Stock Buybacks Destroy Wealth

In 2018 we as a nation took a trillion dollars out to the parking lot and set it on fire.  We will be doing the same if not more in 2019.  We could have used that to pay down student debt, begin converting to a fully renewable energy supply or just to repair our long neglected and crumbling infrastructure.  None of those alternatives were ever considered.  We just threw the money away.  The shovels and matches we used for our national wealth disposal project were share buybacks.

That’s not the official story, it’s just reality.  The official story is either we “returned the money to shareholders” or “we used it to enrich the compensation of corporate executives.”  Both of those are not just said, but strongly believed by large numbers of “informed” observers.  It’s nonsense.

The idea behind all this is that reducing the corporate share count while maintaining earnings will boost Earnings Per Share (EPS.)  As long as the Price/Earnings (PE) ratio stays constant that means the price per share will go up.  That’s the bet placed on the big roulette wheel in the great financial casino in the sky.  We put our money on “black” and then spin the wheel.  At its heart, it’s not a business strategy it’s a gambling strategy.

I spent 35 years in IBM and over 20 years as a senior executive most of which was as VP Corporate Strategy. Part of my job included briefing financial analysts on our strategies.  IBM was and remains a heavy user of stock buybacks and I fielded a lot of questions over the years on the topic.  For a time, I was also a direct and personal beneficiary of the practice. I’m quite knowledgeable on the topic and for those with a penchant towards blame I freely admit my complicity.

In the early days I would respond to questions with something like “at the current stock price we see this as a good investment.”  Later that would change to “we have two major tools to return money to shareholders, dividends and buybacks. Some investors prefer the former while some the latter and we serve both.”  I was not alone.  My counterparts both in IBM and across the market all echoed the exact same refrain.  Most of us believed it, at least at some level.  Investors did too and began expecting and then demanding the practice.  The gamblers all agreed this was a good gambling strategy.  Keep putting that money on the roulette wheel!

To meet these expectations, we established and published a clear EPS roadmap.  Initially that roadmap was built by first laying out our operational plans and then layering in a set of financial plans, including buybacks, to serve as contingencies if the operational plans fell short.  Over time those two flipped. The financial plans, specifically buybacks, came first and began squeezing out operational investments.  We reached the point where our CEO proclaimed internally that our financial manipulations WERE the operational strategy.  The gambling strategy became the corporate strategy.

None of those later stages were admitted publicly, but it was visible to careful observers.  Analysts began making noise about the “quality” of our earnings.  And, then that great roulette wheel in the sky began hitting double zeros and red on a regular basis.  Our PE ratio began compressing right in line with our buybacks.

That wasn’t bad luck. It’s the reality of what happens as the balance sheet gets steadily drained by a gambling addiction.  While the exact details differ, the same story has been unfolding across corporate America for decades.  There are many, many companies who are paying out more in dividends and buybacks than they make in earnings.  In a truly sad story of corporate gambling addiction the formerly great and financially sophisticated GE found itself taking out loans to support their gambling (buy back) addiction.  As every gambler eventually learns to their dismay, the house always ends up winning in the long run.

Most companies have maintained their “returning money to shareholders” story.  Some will add something along the lines of “we see no better use for the money.”  Since they’re just throwing the money away it means they have NO USE for the money, and that’s probably the most accurate description of what’s going on.  It’s not that they lack ideas.  I’ve spent countless hours working with corporations on their innovation programs and never encountered one that didn’t have good ideas.  Modern corporations are not lacking in either intellectual or financial capital.  The shortfalls come in the form of management bandwidth and other forms of human capital.  Those are real factors.  In many cases they reflect true organizational limits.  In others they might be addressed through human capital development policies, such as universal access to higher education.  In all cases, tax cuts are useless on these problems.

That’s the longer version of the story.  Here’s the short and simple one.  Imagine two people sitting across the table from each other.  One is holding one trillion dollars in stock, while the other is holding one trillion dollars in cash.  Together they have two trillion in wealth.  Now they trade.  One gets the trillion in cash.  The other gets the trillion in stock and proceeds to destroy it, to remove it from the table.  Afterwards, the person who originally held a trillion in cash is now sitting with nothing.  That trillion in cash came off their personal balance sheet and is simply gone.  Between the two of them they now hold only one trillion in wealth.  That’s what we’re doing as a nation every year and it’s getting worse.

Like any addict, corporate America is in need of an intervention.  Some family member or close friend needs to pull them aside and explain that putting money on the roulette wheel in the financial casino is no different than taking it out to the parking lot and setting in on fire.  And, since they truly have no idea what to do with all their money, we need to ask our conservative friends why they keep wanting to add to the bonfire rather than putting our country to work building all the things we need and have been neglecting.  There really, truly, are better things our nation can do with a trillion dollars every year.

