(Bloomberg Opinion) -- People are worried about stock buybacks.
One strain of thinking that I see a lot of these days is a sort of crypto-gig-utopianism. The idea here is that some modern technologies—the internet, which allows people all over the world to come together to do stuff; smartphones, which allow you to access that stuff instantly wherever you are; blockchain and cryptocurrencies, which allow distributed coordination among independent agents without a central coordinator who owns the results—have reduced transaction costs to the point that traditional firms are unnecessary. You don’t need a big corporation with a chief executive officer and layers of middle management and a human-resources department and stock options and a permanent headquarters to centrally plan and coordinate projects. People who want a project to happen can form an ad hoc team to do the project, and raise money from people who want it done, and do it, and receive the rewards, and move on to the next thing. New coordination mechanisms—blockchains, tokens, smart contracts, crowdfunding, online clearinghouses for gig workers—will replace the stodgy old coordination mechanisms like having a job, doing what your boss tells you to, and using money from shareholders and lenders to do it.
Another strain of thinking that I see all the time these days is: Stock buybacks are bad because they take money that the corporation could invest in research and development and waste it on just giving it to shareholders instead.
And the historic spending spree on share buybacks has some analysts worried companies are buying their shares at excessive valuations during the peak of the economic cycle and at a time when the market rally is nine years old. Others warn the billions of dollars spent to buy back shares could have gone toward capital improvements like new factories or technology that could lead to stronger long-term growth.
“The S&P 500 Buyback index, which tracks the share performance of the 100 biggest stock repurchasers, has gained just 1.3% this year, well underperforming the S&P 500.” And:
“The majority of capital deployed is going right back to shareholders and not reinvestment in businesses,” said Gregory Milano, chief executive at Fortuna. “If that’s the only thing you’re relying on, it’s going to end badly.”
If your view of the corporation is that it is eternal and essential, then this is bad. If there are, like, 10 companies, and they are the only 10 companies that could ever be, and they decide to stop investing in finding new ideas and instead just give their money back to shareholders, and the shareholders use the money to purchase bonbons and yachts, then no one will invent anything new and the economy and the world will stagnate. Obviously this does not correspond to reality, though, so don’t worry about it.
If your view of the corporation is that companies are locked in an eternal Darwinian struggle to survive, then this is ... what it is. If there are, like, 500 big public companies in the S&P 500, and some of them see limited growth opportunities and decide to scale back and return money to shareholders, and others invest heavily in new ideas and new capacity, and smaller private companies raise and spend mountains of private capital in a desperate attempt to disrupt and displace the big stodgy incumbents, then, yeah, you know, the scale-back-and-return-cash companies might underperform the fast-growing ones, and eventually some of the ambitious disruptors might replace them at the top of the heap. And some of those disruptors will then run out of steam and start returning capital, and there’ll be new disruptors, etc. etc. etc. circle of life.
This is I think a very standard and essentially correct view of the corporation, and should make you feel more or less fine about buybacks as a concept, though it might also worry you if you are a shareholder in all of those big repurchasers who are trailing the S&P 500. Are they buying back stock because they are out of ideas, and are they in danger of being disrupted by someone else with a better idea? Sure that's possible why not!
But you don’t have to have that standard view of the corporation. Your view could be that the corporation is on the way out, that legal entities with perpetual lives and thousands of full-time employees will not be the way we organize economic activity in the future. Instead we’ll find ways to put money and people together to make a thing, and then the thing will be made, and then the money and people will disperse and go make other things. The organizing principle will be the making of the things, not the permanent entity with a name and a logo and a celebrity CEO who decides what things to make when. Central coordination and perpetual existence will be replaced by the coordination of the market and the internet. “We must permanently amass capital in this entity, because otherwise how will anyone make things,” will stop being a reasonable-sounding thing to say, to be replaced with “let’s raise some money to make this thing, and then give some of the profits of it back to the people who gave us the money so they can invest those profits in making new things.”
If that is your view, then stock buybacks—where companies that have used shareholder money to make a thing return the profits of making that thing to shareholders—are a small step toward a future where the perpetual corporation just doesn’t matter that much.
