A $9T corporate debt bomb is 'bubbling' in the US economy

This article is from 2012 but illustrates the point (it's also why I left the company, they restructured debt, issued a dividend which, even though they're publicly traded they were(are?) 75% held by Carlysle Group so it was basically a self bonus, then cut employee benefits) https://www.forbes.com/sites/abrambrown/2012/07/11/booz-alle...

How is a declining market threatening a profitable company that, at some point in its past, bought back shares? There are no on-going financial commitments a company has that are tied to the daily fluctuations of the stock market.

Even if they have taken on debt to finance a buyback, a future decline of the stock market has no bearing on them, except to possibly make it less lucrative to issue new stock.

As long as they make a profit in their core business, and those profits allow them to pay the 3% or 4% interest on any debt, they are completely save. A rise in interest rates does have a meaningful impact here, yes. But (a) interest rates have been rather stable for going on 40 years now, and this is a well-known risk that is an obvious part of any decision to take on debt. It can, and often is, also be hedged by agreeing to fixed interest rates, or hedging.

The wisdom of privately buying stock with debt stems from a consideration of the risks involved. But a company is going to shoulder its risk of operations, no matter how you turn it.

I also don't get your criticism of Apple's practice: It's well understood that it happened for tax considerations, and surely them holding billions of dollars in cash cannot, in anyway, be worse than not having billions of dollars in cash? In any case, the current tax "amnesty" seems to be in the process of resolving that particular accounting nightmare of yours.

>a company buys their own stock... [and] each stock appraises

That lines up exactly with what I've described. If you're saying I'm wrong, you're going to have to be more specific because I don't see where we disagree.

Technically true, but the company had a choice about how to return profits to investors and chose the buyback over the dividend, so the remaining owners don't get a larger percentage of profits unless the company also issues a dividend. It's generally an either-or these days.

Imagine an extreme case where McDonald's buys every single share but one. That remaining stock-owner will therefore own 100% of McDonald's, and get every last profit made from the world's obese.

Not all McD's stock is publicly traded. Moreover, a fair amount of McD's stock cannot be legally sold due to it being owned by ESOPs. That being said, the remaining stock owner would not own 100% of McDs, they would own 1 share of McDs (and 100% of then-outstanding stock). There would still be several million shares authorized and in reserve that could be sold or re-issued at a moment's notice. The decision to sell/re-issue those shares is made by the company, not the owner, and the fact that he theoretically owns 100% of the company at that time is meaningless because he owns only a fractional percent of the company's authorized shares and thus has no actual power.

It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over.

That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature.

At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits.

This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.

Could it be that the expectation for all companies, everywhere to grow at a constant rate is not reasonable?

Why are buybacks much more tax effective? Is this due to the way the accounting is done on them?

This is true. It is always better to return money to shareholders if there aren't any avenues of future growth.

But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.

It doez though illustrate technically and reality are 2 different things.

And the reality is the US can default. While the option is there to endless print money and technically avoid default, should that situation happen, USD will become worth less the more they print. So you end up hitting a point where you essentially issue money of near no value. Once a govt sees this happening it's more realistical they bite the bullet, hit the reset button and default. Because a country needs a functioning currency that people have confidence in to run and recover. No reasonable govt is going to keep issuing money to 'avoid default' at the cost of recovering the economy.

And arguably even if they did, issuing worthless money would in the spirit of debt repayment, be considered a form of default.

- Aggregate financial liability is the flip side of aggregate financial assets. Net financial savings/debt is zero for the economy as a whole. Because of this, looking at particular companies or sectors is very different than looking at the economy as a whole.

- When looking at entire countries especially large ones, there are important aggregate effects so depending on what you are trying to understand, it often makes sense to take an aggregate perspective where this net savings/debt are zero (ignore international imbalances, cross country debt etc. ) .

- Debt is usually denominated in a currency, government debt is particularly intertwined with the behavior of its currency, so it makes sense to take into account central bank regimes, the effect of inflation etc.

-When taking the aggregate, whole economy perspective where net financial assets net to zero, it's important to keep some focus on the non financial assets that makes up the residual non-zero net positive. This is the stock of economic capital: physical intrinsically valuable forms of wealth such as inventory, stockpiles, infrastructure, factories, machinery, tools, knowledge, land, natural resources, production capacity, energy, technological advancement etc... The financial assets, the debt, is just indirect claims on this capital and on the future production you might get from it.

