Yves here. Many commentators have written about how companies are increasingly more concerned with the business of managing their stock prices than the business of their business. We commented on this sorry development early on, in a 2005 Conference Board Review article, The Incredible Shrinking Corporation.
Richard Murphy gives a particularly clear and terse explanation of where this sorry trend has led, to corporate cash flow and even borrowings being used primarily to prop up stock prices, and that the scale and deep entrenchment of this process means that the equity markets have become Ponzi schemes.
By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK
The FT has reported this morning that:
Debt at UK listed companies has soared to hit a record high of £390bn as companies have scrambled to maintain dividend payouts in response to shareholder demand despite weak profitability.
They added:
UK plc’s net debt has surpassed pre-crisis levels to reach £390.7bn in the 2017-18 financial year, according to analysis from Link Asset Services, which assessed balance sheet data from 440 UK listed companies.
So what, you might ask? Does it matter that companies are making sense of low-interest rates to raise money when I am saying that government could and should be doing the same thing?
Actually, yes it does. And that’s because of what the cash is being used for. Borrowing for investment makes sense. Borrowing to fund revenue investment (that is training, for example, which cannot go on the balance sheet but still adds value to the business) makes sense. But borrowing to pay a dividend when current profits and cash flow would not support it? No, that makes no sense at all.
Unless, of course, you are CEO on a large share price linked bonus package and your aim is to manipulate the market price of the company. It is that manipulation that is going on here, I suggest. These loans are being used to artificially inflate share prices.
The problem is systemic. In the US the problem is share buybacks, which I read recently have exceeded $5 trillion in the last decade, meaning that US companies are now by far the biggest buyers of their own shares. That is, once again, market manipulation.
And this manipulation does matter.
People think their savings and pensions are safe because of rising share prices. They do not realise it is all a con-trick.
And companies claim that their pension funds are better funded as a result of these share prices, and so they are meeting their obligations to their employees when that too is a con-trick. They may be insolvent when the truth is known, so serious is the fraud.
And sentiment is, wholly irrationally, but nonetheless definitely, based on the fact that if markets are high then all must be right in the world. After all, why else is the FTSE reported every hour on every news bulletin but to tell us the national financial mood?
And what is actually being reported is a fraud. The corporate world is not all right. It is out of ideas. And it is so bereft of ideas that it can’t even run outsourcing businesses, which were said to be the easiest thing in the world to get right.
And as fiasco after fiasco shows, the reports of well being in the form of the financial statements are themselves manipulated, or just blatantly cooked.
No one knows where the tipping point for any crisis will come from. I am not claiming I do. But the charade that current stock market valuations represent will be seen through some time soon. Those values are being maintained by Ponzi schemes. And such schemes always end in tears.
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‘Ponzi’ is not the same thing as speculation: there IS a massive speculation out there that the true cost of borrowing at today’s rates and then later refinancing will be low or even negative after adjusting for inflation; this prediction may or may not turn out to be true (that’s a speculative but historically not implausible betting proposition) and is quite different from a Ponzi scheme where new entrants’ monies are used to pay outsize returns to a few favoured early participants.
If there are not many new ideas for profitable business out there, it makes a certain sense for capitalist shareholders to borrow in order to buy out other shareholders. Look say at Dell the computer company. It was taken private and now may be looking to go public again. The lenders and capitalists will know whether the transaction will turn out well for their P&L, that is their risk but this is in no sense is this a Ponzi.
Three points. The UK economy is treading water because of unnecessary Austerianism and Brexit incompetency and lack of legislation preventing company directors engaging in control fraud on the companies employing them through share buy-backs which link to their remuneration packages.
Central Bank buys bonds, giving “investors” cash.
Cash seeking yield purchases increasingly risky assets from corporations that make nothing but quarterly earnings statements, having outsourced, off shored and otherwise financialized their nominal raison d’etre.
The absorption of all such newly created fiat into the “financial markets”, rather than the real economy still suffering from two generations of post Proposition 13 fiscal austerity, eliminates demand for real goods and services due to the simple lack of money sustained austerity yields.
