No Bailout for Stock Buybacks
Credit: The Daily Star

No Bailout for Stock Buybacks

by Daniel Lubienietzky - March 18, 2020

If history does not repeat itself, it certainly does rhyme. It feels like yesterday that the very controversial 2008 US bank bailout for $700 billion was being debated. At the time the financial world was facing a perceived armageddon and it seemed the only way to avoid the abyss was to bring to life moral hazard and nationalize the banks' losses.

The result of course was far from ideal. Banks for the most part did avoid collapse, however credit markets froze nonetheless and the US stock market fell a further 30% to finally bottom five months later in March 2009. In the years following the crash, the recovery consisted of many of the plays that caused the bubble in the first place. Central banks kept short-term interest rates lower for longer than the previous decade, creating a far larger debt bubble in all sectors public, corporate, and household than before the crash.

Effective Federal Funds Rate (1990-2020)

Effective Funds Rate

Total Debt Securities All Sectors (1990-2020)

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Low interest rates incentivize borrowing and stock buybacks and disincentive saving and paying off debt.

This access to ultra-low interest debt financing for corporations has created a massive stock buyback feast that has left corporations with severely weakened balance sheets, unable to weather short-term demand shocks. According to a 2019 Bank of America report, over the past five years US companies bought back $2.7 trillion of their own stock while simultaneously taking on $2.5 trillion in additional debt.

Of the earnings that are actually coming in, the vast majority of it is simply being returned to shareholders by way of buybacks and dividends instead of being reinvested for future projects and R&D. Harvard Business Review stated in January that between 2009 and 2018, the 465 companies that were in the S&P 500 for the previous decade spent $4.3 trillion on buybacks and $3.3 trillion on dividends, representing 52% and 39% of net income respectively, leaving only 9% remaining. 2018 maybe have been the most egregious, where buybacks accounted for 68% and dividends for 41% of net income; all while corporate earnings were at all-time highs due to US President Trump’s record-sizeed one-time corporate tax cut in 2017.         

Management gamed earnings per share with buybacks for higher bonuses

The reasoning for such poor fiduciary decision making by managers is simple. Stock buybacks increase a company’s earnings per share, which is a key metric for determining management compensation. By reducing the number of shares outstanding with ultra-low-cost debt, management can increase earnings per share even in an economic environment where earnings are barely growing.

"Global financial crisis, part deux" - it's a working title

This brings us to today. The world faces a widespread public health emergency which has caused a massive negative demand shock and has significantly reduced economic activity; putting many companies, employees, and households in financial strain. Many of the hardest hit companies are airlines and cruise operators which are facing complete revenue collapse as global travel grinds to a halt. Airlines happen to be some of the biggest culprits of debt-fueled stock buybacks and are now wishing they had that cash.

Airlines have been the worst culprits of debt fueled stock buybacks

Bloomberg revealed this week that the biggest US airlines spent 96% of their free cash flow in the last decade on buying back their own stock. American Airlines spent $12.5 billion buying back its own stock over the last decade while having negative cumulative free cash flow, therefore not only did all their earnings go to buybacks but they took on additional debt to buy back shares. Another large US airline, United Airlines spent 80% of their free cash flow on buybacks during the last decade. All while the S&P 500 Index allocated 50% of its free cash flow to stock buybacks.

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In total, the five largest air carriers in the US bought back nearly $45 billion worth of stock since 2009. This is almost the same size as the requested $50 billion bailout for which the airline industry is asking of the US government.

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They bought stock when times were good, they should sell stock when times are bad.

It is inconceivable that taxpayers should be footing the bill for corporations like the airlines and others that have spent the last decade buying back tens of billions of dollars of their own stock only to find themselves unable to meet their short term obligations in a demand shock. How is it anything but logical that companies that had extra cash and decided to buy back stock instead of pay down debt or shore up reserves shouldn’t be forced to sell stock when faced with a cash crunch?

Privatizing gains and nationalizing losses

President Trump famously said in his 2019 State of the Union Address that “America will never be a socialist country.” However, as the famous aphorism ‘there are no atheists in foxholes’ goes, so too can one say ‘there are no capitalists in financial crises.’

The newborn will be named: Moral Hazard! (b. October 3, 2008)

Corporate executives learned from the 2008 bank bailout that if their corporations were considered “too big to fail,” they would always be rescued from collapse by taxpayers, no matter how financially irresponsible they act. Now executives from airlines, cruise lines, Boeing, shale oil, and others are all asking the US federal government for financial assistance after having wasted all their excess cash on stock buybacks instead of paying down debt or shoring up reserves.

Speak Up!

If you are like me and still believe in free markets, this privatization of gains and nationalization of losses should trouble you greatly. I do believe that employees, suppliers, and some senior secured creditors should get some relief as this global demand shock may place them at significant peril. However, any taxpayer bailout for stakeholders further down the capital stack, particularly common equity shareholders is completely unacceptable and should be protested. Corporations should be forced to sell equity to shore up cash reserves if debt financing is not available to them. If this means common equity gets wiped out, then that is a function of free markets. It would actually be a net positive as it is most likely that the creditors would act as much better fiduciaries of the companies than the previous management did anyways.

Given the news cycle, it is likely that a large taxpayer bailout is being worked as we speak. Some proposals being mentioned are of an $850 billion bailout package where $50 billion will go to airlines. You must act quickly, call and write elected officials telling them that you oppose any taxpayer bailouts that protect equity of corporations that have bought back their own stock, especially if these corporations have not completed an equivalent size equity offering of their previous decade’s buybacks.

If these equity bailouts are allowed to occur, it will solidify the moral hazard that was born in 2008 and absolve all the fiduciary irresponsibility of the previous decade. This will surely make the next crisis worse.


Daniel Lubienietzky is a finance and business professional based in Toronto, Canada. Daniel has held corporate development, sales, and analyst roles at a private equity firm, corporate bank, central bank, and technology resourcing firm. Daniel has an MBA from University of Toronto's Rotman School of Management. Daniel is an avid stock and real estate investor with a strong interest in macroeconomics. 

André Nogueira

Data Analytics | Business Intelligence | Program Management

4y

Well written and agreed. The least interference from the government, the better. We should also call for changes to the tax system because it encourages debt and the share buy back situation you described.

George Chigrichenko

Helping massive SQL table joins happen

4y

No bailouts. Money should go directly to physical individuals.

Thavash Govender

Data and AI Consultant | ex-Microsoft

4y

The employees who lose jobs will suffer 

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Rob McPherson

Ex-P&G/Sandoz/Kraft Foods/Bacardi - *NOW POSTING EXCLUSIVELY ON SUBSTACK (all the best stuff)*

4y

I guess the challenge is, what do you tell the innocent employees who get laid off in those companies? Maybe the answer is a loan that is actually paid back - some real teeth in it. 

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