From David Stockman and Contra Corner
by Financial Times • May 17, 2016
By Rana Foroohar at Financial Times
One of the great ironies of business today is that the richest and most powerful companies in the world are more involved than ever before in the capital markets at a time when they do not actually need any capital. Take Apple, which has around $200bn sitting in the bank, yet has borrowed billions of dollars in recent years to buy back shares in order to bolster its stock price, which has lagged recently.
Why borrow? Because it is cheaper than repatriating cash and paying US taxes, of course. The financial engineering helped boost the California company’s share price for a while. But it did not stop activist investor Carl Icahn — who had manically advocated borrowing and buybacks — from dumping the stock the minute revenue growth took a turn for the worse in late April.
Apple is not alone in eschewing real engineering for the financial kind. Top-tier US businesses have never enjoyed greater financial resources. They have $2tn in cash on their balance sheets — enough money combined to make them the tenth largest economy in the world. Yet they are also taking on record amounts of debt to buy back their own stock, creating a corporate debt bubble that has already begun to burst (witness Exxon’s recent downgrade).
The buyback bubble is only one part of a larger trend, which is that the business of corporate America is no longer business — it is finance. American firms today make more money than ever before by simply moving money around, getting about five times the revenue from purely financial activities, such as trading, hedging, tax optimisation and selling financial services, than they did in the immediate postwar period. No wonder share buybacks and corporate investment into research and development have moved inversely in recent years. It is easier for chief executives with a shelf life of three years to try to please investors by jacking up short-term share prices than to invest in things that will grow a company over the long haul.
It is telling that private firms invest twice as much in things like new technology, worker training, factory upgrades and R&D as public firms of similar size — they simply do not have to deal with market pressure not to.
Indeed, the financialisation of business has grown in tandem with the rise of the capital markets and the financial industry itself, which has roughly doubled in size as a percentage of gross domestic product over the past 40 years (even the financial crisis did not keep finance down; the industry itself shrank only marginally and the largest institutions that remained became even bigger). As finance grew, so did its profits — the industry creates only 4 per cent of US jobs yet takes around 25 per cent of the corporate profit share.
Not surprisingly, non-financial businesses wanted a piece of that action. Airlines, for instance, often make more money from hedging on oil prices than on selling seats — even though it undermines their core business by increasing commodities volatility, and bad bets can leave them with millions of dollars in sudden losses. GE, America’s original innovator, only recently stopped being a “too big to fail” bank.
The pharmaceuticals industry, perhaps the most financialised of all, has cut nearly 150,000 jobs since 2008, most in R&D, as companies focus instead on outsourcing, tax optimisation, inversions and “creative” accounting in ways that make them look suspiciously like portfolio management companies — a group of disparate firms operating separately and trying to make as much money as quickly as possible, with little thought to the long-term impact of their decisions.
Even Silicon Valley is not immune. Apple and other tech behemoths now anchor new corporate bond offerings as investment banks do, which is not surprising considering how much cash they hold. If Big Tech decided at any point to dump those bonds, it could become a market-moving event, an issue that is already raising concern among experts at the US Treasury Department’s Office of Financial Research.
None of this is good for the real economy; a wealth of academic research shows that not only has finance become an obstacle to growth, but also that financial engineering is destroying long-term value within companies. Buyback booms of the sort we have seen in the past couple of years tend to happen at the top of the market, when financially manufactured growth is tapped out. With corporate earnings under pressure, US businesses that have not been investing in real, underlying growth and innovation may be in for a fall. The result will be more economic stagnation — and more political populism.