Debt with interest is inherently destructive. Inevitably the demand for debt owed exceeds the actually supply of money. To put it in very simple tangible terms, if the US economy was say $100,000, and say all that money is lent out at a simple 10% interest rate due back in one year, then a year from now the demand to be paid back is $110,000. Where is that extra $10k coming from? It doesn't exist. Lending with interest is designed to fail. The only "solution" is to keep printing more money.
I think you are implying the companies and people borrow money for shits and giggles. The reality is that most companies borrow money only when the availability of extra capital would help them generate more revenues or capture addtional market share. So they would take into account the cost of servicing the debt and repaying the loan.
However, there are cases like IBM raing debt to buy back shares and boost share prices. I have no idea how that will work out for them.
True; but the revenue / additional market share is never a sure thing. The company can't make a contract with the universe. The interest payments, however, are a contractual obligation.
The interest payment is partially because of the risk in the first place. Collateral if any is the only guarantee to the lender. They are taking the risk of losing it all or using a complicated yet sensible metainsurance plan at the cost of direct profit.
If hypothetically we could see the future perfectly the financial market would start to look downright weird as predestined to fail loans would always be rejected but approved loans would go low margin from competition.
Think of a restaurant that needs a new fryer because the one they had broke down. Wihout that new fryer , they will lose their business and livelihood. Debt allows them to make a risk calculation : they will take on an additonal overhead of deb servicing and in return they will keep their business.
Now think of a dentist who wants to open her own practice. Her savings may not cover the cost of buying equipment that is needed. An asset backed loan may be a better opion for her. Of course, there is a risk involved -- she may not generate enough revenues to cover the cost of servicing the debt or her other liabilities. Typically she would consult with her accountant before starting on this journey.
I would argue thay contractual obligations and regularity and severity with which they are enforced are a sobering influence on businesses. There are no contacts with universe needed for debt -- but there is an element of risk that needs to be accounted for.
>I think you are implying the companies and people borrow money for shits and giggles.
Nope. I was just using an example. It could have been $100k and only $50K was lent out. You sill would need $105k at the end of the year to satisfy all debts and have an equilibrium within the economy. Where is the extra $5K coming from? Magic??
> The reality is that most companies borrow money only when the availability of extra capital would help them generate more revenues or capture additional market share.
This doesn't change the fact that the demand back for money will exceed the actually money supply.
It is simple math really. The fact that they are using the cash to, hopefully, generate more revenues is irrelevant.
Private companies have no control over the the supply of money. This is a central banking problem.
>What happens when there are new entrants to your economy?
Nothing.
>Are they all forced to split the 100k?
No, if the new entrant can provide value then someone that already has some that $100K can give it to them for a good or service.
>If not, where does new money come from? Magic?
Comes from the Federal Reserve, when they decided to increase the money supply. The problem is you are on a never ending treadmill that is designed to have bubbles and failures, not that new money has to sometimes be created.
> Comes from the Federal Reserve, when they decided to increase the money supply.
Wait, really? I was pretty convinced that the vast majority of new money is created by private banks, when they decide to loan out money that nobody has paid in. It's called fractional reserve banking.
Private lending actually destroys money supply, contrary to the "money multiplier effect". (Fed recently admitted this was bullshit) that has been taught for a long time. Government/public lending creates money supply
>You sill would need $105k at the end of the year to satisfy all debts and have an equilibrium withing the economy. Where is the extra $5K coming from? Magic??
this makes very little sense. You are not lending the entire economy and then demanding more than the economy be paid back. You only lend a portion of the money supply so that a slightly larger portion is repaid.
Even if that were the case, isnt that what QE does?
>You are not lending the entire economy and then demanding more than the economy be paid back.
You are right that you are not lending the entire economy, I was just making the example as simple as possible. But, the second interest is being charged then the demand of money back exceeds the actual money supply. What companies and investors do to increase revue for 1 particular organization has no effect on the money supply. All companies are doing are vying to try and redistribute the money that already exists in their favor, they aren't creating money (if they are that is called counterfeiting and is illegal).
> Even if that were the case, isn't that what QE does?
Yes, QE increases the money supply. I am not saying that the money supply doesn't get increased (by the Federal Reserve), merely pointing out the fact that once you get on this treadmill it just goes faster and faster and faster, and there is no way to get off without a disaster (bubble).
> But, the second interest is being charged then the demand of money back exceeds the actual money supply.
Not true, and I'm having a hard time finding your argument. You think if I loan you 1$ at 0% that's fine, but 1$ at 1% now exceeds the world's money supply? Even debt > total money supply is payable as long as interest payments are < payments being made.
> once you get on this treadmill it just goes faster and faster and faster, and there is no way to get off without a disaster (bubble).
Not strictly true. I have taken on debt with interest and paid that debt. Why is a disaster needed?
When a company pays back interest to a bank, the interest isn't magically removed from the money supply. So the bank also has $10k more profits, with which it pays its employees more, who can then buy more widgets from the company etc.
Yes, whether this is sustainable does depend on increased economic activity. Which is why it's so important to lend for (sustainable) productivity growth or you get a bubble which creates liquidity problems when it pops.
Jax, I’m sorry but this is just fundamentally incorrect. The economy is not a zero sum game. Clearly there is annual economic growth, and that growth compounded over many years has lead to orders of magnitude growth in the size of the US/World economy.
Companies borrow money in order to invest in their own growth. Borrowing allows increased growth rate and in turn increased spending which has follow-on effects downstream (this is called the money multiple).
I very much enjoyed taking the intro Micro and Macroeconomics classes as part of my Econ degree. There are probably even great courses online for free now. I’d highly recommend it.
> You sill would need $105k at the end of the year to satisfy all debts and have an equilibrium within the economy. Where is the extra $5K coming from? Magic??
The extra $5K come from the same place the initial $100k came.
Value is created out of thin air through work. Sometimes you need to invest before you can do that work. If your money supply doesn't reflect the increase in value that the economy provides through work, then you get deflation.
You’re confusing stocks (such as the stock of debt) and flows (including payments), a common mistake. Every expenditure is another person’s income. Money is spent multiple times around the economy, and some agencies try to measure how quickly it happens, which is what the velocity of money is, and the concept of the fiscal multiplier comes into this.
If the economy is growing, it is true that continual money creation is required to stop deflation, but a lot of people don’t realise to what extent because it isn’t commonly known that not only can the Government create money, but that in fact all bank lending does and is expansionary [1].
But A is in the money business, they should have no interest in X and Y.
- A loans $100K to both B and C at 10%.
- B makes X and Y, C make Q and R.
- B and C can produce and sell X,Y,Q, and R to one another to their mutual hearts content, creating a lot of value, but in the end A can only be satisfied by $220K. Either B or C is going to end up short.
Why would A accept X or Y when it's detrimental to their business interests to do so?
Lets assume the product that B makes has a value which allows a 50% gross margin
A loans $100K cash to B at 10% markup (total value of system= 100K)
B buys raw material from A for 100K cash (total value of system now 200K as a magic 100K of raw materials were just added)
B creates product X and Y, now worth 200K (system is now at 300K)
A buys 60K of product X with cash (doesnt change value of system)
A cannot buy 60K of product Y with cash, though the total value of the system has increased.
There isnt enough cash in the system to settle all debts, but the total value of the system has increased. Cash would need to be printed to cover debts.
Fiat currency to some extent is balanced against the total GDP of the US.
Interest is determined by the risk inherent in the debt. Think of it in terms of consumer credit. Whether a bank or credit card company lends you money at 5% or 15% has more to do with how creditworthy you are, then with how good a use you will make of the money. (Think TVs on installment plans)
> Interest is determined by the risk inherent in the debt.
That's the supply side consideration of the price of debt, but interest, like all prices, is determined by intersection of supply and demand, not supply alone.
Demand side consideration is “what new income in the future does taking on this debt now enable?”
Loans fundamentally create virtual currency in the first place. Not to mention that if the economy has the same amount of value a year from now something has gone very wrong here - an entire nation of people working and yet they don't have more or better?
It brings to mind a reducto ad absurdum of fixed currency amounts with massive deflation where your grandfather's couch cushion change is worth more than a new couch as why absolute fixed currencies are unviable.
Spending money doesn't destroy it, it can be spent more than once in a year; even with no additional money, you just need higher velocity of money for their to be more money spent in one year than another. The extra $10K doesn't need to come from anywhere, the same way the base $100K (which was already spent the first year and thus "consumed" if you mistakenly assume money is single-use) doesn't.
The interest doesn't disappear, it lands in the pocket of the lender, only the principal does disappear.
If you do indeed lend 100k$ from a central bank and they "print" the money then the money supply increases by 100k$ for the duration of the loan. When you pay it back the money vanishes into nothingness again. Interest payments go to the central bank which makes a profit, governments spend the income and the money starts circulating within the economy again. [1]
According to the chicken-littles, the Fed can't raise interest rates or supposedly the bond market will collapse and then supposedly the stock market will tank because corporations have over-extended themselves based on complacency about cheap money/QE making non-capital asset investments rather than capital investment business expansion. Cats will live with dogs, and the Stay Puft Marshmallow Man will eat your children.
Obviously, Sherlock. The govt with the Fed are (or should be, if things don't spiral out of control) the economic governors. You can't talk about either one in isolation because they are symbiotic, not mythologically-utopian, hermetically-closed model boxes that can exist without the other.
The Fed will be pressured to reduce interest rates because corporations are playing Russian roulette too-big-to-fail brinksmanship and will expect a bailout as per usual.. an action the majority undertake will always be excused in a democracy because of political pressure.