With the productive base liquidated or exported and the “financial markets” decoupled from most activity in the real economy except as a parasitic syphon of poor peoples money, the only thing keeping the fiction of “capitalism” alive for the last decade has been the coordinated seignorage of global Central Banks, who by controlling fiat have infinite Ponzi potential until real, external events puncture the financial perpetual motion machine they have created.
The problem with valuing company’s via a stock price is it is not scientifically done. A lot of hope drives this process and company’s like GE ,for example , got away with it in the 80s and 90s and are facing the reality today.
Imagine you are retired. You suddenly have money to invest (indemnization or asset sale) and want a safe place for it. What to do?
-Government bonds are poised to loose as Fed/BCE raise rates.
-Stocks are a Ponzi scheme
-Corporate debt… not to mention!
-Cryptoshit is ruled out by principle
– What kind of investment fund can be trusted these days?
Please, delete this if it is not the kind of post to be made here
Life is a gamble. People live in the casino. If you have money, put your money down on the roulette wheel. But there is no safe bet in life, or free lunch, or immortality.
In life there is risk and one wisely measures risk before taking it.
A gamble? That is when you take on a high risk situation.
But life as a compulsive gamble without regard to the well-being of others:
Call Gamblers Anonymous. It’s not too late.
below inflation interest rates = it’s a feature not a bug.
The global hamster-wheel economy is being held up by almost everyone (especially the American consumer) spending beyond their means.
Mercantilists gotta mercantile. Bread + circuses = 60″ TVs + social media + subsidized food + booze + pot
If you are trying to stay in cash-like assets until the bottom falls out of everything else, you could keep rolling-over shorter duration T-Bills? 2% isn’t much, but its not nothing.
I see your point, but I’m also wary of the lengths they will go through to make the compulsive gamblers of life whole again – after the next doozy of a crash.
Buy real assets that will serve you whether or not the stock market crashes. Use the money to fund community building activities.
Yep. Put your cash into adaptive materials and activities wherever possible.
I don’t own stock. Instead I have property, antiques, collectibles and jewelry. If I need money, I just sell something.
I’m in a similar boat, though, if I’m to be honest, if/when I ever find myself at the coal face of some major life setback, I’ll have a hard time liquidating any number of my already less liquid assets. It’s a good reason not to die, too; who’d get my stuff? Oh, I sooth myself with the notion that I can just “sell it all” and that I would rather “invest in the good stuff” than this or that fund, but the reality is, I don’t collect as a hedge against poverty.
might you do a post on this subject please?
Ignacio raises a serious conundrum that confronts everyone: in an “everything bubble” in which all assets are extraordinarily overpriced, what is to be done with savings?
He didn’t mention property, but even that bubble is back with a vengeance after its crack-up a decade ago.
ocop’s suggestion to accept near-zero but safe returns in T-bills until riskier assets are repriced is sensible. So is diptherio’s approach of acquiring real assets — including intangible assets such as know-how and social capital.
In an everything bubble, social capital itself is overvalued.
buy a rental property in a third-tier market (nashville, raleigh, etc.)
Tucson is that kind of market. And I know more than a few rental property owners who aren’t having the best of times in the business.
There’s a real shortage of good tenants around here, and there’s a limit to how much rent you can charge before they find a better deal elsewhere. The bad tenants? The less that’s said about them, the better.
The utility of real property requires a functioning government: water, power, sewer, road maintenance, etc. A go-it-alone strategy is doomed.
allocate among a wide range of assets.
shift allocations as needed.
when in doubt Cash is King, but don’t have too much of it.
Thank you all for your ideas. Real assets is something I’m thinking about. For instance renewable energy production facilities. My wife commented that she participates in two investment funds that invest in US stocks: one is in dollars and the second is in Eur. The former has been doing better in euro terms. I just told her beware the corrections!! I also emailed her this article.
The 30 yr bond pays more than inflation. IMO any downturn will return us to a deflationary era, falling asset prices and wages. And falling rates, too… I expect the bond to go under 2%, meaning a nice rise in value. Then, after stocks fall for around 18 months, shift some into equities.
Just my 0.02…
Permit me to share Arizona Slim’s Super-Simple Investment Screen:
1. Is it a good thing?
2. Does it make money?
3. Does it bring me joy?
If the answer to these three questions is yes, consider investing in it. But remember, the key word in the previous sentence is “consider.”
