Professor Pearlstein has written an unsettling article for WaPo on the current financial trends in the corporate world:
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.
But wait, it gets worse:
As a result of all this corporate borrowing, Daniel Arbess of Xerion Investments calculates that more than a third of the largest global companies now are highly leveraged — that is, they have at least $5 of debt for every $1 in earnings — which makes them vulnerable to any downturn in profits or increase in interest rates. And 1 in 5 companies have debt-service obligations that already exceed cash flow — “zombies,” in the felicitous argot of Wall Street.
“A new cycle of distressed corporate credit looks to be just around the corner,” Arbess warned in February in an article published in Fortune.
Mariarosa Verde, senior credit officer at Moody’s, the rating agency, warned in May that “the record number of highly-leveraged companies has set the stage for a particularly large wave of defaults when the next period of broad economic stress eventually arrives.”
Right out front, I’ll say my expertise in corporate finance is extremely limited. When I invest, I specialize in the story the potential investment is trying to tell me, and I try to evaluate for whether it’s a credible story. Sometimes I’m right, sometimes not. My advisor conducts his own investigation, and then we get together and thrash it out.
When I look at something like this, I try to translate the numerical measures into something more concrete, yet somehow allegorical. In this case, I’m seeing a great deal of what I’ll call innocent greed. It’s the belief that the naked pursuit of money is a good thing, a sort of libertarian trope, true or not. Whether it’s share buybacks to force the price of shares up (a disastrous move when the market chooses – or, to force more responsibility on the companies in question, the company’s results – to force the price of the shares down, leaving the company executing the buyback holding shares worth less than what they paid for them), often financed through debt, or dividends backed not by corporate profits but, again, by debt, the basic story seems to be about pride, prestige, face.
We’ve kept our dividends going for fifty years now, never mind how! Look at that, our stock price climbed another 20%! Isn’t it wonderful?! And we hold ever so many of our own shares!
A few years after the Great Recession that started in 2008, I read an article on the demise of Lehman Brothers. For younger readers and those who don’t recall, Lehman Brothers was more than just an obscure name appearing in Despicable Me (2010), it was one of the monster investment banks of Wall Street. One might write, Lehman Brothers (1850-2008), because it was the distressed institution that was not rescued by either the Bush or Obama Administrations during the Great Recession. The article, which might have been written by Morgan Housel of The Motley Fool, but I cannot recall with certainty, purported to recount one of the last meetings Lehman Brothers exec had with investors, and the theme of the meeting was how Lehman Brothers was dedicated to making profits for those investors.
Sounds harmless, even typical, doesn’t it? Yet, a few days later Lehman Brothers was dead, the victim of its own mad financial machinations, ripped to pieces when those knotted messes were ripped apart by the inertia of a falling market and a world wide recession.
I would contend, as did the author of that article, that it was a primary symptom of a foundational illness that ultimately doomed Lehman Brothers. Look, from a societal point of view, companies do not exist to make money. I know the general wisdom of the private sector would differ with me, but if you think it through, it becomes obviously right. The proper formulation is, Companies provide specific services thought to be useful to their consumers, and the best ones are profitable because they have the right combination of efficiency and service content.
Why is this important? It brings back into focus that a company is not an instrument for the implementation of greed, for the collection of more and more proxies of wealth, which can fluctuate in their value to a dismaying degree, by which I mean dollars (or whatever might be your local currency). The private sector wisdom leads to a corporate function which contributes nothing to the advancement of society. Stock buybacks as a form of returning profits to shareholders, dividends as expression of pride, the drive to use tax loopholes, none of these are reflective of the purpose of companies as seen from a societal viewpoint, and they are all the spawn of the prevailing wisdom of the purpose of the private company.
By contrast, a company which concentrates on providing those services of value, whether it be your local supermarket working to satisfy the local appetite for apples or for being localvores, or Apple, Inc, providing advances in communication technology which arguably does advance society, and then collects the profit … well, I’m sure it sounds very unsophisticated, even Puritan-like, to the advanced private sector investment banker who is deep into ETFs, and maybe advocated credit default swaps just prior to the Great Recession.
But I think getting back to the roots of the motivation for companies in the societal view is an instructive exercise in evaluating just what the hell is going on in Pearlstein’s article. I recommend reading it in full, whether or not you’re an investor, and thinking about what it may mean for your future. The Trump Recession may be far worse than the Great Recession. It may become the Trump Depression, and it’ll be caused by the nakedly greedy pursuit of wealth, rather than the wise pursuit of stability and justice.
Americans have always been distracted by the tangibles, haven’t they?