Heck, when government entities take on too much debt, the bond vigilantes get involved, interest rates spike upwards and bad economic things happen! Inflating your debt away will just save you from outright sovereign default - it won't save you from the bond vigilantes and from spiking nominal rates.
Yes, clearly, just like they did in Japan. Oh, wait, no, Japan only proved that the Government is fully in control of the bond market.
The private sector wants Government bonds. If they won’t buy all of them at the interest rate the Government wants to sell them for, there’s no practical reason they can’t just sell excess bonds to the central bank (except for silly policy in some countries).
MMT still has plenty to say about the private sector, as well as non-monetarily sovereign monetary systems, etc. It’s the common fiscal policy recommendations informed by MMT that mostly have to do with Government debt. It’s important to separate the theory from the policy - MMT is way more than just overt-money financing.
But yeah, the parent comment is confused, corporate debt (and private debt in general) is the real looming threat to worry about in a currency-issuing country that only issues bonds denominated in their own currency (such as the US) - not the Government deficit or debt.
Over the past decade, companies have taken advantage of low rates both to grow their businesses and reward shareholders.
Total corporate debt has swelled from nearly $4.9 trillion in 2007 as the Great Recession was just starting to break out to nearly $9.1 trillion halfway through 2018, quietly surging 86 percent, according to Securities Industry and Financial Markets Association data. Other than a few hiccups and some fairly substantial turbulence in the energy sector in late-2015 and 2016, the market has performed well.
"Reward shareholders" is code for stock buybacks - the practice of a company using ultra-low interest financing to buy its own stock on margin. It's an unsustainable way to manipulate the price/earnings ratio, and thereby make a company look like a better buy than it is.
Buybacks in turn have been a major source of funding for the stock market's unprecedented run:
I suspect those looking for a soft landing here haven't considered the reversible nature of this debt-fueled stock market rally. Nor have they considered the amplifying effect of debt on the upside and downside.
I know less about shareholder buybacks than I do about divideds, but they are pretty similar to dividends. A buyback is returning $X in bigger chunks to a few shareholders, and a dividend it returning a $X to all shareholders. A dividend usually drops stock value in line with amount of dividend paid out, so in a sense you could think if it as the company saying "I'm buy 1% of your $100 share, so you get $1 and the share is now worth $99".
Anytime a company pays a dividend AND increases their outstanding debt in the same time period, you could draw ths conclusion that they financed the dividend using debt.
On the summary page you can see they pay about a 15% dividend. On their income statement you can see their net income is less than $100 million USD. On the balance sheet, you can see the long term debt has increased by a serveral hundred million over the last few years. That dividend sure sounds like it is financed by debt, although you'd have to dig into what is really going on to know for sure.
This article is from 2012 but illustrates the point (it's also why I left the company, they restructured debt, issued a dividend which, even though they're publicly traded they were(are?) 75% held by Carlysle Group so it was basically a self bonus, then cut employee benefits) https://www.forbes.com/sites/abrambrown/2012/07/11/booz-alle...
I don’t believe it’s fair to call the practice “unsustainable” without qualifications.
It’s just the opposite of issuing stock. Even when done with borrowed money, it is simply replacing one source of funding (investment) with another (debt). When interest rates are low, the latter becomes attractive. If/when they rise, trouble may ensue. But for a profitable company, the normal, entirely adequate, reaction would just be the reverse transaction, retiring the remaining debt with newly issued stock.
Those are some phrases I have heard before. And I agree that those posting them did come off somewhat intelligent, usually. Unfortunately, I don't quite get the intended meaning here.
How is a declining market threatening a profitable company that, at some point in its past, bought back shares? There are no on-going financial commitments a company has that are tied to the daily fluctuations of the stock market.
Even if they have taken on debt to finance a buyback, a future decline of the stock market has no bearing on them, except to possibly make it less lucrative to issue new stock.
As long as they make a profit in their core business, and those profits allow them to pay the 3% or 4% interest on any debt, they are completely save. A rise in interest rates does have a meaningful impact here, yes. But (a) interest rates have been rather stable for going on 40 years now, and this is a well-known risk that is an obvious part of any decision to take on debt. It can, and often is, also be hedged by agreeing to fixed interest rates, or hedging.
Buying back shares is not unsustainable in and of itself. Buying back shares to artificially inflate your stock price is.
The unsustainable part is giving investors the impression that, while the Dow plunges 500 points, your stock remains stable. Then when your buybacks stop and your shares plummet with the rest of the market, it gives the impression that something suddenly happened and your company is in a dire situation.
Either you keep buying shares to inflate the value (which gets expensive) or you stop and accept that your shares will go down (which looks worse now that your stock price has not declined with the rest of the market). Either way, if you're using buybacks to keep your stock price up in a market that's down, you're going to get burned eventually.
The better question might be, why would a profitable company borrow money for the purpose of buying back shares?
If they want to reward shareholders, they can issue a dividend. If they think the company will grow, the can invest in growth. The "argument" made is that companies think their stock is undervalued by the market and want to capture that price growth. Why would so many companies think their stocks are "undervalued" in 2018 after a 10 year bull market?
Before 1982, we viewed buybacks as market manipulation and it was illegal [1]. In reality, companies do this in order to increase their stock price and earnings per share, the two things for which executives are typically compensated. If you take the same earnings and divide over fewer shares, you have magically increased your EPS without improving the actual business.
No, the argument is that debt-financing at times is simply cheaper than equity financing.
Equity carries more risk, because stockholder are paid after bondholder in the event of bankruptcy. Therefore, equity investors (stockholders) demand higher returns than lenders. Depending on a few other factors, borrowing is the better option to raise operational capital than issuing stock. Conversely, when your need for capital decreases, you no longer want to pay for it.
And just as you may repay a loan (early) in that case (if you are debt-financed), you may buy back shares, if you are financed by equity.
maybe buybacks aren't done with an interest in being sustainable - don't they provide a good opportunity for shareholders to exit their investment at a higher price than they entered?
I think doing this points to a dysfunctional system.
You're betting that your company's financials and stock price will improve, so you get debt to buy back the stock. It's no different than an individual getting into debt to buy say Nvidia stock because they think the price of the stock will keep rising. This is always a mistake in the long term, and it should be discouraged - for both individuals and companies.
It's even worse when you see companies like Apple with tens or hundreds of billions of dollars in cash getting debt to buy back its stock. Come on. This is a disaster waiting to happen. We shouldn't have to wait until the economy slows down/a recession arrives to figure this one out. It's clearly dysfunctional/a bad thing to have in an economy.
I could just as easily describe the net result as companies using debt instead of investment to finance operations. A practice that is far older than publically-traded stocks, and absolutely common.
The wisdom of privately buying stock with debt stems from a consideration of the risks involved. But a company is going to shoulder its risk of operations, no matter how you turn it.
I also don't get your criticism of Apple's practice: It's well understood that it happened for tax considerations, and surely them holding billions of dollars in cash cannot, in anyway, be worse than not having billions of dollars in cash? In any case, the current tax "amnesty" seems to be in the process of resolving that particular accounting nightmare of yours.
It's worth calling out the systematic distortion here. As a rational investor one may buy into a stock under the thesis that the company is going to perform buybacks with debt. As you can be long until the debt buybacks end, and the company implodes.
A smarter investor would acquire large stakes in companies capable of issuing debt and lobby the boards to perform buybacks, allowing a form of corporate raiding with less capital invested and dramatically more reward.
Both of these strategies rely on the greater fool hypothesis, but in a period with historically low interest rates and an implicit hedge that the fed would stimy any wide spread defaults it's a valid investment strategy.
I keep an eye on a lot of tech stocks, and I think it's crazy how much crap companies like IBM and Oracle got 3-5 years ago for their stock buybacks [1] contrasted to how praised stock buybacks are now [2]. The impact back then was the market was great but IBM/Oracle/etc's share prices weren't doing great. The impact now is the market is not doing great, and stock buybacks are a band-aid over the inevitable decline.
Anyone who doesn't see that is going to be caught off guard when the money runs out, the buybacks stop, and the market crashes "overnight". In reality, the market is crashing right now, it's just hidden behind trickery designed to artificially inflate the value of the market. It's like if I lost my job but kept financing my same lifestyle out of my savings account. Eventually that savings will run out and reality will hit like a ton of bricks, and no one will have seen it coming.
I think you are operating from a seriously mistaken assumption of how stock buybacks work.
When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits.
Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.
All this requires no ongoing buybacks from the company. You do it once, and because the denominator shrinks, each stock appraises. After that, as long as profits remain stable, earnings per share will, and so should, absent external factors, the stock price.
None of what you said conflicts with my understanding of how stock buybacks work. I never said it was an ongoing activity, just criticizing companies who do stock buybacks to artificially inflate their share price in a down market. My argument has nothing to do with profits or dividends or ownership, just share price.
>a company buys their own stock... [and] each stock appraises
That lines up exactly with what I've described. If you're saying I'm wrong, you're going to have to be more specific because I don't see where we disagree.
>just criticizing companies who do stock buybacks to artificially inflate their share price in a down market. My argument has nothing to do with profits or dividends or ownership, just share price.
There is nothing inherently wrong with performing stock buybacks, from a cashflow perspective it is equivalent of paying a dividend, in fact it can be prudent from a tax perspective. You did imply that it is a continuous process when you suggested:
> when the money runs out, the buybacks stop
Performing a stock buyback based off the proceeds of debt in a down market makes perfect sense actually because you can significantly reduce your cost of capital if you believe your future cashflow will be strong enough to continue making coupon payments.
You can issue debt at say 3.5% and buy out shares that require 7% cost of capital and as long as interest rate and credit risk don't drastically deteriorate significantly increase the value of your company from a simple capital markets operation.
