WaPo and SEC Commissioner Wake Up to Looming Crisis from Stock Buybacks

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by Pam Martens and Russ Martens, Wall St On Parade:

Last Friday, Steven Pearlstein, a Pulitzer Prize-winning business and economics columnist at the Washington Post, penned an in-depth article on the hubris of stock buybacks and the role they are playing in retarding future growth of the U.S. economy as well as fueling the next debt implosion. That dire warning was followed yesterday by equally ominous remarks delivered at the progressive think tank, the Center for American Progress, by newly appointed SEC Commissioner Robert J. Jackson, Jr. (Jackson was appointed by President Trump to fill a Democratic seat on the SEC.)

Pearlstein outlined the looming problem as follows:

“Last year, public companies spent more than $800 billion buying back their own shares and, thanks to all the cash freed up by the recent tax bill, Goldman Sachs estimates that share buybacks will surge to $1.2 trillion this year. That comes at a time when share prices are at an all-time high — so companies are buying at the top — and when a growing global economy offers the best opportunity to expand into new products and new markets. This is nothing short of corporate malpractice…

“The most significant and troubling aspect of this buyback boom, however, is that despite record corporate profits and cash flow, at least a third of the shares are being repurchased with borrowed money, bringing the corporate debt to an all-time high, not only in an absolute sense but also in relation to profits, assets and the overall size of the economy…

“A decade ago, in 2008, there was $2.8 trillion in outstanding bonds from U.S. corporations. Today, it’s $5.3 trillion, after the record $1.7 trillion of new bonds issued last year, according to Dealogic, and $500 billion more issued this year.”

Pearlstein warns further that much of this corporate debt is landing in ETFs, a popular retail product for mom and pop investors, who may decide to run for the exits if things go south. The debt is also landing in Collateralized Loan Obligations (CLOs) which Pearlstein correctly compares to the dodgy subprime mortgage securitizations that blew up in the 2008 financial crisis.

The upshot of all of this says Pearlstein is that “Corporate America, in effect, has transformed itself into one giant leveraged buyout.”

Jackson’s speech yesterday honed in on corporate executives abusing the stock buybacks for personal gain. (Jackson, a former law professor at NYU and Columbia, calls himself a “recovering researcher.” The 28 wonky footnotes he appended to his refreshingly candid speech suggest he’s only part way through the recovery process.)

Jackson says “there is clear evidence that a substantial number of corporate executives today use buybacks as a chance to cash out the shares of the company they received as executive pay,” noting that “in the years leading up to the financial crisis, top executives at Bear Stearns and Lehman Brothers personally cashed out $2.4 billion in stock before the firms collapsed.”

Data was compiled by Jackson and his SEC staff on 385 stock buybacks that occurred over the past 15 months, finding that a buyback announcement tends to drive up the share price. They then compared the data on buyback announcements to information in SEC filings on executives who sold their stock after a buyback announcement. They found that “twice as many companies have insiders selling in the eight days after a buyback announcement as sell on an ordinary day.” An even more dramatic finding by Jackson and his staff was this:

“On average, in the days before a buyback announcement, executives trade in relatively small amounts—less than $100,000 worth. But during the eight days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day—a fivefold increase. Thus, executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement.”

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