-Since economy wide financial crises are about claims on things, about coupons, about promises that net to zero, they can pretty much always be resolved smoothly through sufficient central banks accommodation that, through inflation, readjust the real value of all these claims to be in line with what is actually reasonably redeemable in a timely manner. However, this can result in some unfair redistribution or painfully high inflation (It's still much less unfair, and much much less painful than widespread defaults and gridlock in the investment and labor markets).

-Central banks are often not competent enough to maintain stability and readjust properly. I don't know what can be done about that. The ECB's performance for example, has been pathetic. It was so procyclical as to almost bring down western civilization IMO, emboldening foes such as Russia and China and utterly destroying Greece and Italy, those poor Europeans. The US Fed has also been somewhat bad, failing to hit its inflation target for years after the financial crisis, a time when it should have been overshooting a little, but has recently been doing better. On the flip side, the Canadian central bank was great during the financial crisis, and saved Canada from a large part of the downsides. Marc Carney who was heading the Bank of Canada, then moved to head the UK's Bank of England and saved the British from Brexit turning into a massive disaster that brought unemployment in the tens or twenties of percents. However, the UKs proximity to the eurozone resulted on some splash damage from the ECB. Australia's money supply has been competently managed. Japan was horrible in the 90s but has been doing better in the last decade. BTW Japan is an interesting case to look at from a debt perspective because its government has by far the highest level of debt per capita.

-The assumption that savings must always have positive real returns, that interest rates must be positive, is one of the most weirdly persistent fallacy in economic debates. Historically, negative real returns on stores of value were the norm. Before financial systems existed, almost all investments had negative returns if you didn’t put work and energy into them. To store value, you had to accumulate stuff, buildings or land. Most options either had high maintenance costs, were subject to risk of damage from natural causes and theft, were very volatile or required hard labor to get production out of. Even in societies with financial systems, getting low risk, hassle free, liquid, positive real returns has been difficult for a large part of history. This just reflects the natural laws of thermodynamics that tell us that everything tends to decay without a constant supply of work and energy. In general, most things require maintenance to keep their worth. The 20th century was probably the most notable exception. Because of unprecedented demographic and technological growth, positive risk free real returns were easy to find. The effect of recency on our collective minds probably explains some of the confusion people have about this. It is possible that under favorable conditions, wealth can have positive returns and even compound into very good long run returns but it is not a guarantee and there is nothing natural about it. It may not continue forever, particularly amidst an aging and retiring population in a world no longer as rich in easy to exploit natural resources. While people are used to get negative returns on very short term purchases, you buy fresh vegetables at the supermarket, even if they degrade over time, many can’t seem to accept the normalcy of negative returns on longer term assets. In nature, squirrels’ nut caches have a certain percentage of losses from theft and spoilage. Real returns tending towards the negative is natural even if they can seem unusual for people just out of the 20th century. There are good reasons to keep government debt low enough but long term possibility of repayment is not a huge worry when market real interest rates and safe asset returns are very low or negative. In the latter case, you can just wait and let the real debt evaporate through inflation.

The private sector wants Government bonds. If they won’t buy all of them at the interest rate the Government wants to sell them for, there’s no practical reason they can’t just sell excess bonds to the central bank (except for silly policy in some countries).

If hypothetically we could see the future perfectly the financial market would start to look downright weird as predestined to fail loans would always be rejected but approved loans would go low margin from competition.

Now think of a dentist who wants to open her own practice. Her savings may not cover the cost of buying equipment that is needed. An asset backed loan may be a better opion for her. Of course, there is a risk involved -- she may not generate enough revenues to cover the cost of servicing the debt or her other liabilities. Typically she would consult with her accountant before starting on this journey.

I would argue thay contractual obligations and regularity and severity with which they are enforced are a sobering influence on businesses. There are no contacts with universe needed for debt -- but there is an element of risk that needs to be accounted for.

edit : typos

Debt restructuring and bankruptcy are things, too. A contractual obligation isn't immutable or inviolable.

this makes very little sense. You are not lending the entire economy and then demanding more than the economy be paid back. You only lend a portion of the money supply so that a slightly larger portion is repaid.

Even if that were the case, isnt that what QE does?

The extra $5K come from the same place the initial $100k came.

That's the supply side consideration of the price of debt, but interest, like all prices, is determined by intersection of supply and demand, not supply alone.

Demand side consideration is “what new income in the future does taking on this debt now enable?”