Permanently low interest rates

[drumminj]

Seems like I may be missing something here?

They're borrowing money to buy back stock?

[Tortoise]

They're borrowing money to buy back stock?

In other words, my assumption that companies only do share buybacks when they have surplus capital was apparently incorrect. Interesting.

Follow-up question: What is the likely thought process of a corporate executive who borrows money to buy back shares? Is the idea that unless the shareholders see a return in the form of dividends or increased earnings per share from a buyback, they might start losing faith in the company's profitability (i.e., they'll actually start to see the truth)?

[pmward]

In other words, my assumption that companies only do share buybacks when they have surplus capital was apparently incorrect. Interesting.

Follow-up question: What is the likely thought process of a corporate executive who borrows money to buy back shares? Is the idea that unless the shareholders see a return in the form of dividends or increased earnings per share from a buyback, they might start losing faith in the company's profitability (i.e., they'll actually start to see the truth)?

In a general sense. You also have to think about the motivations of executives, most executives are paid the majority of their wages in company stock. So by buying back shares, they are in essence propping the stock price up until they vest. If they announce a buy-back, they then can buy the stock back up any time it starts to dip. So there are some personal benefit they get from it, aside from appeasing the shareholders. This is why it's been so controversial recently. I'm not an executive, but I get a substantial amount of my yearly pay in the form of company equity that vests over time. It does help me feel a bit safer when my company announces a buyback, especially since I work for a high growth tech company with a triple digit P/E valuation. The high valuation does make me nervous in general.

I don't think that in a normal interest rate environment this is an issue, but when a company can borrow money dirt cheap it enables them to borrow to buy back shares, and generally enables wasteful spending practices.

[drumminj]

It's also worth noting that stock buybacks were illegal prior to 1982.

[pmward]

It's also worth noting that stock buybacks were illegal prior to 1982.

Yeah, I actually just learned that a few weeks ago. I wasn't aware it was ever banned. But yeah, some politicians are moving to ban it again because they think it's unethical to allow executives to raid their companies balance sheets for their own personal benefit. Of course, the real question is, is that fixing the real problem or just treating the symptom of the problem?

[Tortoise]

It seems like stock buybacks should be allowed as long as they’re done with excess capital, i.e., not with borrowed funds.

In a sense, stock buybacks are the opposite of issuing new stock. Companies issue new stock to raise capital, so the opposite activity (buying back shares) should be done to drain excess capital.

[Kriegsspiel]

I remember reading an interesting idea in Korten's When Corporations Rule The World where he proposed (IIRC) requiring companies to distribute x% of profits as dividends. I wonder if that's a better scenario for corporations than one where they have the option to buy back shares.

[pmward]

It seems like stock buybacks should be allowed as long as they’re done with excess capital, i.e., not with borrowed funds.

In a sense, stock buybacks are the opposite of issuing new stock. Companies issue new stock to raise capital, so the opposite activity (buying back shares) should be done to drain excess capital.

It would be very difficult to enforce that. There would wind up being loopholes that they would exploit one way or another. Plus, at the moment it's already too late. The bubble has already been filled. Companies have already assumed massive amounts of non-productive debt in the forms of leveraged buybacks and malinvestment. The more responsible companies with good balance sheets will do fine in the next down turn. But the companies that have been taking out massive amounts of debt that has not generated a return, companies that are either not investment grade (junk bonds) or borderline investment grade (that will get downgraded to junk), companies that have been following the trend of using collateralized loan obligations (CLO's) that are highly leveraged with variable rates, etc... well what happens to those companies is not going to be pretty.

[pmward]

A pair of articles written this week by Kevin Muir on MMT, analyzing it and trying to separate the wheat from the chaff, and looking at how we as investors should look at and prepare for MMT. It is very unbiased and is not political in any way (though he does mention that under Trump we actually are already in the most MMT regime we have ever had):

https://www.themacrotourist.com/posts/2019/04/23/mmt1/
https://www.themacrotourist.com/posts/2019/04/24/mmt2/

[boglerdude]

Is inflation low? Trillion dollar deficits for 10 years, thats 10 trillion of inflationary pressure. And they say banks create 90% of new money? How much are they lending compared with how much gets payed back (destroyed)

Food is cheap, but also subsidized. What if the subsidies ended. Whats the point of putting deflationary things in the CPI. You'd think the point of talking about inflation would be to figure out exactly how much the inflation tax is. I was thinking the 30 year rate might tell you market expectations of inflation, but if the Fed steps in to buy they'll lower the rate. "financial repression." Maybe things in fixed supply can give you an idea, like gold or college tuition

[pmward]

Is inflation low? Trillion dollar deficits for 10 years, thats 10 trillion of inflationary pressure. And they say banks create 90% of new money? How much are they lending compared with how much gets payed back (destroyed)

Food is cheap, but also subsidized. What if the subsidies ended. Whats the point of putting deflationary things in the CPI. You'd think the point of talking about inflation would be to figure out exactly how much the inflation tax is. I was thinking the 30 year rate might tell you market expectations of inflation, but if the Fed steps in to buy they'll lower the rate. "financial repression." Maybe things in fixed supply can give you an idea, like gold or college tuition

Yes inflation is low; problematically so. It's the sole reason the Fed can't get interest rates off the floor. Also, do keep in mind that inflation and growth are correlated, we have low inflation because we have had low growth. An increase in growth would lead to an increase in inflation, which would allow the Fed to raise rates to a more normal level, which in turn would provide us protection in a downturn. Also, higher interest rates would help eliminate the deflationary pressures we currently are still experiencing, as low interest rates over a long period of time are inherently deflationary.