Obviously a lot about this sort of crypto-gig-utopianism is overstated or implausible; some of it is downright dystopian. But whenever I read about the people worrying about stock buybacks, I feel like it can’t come soon enough.
GSO Capital Partners, the credit unit of Blackstone Group LP, concocted a clever trade in which it (1) bought credit-default swaps on homebuilder Hovnanian Enterprises Inc., (2) offered Hovnanian attractive financing, (3) in exchange asked Hovnanian to agree to do a quickie default on a small amount of debt owned by its affiliate in order to trigger GSO’s CDS, and (4) also got Hovnanian to issue weird new bonds that would trade at low prices in order to maximize CDS recovery. GSO would get a windfall from its CDS, and could use some of that money to make Hovnanian’s financing more attractive. I thought this was pretty cute, and GSO obviously thought it was pretty cute, but Goldman Sachs, the pope and the Commodity Futures Trading Commission all disagreed, and eventually GSO backed away from the trade, settling with its CDS counterparties and letting Hovnanian drop its “manufactured default.” (Everyone on every side of the trade seems to have done fine on it?)
Here is the Wall Street Journal with a report on why GSO backed down, which is not because of Goldman or the pope, but because the CFTC told GSO to knock it off:
CFTC officials were reluctant to intervene but became convinced by April that market participants were unlikely to resolve the situation on their own, according to people familiar with the agency’s thinking.
As the May 1 default approached, the CFTC grew more vocal about the consequences, though it was careful not to name names publicly. The pressure took both private and public forms. The CFTC had been warning Blackstone through private meetings before issuing an unorthodox public bulletin a week before the default deadline that said manufactured defaults could be considered market manipulation, these people said.
Here is how CFTC Director of Enforcement James McDonald put it:
“The nature of most violations means we find out about them after they occur, and our only option is to bring an enforcement action,” Mr. McDonald said. “But sometimes we see a concerning market event in advance, where we can be proactive to ensure market participants understand the view of the Commission staff before the activity takes place.”
One way of saying that is that most people who think they are violating the law try not to tell regulators about it. GSO, obviously, did not think it was violating the law. In favor of that position were, for instance, the facts that there was no actual law against what it was doing, and that a federal judge reviewed what it was doing and found no problem with it. On the other hand, against that position there was the fact—quite relevant as a matter of legal realism—that the CFTC didn’t like it.
Now, normally, when you do a thing that you think is legal and that a civil regulator thinks is illegal, the regulator sues you. Often, then, you settle: It is generally good to have good relationships with your regulators, which means that it can be sensible to apologize rather than dig in even if you think you are right. Plus if you go to trial, a jury will probably sympathize more with the CFTC than with a credit hedge fund run by the Blackstone Group that engineered a fake default. Still you sometimes go to trial, if you think you did nothing wrong and want to establish a precedent, or if the cost of settlement—in monetary penalties or in shame—is too high relative to the cost of fighting.
But here GSO hadn’t done the thing yet. (Well, it had, but not irrevocably.) Its choices weren’t “fight or settle with the regulators”; they were “fight or walk away.” When the CFTC came to it and said “if you do this thing we will go after you,” it would have been close to malpractice for GSO to say “we’re doing it, see you in court.” Saying “ugh, fine, never mind” is much easier. It’s easier and more pleasant—though less dramatic and reputation-enhancing—for the regulators too. Really more regulation should go like this, seeing people doing a thing and telling them to stop, rather than waiting for them to finish the thing and then trying to punish them for it.
We talked on Friday about how Credit Suisse Group AG’s Asia investment-banking division hired the children of government officials as bankers in order to win favor with those officials. This is something that the U.S. government frowns upon, and Credit Suisse ended up paying $77 million in fines for doing it. I said that, while the government was obviously right that these job offers were just bribes, it was not so clearly right that the children were unqualified, since after all the children really did bring in deals. (From their parents.) (They were adult children, by the way; it is fun to say “children” but they weren’t actually toddlers making pitchbooks in crayon or anything.) The claim that they were unqualified, I wrote, “seems to me to claim too much, to misunderstand what banking is, to assume that there is some objective measure of investment-banking qualification that is separate from the ability to win and execute deals.”