If that's what people understood as implied, it was not what I meant to imply and I apologize. What I meant by that was, you can only buy back stocks up until the point where you run out of money. Not that you HAVE to, but if your goal is to manipulate your share price, you can only do it up to the point where you're out of money. If I'm spending money from my savings account, there is no law saying I have to spend all the money in my savings account, just a law saying I can only spent up to the balance in my savings account.
I guess you assumed I was arguing that companies who do buybacks must dump all of their money into buybacks, which I certainly did not mean to imply. Big difference between "able to" and "must".
The point is, if you as a company are trying to manipulate your share price in a down market by buying back stocks and you choose to continue buying your stock until the market rises again, you're taking the risk that you will run out of money before the stock market rises again. At that point your share prices fall no matter what.
> I guess you assumed I was arguing that companies who do buybacks must dump all of their money
No, wrong again. People take issue with your representation of stock buybacks as "short-term market manipulation". The major effect of buybacks comes not (just) from the increase in demand, but from lowering the denominator future profits are divided by. It directly increases earnings per share.
Okay I am done with this thread and everyone (what I can only assume is intentionally) putting words in my mouth that I never said, while ignoring words that I did say.
I never said companies must spend all their money on stock buybacks, yet that argument is being used to paint me like an idiot.
I never said every company who does buybacks is doing it to manipulate the market, yet that argument is being used to paint me like an idiot.
I never said anything about dividends or profits or ownership, in fact I literally said I'm just criticizing companies who do buybacks in order to increase their share price during a down market, yet the argument that "not everyone who does buybacks is manipulating the market" keeps getting thrown at me like that thought has never crossed my mind. I know you think I'm an idiot but I did say words that have meaning and I used those words intentionally to convey the exact meaning that society has agreed those words are supposed to mean. It is not my fault you intentionally choose to ignore those words and their meaning.
I've had enough of it. Either read my words then comment or don't comment at all. I'm sick of this, defending my comments against people who only have bad faith and want to pretend that they're smarter than me because they purposefully misread my comments.
Your entire argument is based on an intentional misreading of words I never said and in direct response to the comment where I argued against that intentional misinterpretation and I'm not engaging with this any more.
A company regains the control and share of profit from the stock they buy back. The one remaining stock holder in that example would not hold 100% of profit or control of McDonalds, they would hold the same percentage of profit and control that their stock certificate was originally issued for.
Edit: Downvoted? Source:
> A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors.
So, then, with only a single owner left, owning the last remaining share: Who else gets parts of the profits, and which other people get to cast votes in elections to the board?
Edit: Quote from your link
By reducing the number of outstanding shares, a company's earnings per share (EPS) ratio is automatically increased – because its annual earnings are now divided by a lower number of outstanding shares.
> While EPS is widely used as a way to track a company’s performance, shareholders do not have direct access to those profits. A portion of the earnings may be distributed as a dividend, but all or a portion of the EPS will be retained by the company.
Would you, please, apply your point to the original statement, namely:
they would hold the same percentage of profit and control that their stock certificate was originally issued for.
Then, pray tell, in your opinion, when a company buys back one of two remaining shares, making you the sole owner of the company, does this
a) Have absolutely no effect on your share
b) makes your share more valuable, because it has become a rare collectors' item
or
c) doubles the future percentage of profits your receive, from 50% to 100%, because irrespective of any profits distributed via dividends or not, the question was only about the share of those profits and not their absolute amount, and even under that strange misreading, even the profits you receive in absolute terms would double under the typical assumption of "all else being equal" and "nobody is really that stupid"
B) No, because there are still plenty of authorized shares being held in reserve by the company that it can reissue.
C) Theoretically yes, because dividends are allocated pro rata on a % basis of outstanding stock (assuming 1 class of common stock). If there are multiple classes, or preferred stock, or the company reissues shares, or a million other things, then this may or may not still be true.
How, can (a) and (c) both be correct, if (a) is “no effect”, and (c) is, in your opinion, “yes it doubles the value, but may have different effects if bla bla...”
It doesn't double the value of his shares. It merely doubles the size of the dividend he receives, assuming that the company doesn't change the size of the dividend to account for having fewer shareholders (which was an explicit part of the hypothetical of the comment I replied to).
In the real world, the company would simply reduce the size of the dividend so his take-home is the same.
> Public float - The portion of a company's outstanding shares that is in the hands of public investors, as opposed to company officers, directors, or controlling-interest investors.
What's your point? Neither the public float nor the shares owned by company officers, directors, or controlling-interest investors are owned by the company.
Shares issued to investors are considered "outstanding" shares. Shares bought back from investors reduce the number of outstanding shares, and usually the bought-back shares go into the pool of "reserved" shares to be re-issued later.
Stock of a corporation is not an indicator of % ownership, especially not for publicly traded companies or companies with multiple classes of stock. % ownership isn't particularly relevant to the corporate form of business; you're probably thinking of the partnership or hybrid business forms (including LLCs) where, due to the pass-through nature of the form, everything flows to the owners on a % basis.
For corporations, very little flows through to the owners directly, so % ownership matters very little on a practical basis. While allocations of dividends are generally based (directly or indirectly) on % ownership of outstanding stock, the stock that carries the most voting rights (i.e., control rights) usually has the lowest dividend participation rights (i.e., profit rights).
When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits.
Technically true, but the company had a choice about how to return profits to investors and chose the buyback over the dividend, so the remaining owners don't get a larger percentage of profits unless the company also issues a dividend. It's generally an either-or these days.
Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.
Not all McD's stock is publicly traded. Moreover, a fair amount of McD's stock cannot be legally sold due to it being owned by ESOPs. That being said, the remaining stock owner would not own 100% of McDs, they would own 1 share of McDs (and 100% of then-outstanding stock). There would still be several million shares authorized and in reserve that could be sold or re-issued at a moment's notice. The decision to sell/re-issue those shares is made by the company, not the owner, and the fact that he theoretically owns 100% of the company at that time is meaningless because he owns only a fractional percent of the company's authorized shares and thus has no actual power.
Who, if anyone, owns the shares that are held in reserve?
Surely they can’t be used to vote, unless they are
held as an asset by the company in the same way the company might hold shares in other companies as assets.
Nobody owns the shares in reserve and while in reserve they have no voting or dividend rights.
While in reserve, they are neither assets or liabilities or really even anything other than a hypothetical number. Many companies used to disclose the number of shares in reserve, so that shareholders were aware of the potential dilution of their investment, but in an era of buybacks, that has become less popular.
As others have pointed out, it is important to evaluate these actions on a company by company basis. On the other hand, if you invest in index funds, then the proportion of who is doing them and why matters a lot.
The worst case scenario is a company with declining market share, that is cash flow negative, and is buying back shares with debt because the executives set their bonuses based on an earnings per share target.
I strongly suggest novice investors is to look at shares outstanding for a company over time. Just as one could claim share buybacks mask a companies problems, you can make a case that issuing new shares steals money from existing shareholders. Indeed, there are public companies which have been around 10+ years and stay afloat solely by creating new shares and have generated 0 return for long term shareholders.
Which is part of why stock buybacks (of one format) have some major upsides: if/when the company decides it wants/needs capital, it can sell shares from its own holdings, and not be issuing new shares
Companies with low growth have a few options (assuming strong cash flow).
1. Distribute cash back to shareholders via buybacks or dividends
2. Increase R&D spending on new initiatives
3. Acquisitions
Buybacks are at least much more tax effective than issuing dividends. Large acquisitions tend to fail and I imagine it could be hard for an established company to regain the "growth mindset" of a startup.
Should a company load up on debt or pursue buybacks way above intrinsic value? Probably not. But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).
> But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).
It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over.
That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature.
At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits.
This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.
Well, if you have that attitude, you won't be CEO for long. Shareholders want return, and get to replace the CEO. So for public companies this doesn't work.
I get your rationale, but you have to remember that this hypothetical company would probably generate a fair amount of cash. The question then becomes, what do they do with that cash? Say a company has a steady state $10B revenue, $2B profit and requires $1B of reinvestment capital with a market cap of $20B. After 5 years, the market cap becomes $25B all things being equal due to an additional $5B of cash on the books. Eventually, the company's value would start to be primarily cash. In a low interest rate environment, it could be hard for this company to make money on this cash, and investors are probably more interested in the company executing its mainlines of business versus turning into a hedge fund to manage of huge cash position. A stock buyback is one way this company could "grow" in revenue and earnings per share, but not have to try and grow top line revenue.
I guess I don't understand the mindset in which having extra cash is some sort of problem to solve. Apple, Microsoft, Cisco, Oracle, Qualcomm, etc. all have large stockpiles of cash and no one thinks of them as hedge funds, right?
Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly.
Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.
Usually true, but they want the optionality of being able to purchase in cash if the buyer demands it. DoubleClick ($3.1B) and Motorola ($12.5B) were both purchased for cash. Not many buyers have $12B in cash sitting around.
Too much cash can also lead to behavioral finance issues down the road as well such as companies making ill-fated acquisitions such as Microsoft did under Ballmer's helm.
Excuse me if this sounds tongue-in-cheek, but is "behavioral finance issues" another way to say that the people placed in charge of the large pile of cash can't be trusted with it? Are you saying the solution to that is to just not to hold any cash?
That fund does not remotely resemble a hedge fund. They strictly invest in low-risk securities (e.g. highly rated government bonds) to generate a modest return and minimize loss against inflation.
Why not give the cash to the owners. That's what stocks are for, right. Doesn't seem like a problem at all. A "low growth" company is a stable company. High growth is high risk.