Be careful out there — especially when it comes to your money!
“What kind of investment fund can be trusted these days? ”
I dunno… canned food and shotguns?
https://www.youtube.com/watch?v=1JITC1fo2HA
Dmitri Orlov (used to be linked here sometimes) reccomends paraffin bricks buried somewhere; they’ll never go to zero!
I am not an economist as my comments typically betray, but I think there is something deeper here, too. I just paid off a car loan. I borrowed the money and paid it all back plus service charges (interest) and I now own the car free and clear.
When stock is “sold” a certain amount of money is provided the company issuing the stock to use to enhance the business. As the loaner, I get security (shares) and service charges (dividends). But there is no end to this.Is it not the case that the dividends exceed (at least in some cases) the money borrowed? Apple, for example has paid out billions to its shareholders, far in excess of the money it acquired through the issuance of the stock. And they keep paying. It seems that the only way to keep from paying … forever … is to buy back the stock at the price inflated by the actions of the company itself to being many times the amount owed. This does not always work out this way but it seems to.
Also, the original stock owner may have sold the stock and it may have been sold and resold, etc. all to acquire the unending payments of dividends and or ever inflated prices for said stock shares. Yes, there is risk involved, but during my lifetime, the stock markets have only increased in value (long term, not short).
Would not a bank-like lending scheme work better, much as the Japanese had (and bungled).
“Yes, there is risk involved, but during my lifetime, the stock markets have only increased in value (long term, not short)”
There was a post on NC the other day about the small number of stocks responsible for long-term gains over the decades and currently. Those mentioned were all defense/govt contractors except for one.
War economy. The growth in the economy ovee the decades is the wages of war. Money is created for guaranteed and perpetual war, but hands suddenly get tied when it comes to guaranteeing and perpetuating the health of its citizens. Creating money for that is suddenly problematic.
Funny that I’ve heard Social Security called a Ponzi scheme and Medicare( a form of govt subsidized healthcare) derided, but here you have a govt subsidized (on steroids) stock market (on top of the buybacks).
“during my lifetime, the stock markets have only increased in value (long term, not short)” — Steve Ruis
During Boomers’ lifetimes, the lowest 20-year real return on stocks (using CPI for inflation adjustment) was 0.56% annually compounded, from Feb 1962 to Feb 1982. At the start of the period, Shiller’s CAPE (price / 10-year average real earnings) was an ebullient 21.5.
Conversely, the highest 20-year real return was 13.86% annually compounded from March 1980 to March 2000. At the start of the period in March 1980, Shiller’s CAPE was at an epicly depressed 8.1.
Today Shiller’s CAPE is at 31.8. Real return since May 1998, when CAPE was at a towering 37.0, is 4.35% and falling. On the back side of Bubble III, 20-year real return should approach zero again, or even go negative if a low in March 2020 happens to coincide with an unfavorable comparison to the peak of March 2000.
You may be conflating stocks and bonds a little bit.
When you buy a stock, you in essence become a part owner of the company. As long as the company turns a profit, you will continue to get a dividend as you share in the profits with the rest of the stockholders. There is no money being loaned here. This mirrors the situation you would have if you were the sole owner of a profitable small private business – the profits accrue to you for as long as you keep the business open.
If you buy bonds, then you are loaning the company money but they agree to pay it back to you at a set rate over a set period of time. Payments stop once the company’s obligations to you are over.
Stock buybacks don’t do anything to stop a company from having to make payments. They are still obligated to pay back the bondholders. A company is also under no obligation to pay any dividends to stockholders and if they do, they can stop them if they feel like it.
And touching on the subject of the post, IMO the Ponzi aspect comes in regarding those companies who do not and have never paid dividends. If a stock pays a dividend, a would-be purchaser can decide to buy a certain number of shares based on the fact that they can expect an income from those shares regardless of the share price. Here’s a theoretical example – you could buy a share for $20 that pays out $5 in dividends per year. You hold it for 20 years and then sell. If the stock itself has not appreciated in value at all and you sell at the same $20 you bought it for, you still made $100 over the time you held the share. However if the stock does not pay dividends, the only way you can make money is if somebody else is willing to pay more money than you did originally to take the stock off your hands. In other words, older investors make money only by having new investors willing to buy in.
