income generated in the economy; by 2012 it was approaching 20 percent. The top 1 percent controlled nearly 42 percent of the wealth, a level not seen since the roaring ’20s.

This increased inequality does not support, and even inhibits, the consumer spending that drives economic growth in the United States because it leaves the middle class with less buying power.

Those who are supposedly smart on the issue point to a range of reasons for economic inequality, such as technological change, the decline of unions, globalization and trade agreements. Often overlooked is the expansion of the financial sector and corporate America’s Ahab-like obsession with short-term thinking.

According to the Bureau of Economic Analysis, in 1970 the finance and insurance industries accounted for 4.2 percent of gross domestic product, up from 2.8 percent in 1950. By 2012, the sector represented 6.6 percent.

The story with profits is similar: In 1970, finance and insurance industry profits made up about one quarter of the profits of all sectors, up from 8 percent in 1950. Despite the after effects of the financial crisis, that number had grown to 37 percent by 2013. Yet these industries create only 4 percent of all jobs, so profits go to a small minority.

The increase in the influence of financial sector extends to public corporations that face increased pressure to make immediate investor payouts through stock buybacks. According to Research Affiliates, S&P 500 companies spent $521 billion on stock buybacks in 2013 and $634 billion in 2014. More than

$6.9 trillion has been spent on share buybacks since 2004. Not one dime of this money has gone into expanding operations, hiring more employees, increasing wages, research and development, enhancing productivity, and improving the customer experience.

An important part of the appeal of stock buybacks is their ability to increase earnings per share. In theory, buybacks tend to jack up the share price, at least in the short term, by decreasing the number of shares outstanding while increasing earnings per share. Corporations frequently finance these buy backs by issuing debt, taking advantage of the Federal Reserve holding interest rates underwater and the fact that interest expense on the debt is tax deductible.

Underlying all this are two notions. First, the only responsibility of the corporation is to maximize shareholder value as reflected in the stock price, as opposed to getting sidetracked by talk about multiple stakeholders such as employees, customers and the community.

The second is that corporate management should be compensated in stock to align their interest with those of shareholders. Since managers’ pay is tied to the firm’s stock performance even at the expense of long-term shareholder wealth, the temptation to manage earnings to meet short-term investor expectations instead of long-term shareholder value is quite strong. For example, if the choice is between repairing the roof on the factory in Toledo this quarter or missing the quarterly earnings figure, which could cause earnings per share to tumble, corporate management might decide not to make the capital investment.

Stock-based compensation has also contributed to the sharp rise in CEO compensation. Between 1978 and 2013, CEO compensation increased by nearly 10-fold while workers experienced stagnant wages and increasing job insecurity.

While corporate and finance executives live in a second gilded age, stock buybacks and short-term thinking contribute to under investing in innovation and skilled workers, and ultimately to more economic inequality. But none of this troubles the 1 percenters, and they appear to be the only ones who really matter.

Originally Published: Jul 23, 2016

While America’s losses mount, the top 1% makes huge gains

Posted on October 5, 2013September 25, 2019 by j.giglio

Several weeks ago, the Federal Reserve decided not to cut back, or taper as the finance mavens say, the billion-dollar bond buying program known as quantitative easing, which is a euphemism for printing money. A gradual reduction of QE had been expected since June, when Fed chairman Ben Bernanke said the economy was getting stronger and he might reduce the monthly purchases by the end of the year.

But the Fed got cold feet and changed its mind because its leaders don’t believe that economic activity and labor market conditions are strong enough to merit reducing the bond purchases. Economic growth is lackluster. The unemployment rate is too high, labor force participation is at a 34-year low and too many newly created jobs are low paying and/or part time. Consequently the Fed will continue buying $85 billion of Treasury and mortgage bonds each month and remain committed to holding short-term rates near zero at least so long as the unemployment rate remains above 6.5 percent.

So the training wheels stay on the bicycle and continue to feed an addiction to cheap money.

After five years of depending on a monthly injection of liquidity, it may well be that QE will become a permanent tool of the Fed for managing the business cycle and garden-variety recessions. Since it began in the Paleozoic era, circa late 2008, the Fed has hoped that QE would stimulate economic growth and hiring by holding down interest rates and encouraging households and businesses to spend and invest.

But given that the wealthy own a disproportionate amount of equities, the stock market’s gains are unequally distributed. While a rising stock market may make people feel wealthier, the run-up in their pension accounts -thanks to the stock market reaching new highs – does not send the average American running to the nearest retail store.

Corporations are using the record-low interest rates to take on new debt for acquisitions, increase dividends, and engage in share buybacks rather than investing in the real economy, which has certainly not helped the labor market. Of course, thanks to the Fed, the interest rate paid on the national debt is at a historic low of2.4 percent, according to the Congressional Budget Office. This keeps debt service costs down and understates the budget deficit.

The danger is that as everyone becomes addicted to cheap money, the Fed’s moves are setting the stage for a new bubble. Printing money floods the market with more dollars, which makes dollars worth less, which means that tangible assets priced in dollars, such as oil and food, end up costing more.

Prolonged low interest rates and an abundant money supply have punished savers and retirees. Their money has generated little return, which forces them into high-risk investments to try and keep up with inflation. The younger generation hurt by high unemployment is not increasing its consumption to make up for the decline in spending among older Americans. And as middle America struggles with rising food and gas prices, weighed down by high unemployment and stagnant wages, the gap between the wealthy and everyone else is growing.

While the question of whether the Fed’s monetary policy has helped the real economy and the average American remains unanswered, a new study from the University of California at Berkeley finds that the top 1 percent have captured 95 percent of the gains during the so-called recovery. Additionally, according to the Census Bureau, middle-class incomes have largely remained stagnant even after the recession ended. With high unemployment, corporations are under no pressure to increase workers’ mcomes.

The gap between the top 1 percent and the rest of the country is the greatest it has been since the 1920s. A large reason for this growing disparity is that the wealthiest households have benefited far more that ordinary Americans have from the Dow Jones Industrial Average more than doubling in value since it bottomed out in early 2009.

So much for the presumption that once the Great Recession ended, the American consumer would once again fuel economic growth.

originally published: October 5, 2013