That's essentially what a stock buyback does. The two options to return earnings to the owners are to issue a dividend, which is taxed at a higher rate or to buy back stock which drives up the value of outstanding shares thus returning value to the shareholders
I've read this explanation (two equivalent choices, one is taxed higher than the other) so many times, but I can't believe there's no downside to stock buybacks. Something about it just feels very wasteful, like picking the fruits of a tree just to grind them into compost for the soil under the same tree.
>like picking the fruits of a tree just to grind them into compost for the soil under the same tree
The difference being that your example would at least enrich the soil and potentially improve future yields (like R&D), while buybacks are essentially just propping up the stock price with no fundamental contribution to future success.
Buybacks only return money to shareholders who choose to sell. Instead of distributing the company’s profits proportionally to its owners, it becomes a game of chicken as each investor has to decide when they should get out.
Well the population of the U.S. is still increasing at about 2% per year, and the global population faster than that, so a company staying the same size is actually shrinking as a proportion of its market.
Assuming an investor owns the stock in a taxable account, dividends are taxed at ordinary income whereas if the stock appreciates due to stock buybacks, it could be taxable as a long-term gain (if held for more than a year).
Interesting I always think of the "income vs capital gains" as a consideration for individual tax payers. I didn't realize it also pertained to corporate purchases of their own stock.
It does pertain to individual tax payers. Tax payers can either pay ordinary income on dividends or capital gains tax on the sale of share with increased value.
Even better is that as long as the shareholder holds, they have increased value, but can defer taxes.
Simplifying things quite a lot, say that you have a share in a stable company priced at $1000. During the year the company makes $50 per share in profits and the price gradually goes up to $1050. The company can pay a dividend: you get $50 and pay taxes on them (and your share is now worth $1000). The company could also use the money to buy its own shares: you still have a share worth $1050 and no tax is due (yet).
This is true. It is always better to return money to shareholders if there aren't any avenues of future growth.
But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.
@freehunter Yes, you were and are quite right. We´re looking at a feedback loop not entirely dissimilar to the one that caused the '29 crash. Only then it was corporates lending to banks to lend to investors to buy shares. I guess this one is a little more direct.
I personally think there are many reasons to be super careful and expect significant glitches in the economy, stock and especially bond markets, etc. in the next few years. We (US) have been on the up leg of the cycle for very long and a lot of people are used to great paper returns and a feeling of wealth that comes with it. They are also not ready for a change and few entertain "what if" scenarios -- kind of like 2006 when professionals were stretching to buy expensive houses on 2 salaries and would argue "no problem -- if one of us loses a job we will sell the house. price dropping 20%? never going to happen".
That said, I also do not see "reward shareholders" as necessarily sinister. Many companies this late in the cycle are sitting on a LOT of cash (income from operations) and do not see enough opportunities to invest in long term growth. Thus they are using it to pay dividends or buy their own stock. In fact, "reward shareholders" is exactly what the company should be doing in such case and neither of this is a sign of the problem. Problems may still happen, but I doubt about buybacks being the primary cause. My 2c.
It's fair to separate the issues of borrowing and stock-buybacks ... specifically because the borrowing has to be based on the credit worthiness of the company, and the stock-buybacks are a separate thing entirely.
Using debt instead of equity is a rational thing for companies to do if debt is really cheap.
The 'higher stock price' as a result of the buybacks is effectively an adjustment of the equilibrium to that fact: the company is taking advantage of cheap sources of financing.
If the company is doing sneaky things like hiding problems, or if the lenders are failing to do due diligence .... then yes, this can be a problem.
Or of companies are over-leveraging - again a potential problem.
But tapping into cheap debt, even combined with stock-buybacks - this could definitely be characterized as an intelligent kind of financial engineering, I don't think that it should be in and of itself viewed as suspicious or negative.
It's just the CFO doing their job, mostly.
Also ... stocks are quite expensive right now by most measures, so I'm not sure how much buybacks make sense in that context at this moment.
There's one worrying trend where companies on the edge of the investment-grade universe lose their standing and turn into high-yield or junk, sending rates — and defaults — significantly higher. And there's a more positive case where the U.S. continues to outperform the rest of the world and corporate debt problems are limited to overseas and specific companies that aren't systemically important.
My money is literally on the optimistic outcome. Just check old headless from 2009-2017 of all the failed predictions of crisis. Odds are nothing will happen. Profit margins for multinationals are at historic highs. Bondholders of investment-grade debt should have little to fear. Junk debt however is riskier obviously and would avoid it.
==Just check old headless from 2009-2017 of all the failed predictions of crisis.==
You could just as easily check the old headlines from 2006-2008 that told us we were in a "Goldilocks" economy and would live in an endless bull market.
Yes, corrections have historically happened far less frequently than growth periods. Unfortunately, they tend to have much greater impact on people's livelihood as they come fast and hard.
Maybe those big profit margins are paid for with debt.
Multinational corporations are extremely innefficient, so I wouldn't be surprised is reality catches up with them eventually.
Corporations are good at capturing money from the economy but they suck at creating value.
here's a much better article on the subject of corporate debt [1]
basically the total amount of corporate debt has jumped, but corporate debt defaults have also decreased sharply
aka corporate debt has become safer, and investors are buying it up because it has been relatively safe and provided attractive returns
if interest rates begin to rise, corporate debt defaults could start increasing, potentially severely. mass defaults could trigger another crisis
"New McKinsey Global Institute research finds that one-quarter of corporate bonds in Brazil, China, and India are from companies that are already at higher risk of default even at today’s low interest rates.
If interest rates were to rise by 200 basis points [2%], that share could rise to as much as 40 per cent. In advanced economies, most corporate borrowers are in good financial shape, but there are pockets of acute vulnerability, for instance, among speculative-grade borrowers, and in certain sectors like energy and retail...
Is the next global financial crisis at hand? We do not think so. Unlike the subprime mortgages that sparked the previous financial crisis, defaults in the corporate bond market are unlikely to have significant ripple effects across the system.
While mortgages were packaged into securitised assets and multiple layers of synthetic securities were built upon them, the same is not true of corporate bonds. Losses will therefore be sustained by the direct bond owners, but the systemic risks seen in the previous crisis are minimal."
i agree, and a 2% increase in interest rates doesn't seem anywhere near possible with today's current combination of low productivity growth, low global capital demand, and easy liquidity (granted QE is starting to wrap up in the EU at least and the US is toying with the idea of raising rates against Trump's will)
of course this is a McKinsey economist/investment manager somewhat talking their book, so draw your own conclusions, but the FT article on the state of the corporate debt is much more well-researched and written
PS subscribe to and read the FT, you won't regret it. this CNBC coverage is complete garbage
"defaults in the corporate bond market are unlikely to have significant ripple effects across the system"
Is there any reason to believe that we have got any better at understanding these kind of effects than before 2008? A lot of people were thinking they were safe in 2008 only to find out that they were just as doomed as everyone else.
The market cap from US companies has grown from 19 to 32 trillion in the same period. [0]
It’s not accurate to look at single variables in isolation. Problems happen when the aggregate debt in an economy exceed the assets behind them, or the capacity to pay them down. [1] If we are there it’s because of govt and consumer (mortgage) debt. On the corporate side I think it’s just balance sheet efficiency. (Can write off debt payments)
An increase in interest rates ~2% could trigger a large number of junk corporate bond defaults, according to the latest McKinsey analysis
The trigger for interest rates rising by that much in a short period of time is not apparent and/or explored in the article, and frankly I don't see one, but that would be the real worry, and would probably have a large, negative effect on junk government bonds as well
Overall corporate debt levels are at record highs, but the bigger problem is highlighted in the article -- the quality of debt has degraded substantially. There are a ton of companies that have been skating along at BBB/BBB- (in S&P parlance) on the brink of junk bond status. If they get downgraded mutual funds have to dump them. This creates downward pressure on debt and makes it harder for those companies to refinance. In turn, this pushes up credit spreads. This is a viscous cycle and it's going to be extremely nasty for anyone holding either high yield debt or equities. That's the debt bomb that should worry investors.
Since we're on HN, this will also make it far harder for entrepreneurs to raise money since there's now a ton of competing high yield debt opportunities for investors to take advantage of. If anyone wants to dump a few million into a really awesome startup before that happens, let me know!
I've come to realize that debt (at the macro level) really doesn't matter at all in our system. In fact higher levels are better because it means people are doing business. It's a completely different thing than personal debt. The direct cause of the depth and breadth of the Great Depression was seeing money as a "thing" that actually exists and must be conserved, rather than the fed QE policies of Bernanke, which saved us during the Great Recession. If anyone can point to a place where a sovereign democracy with reserve currency status ever went bankrupt or suffered ill effects from too much debt, I'd like to see how that worked.
I agree with you. Modern Money Theorists agree too. America can not go bankrupt because America prints its own currency. The very idea of America going bankrupt is nonsensical.
Macro debt means nothing in the age of fiat currencies.
> If anyone can point to a place where a sovereign democracy with reserve currency status ever went bankrupt or suffered ill effects from too much debt
Sovereign nations operating within the global financial system can certainly go bankrupt. But all US debt is denominated in US dollars. It's technically impossible for us to go bankrupt. In fact, you could argue that almost every single modern debt crisis on this list was only possible because of us, and enriched us at the defaulting country's expense. They are almost entirely fueled by foreign debt held in, you guessed it, USD.
What about the case of China? Their debt management demands attention even with the arguably greater monetary control that the government holds. If they didn't care for too much debt, wouldn't they have taken less conservative actions by now?
>What about the case of China? Their debt management demands attention even with the arguably greater monetary control that the government holds. If they didn't care for too much debt, wouldn't they have taken less conservative actions by now?
