“History doesn’t repeat itself but it often rhymes” -Mark Twain
No one can argue the fact that corporate management and board room members made a decision to forgo the traditional methods of investing in themselves. Historically, both free cash flow and borrowed capital were used for such things as research and development, infrastructure, work force expansion and bricks and mortar. Today,however, tradition has become passe’. The most important usage of capital has been for “stock buyback.”
For the past several years Market volume and participation, by both individuals and institutions, has been declining. On the other hand corporate participation (buybacks) has accelerated at a record pace. One could make the case that without this corporate support the entire equity markets would have collapsed of their own weight. That would, however, have required a naive position of the Federal Reserve’s market role as simply an unbiased observer. You might also have to ignore the Bank of Japan’s position as a top 10 holder in 90% of all Japanese stocks.
Many people see this corporate decision as going into “uncharted waters.” Is this the best use of capital is a question that has been hotly debated. The corporate talking heads and shills of the main stream media respond with “of course it is.”
Why sink money into bricks and mortar when “online” is obviously the future? Why increase or even maintain a domestic workforce when outsourcing to the third world expands the bottom line? Why continue research and development when a simple merger or acquisition accomplishes the same outcome? By process of elimination “stock buyback” continues to be the chief action of choice for the corporate boardroom.
The fact that bonuses, stock options and even equity support would ever play a role in the decision making process will be left for the more cynical among us to debate.
I said that most think that this massive “stock buyback” decision is in uncharted waters. That would not be correct. We’ve been here before, just a wee bit differently.
In 1928/1929 the US stock market was not a place where one achieved gradual wealth. It was a place where people got rich quick.
Banks supplied funds to brokers, brokers supplied that money to customers for margin and then the collateral of stock and cash flowed back to the banks. It was smooth and automatic.
In the early twenties broker loans varied from a billion to a billion and a half dollars. By the end of 1928 they had grown to over six billion dollars and the cost to borrow had reached 12 percent. All around the world the 12% return was the talk of the day. Bankers from London to Hong Kong seeing collateralized cash and stocks so easily sold for liquidity and safety started flooding the canyons of Wall Street with cash.
Corporations also found these rates attractive. It was obvious to most Corporate heads that Wall Street afforded a better opportunity for profitability than simply increasing production. Stock buybacks were left for the future. Instead they simply opened their check books to the brokers and became lenders to the mass for speculation.
“During 1929, Standard Oil of New Jersey contributed a daily average of $69 million to the margin market; Electric Board and share averaged over $100 million per day. A few corporations- Cities Service was one- even sold securities and loaned the proceeds in the stock market”
– Report of the Committee on Banking and currency, 1934
By early 1929 the loans from non- banking sources were approximately the same as those from the banks. Everyone was all in.
“History doesn’t repeat itself but it often rhymes”
Today the corporations have bypassed the brokers to finance others for speculation on margin and have gone directly to becoming the speculators themselves.
Uncharted waters? I don’t think so.
We know how it ended then. We know how it will end now!