What happened in the year 2000? Well, Y2K of course! There was substantial business investment in information technology in preparation for Y2K. There was talk of the world coming to an end because computer systems would cease to work at the stroke of midnight on January 1st, 2000. My father worked on Y2K as an IT consultant; the pay he received back then would be hard to match even today, nearly 20 years later. In 2002, after tall that investment, the technology bubble burst. The Nasdaq 100, the technology stock index, collapsed. That’s not to say that Y2K was an investment in technology; it was primarily an upgrade made to computer systems so that they would be aware that “00” meant 2000, and not 1900. With that said, investors were severely burned by investments in technology companies that were not monetizing their ideas. The tech start-ups of the 90’s and early 2000’s simply could not make money. In the run up to the 2008 crisis, business investment stagnated, and so the Federal Reserve jolted the markets with easy money; they kept interest rates low for a long time. This spurred the housing bubble. Financial engineering covered up the underlying issues of bad loans, so that Wall Street could continue to securitize and sell them as investments. How was this done? It’s actually very complicated, but the gist of it is that banks would sell good loans(debt) packaged together with bad loans (debt that was possibly already delinquent). Because of how complicated it was, and all the fine print in the prospectuses of these securitized loans, investors didn’t do the due diligence to verify exactly what they were buying. Rating agencies, like S&P, Fitch, and Moody’s, gave these bonds higher credit ratings than they deserved; even they probably couldn’t figure out how risky the loans within them actually were. GDP was manufactured in the sense that homes were built and sold with loans that should have never been made; in 2008, when the world economy was on the verge of collapse, the proof arrived that nothing backed those loans, and the mortgages never should have been made.
So how does the debt crisis of 2008 relate to things, specifically share buybacks, that are happening today? We are in a very similar interest rate environment today, as we were in the run-up to the financial crisis of 2008. Interest rates are very low! Well, let’s take a look at who is encouraging share buybacks. Deloitte points to activist shareholders as the potential culprits. Activist shareholders are sharks. They don’t care about the companies they invest in. They take stakes in companies for the sole purpose of bullying the CEO and the board of directors into certain action, whether it be breaking up the company, selling the company, or buying back shares. One of the most famous activist shareholders is Carl Icahn. His activism has recently lost lots of money for Xerox and Newell Brands shareholders. Deloitte researchers point out,
- “…activist shareholders have increasingly coerced companies into focusing on shareholder returns in the short term rather than boosting productivity and growth in the long term. This hypothesis points to a rise in activist campaigns. For instance, there were 231 activist campaigns in 2009, and this number rose steadily to 377 in 2015.7 This theory claims that because of increased pressure from activist shareholders, companies have spent on share buybacks, at the cost of investments in equipment and structures.
Earlier, we mentioned Jamie Dimon and Warren Buffet coming out publicly against short-termism. Short-termism is exactly what is described in the above excerpt: the prioritization of short term returns over long term investing. In the above linked CNBC article, Jamie Dimon and Warren Buffet have called for the end of quarterly profit forecasting. They claim this type of forecasting forces public company management to do things, such as financial engineering, they normally wouldn’t. Their only motivation is meeting, or beating, Wall Street expectations. Interestingly enough, calling for the end of quarterly forecasting will have an unrelated side-effect: to reduce stock market volatility. From CNBC,
“Companies forecast sales and profit numbers to Wall Street analysts, who use it to produce research and stock recommendations for investors. Missing “the number” can often result in big, short-term stock moves. Making a forecast, and then hitting the target, are seen as a way to manage expectations and eliminate volatility.”
The elimination of volatility in markets has been a goal of government regulators ever since the 2008 financial crisis. But eliminating volatility is inherently non-capitalist. Remove volatility is one way of achieving price stability. This should remind us all of the Nixon Price Controls put in place to fight the inflation that ravaged the US in the early 1970’s thru the early 1980’s. The fact that Jamie Dimon is advocating for something that eliminates volatility in markets should not come as a surprise. Jamie Dimon is the CEO of JP Morgan Chase. The banks, including JP Morgan Chase, were socialized during the 2008 Great Recession. This happened through the Emergency Economic Stabilization Act of 2008, among other government actions. The EESA transferred public funds (taxpayer money) to private banks, thereby rendering them no longer private; that is Socialism. Banks like Jamie Dimon’s JP Morgan Chase, have been direct beneficiaries of ZIRP (zero interest rate policy). That policy meant banks like JP Morgan had access to 0% loans directly from the Federal Reserve. In addition, it meant any deposits that banks had with the Fed would earn interest, an interest rate known as the Interest on Excess Reserve.
Furthermore, this meant big banks like JP Morgan monopolized banking; a combination of ZIRP and the Fed put meant banks could operate knowing the Fed was a guaranteed backstop for its business. Removing volatility would hurt small financial institutions and traders, not big banks. Volatility creates opportunities for traders, and smaller investors, to be able to get in and out of investments, since volatility brings with it liquidity. Although volatility has been vilified to some extent in books like Michael Lewis’ Flashboys, volatility is a part of capitalism. It occurs because of a fundamental component of market economies: price discovery. The result of the Federal Reserve’s war on volatility can be seen in the VIX index.
The VIX index measures stock market volatility. The chart below courtesy of FRED shows the VIX index since 2008; it has declined significantly. With that said, there have been spikes. Those spikes in volatility happen because of crises, or perceived crisis, in the financial markets. Things such as interest rate spikes, currency devaluation in China, debt crisis in Europe, or government shutdowns in the US, have all caused spikes in the VIX. Notice those spikes have all been short-lived. With that said, the largest spikes that are yet to come will be completely uncontrollable by the Federal Reserve. They will be a result of government debt induced inflation, and a US Dollar devaluation, similar to what happened in the 1970s.