It's all about bonds. Nobody wants Chinese bonds yet. So no matter how big they are, they still have to play the same global financial game like everyone else and use foreign debt to raise cash. Depending on the current value of their currency against the international reserve (USD), that may or may not be financially viable. When the US needs money, we just say "Hey everyone, buy our bonds. Here's the price."
People buy US bonds because our workers are the most productive, and our political system is the most transparent and stable. A US bond is essentially just a promise from the government that an American worker will produce $X amount of value in the future, and as long as we have the most productive economy per worker hour, our bonds will always be the most valuable. The Eurozone is catching up on that front, and it's why the Euro has exploded as a reserve currency in the last 10 years. But the Yuan has a long, long way to go.
Technically, yes. But if you start print money too recklessly, you will trigger inflation and inflation expectations. Your creditors from abroad will either add heavy markup on future USD debt, or ask for debt in different currency. The only reason this doesn't seem like an immediate threat for US is decades of responsible monetary policy that built trust. US definitely can get in a position it won't be able to sell debt in its own currency.
>The only reason this doesn't seem like an immediate threat for US is decades of responsible monetary policy that built trust. US definitely can get in a position it won't be able to sell debt in its own currency.
I think this line of reasoning is absolutely valid in a purely theoretical framework, where there is an endless supply of possible creditors and perfect market competition. But we live on planet earth, and if you look at the Realpolitik of global trade, the US is uniquely situated to dominate markets no matter what. We have more fresh water than the rest of the planet combined, and more arable land than China or India. It's too productive of an economy, with too many fundamental geographical advantages that position it above any other political entity in the world, that it's impossible to imagine a scenario short of nuclear apocalypse or total political breakdown where the US cannot repay its' debts.
Technically, the US has defaulted in '79... but I think we can agree that was not a true default in the spirit of this conversation.
It doez though illustrate technically and reality are 2 different things.
And the reality is the US can default. While the option is there to endless print money and technically avoid default, should that situation happen, USD will become worth less the more they print. So you end up hitting a point where you essentially issue money of near no value. Once a govt sees this happening it's more realistical they bite the bullet, hit the reset button and default. Because a country needs a functioning currency that people have confidence in to run and recover. No reasonable govt is going to keep issuing money to 'avoid default' at the cost of recovering the economy.
And arguably even if they did, issuing worthless money would in the spirit of debt repayment, be considered a form of default.
That's an interesting theory, but if you are wrong, really bad things can happen, such as global war. And even if we survive a debt-induced crash, currency-related investors won't trust us afterward. I'd sleep better at night if we kept debt under control, and I'm sure investors would also.
It's not that debt doesn't matter. It does. But at the macro level, it works in counter intuitive ways mostly because of the fact that every dollar of debt is someone else's saving (the person the debt is owed to). If you reduce debt by $1T you necessarily reduce savings by $1T. Whether this is good or bad depends on finer details that are rarely discussed in internet forums and that seem only to be fully grasped by the best economists.
I don't suppose you could give us a detailed example of some particular company's/country's debt situation? (Just, since it's rare to find people who can explain that depth)
Well, I'm not an economist and a detailed example would be a lot of work. But here are some points to consider:
- Aggregate financial liability is the flip side of aggregate financial assets. Net financial savings/debt is zero for the economy as a whole. Because of this, looking at particular companies or sectors is very different than looking at the economy as a whole.
- When looking at entire countries especially large ones, there are important aggregate effects so depending on what you are trying to understand, it often makes sense to take an aggregate perspective where this net savings/debt are zero (ignore international imbalances, cross country debt etc. ) .
- Debt is usually denominated in a currency, government debt is particularly intertwined with the behavior of its currency, so it makes sense to take into account central bank regimes, the effect of inflation etc.
-When taking the aggregate, whole economy perspective where net financial assets net to zero, it's important to keep some focus on the non financial assets that makes up the residual non-zero net positive. This is the stock of economic capital: physical intrinsically valuable forms of wealth such as inventory, stockpiles, infrastructure, factories, machinery, tools, knowledge, land, natural resources, production capacity, energy, technological advancement etc... The financial assets, the debt, is just indirect claims on this capital and on the future production you might get from it.
-Since economy wide financial crises are about claims on things, about coupons, about promises that net to zero, they can pretty much always be resolved smoothly through sufficient central banks accommodation that, through inflation, readjust the real value of all these claims to be in line with what is actually reasonably redeemable in a timely manner. However, this can result in some unfair redistribution or painfully high inflation (It's still much less unfair, and much much less painful than widespread defaults and gridlock in the investment and labor markets).
-Central banks are often not competent enough to maintain stability and readjust properly. I don't know what can be done about that. The ECB's performance for example, has been pathetic. It was so procyclical as to almost bring down western civilization IMO, emboldening foes such as Russia and China and utterly destroying Greece and Italy, those poor Europeans. The US Fed has also been somewhat bad, failing to hit its inflation target for years after the financial crisis, a time when it should have been overshooting a little, but has recently been doing better. On the flip side, the Canadian central bank was great during the financial crisis, and saved Canada from a large part of the downsides. Marc Carney who was heading the Bank of Canada, then moved to head the UK's Bank of England and saved the British from Brexit turning into a massive disaster that brought unemployment in the tens or twenties of percents. However, the UKs proximity to the eurozone resulted on some splash damage from the ECB. Australia's money supply has been competently managed. Japan was horrible in the 90s but has been doing better in the last decade. BTW Japan is an interesting case to look at from a debt perspective because its government has by far the highest level of debt per capita.
-The assumption that savings must always have positive real returns, that interest rates must be positive, is one of the most weirdly persistent fallacy in economic debates.
Historically, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of.
Even in societies with financial systems, getting low risk, hassle free, liquid, positive...
I am eagerly awaiting the next bubble. I hope it will be the worst since the great depression. I will
probably lose my job but that's OK - It will be worth it; all the bankrupt corporations and the jailed executives
will need replacements which means more opportunities for everyone else.
The financial position of the United States includes assets of at least $269.6 trillion (1576% of GDP) and debts of $145.8 trillion (852% of GDP) to produce a net worth of at least $123.8 trillion (723% of GDP)[a] as of Q1 2014.
Corporate bonds mature and the principle is paid back. Unlike publicly traded stock, the bond asset never has to be sold on the open market to get rid of it so this part isnt a concern.
If there is a threat that the corporation cannot pay back, or if the corporation merely feels like it, they will issue new bonds and use the proceeds to pay back old ones. Yes it is exactly what it sounds like and there is enough investor appetite for it.
When the corporation’s bond offerings are no longer investment grade then there is less of a chance of their being investor appetite for a future bond rollover and the corporation should try to pay the existing bond.
Therefore the SIZE of the corporate debt outstanding is only clickbait.
This article talks about how there are signs that some companies historically wouldnt be able to tap into bond investor appetite to issue new bonds to cover their cash shortfalls on current bonds. Investor appetite may still be there or the company puts more resources into paying back current bonds in full before they mature, YEARS from now.
Notably this article didnt talk about maturity dates.
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[ 3.7 ms ] story [ 276 ms ] threadHowever, there are cases like IBM raing debt to buy back shares and boost share prices. I have no idea how that will work out for them.
If hypothetically we could see the future perfectly the financial market would start to look downright weird as predestined to fail loans would always be rejected but approved loans would go low margin from competition.
Now think of a dentist who wants to open her own practice. Her savings may not cover the cost of buying equipment that is needed. An asset backed loan may be a better opion for her. Of course, there is a risk involved -- she may not generate enough revenues to cover the cost of servicing the debt or her other liabilities. Typically she would consult with her accountant before starting on this journey.
I would argue thay contractual obligations and regularity and severity with which they are enforced are a sobering influence on businesses. There are no contacts with universe needed for debt -- but there is an element of risk that needs to be accounted for.
edit : typos
Debt restructuring and bankruptcy are things, too. A contractual obligation isn't immutable or inviolable.
Nope. I was just using an example. It could have been $100k and only $50K was lent out. You sill would need $105k at the end of the year to satisfy all debts and have an equilibrium within the economy. Where is the extra $5K coming from? Magic??
> The reality is that most companies borrow money only when the availability of extra capital would help them generate more revenues or capture additional market share.
This doesn't change the fact that the demand back for money will exceed the actually money supply.
It is simple math really. The fact that they are using the cash to, hopefully, generate more revenues is irrelevant.
Private companies have no control over the the supply of money. This is a central banking problem.
I mean have never even thought about it?
>What happens when there are new entrants to your economy?
Nothing.
>Are they all forced to split the 100k?
No, if the new entrant can provide value then someone that already has some that $100K can give it to them for a good or service.
>If not, where does new money come from? Magic?
Comes from the Federal Reserve, when they decided to increase the money supply. The problem is you are on a never ending treadmill that is designed to have bubbles and failures, not that new money has to sometimes be created.
Wait, really? I was pretty convinced that the vast majority of new money is created by private banks, when they decide to loan out money that nobody has paid in. It's called fractional reserve banking.
this makes very little sense. You are not lending the entire economy and then demanding more than the economy be paid back. You only lend a portion of the money supply so that a slightly larger portion is repaid.
Even if that were the case, isnt that what QE does?
You are right that you are not lending the entire economy, I was just making the example as simple as possible. But, the second interest is being charged then the demand of money back exceeds the actual money supply. What companies and investors do to increase revue for 1 particular organization has no effect on the money supply. All companies are doing are vying to try and redistribute the money that already exists in their favor, they aren't creating money (if they are that is called counterfeiting and is illegal).
> Even if that were the case, isn't that what QE does?
Yes, QE increases the money supply. I am not saying that the money supply doesn't get increased (by the Federal Reserve), merely pointing out the fact that once you get on this treadmill it just goes faster and faster and faster, and there is no way to get off without a disaster (bubble).