That’s pretty much the definition of a Ponzi scheme.
‘Does it matter that companies are making sense of low-interest rates to raise money when I am saying that government could and should be doing the same thing?‘ — Richard Murphy
It must be a lovely planet that Richard Murphy lives on. But on this one, governments that are already up to their necks in debt are running permanent deficits, as social promises they can’t meet come due.
Eight of the 34 OECD rich countries have government debt exceeding 90 percent of GDP. The Haygood wager asserts that the deadweight eight will grow less than the remaining 26 during 2019-2028.
For these governments, more borrowing is the equivalent of a trapped moth writhing on a spider’s web and only getting more entangled, as the big arachnid calmly waits to dine.
There is no social promise payable in fiat a fiat gov cannot meet.
All debts of a fiat gov can be paid instantly. No borrowing was ever necessary.
Regarding inflation… so long as there are no serious shortages of real goods such as food and fuel there will not be serious inflation.
However, when a gov borrows in a foreign currency it may have serious problems paying debt. And when a country imports substantial amounts of real goods such as food or fuel, they similarly may have difficulty servicing the debt because payments are made in a foreign currency. Argentina and Southern Europe are similar in this regard.
The US, the exceptional country, will continue to be exceptional in this regard so long as foreign savers are willing to send us oil and other things in exchange for the green paper they covet for their mattress.
This is Corporate Finance 101. Never ever fund a dividend by issuing debt (I would extend that to share buybacks as well). Where are the CFOs? The auditors? Regulators?
Thanks for posting this Yves. It is time more people starting talking about this stupidity.
You studied Corporate Finance 101.
They studied Bribery and Bail-Outs 101.
Government Finance 101: fund Social Security and Medicare benefits by issuing debt.
It’s workin’ great … so far.
Why do you blame government for private debt?
Which arm of Government do you want to blame?
The US Fed , and it’s equivalents in other countries, for keeping interest rates ridiculously low for a decade.
Politicians for setting such a bad example to us plebs by ever increasing borrowings to pay their bills, especially their bills to the military industrial complex.
Both of the above for their pathetically weak attitude to Wall St. generally, and the Banksters in particular.
Take your pick.
SS and Medicare benefits are NOT funded by issuing debt. Ask any worker about their payroll taxes or current Medicare beneficiaries about the payment of monthly premiums.
The “unsustainability” of current payments to these programs could be readily controlled by small adjustments in the payroll tax (increasing the ‘cap’) and controlling the ridiculously expenses of US medical care (hospitals and doctors).
The bigger problem is having a society with few good paying jobs for a higher educated population.
When the Social Security Trust Fund shrinks — as it’s projected to do this year with a $25.4 billion drawdown (Trustees Report, page 41, Table IV.A.1) — that amount must be borrowed, as all of FICA taxes are being used to pay benefits.
This chart, drawn from the 2018 Medicare trustees report, shows that Medicare requires general revenue transfers of 1.5% of GDP, over and above payroll taxes and premiums.
With the general budget running a 3% of GDP deficit, and Medicare alone requiring a 1.5% of GDP subsidy, borrowing is what keeps Medicare afloat — as has been the case since the 1970s.
For several decades ever since the Great Reagan Rescue of 1983, we have been paying FICA taxes amounting to MORE than what SS has been paying out in benefits. The un-payed-out difference was intended to be the “surplus” , described as being held in the Social Security Trust Fund. Its exact purpose was to pay back out benefits to the boomers who payed so much into it ever since 1983.
When the “Trust Fund” shrinks itself to pay out money to beneficiaries, is it “borrowing” that money? Or is it “collecting” that money back from other branches of government who “borrowed” that money FROM the Trust Fund?
