Stock Buybacks, Yes?, No?, or Regulate?
I hope this post finds you well.
The Stock Market in 1929:
Herbert Hoover was inaugurated on March 4, 1929. In his speeches he claimed, we are financially secure and there was prosperity for all. The prosperity started in 1921. In the 9 years following, the stock market increased 6 times. Investments in stocks were considered safe and resulted in great returns. Everyone was happy and investing.
Stockbrokers at banks lent money to regular people to buy stocks, called buying on the margin. With 10% down you can buy stocks. Say, $100 as a down payment gets you $1000 worth of stocks. Since market was doing well, stable with steady increases, people mortgaged homes and businesses. Turns out the collateral for the loan are the stocks. If the stocks fall the stockbroker can do a margin call which requires the investor give more money to recover loan or they have to sell the stocks to pay it back.
Since 1921 the stocks steadily rose, and everyone got into it. With the combination of easy to borrow money and the feeling of the market was a low risk, most people got into the market. Also, new investors continue to fuel the stock rise, which helped.
The Crash:
Black Tuesday occurred on Oct 29, 1929. But the crash started a day before. Apparently, a market expert had claimed the stock market had reached its peak. This prediction helped fuel a frenzy of distrust in the stability of the market. Before the crash, the Federal Reserve Bank of New York raised the lending rate to discourage borrowing, to try and slow down the growth rate and stabilize the market. Unfortunately, the European nations raised their rate to equal the U.S. resulting in the European nations going into a recession. So, with disbelief in the market along with expert analysis view that we were at the top. In order for all the investors to pay off their loan they started to sell. On Black Tuesday most investors in a frenzy, started selling, the crash. It was the fear of the peak was here and not being able to pay off their loan, that created the selling frenzy.
So, it started on Oct 29, 1929. The DOW crashed and finally hit bottom a few years later in 1932, during the great depression. For the individual investors, the losses were staggering, some losing all, Like farms, houses, and businesses.
After The Crash:
After the crash, owners, executives and staff started looking for other ways to profit from the market. They invented the stock buyback. Basically, by using a portion of the company profits to buy back the stocks from the market, they reduced the number of shares in the market. This reduction in number of shares, along with new investors caused the price to rise.
Then in 1932, a NY Times article wrote about the abuses made by owners, executives and early investors with stock buyback. A practice called insider trading, flourished. They used corporation funds to buy back shares from directors, offices, and others friendly to management. President signed law to stop this activity. President Hoover put a stop by enacting the Securities and Exchange Act of 1934. Used to crack down on stock manipulation and insider trading. Corporations stopped the buyback campaign. Fortunately, this had some good side effects. Corporations now had just three choices for what to do with profits.
1. Reinvest back into company, build new factories, create new products.
2. Raise wages for employees.
3. Dividend, give profits to investors
Productivity nearly doubled in 30 years after WW II, leading up to 1982. hourly wages increased also. This built the American middle class.
Unfortunately, in 1982, President Reagan changed things, although, productivity was rising, and wages were commensurate with profits. Reagan appointed a former investment banker named John Shad, to be the top enforcement person at the Securities and Exchange. Shad wanted corporations to put more of their profits to investors and less to wages and reinvesting, Essentially, allowing companies to buyback stocks. I believe this is because he is an investment banker himself.
This was a boom for investors, giving them more activity. Also, to keep the money flowing, the owners and executives changed the way they get compensated. The company executives would get a salary and a bonus based on stock price. One way to increase the stock price was thru stock buyback.
Before 1982, companies spent less than 1% of profits on executive compensation. But by 2008, before the recession, it was 77%. Today’s it’s 65%. The pay disparity from executives to workers went from 15:1 in 1965 to 220:1 in 2018. This also resulted in productivity loss and wages stagnation. The Auto companies fell behind, Plants closed, and lost to foreign competition. All so a few at the top would be able to get more money.
From the Economic Policy Institute. Since 1978, executive pay / compensation rose 1322% while worker’s wages rose 18%. The executives were making 20 times more than the typical worker up until 1982. After that, it skyrocketed to 350 times in 2020.
A lot of people liked President Reagan, after all, he caused the breakup of the Soviet Union and reduced taxes for corporations. It’s unfortunate. Essentially, they were responsible for wrecking our economy, shrinking the middle class, stagnating wages and companies falling behind international competition. All this so a few can make a lot of money. Hmmm …
It makes me wonder. The executives are supposed to be top in their class, from top universities with business degrees. Well, this time our meritocracy didn’t work. In the future history will tell the story of how so few, can bring down so many. On their watch, the past 30 years have resulted in an economic disaster. I guess Greed is not Good after all.
There is more: As I write this, I am struck by how irresponsible and incompetent our business leaders are. Were in a perfect storm of sorts, or a catch-22. The current price of stocks is artificially high, maybe due to stock buybacks. There are a huge number of workers, retired and soon to be retired, with entitlements that are invested in stocks, depending on a high stock price.
If you stop buybacks, you will force the executives to invest profits to reinvest and give higher wages, this is good and will be healthy for the economy. Unfortunately, the stock price may go down, leading to Americans getting less from their entitlements, which are invested in stocks.
On the other hand, if we continue enabling the executives to buyback stocks, we will continue to wreck our economy. Our companies will fall behind the technology curve, because we are not reinvesting, and continue to fall behind our international competitors.
Damned if you do, damned if you don’t. I’ll say this again, it’s amazing how so few can screw up so many.
Another option is to regulate the stock buyback. Say less than 1% of company profits. This way we can reduce the manipulation component of buybacks, yet still allow executive compensation to be based on the stock price.
Notes:
How American CEOs got so rich – YouTube This is a must watch video.
Corruption is Legal in America – YouTube This video describes how, support for legislation by American citizens has a 30% percent chance in passing. While, legislation supported from the elites, (companies, top 1%), has a 60% likely hood of passing. The authors of this video have called it “Corruption is legal in America”. It’s worth a watch.