Not true, and I'm having a hard time finding your argument. You think if I loan you 1$ at 0% that's fine, but 1$ at 1% now exceeds the world's money supply? Even debt > total money supply is payable as long as interest payments are < payments being made.
> once you get on this treadmill it just goes faster and faster and faster, and there is no way to get off without a disaster (bubble).
Not strictly true. I have taken on debt with interest and paid that debt. Why is a disaster needed?
Yes, whether this is sustainable does depend on increased economic activity. Which is why it's so important to lend for (sustainable) productivity growth or you get a bubble which creates liquidity problems when it pops.
Companies borrow money in order to invest in their own growth. Borrowing allows increased growth rate and in turn increased spending which has follow-on effects downstream (this is called the money multiple).
I very much enjoyed taking the intro Micro and Macroeconomics classes as part of my Econ degree. There are probably even great courses online for free now. I’d highly recommend it.
The extra $5K come from the same place the initial $100k came.
Companies, and their profits, can't and don't create cash out of thin air. That isn't how the money supply works. This is a central banking problem.
Value != money supply
If the economy is growing, it is true that continual money creation is required to stop deflation, but a lot of people don’t realise to what extent because it isn’t commonly known that not only can the Government create money, but that in fact all bank lending does and is expansionary [1].
1. https://www.bankofengland.co.uk/-/media/boe/files/quarterly-...
- A loans $100K to B at 10%.
- B buys raw materials from A for $100K and creates products X and Y.
- A buys product X from B for $60K.
- B returns $60K to A.
- A buys product Y from B for $60K.
- B returns $50K to B.
A ends up with $90K and product X and Y. B ends up with $10K. At no step was money created out of thin air. Total supply still $100K.
You could simplify it some more by allowing B to pay back A using product X and Y instead of moving $60K around back and forth.
- A loans $100K to both B and C at 10%.
- B makes X and Y, C make Q and R.
- B and C can produce and sell X,Y,Q, and R to one another to their mutual hearts content, creating a lot of value, but in the end A can only be satisfied by $220K. Either B or C is going to end up short.
Why would A accept X or Y when it's detrimental to their business interests to do so?
Lets assume the product that B makes has a value which allows a 50% gross margin
A loans $100K cash to B at 10% markup (total value of system= 100K)
B buys raw material from A for 100K cash (total value of system now 200K as a magic 100K of raw materials were just added)
B creates product X and Y, now worth 200K (system is now at 300K)
A buys 60K of product X with cash (doesnt change value of system)
A cannot buy 60K of product Y with cash, though the total value of the system has increased.
There isnt enough cash in the system to settle all debts, but the total value of the system has increased. Cash would need to be printed to cover debts.
Fiat currency to some extent is balanced against the total GDP of the US.
That's the supply side consideration of the price of debt, but interest, like all prices, is determined by intersection of supply and demand, not supply alone.
Demand side consideration is “what new income in the future does taking on this debt now enable?”
It brings to mind a reducto ad absurdum of fixed currency amounts with massive deflation where your grandfather's couch cushion change is worth more than a new couch as why absolute fixed currencies are unviable.
Spending money doesn't destroy it, it can be spent more than once in a year; even with no additional money, you just need higher velocity of money for their to be more money spent in one year than another. The extra $10K doesn't need to come from anywhere, the same way the base $100K (which was already spent the first year and thus "consumed" if you mistakenly assume money is single-use) doesn't.
If you do indeed lend 100k$ from a central bank and they "print" the money then the money supply increases by 100k$ for the duration of the loan. When you pay it back the money vanishes into nothingness again. Interest payments go to the central bank which makes a profit, governments spend the income and the money starts circulating within the economy again. [1]
[1] https://www.ecb.europa.eu/explainers/tell-me-more/html/ecb_p...
https://youtu.be/5baKgv7Zl5g
http://www.usdebtclock.org
I wasn't the one who downvoted you but as a fyi... this particular article is about corporate debt. MMT is about government debt.
When non-government entities such as businesses and consumers take on too much debt that they can't service, bad economic things happen.
The Fed will be pressured to reduce interest rates because corporations are playing Russian roulette too-big-to-fail brinksmanship and will expect a bailout as per usual.. an action the majority undertake will always be excused in a democracy because of political pressure.
The private sector wants Government bonds. If they won’t buy all of them at the interest rate the Government wants to sell them for, there’s no practical reason they can’t just sell excess bonds to the central bank (except for silly policy in some countries).
But yeah, the parent comment is confused, corporate debt (and private debt in general) is the real looming threat to worry about in a currency-issuing country that only issues bonds denominated in their own currency (such as the US) - not the Government deficit or debt.
Let me stop you right there.
Total corporate debt has swelled from nearly $4.9 trillion in 2007 as the Great Recession was just starting to break out to nearly $9.1 trillion halfway through 2018, quietly surging 86 percent, according to Securities Industry and Financial Markets Association data. Other than a few hiccups and some fairly substantial turbulence in the energy sector in late-2015 and 2016, the market has performed well.
"Reward shareholders" is code for stock buybacks - the practice of a company using ultra-low interest financing to buy its own stock on margin. It's an unsustainable way to manipulate the price/earnings ratio, and thereby make a company look like a better buy than it is.
Buybacks in turn have been a major source of funding for the stock market's unprecedented run:
https://seekingalpha.com/article/4156578-buyback-bubble-will...
I suspect those looking for a soft landing here haven't considered the reversible nature of this debt-fueled stock market rally. Nor have they considered the amplifying effect of debt on the upside and downside.
https://www.bloomberg.com/news/articles/2017-09-05/apple-ret...
Anytime a company pays a dividend AND increases their outstanding debt in the same time period, you could draw ths conclusion that they financed the dividend using debt.
Check out the financials for Vector group...
https://finance.yahoo.com/quote/VGR/financials?p=VGR
On the summary page you can see they pay about a 15% dividend. On their income statement you can see their net income is less than $100 million USD. On the balance sheet, you can see the long term debt has increased by a serveral hundred million over the last few years. That dividend sure sounds like it is financed by debt, although you'd have to dig into what is really going on to know for sure.
This article is from 2012 but illustrates the point (it's also why I left the company, they restructured debt, issued a dividend which, even though they're publicly traded they were(are?) 75% held by Carlysle Group so it was basically a self bonus, then cut employee benefits) https://www.forbes.com/sites/abrambrown/2012/07/11/booz-alle...
It’s just the opposite of issuing stock. Even when done with borrowed money, it is simply replacing one source of funding (investment) with another (debt). When interest rates are low, the latter becomes attractive. If/when they rise, trouble may ensue. But for a profitable company, the normal, entirely adequate, reaction would just be the reverse transaction, retiring the remaining debt with newly issued stock.
How is a declining market threatening a profitable company that, at some point in its past, bought back shares? There are no on-going financial commitments a company has that are tied to the daily fluctuations of the stock market.
Even if they have taken on debt to finance a buyback, a future decline of the stock market has no bearing on them, except to possibly make it less lucrative to issue new stock.
As long as they make a profit in their core business, and those profits allow them to pay the 3% or 4% interest on any debt, they are completely save. A rise in interest rates does have a meaningful impact here, yes. But (a) interest rates have been rather stable for going on 40 years now, and this is a well-known risk that is an obvious part of any decision to take on debt. It can, and often is, also be hedged by agreeing to fixed interest rates, or hedging.
The unsustainable part is giving investors the impression that, while the Dow plunges 500 points, your stock remains stable. Then when your buybacks stop and your shares plummet with the rest of the market, it gives the impression that something suddenly happened and your company is in a dire situation.
Either you keep buying shares to inflate the value (which gets expensive) or you stop and accept that your shares will go down (which looks worse now that your stock price has not declined with the rest of the market). Either way, if you're using buybacks to keep your stock price up in a market that's down, you're going to get burned eventually.
If they want to reward shareholders, they can issue a dividend. If they think the company will grow, the can invest in growth. The "argument" made is that companies think their stock is undervalued by the market and want to capture that price growth. Why would so many companies think their stocks are "undervalued" in 2018 after a 10 year bull market?
Before 1982, we viewed buybacks as market manipulation and it was illegal [1]. In reality, companies do this in order to increase their stock price and earnings per share, the two things for which executives are typically compensated. If you take the same earnings and divide over fewer shares, you have magically increased your EPS without improving the actual business.
[1] https://www.forbes.com/sites/aalsin/2017/02/28/shareholders-...
Equity carries more risk, because stockholder are paid after bondholder in the event of bankruptcy. Therefore, equity investors (stockholders) demand higher returns than lenders. Depending on a few other factors, borrowing is the better option to raise operational capital than issuing stock. Conversely, when your need for capital decreases, you no longer want to pay for it.
And just as you may repay a loan (early) in that case (if you are debt-financed), you may buy back shares, if you are financed by equity.
You're betting that your company's financials and stock price will improve, so you get debt to buy back the stock. It's no different than an individual getting into debt to buy say Nvidia stock because they think the price of the stock will keep rising. This is always a mistake in the long term, and it should be discouraged - for both individuals and companies.
It's even worse when you see companies like Apple with tens or hundreds of billions of dollars in cash getting debt to buy back its stock. Come on. This is a disaster waiting to happen. We shouldn't have to wait until the economy slows down/a recession arrives to figure this one out. It's clearly dysfunctional/a bad thing to have in an economy.
The wisdom of privately buying stock with debt stems from a consideration of the risks involved. But a company is going to shoulder its risk of operations, no matter how you turn it.
I also don't get your criticism of Apple's practice: It's well understood that it happened for tax considerations, and surely them holding billions of dollars in cash cannot, in anyway, be worse than not having billions of dollars in cash? In any case, the current tax "amnesty" seems to be in the process of resolving that particular accounting nightmare of yours.