Capitalism isn’t working. RM has opened up the big question. But, not to panic. It is a ponzi, it has always been a sub-chronic ponzi casino but now it’s “out of ideas.” Being out of ideas is the key point. Out of ideas at the same time that we have fouled our own nest almost to suffocation… not good. Financialization crept in to supplant capitalism so of course it’s not working. But the real crux is this: both financialization and capitalism are birds of a feather – they both supplant the real value of things for the sake of mindless growth for no reason except profit… or so they evolved. But we can come up for air, that’s the good news. Because money is nothing more, or less, than cooperation. We are on the verge of turning the rotten old casino into a planned, responsible civilization. To be out of ideas is like being out of cards.
All out of ideas except the overarching one: war.
A war economy’s go-to-idea is war.
Yes. I agree. It seems to be the unacknowledged law of human nature to take the irrational to the very end, no matter how pointless, before it can stop. The law of exhaustion.
I think a major fundamental problem is that we have now all been (fairly willingly) indoctrinated to value everything in terms of money. The corollary is that if you can’t put a price on something it is not worth anything.
Which explains why we humans have caused the extinction of one third of the species on the planet during my adult lifetime (source – WWF) whilst doubling our own population to 7billion.
Those now extinct species did not come with a price tag or barcode, so we did not value them.
There are little sayings which can maybe help weaken or even break that conditioning of “everything is only worth its price in money”.
Sayings like the Wise Old Indian once said: ” When the last can of catfood is gone from the last shelf in the last Walmart, then the White Man will learn he can’t eat money.”
Or another: Chief Seattle to President Franklin Pierce 1854:
“This we know:the earth does not belong to man; man belongs to the Earth. This we know. All things are connected like the blood which unites one family
Whatever befalls the Earth befalls the sons of the Earth. Man did not weave the web of life, he is merely a strand in it. Whatever he does to the web he does to himself.”
A small section of a speech which has been described as the most profound environmental statement ever made.
We havn’t learnt much, have we?
Matt Taibbi says much along the same lines, and adds it’s a great time to start taxing transactions to slow down this inflating debt bubble in speculation.
https://www.rollingstone.com/politics/politics-features/financial-transactions-tax-695000/
UK already taxes (some) transactions (it’s called stamp duty). I can’t think of any research that shows it slows the transactions down.
What would be better, but really impossible to implement, is to say run the trading day just once (i.e. you get in all offers/bids, and once a day an auction is run where it clears. Any participant can sell or buy exactly once a day, and not both in the same day). Once a week would be even better, but that would be entirely out of the realm of possible.
The traders collectively object! How can they make money if they are not permitted to hold stawks for a fraction of a second?
Land and lumber.
A well maintained, newly established forest appreciates at 10-12% per year with minimal inputs, just based on growth rates of young modern lumber varieties. Mature forests in eastern regions of North America produce extremely high value understory crops.
Well maintained agriculture land produces tangible goods with inelastic demand, and rents will generate $150-300 per acre depending on region and productive capacity.
This post recalled to me the book “The Late George Apley”. I pulled a few quotes from that book:
“A great many “crackpots” have advanced a great many absurd ideas, but these do not disturb me as they used to. I notice that every time good sound common sense triumphs in the end. There is a substratum of common sense upon which we can all count. We all know in our heart of hearts that we are a good deal more comfortably off than we would be anywhere else. The stock market reflects this feeling, but it is a great deal too high. 1 am now well out of it and back into tax-exempt Governments and Municipals.”
“It will be remembered that Apley was one of the few who sensed the impending difficulties in the orgy of the 1929 market, …”
“At any rate there is one thing I am certain of. This business will not last, this extravagance of thought and money is abnormal; it is bound to be, with General Electric selling where it is today.” [This is from a letter after the crash suggesting GE was selling at an unreasonably low price, and that therefore the stock market should not remain at its low levels and must eventually come back — but times have changed some.]
There’s currently nothing to stop companies from directing large buyback programs to actively intervene and prop up share prices which drop below some predetermined level. There are however four quarterly blackout periods a year, lasting about four-weeks each, when share buybacks cannot be dynamically used by a company to prop up its share price.