But Andrew Tuch of Washington University School of Law reminded me by email that there are some objective standards for investment bankers, at least in the U.S. Investment banks in the U.S. register as broker-dealers, and their client-facing bankers have to be licensed, which means passing some licensing exams. (In my day it was the Series 7, which had only a glancing connection to investment banking; now it is the Series 79, which seems a bit more relevant, but still I doubt anyone who has taken these exams believes that the knowledge they test is either necessary or sufficient to be a competent investment banker.) The Securities and Exchange Commission and Justice Department did not mention any of Credit Suisse’s princeling hires failing any regulatory exams, though I am not sure if that is because they all passed their exams, or exams weren’t required in their jurisdictions, or just because the SEC and DOJ didn’t think to ask.
But, yes, fine: The essential job of an investment banker is to convince clients to do deals with her, but the almost-as-essential other job is to actually do the deals. It is not a pure sales job; there is substance too, and the people involved in selling the business are, traditionally, also the people who do the business. Ideally you hire people who are good at both. Commercially it can be a good idea to hire some people who are only good at selling it, and let other people do it. But that is not great for banking’s self-esteem as a profession, and it’s not necessarily great for clients either, so there are at least some minimal efforts to prevent it.
The Work of Art in the Age of Targeted Advertising.
Here is a pretty grim story about AT&T Inc.’s plans for HBO, as explained by AT&T’s new head of Warner Media in a town hall with HBO employees:
“I want more hours of engagement. Why are more hours of engagement important? Because you get more data and information about a customer that then allows you to do things like monetize through alternate models of advertising as well as subscriptions, which I think is very important to play in tomorrow’s world.”
He said that to the people responsible for commissioning some of the greatest American art made during my lifetime. He told the people who made “Deadwood” and “The Wire” to go out and get more data and information about a customer. What, really, is the point of anything? I guess it’s to monetize through alternate models of advertising as well as subscriptions. Anyway, if you enjoy reading this newsletter, please read it some more, and please also send me your … social security number … and your … shoe size? … I just … gah.
How’s Martin Shkreli doing?
Very glad to see the WSJ take Greenlight down a notch. There’s a joke in there about me. Well, I guess the jokes on Einhorn. He passed on my company and I project that is up about 4x. Meanwhile his Greenlight fund is… uh… not doing so well, apparently. I’m far better off than he was at my age, and at the rate he is losing money and I’m making it, I’ll be wealthier than him soon even without the 15 years he has on me. Keep shorting NFLX and AMZN bro, you gotta be right someday.
Honestly, man: Martin Shkreli. People read Marcus Aurelius or Victor Frankl or whoever to give them strength and comfort in times of adversity, but have you considered the possibility that Martin Shkreli is the great stoic philosopher of our time? Here he is doing seven years in a federal prison, and he reads a front-page Wall Street Journal article about a billionaire who plays high-stakes poker for fun, drops tens of thousands of dollars at the club, owns part of an NBA team, chairs a prestigious charity, coaches his children’s sports teams and takes an afternoon nap every day—and his reaction is “I’m far better off”? I get mad when the subway is delayed! I feel like I should be taking some pointers on gratitude and positive thinking from Martin Shkreli.
Oh also he is spending some of his time in prison doing reviewing books:
This is one of the worst books I’ve ever read. Most investing books suck, and Pabrai breaks new ground in the arcane field of suction engineering. Pabrai is what I would call a weak-form Buffett clone, and appropriately comes off as embarassingly clueless. The only property of this work worse than its content, which lacks one original thought, is Pabrai’s putrid writing style. I lost count at how many times he printed his meaningless platitude “heads I win, tails I don’t lose much”. Pabrai believes he’s doing the world a favor by writing, but I suggest he finds a new hobby.
I guess his thinking isn’t all positive.
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