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Capitalism Vs Socialism is Gibberish

One of the Republican Party’s main strategies for 2020 is to campaign against “socialism” and for “capitalism.”  The reality in 2020 is that neither of those words has any semantic meaning.  They’ve become expletives to be hurled at enemies and gang colors to rally trolls.  The entire conceptual framework behind those words has become hopelessly encrusted with bad history, rhetorical abuse and the gradual decay of a set of imperfect ideas over the course of centuries.  Whatever useful relevance those terms had in the 18th and 19th centuries eroded steadily as the 20th century blurred the lines, winnowed out proven failures and blended mixtures of public and private sectors all over the world. In fact, the assumption that there’s a clear and stark distinction between public and private requires one to ignore the impossibly intertwined fabric of how our actual social governance functions.  The real world isn’t black and white, it’s all shades of grey.

 

Journalists now regularly ask politicians whether they’re capitalists or socialists a question that is utter gibberish.  No two people share the same definition of the words and for many people the words change meaning from one context or conversation to the next.  It’s becoming the topic of the day which unfortunately creates a useless framing designed by trolls to minimize our ability to have a constructive discussion about the nature of our society and what we want it to become.

 

And, that’s the real topic on the table.  What do we want to become in the 21st century?  Over the course of our history we’ve had four very distinct socioeconomic paradigms.  The first held sway from our founding to the end of the Civil War.  We were primarily an agrarian society with two models – family farms organized around small communities and plantations worked by slaves.  The abolition of slavery and the growth of industrial production fueled by the labors of immigrants arriving from Europe led to the second paradigm.  It was an era dominated by ruthless monopolies backed by government forces.  Efforts to improve working conditions or wages were met with military operations that often killed those who expected to be able to feed a family on the wages of a 60-70 hour work week.  That paradigm lasted until it collapsed in the early 1930s.  The New Deal redesigned the economy using government resources and laws to create a more sustainable economic growth environment.  That economic paradigm lasted until the early to mid 1970s when it was replaced with a paradigm that grew out of the Austrian School of economics and became known as neoliberalism.  The neoliberal paradigm has prevailed to this day and has dominated the beliefs and policies of both parties.

 

I defy anyone to use the words “socialism” or “capitalism” in a way that usefully describes the similarities and differences across those four paradigms.  They were enormously different and produced dramatically different economic patterns.  But, those words serve to obscure the important realities of those periods rather than elucidate them.

 

The real issue of the day is that essentially every material aspect of the neoliberal paradigm has proven false, socially harmful, or economically destructive.  Its days are coming to an end and the question is what will replace it.  That’s the real topic for 2020 – what’s our next socioeconomic paradigm?

 

It’s worth observing that all our prior transitions were born amidst crises.  The first paradigm was born from the revolution that founded our nation.  One can argue whether Madison, Hamilton or Jefferson is most associated with the establishment of our original framework, but government leadership was its very essence.  The second grew out of the Civil War and it was largely the leadership of Lincoln that set us on our new path.  The third arose from the Great Depression and WWII through the leadership of Franklin Delano Roosevelt.  The fourth was born out of Vietnam, Watergate and our failures to deal with oil shocks and stagflation.  The leader who cemented the fourth paradigm was unquestionably Ronald Reagan.  It’s no coincidence that the leaders who were able to shift the country from a failing paradigm to a new one are among our most revered.  Change on that scale isn’t easy.

 

One of the favorite phrases of consultants who help CEO’s implement large scale change is “a crisis is a terrible thing to waste.”  When Obama took office, he was confronted immediately with an economic collapse that brought with it the peril of another Great Depression.  In an odd way it was a gift.  It was the perfect crisis to use to put us on a path out of the failing neoliberal paradigm and into whatever name historians will eventually use for our fifth paradigm.

 

Obama avoided another Great Depression but completely failed the leadership challenge of putting us on that new path.  He was a believer in neoliberalism and was effectively blind to its many profound failings.  That set the stage for Trump who capitalized on the widespread resentment that inevitably spreads as a socioeconomic paradigm breaks down for most citizens.  Trump’s failure to see the real problems, let alone offer leadership out of the crisis, is far deeper and more cynical than Obama’s.  In fact, Trump seems to be doing everything in his power to make the situation far, far worse.

 

The crises of 2020 may not be as clear cut as the financial collapse Obama was handed, but if anything, it is far more pervasively felt.  What’s needed is the leadership to help everyone understand the real sources of our problems and then to begin guiding a process to redefine how our economy works.  That won’t come from “unifying” different factions, most of whom are hopelessly lost, and it certainly won’t come from babbling on about archaic 19th century “isms.”

 

This needs to be the real criteria for our next President.  Not whether he or she can “beat Trump,” but whether they have the vision, conviction and leadership skills to systematically address the failures of the neoliberal paradigm.  There are important lessons we can learn from the redesign of the economy in the 1930s, but we can’t simply go back to the same solutions.  The 21^st century is a very, very different beast.  Today’s technology, socioeconomics, industry maturity and global context are all radically different and will need solutions relevant to the 21^st century not the early to mid 20^th century.  This is both our challenge, and, I believe, our enormous opportunity – to reshape our socioeconomic paradigm so our entire nation can thrive in the future not wallow in the past nor cringe in fear.  Anybody up for the task?