A blackout period is a U.S. SEC rule to prevent insider trading by restricting a company ( and employees ) from trading its shares during the time period around an earnings release. Most publicly traded companies establish blackout periods that restrict trading just prior to the quarter end, and immediately after the company reports. This typically lasts from two weeks prior to quarter end through 48 hours after earnings are released. This does not mean that companies are completely restricted from making share buybacks during a blackout period. During this blackout period, the SEC Rule 10b5-1 allows companies to set up a daily buyback plan that automatically purchases a predefined number of shares, over a predefined range ( minimum to maximum ) of market prices. Share buybacks during the blackout period, however, cannot deviate from these predefined purchases or move to support their companies share price if markets fall. So every year there are quarterly buyback blackouts from approximately 3/15 – 4/15, 6/15 – 7/15, 9/15 – 10/15, and 12/15 – 1/15.
We’re currently in a blackout period, which probably is the reason for higher volatility and some steep unchallenged market drops since June 15th.
Lee Camp from Redacted Tonight interviewed Tan Liu of The Ponzi Factor:
The Huge Fraud Behind Our Stock Market
I watched that one a few weeks ago since I’d heard about the book and wanted to hear what the author had to say. Liu comes across as more than a little ignorant in that interview to the point where Camp seemed to get flustered. It’s a good thing Camp was there to explain for Liu what he meant, because the point he was trying to make was a good one.
How about abolishing the corporate income tax and replacing it with taxes on the wealth and income of the beneficiary owners of corporations, the stock and bond holders? Aside from the fact that some portion of the incidence of corporate income taxes is paid by customer prices, without a corporate income tax there would be no incentive for corporate tax evasion strategies with their distortionary effects, no interest rate deductions which encourage leveraging and PE LBOs, an incentive to invest on the basis of retained earnings and real equity growth, which would enhance stability and enforce concentration on the prospects for real lines of business, etc. Artificial inflation of financial asset prices would make less sense in such a world, because it would simply increase the effective tax rate.
I may be too cynical, but I’d suggest this would be implemented in two phases
1. abolishing the corporate income tax
Then at a MUCH, MUCH later date:
2. replacing it with taxes on the wealth and income of the beneficiary owners of corporations, the stock and bond holders
There are personal liability reasons for incorporation, and, to me, it is entirely fair for corporations to pay a tax to have this limited liability granted by the government.
For that matter, one could remove the tax deductibility of corporate debt immediately, pushing corporations to have higher hurdles for borrowed money and encouraging them to re-invest earnings.
After all, credit card interest incurred for personal expenses is not deductible. Neither is auto loan interest, nor interest on furniture/appliance loans and student loan interest deduction is limited to $2500/year, subject to income hurdles.
And there are already corporations that function the way you propose, with income and losses flowing directly to the beneficial owners, those being Subchapter S corporations.
The Subchapter S owners are probably doing what they can to minimize THEIR taxes right now.
I suspect there would still be incentives for indirect tax evasion strategies at the corporate level as the corporations would search for ways to remit their earnings to beneficial owners such that the owners pay lower taxes (maybe to owners in low tax rate countries, maybe to untaxed foundations?).
The shares of companies who played this game the best might command a premium, leading to artificial inflation of asset prices.
A Ponzi scheme 1) promises inordinately high returns at inordinately low risk (check), and 2) uses new investments to pay on old investments because there is no other way to pay on old investments (check). In contrast, Social Security and Medicare are examples of fiduciary fraud, namely: 1) Congress repeatedly pulls money from both to cover other expenses, 2) Congress never pays these “loans” back, and 3) Congress instead points at the diminished balance sheets of both as evidence that they “can’t work.” It’s no great feat to make a pension fund look bad if you continually raid both its res and its return.
Different people should keep pointing this out in different ways. It is the General Budget government which is embezzling money FROM the Social Security Trust Fund. The GenBud Governators want to never ever pay the embezzled money back which is why they all collaborate with the Peterson Propaganda about Social Security going broke and being unfunded and so forth.
The actual secret agenda ( the Greenspan agenda) behind the Great Reagan Rescue was precisely to embezzle all the surplus money from the Social Security Trust Fund, usually in the form of tax cuts and undertaxation to the upper class; with the clear secret intention of borrow-bezzling so much money out of the Trust Fund that it could “never ever” be paid back. The Governators would then seek and demand the FICA taxpaying public’s aquiescence in the abolition of Social Security and the eternal non-payback-ever of the money bezzle-borrowed from out of Social Security by Social Security’s social class enemies.