A smarter investor would acquire large stakes in companies capable of issuing debt and lobby the boards to perform buybacks, allowing a form of corporate raiding with less capital invested and dramatically more reward.
Both of these strategies rely on the greater fool hypothesis, but in a period with historically low interest rates and an implicit hedge that the fed would stimy any wide spread defaults it's a valid investment strategy.
Anyone who doesn't see that is going to be caught off guard when the money runs out, the buybacks stop, and the market crashes "overnight". In reality, the market is crashing right now, it's just hidden behind trickery designed to artificially inflate the value of the market. It's like if I lost my job but kept financing my same lifestyle out of my savings account. Eventually that savings will run out and reality will hit like a ton of bricks, and no one will have seen it coming.
[1] https://www.fool.com/investing/general/2014/12/05/share-buyb...
[2] https://www.fool.com/investing/2018/12/09/why-investors-shou...
When a company buys their own stock, there are simply fewer shares free-floating, in the hands of owners. The company's profits therefore are divided among a smaller group, and each share receives a larger percentage of those profits.
Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.
All this requires no ongoing buybacks from the company. You do it once, and because the denominator shrinks, each stock appraises. After that, as long as profits remain stable, earnings per share will, and so should, absent external factors, the stock price.
>a company buys their own stock... [and] each stock appraises
That lines up exactly with what I've described. If you're saying I'm wrong, you're going to have to be more specific because I don't see where we disagree.
There is nothing inherently wrong with performing stock buybacks, from a cashflow perspective it is equivalent of paying a dividend, in fact it can be prudent from a tax perspective. You did imply that it is a continuous process when you suggested:
> when the money runs out, the buybacks stop
Performing a stock buyback based off the proceeds of debt in a down market makes perfect sense actually because you can significantly reduce your cost of capital if you believe your future cashflow will be strong enough to continue making coupon payments. You can issue debt at say 3.5% and buy out shares that require 7% cost of capital and as long as interest rate and credit risk don't drastically deteriorate significantly increase the value of your company from a simple capital markets operation.
I guess you assumed I was arguing that companies who do buybacks must dump all of their money into buybacks, which I certainly did not mean to imply. Big difference between "able to" and "must".
The point is, if you as a company are trying to manipulate your share price in a down market by buying back stocks and you choose to continue buying your stock until the market rises again, you're taking the risk that you will run out of money before the stock market rises again. At that point your share prices fall no matter what.
No, wrong again. People take issue with your representation of stock buybacks as "short-term market manipulation". The major effect of buybacks comes not (just) from the increase in demand, but from lowering the denominator future profits are divided by. It directly increases earnings per share.
I never said companies must spend all their money on stock buybacks, yet that argument is being used to paint me like an idiot.
I never said every company who does buybacks is doing it to manipulate the market, yet that argument is being used to paint me like an idiot.
I never said anything about dividends or profits or ownership, in fact I literally said I'm just criticizing companies who do buybacks in order to increase their share price during a down market, yet the argument that "not everyone who does buybacks is manipulating the market" keeps getting thrown at me like that thought has never crossed my mind. I know you think I'm an idiot but I did say words that have meaning and I used those words intentionally to convey the exact meaning that society has agreed those words are supposed to mean. It is not my fault you intentionally choose to ignore those words and their meaning.
I've had enough of it. Either read my words then comment or don't comment at all. I'm sick of this, defending my comments against people who only have bad faith and want to pretend that they're smarter than me because they purposefully misread my comments.
Your entire argument is based on an intentional misreading of words I never said and in direct response to the comment where I argued against that intentional misinterpretation and I'm not engaging with this any more.
Edit: Downvoted? Source:
> A buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors.
https://www.investopedia.com/ask/answers/042015/why-would-co...
Edit: Quote from your link
By reducing the number of outstanding shares, a company's earnings per share (EPS) ratio is automatically increased – because its annual earnings are now divided by a lower number of outstanding shares.
https://www.investopedia.com/terms/e/eps.asp
Would you, please, apply your point to the original statement, namely:
they would hold the same percentage of profit and control that their stock certificate was originally issued for.
Then, pray tell, in your opinion, when a company buys back one of two remaining shares, making you the sole owner of the company, does this
a) Have absolutely no effect on your share
b) makes your share more valuable, because it has become a rare collectors' item
or
c) doubles the future percentage of profits your receive, from 50% to 100%, because irrespective of any profits distributed via dividends or not, the question was only about the share of those profits and not their absolute amount, and even under that strange misreading, even the profits you receive in absolute terms would double under the typical assumption of "all else being equal" and "nobody is really that stupid"
B) No, because there are still plenty of authorized shares being held in reserve by the company that it can reissue.
C) Theoretically yes, because dividends are allocated pro rata on a % basis of outstanding stock (assuming 1 class of common stock). If there are multiple classes, or preferred stock, or the company reissues shares, or a million other things, then this may or may not still be true.
In the real world, the company would simply reduce the size of the dividend so his take-home is the same.
No, a corporation cannot own itself.
http://www.investorwords.com/3936/public_float.html
The certificates says how many shares the person owns, not the percentage of the company they represent.
Shares issued to investors are considered "outstanding" shares. Shares bought back from investors reduce the number of outstanding shares, and usually the bought-back shares go into the pool of "reserved" shares to be re-issued later.
Stock of a corporation is not an indicator of % ownership, especially not for publicly traded companies or companies with multiple classes of stock. % ownership isn't particularly relevant to the corporate form of business; you're probably thinking of the partnership or hybrid business forms (including LLCs) where, due to the pass-through nature of the form, everything flows to the owners on a % basis.
For corporations, very little flows through to the owners directly, so % ownership matters very little on a practical basis. While allocations of dividends are generally based (directly or indirectly) on % ownership of outstanding stock, the stock that carries the most voting rights (i.e., control rights) usually has the lowest dividend participation rights (i.e., profit rights).
Technically true, but the company had a choice about how to return profits to investors and chose the buyback over the dividend, so the remaining owners don't get a larger percentage of profits unless the company also issues a dividend. It's generally an either-or these days.
Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.
Not all McD's stock is publicly traded. Moreover, a fair amount of McD's stock cannot be legally sold due to it being owned by ESOPs. That being said, the remaining stock owner would not own 100% of McDs, they would own 1 share of McDs (and 100% of then-outstanding stock). There would still be several million shares authorized and in reserve that could be sold or re-issued at a moment's notice. The decision to sell/re-issue those shares is made by the company, not the owner, and the fact that he theoretically owns 100% of the company at that time is meaningless because he owns only a fractional percent of the company's authorized shares and thus has no actual power.
Who, if anyone, owns the shares that are held in reserve?
Surely they can’t be used to vote, unless they are held as an asset by the company in the same way the company might hold shares in other companies as assets.
Do they exist on the balance sheet?
While in reserve, they are neither assets or liabilities or really even anything other than a hypothetical number. Many companies used to disclose the number of shares in reserve, so that shareholders were aware of the potential dilution of their investment, but in an era of buybacks, that has become less popular.
The worst case scenario is a company with declining market share, that is cash flow negative, and is buying back shares with debt because the executives set their bonuses based on an earnings per share target.
I strongly suggest novice investors is to look at shares outstanding for a company over time. Just as one could claim share buybacks mask a companies problems, you can make a case that issuing new shares steals money from existing shareholders. Indeed, there are public companies which have been around 10+ years and stay afloat solely by creating new shares and have generated 0 return for long term shareholders.
1. Distribute cash back to shareholders via buybacks or dividends
2. Increase R&D spending on new initiatives
3. Acquisitions
Buybacks are at least much more tax effective than issuing dividends. Large acquisitions tend to fail and I imagine it could be hard for an established company to regain the "growth mindset" of a startup.
Should a company load up on debt or pursue buybacks way above intrinsic value? Probably not. But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).
It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over.
That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature.
At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits.
This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.
Could it be that the expectation for all companies, everywhere to grow at a constant rate is not reasonable?
Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.
They didn't just write a check for $19B.
https://qz.com/393093/the-mysterious-fund-in-the-desert-that...
Too much cash can also lead to behavioral finance issues down the road as well such as companies making ill-fated acquisitions such as Microsoft did under Ballmer's helm.
The difference being that your example would at least enrich the soil and potentially improve future yields (like R&D), while buybacks are essentially just propping up the stock price with no fundamental contribution to future success.
Why are buybacks much more tax effective? Is this due to the way the accounting is done on them?
https://mebfaber.com/2016/05/02/much-dividends-costing/
>>> In a taxable account dividends could have cost you anywhere from 0.3% to over 3.0% in returns PER YEAR since 1974.
Even better is that as long as the shareholder holds, they have increased value, but can defer taxes.
This is true. It is always better to return money to shareholders if there aren't any avenues of future growth.
But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.
That said, I also do not see "reward shareholders" as necessarily sinister. Many companies this late in the cycle are sitting on a LOT of cash (income from operations) and do not see enough opportunities to invest in long term growth. Thus they are using it to pay dividends or buy their own stock. In fact, "reward shareholders" is exactly what the company should be doing in such case and neither of this is a sign of the problem. Problems may still happen, but I doubt about buybacks being the primary cause. My 2c.
Using debt instead of equity is a rational thing for companies to do if debt is really cheap.
The 'higher stock price' as a result of the buybacks is effectively an adjustment of the equilibrium to that fact: the company is taking advantage of cheap sources of financing.
If the company is doing sneaky things like hiding problems, or if the lenders are failing to do due diligence .... then yes, this can be a problem.
Or of companies are over-leveraging - again a potential problem.
