Thursday, August 13, 2015

August 13 2015. STOCK BUYBACKS. The financialization of the economy—and its many unfortunate manifestations.





DEFININITIVE INSIDERS. As far as most of us are concerned, trading with special knowledge of a company’s situation—knowledge which is not generally available—is illegal. In fact, it can earn you a prison sentence. It is not regarded as a trivial crime. It is not a technicality. It is cheating and is a felony (as Martha Stewart found out to her cost).

An underlying principle (and myth) of a free market economy is that we all compete on an equal basis—so called ‘fair competition.’

Is the current American Business Model really based upon fair competition? No! Of course it isn’t. This is an ABM (American Business Model) propaganda fiction. Some degree of competition does, of course, exist—but corporations work very hard to minimize or eliminate it. They do that in numerous ways. These include.

  • MERGERS & ACQUISITIONS. You buy up the competition. U.S. business is now more concentrated than ever before. Large businesses have the advantage here. They can raise the necessary funds required more cheaply and more easily than their smaller competitors. For instance, the financial system is so structured that the Big Banks can borrow more easily and cheaply from the Federal Reserve than smaller banks (and no one else can borrow from the Fed at all). Is that free competition? No, it is not.
  • INFORMAL (& ILLEGAL) PRICE FIXING AGREEMENTS. Such agreements are not written down, but are very much the standard. They are easy to maintain, on a nod and a wink basis, when most market sectors are dominated by only a few corporations—with one normally recognized as de facto leader.
  • USING THE LEGAL SYSTEM TO RESTRAIN TRADE. This is particularly an American phenomenon. The fact that many states will not allow car manufacturers to sell their vehicles directly is a perfect example. Car dealers have to be involved by state law—thus raising car prices. Tesla have been a victim of this. Restrictions of this type are common.
  • RAISING THE ENTRY BARRIER THROUGH COMPLEXITY. Smaller companies have a very hard time dealing with large bureaucracies so this is particularly a feature of any activity involving the government. The little guy with the better idea, or cheaper quote, is filtered out—or only allowed in if he works under a big guy. Sub-contracting is not quite what it seems..   
  • HAVING REVOLVING-DOOR TYPE RELATIONSHIPS WITH GOVERNMENT. These constitute a blatant conflict of interest, but are so so common, they may be considered the norm. They are virtually the standard in the MICC (Military Industrial Congressional Complex) but most other sectors are not far behind. Indeed, it is now common for former congressmen to become lobbyists. The expression ‘crony capitalism’ has a great deal of validity—and it is the cronies who get the cake.

However, the fact that fair competition is the exception rather than the rule will have to be the subject of another blog. It is relevant to know the context, but my focus here is on insider trading.

If any group could be classified as “insiders” it should be the CEO’s and senior executives of public corporations who buy back their own stock. They do it from earnings and sometimes they borrow—and they do it on a scale that defies credulity. Trillions of dollars is serious money. They also do it as a conscious choice instead of paying out the money as dividends to shareholders, or investing it in such fundamentals as research and development, plant and equipment, information technology, and training. 

In short, it may well be argued that they choose to gamble on the stock market, with limited corporate resources, instead of investing them productively.

It is no accident that productivity has declined in parallel with this trend towards share-buybacks. Similarly, wages and salaries have been squeezed in an unprecedented way. This has certainly lowered labor costs, and increased corporate profitability in the short-term, but it has also.

  • Reduced demand.
  • Lowered growth.
  • Demotivated workers.
  • Lowered productivity growth.
  • Failed to make the U.S. adequately competitive globally. In fact, the U.S. balance of trade has been negative for decades.

Priority is given quite blatantly towards pushing up the share price. It is based upon the notion that a corporation’s only focus should be on maximizing shareholder value—and that all are interests (of workers, customers, suppliers, the local community, and the nation) are irrelevant. It is a key credo of the American Business Model—and represents a fundamental difference with the kind of socially democratic capitalism that is practiced in Europe.

WHY DO THEY DO IT? They do so because it puts up the share prices—which, since they are largely paid in stock, benefits them directly. Because they are employed by such companies at senior level, it is self-evident that they have information about their corporations which is not generally available. They are the very definition of insiders—yet what they do is not regarded as illegal.

TWO LEGAL SYSTEMS. Why not? No good reason has been given. It is just another example of a rigged economy, regulators being muzzled (the SEC in this case) and two legal systems. There is a law for the rich—and a law for the rest.

CONSEQUENCES.Share buybacks should be illegal. Other insider trading is. They:

  • Accentuate short-term thinking—so called ‘short-termism.’ In contrast, our competitors largely think and plan strategically and take the long view.
  • Distort the stock market. Prices are not a reflection of genuine supply and demand.
  • Represent a misuse of corporate resources.
  • Sometimes leads to quite unnecessary borrowing.
  • Lead to underinvestment in R&D, plant,. equipment, training—and other factors to do with the long term health of the company.
  • Fail to add real value.
  • Have coincided with a loss of international competitiveness, poor productivity, and a decline in the real earning power of most Americans. Cause and effect?

The following is an extract from the New York Times of August 10 2015.

Since 2004, companies have spent nearly $7 trillion purchasing their own stock — often at inflated prices, according to data from Mustafa Erdem Sakinc of the Academic-Industry Research Network.

That amounts to about 54 percent of all profits from Standard & Poor’s 500-stock index companies between 2003 and 2012, according to William Lazonick, a professor of economics at the University of Massachusetts Lowell.

The buyback craze, in which virtually every big company from Apple to General Electric to Walmart has participated, has led to a backlash from some investors and government officials, who have questioned whether such use of profits is a productive way to deploy capital rather than reinvesting in businesses and jobs.

Laurence D. Fink, the founder of BlackRock, the largest asset manager in the world, with more than $4 trillion under management,started a debate about the topic this year among chief executives, suggesting the buyback phenomenon “sends a discouraging message about a company’s ability to use its resources wisely and develop a coherent plan to create value over the long term.”

At this point, you may well ask which economic system works better—the ABM (American Business Model) or European Social Democracy. The answer is: It depends.

  • The ABM seems to work extremely well for a very small number of U.S. CEOs, senior executives, and the ultra rich. It is proving to be disastrous for most Americans, their communities, and the National Interest.
  • European Socially Democratic Capitalism—as far as most Europeans are concerned—is hands-down the winner.

Do most Americans know this—or care? It would appear not.

No comments:

Post a Comment