But tapping into cheap debt, even combined with stock-buybacks - this could definitely be characterized as an intelligent kind of financial engineering, I don't think that it should be in and of itself viewed as suspicious or negative.
It's just the CFO doing their job, mostly.
Also ... stocks are quite expensive right now by most measures, so I'm not sure how much buybacks make sense in that context at this moment.
I'm curious why this would be done on margin. Are they using call options then for their own stock?
My money is literally on the optimistic outcome. Just check old headless from 2009-2017 of all the failed predictions of crisis. Odds are nothing will happen. Profit margins for multinationals are at historic highs. Bondholders of investment-grade debt should have little to fear. Junk debt however is riskier obviously and would avoid it.
Past performance doesnt indicate future performance.
Also, Odds are, we will have a recession at some point. Not sure what you are trying to say with "Odds are nothing will happen".
You could just as easily check the old headlines from 2006-2008 that told us we were in a "Goldilocks" economy and would live in an endless bull market.
Why not "bubble is growing"?
"Volcano is bubbling"?
"Bomb is ticking"?
https://en.wikipedia.org/wiki/Tulip_mania
My comment is lighthearted - I'm just saying they mixed metaphors.
Yes baking soda and vinegar put in plastic bag and watch bubbles till it explodes.
basically the total amount of corporate debt has jumped, but corporate debt defaults have also decreased sharply
aka corporate debt has become safer, and investors are buying it up because it has been relatively safe and provided attractive returns
if interest rates begin to rise, corporate debt defaults could start increasing, potentially severely. mass defaults could trigger another crisis
"New McKinsey Global Institute research finds that one-quarter of corporate bonds in Brazil, China, and India are from companies that are already at higher risk of default even at today’s low interest rates.
If interest rates were to rise by 200 basis points [2%], that share could rise to as much as 40 per cent. In advanced economies, most corporate borrowers are in good financial shape, but there are pockets of acute vulnerability, for instance, among speculative-grade borrowers, and in certain sectors like energy and retail...
Is the next global financial crisis at hand? We do not think so. Unlike the subprime mortgages that sparked the previous financial crisis, defaults in the corporate bond market are unlikely to have significant ripple effects across the system.
While mortgages were packaged into securitised assets and multiple layers of synthetic securities were built upon them, the same is not true of corporate bonds. Losses will therefore be sustained by the direct bond owners, but the systemic risks seen in the previous crisis are minimal."
i agree, and a 2% increase in interest rates doesn't seem anywhere near possible with today's current combination of low productivity growth, low global capital demand, and easy liquidity (granted QE is starting to wrap up in the EU at least and the US is toying with the idea of raising rates against Trump's will)
of course this is a McKinsey economist/investment manager somewhat talking their book, so draw your own conclusions, but the FT article on the state of the corporate debt is much more well-researched and written
PS subscribe to and read the FT, you won't regret it. this CNBC coverage is complete garbage
[1] https://www.ft.com/content/bc1d327a-91c1-11e8-bb8f-a6a2f7bca...
Is there any reason to believe that we have got any better at understanding these kind of effects than before 2008? A lot of people were thinking they were safe in 2008 only to find out that they were just as doomed as everyone else.
Was said about the mortgages too.
It’s not accurate to look at single variables in isolation. Problems happen when the aggregate debt in an economy exceed the assets behind them, or the capacity to pay them down. [1] If we are there it’s because of govt and consumer (mortgage) debt. On the corporate side I think it’s just balance sheet efficiency. (Can write off debt payments)
[0] https://data.worldbank.org/indicator/CM.MKT.LCAP.CD?start=20...
[1] https://en.m.wikipedia.org/wiki/Minsky_moment
The trigger for interest rates rising by that much in a short period of time is not apparent and/or explored in the article, and frankly I don't see one, but that would be the real worry, and would probably have a large, negative effect on junk government bonds as well
https://www.mckinsey.com/business-functions/strategy-and-cor...
Since we're on HN, this will also make it far harder for entrepreneurs to raise money since there's now a ton of competing high yield debt opportunities for investors to take advantage of. If anyone wants to dump a few million into a really awesome startup before that happens, let me know!
Macro debt means nothing in the age of fiat currencies.
Plenty of them: https://en.wikipedia.org/wiki/List_of_sovereign_debt_crises
Reserve currency is the key word here.
Sovereign nations operating within the global financial system can certainly go bankrupt. But all US debt is denominated in US dollars. It's technically impossible for us to go bankrupt. In fact, you could argue that almost every single modern debt crisis on this list was only possible because of us, and enriched us at the defaulting country's expense. They are almost entirely fueled by foreign debt held in, you guessed it, USD.
It's all about bonds. Nobody wants Chinese bonds yet. So no matter how big they are, they still have to play the same global financial game like everyone else and use foreign debt to raise cash. Depending on the current value of their currency against the international reserve (USD), that may or may not be financially viable. When the US needs money, we just say "Hey everyone, buy our bonds. Here's the price."
People buy US bonds because our workers are the most productive, and our political system is the most transparent and stable. A US bond is essentially just a promise from the government that an American worker will produce $X amount of value in the future, and as long as we have the most productive economy per worker hour, our bonds will always be the most valuable. The Eurozone is catching up on that front, and it's why the Euro has exploded as a reserve currency in the last 10 years. But the Yuan has a long, long way to go.
I think this line of reasoning is absolutely valid in a purely theoretical framework, where there is an endless supply of possible creditors and perfect market competition. But we live on planet earth, and if you look at the Realpolitik of global trade, the US is uniquely situated to dominate markets no matter what. We have more fresh water than the rest of the planet combined, and more arable land than China or India. It's too productive of an economy, with too many fundamental geographical advantages that position it above any other political entity in the world, that it's impossible to imagine a scenario short of nuclear apocalypse or total political breakdown where the US cannot repay its' debts.
It doez though illustrate technically and reality are 2 different things.
And the reality is the US can default. While the option is there to endless print money and technically avoid default, should that situation happen, USD will become worth less the more they print. So you end up hitting a point where you essentially issue money of near no value. Once a govt sees this happening it's more realistical they bite the bullet, hit the reset button and default. Because a country needs a functioning currency that people have confidence in to run and recover. No reasonable govt is going to keep issuing money to 'avoid default' at the cost of recovering the economy.
And arguably even if they did, issuing worthless money would in the spirit of debt repayment, be considered a form of default.
- Aggregate financial liability is the flip side of aggregate financial assets. Net financial savings/debt is zero for the economy as a whole. Because of this, looking at particular companies or sectors is very different than looking at the economy as a whole.
- When looking at entire countries especially large ones, there are important aggregate effects so depending on what you are trying to understand, it often makes sense to take an aggregate perspective where this net savings/debt are zero (ignore international imbalances, cross country debt etc. ) .
- Debt is usually denominated in a currency, government debt is particularly intertwined with the behavior of its currency, so it makes sense to take into account central bank regimes, the effect of inflation etc.
-When taking the aggregate, whole economy perspective where net financial assets net to zero, it's important to keep some focus on the non financial assets that makes up the residual non-zero net positive. This is the stock of economic capital: physical intrinsically valuable forms of wealth such as inventory, stockpiles, infrastructure, factories, machinery, tools, knowledge, land, natural resources, production capacity, energy, technological advancement etc... The financial assets, the debt, is just indirect claims on this capital and on the future production you might get from it.
-Since economy wide financial crises are about claims on things, about coupons, about promises that net to zero, they can pretty much always be resolved smoothly through sufficient central banks accommodation that, through inflation, readjust the real value of all these claims to be in line with what is actually reasonably redeemable in a timely manner. However, this can result in some unfair redistribution or painfully high inflation (It's still much less unfair, and much much less painful than widespread defaults and gridlock in the investment and labor markets).
-Central banks are often not competent enough to maintain stability and readjust properly. I don't know what can be done about that. The ECB's performance for example, has been pathetic. It was so procyclical as to almost bring down western civilization IMO, emboldening foes such as Russia and China and utterly destroying Greece and Italy, those poor Europeans. The US Fed has also been somewhat bad, failing to hit its inflation target for years after the financial crisis, a time when it should have been overshooting a little, but has recently been doing better. On the flip side, the Canadian central bank was great during the financial crisis, and saved Canada from a large part of the downsides. Marc Carney who was heading the Bank of Canada, then moved to head the UK's Bank of England and saved the British from Brexit turning into a massive disaster that brought unemployment in the tens or twenties of percents. However, the UKs proximity to the eurozone resulted on some splash damage from the ECB. Australia's money supply has been competently managed. Japan was horrible in the 90s but has been doing better in the last decade. BTW Japan is an interesting case to look at from a debt perspective because its government has by far the highest level of debt per capita.
-The assumption that savings must always have positive real returns, that interest rates must be positive, is one of the most weirdly persistent fallacy in economic debates. Historically, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of. Even in societies with financial systems, getting low risk, hassle free, liquid, positive...
https://en.wikipedia.org/wiki/Financial_position_of_the_Unit...
If there is a threat that the corporation cannot pay back, or if the corporation merely feels like it, they will issue new bonds and use the proceeds to pay back old ones. Yes it is exactly what it sounds like and there is enough investor appetite for it.
When the corporation’s bond offerings are no longer investment grade then there is less of a chance of their being investor appetite for a future bond rollover and the corporation should try to pay the existing bond.
Therefore the SIZE of the corporate debt outstanding is only clickbait.
This article talks about how there are signs that some companies historically wouldnt be able to tap into bond investor appetite to issue new bonds to cover their cash shortfalls on current bonds. Investor appetite may still be there or the company puts more resources into paying back current bonds in full before they mature, YEARS from now.
Notably this article didnt talk about maturity dates.