Fri, 06/05/2020 – 22:23
It was all the way back in 2012 when we first described in “How The Fed’s Visible Hand Is Forcing Corporate Cash Mismanagement” that the era of ultra cheap money unleashed by the Fed is encouraging corporations not to invest in capex or growth or investing in a satisfied employee base, but to rush and spend it on cheap, short-term gimmicks such as buybacks and dividends which benefit the company’s shareholders in the short term while rewarding management with by bonuses for reaching stock price milestones, vesting incentive compensation.
We concluded by saying that this was “the most insidious way in which the Fed’s ZIRP policy is now bleeding not only the middle class dry, but is forcing companies to reallocate cash in ways that benefit corporate shareholders at the present, at the expense of investing prudently for growth 2 or 3 years down the road.”
For years, nobody cared about what ended up being one of the most controversial aspects of capital mismanagement in a time of ZIRP/NIRP/QE, then suddenly everyone cared after the coronavirus crisis, when it emerged that instead of prudently deploying capital into rainy day funds, companies were systematically syphoning cash out (usually by selling debt) to rewards shareholders and management, confident that if a crisis struck the Fed would bail them out: after all the Fed bailed out the banks in 2008, and by 2020 US corporate debt had reached $16 trillion, or over 75% of US GDP, making it a systematic risk and virtually assuring that expectations for a Fed bailout would be validated.
Sure enough, that’s precisely what happened.
But while none of this should come as a surprise to anyone following events over the past decade, what came next may be a shock, because in response to creating a massive debt bubble whose proceeds were used to make shareholders extremely rich at the expense of a miserable employee base and declining corporate viability, the Fed… doubled down and virtually overnight gave companies a green light to do everything they did leading to the current disaster.
In a Bloomberg expose written by Bob Ivry, Lisa Lee and Craig Torres, the trio of reporters show how, 12 years after we first laid out the “New Normal” capital misallocation paradigm, we are again back to square one as the Fed actions – which as even former NY Fed president Bill Dudley admits are brazen moral-hazard – have prompted a record debt binge even as corporate borrowers are firing millions of workers while using the debt to – drumroll – make shareholders richer.
Take food-service giant Sysco, which just days after the Federal Reserve crossed the final line into centrally-planned markets on March 23 when it assured that it would make openly purchase corporate debt, Sysco sold $4 billion of debt. Then, just a few days after that, the company announced plans to cut one-third of its workforce, more than 20,000 employees, even as dividends to shareholders would continue.
That process repeated itself in April and May as the coronavirus spread. The Fed’s promise juiced the corporate-bond market. Borrowing by top-rated companies shot to a record $1.1 trillion for the year, nearly twice the pace of 2019.
What happened then was a case study of why Fed-endorsed moral hazard is always a catastrophic policy… for the poor, while making the rich richer:
Companies as diverse as Sysco, Toyota Motor Corp., international marketing firm Omnicom Group Inc. and movie-theater chain Cinemark Holdings Inc. borrowed billions of dollars — and then fired workers.
Just two weeks ago, Fed chair Powell testified before Congress, and when asked why the Fed is buying investment grade and junk bond debt, Powell responded “to preserve jobs.” That was a blatant lie, because as Bloomberg notes, the actions of the companies that benefited from the Fed’s biggest ever handout called into question the degree to which the U.S. central bank’s promise to purchase corporate debt will help preserve American jobs.
Unlike the Small Business Administration’s Paycheck Protection Program, which has incentives for employers to keep workers on the job and is only a grant if the bulk of the proceeds are used to retain workers, the taxpayer-backed facilities that the Fed and Treasury Department created for bigger companies have no such requirements. In fact, to make sure the emergency programs help fulfill one of the Fed’s mandates – maximum employment – the central bank is simply crossing its fingers that restoring order to markets will translate to saving jobs.
Instead, what the Fed’s actions have unleashed so far is a new record debt bubble, with more than $1.1 trillion in new debt issuance in just the first five months of the year, even as companies issuing debt are quick to lay off millions!
“They could set conditions, say to companies, hire back your workers, maintain your payroll to at least a certain percentage of prior payroll, and we will help,” said Robert Reich, the former Secretary of Labor for President Bill Clinton who now teaches economics at the University of California, Berkeley. “It’s hardly clear that if you keep companies afloat they’ll hire employees.”
Just don’t tell the Fed Chair: in a May 29 webinar, Jerome Powell said that it’s “really it’s all about creating a context, a climate, in which employees will have the best chance to either keep their job, or go back to their old job, or ultimately find a new job. That’s the point of this exercise.”
The exercise has failed, because just as soon as the bailout funds expire, America will see a second wave of epic layoffs: the extra $600 a week in unemployment benefits that Congress approved in March stops on July 31, while the prohibition against firing workers in the $25 billion government rescue of U.S. airlines expires Sept. 30, and the biggest recipients have said they intend to shed employees after that date.
But where did all the hundreds of billions in newly issued debt go? Well, dividends for one. Without provisions for employees, “the credit assistance will tend to boost financial markets, but not the broad economic well-being of the great majority of the population,” Marcus Stanley, Americans for Financial Reform’s policy director, told Bloomberg.
Of course, when confronted with this reality, the Treasury Secretary did what he normally does: he lied.
“Our No. 1 objective is keeping people employed,” Mnuchin said during a May 19 Senate Banking Committee hearing after Senator Elizabeth Warren, a Massachusetts Democrat, accused him of “boosting your Wall Street buddies” at the expense of ordinary Americans. “What we put in the Main Street facility is that we expect people to use their best efforts to support jobs,” Mnuchin said.
The phrase “best efforts” echoes the original terms for the Main Street program, which required companies to attest they’ll make “reasonable efforts” to keep employees. The wording was subsequently changed to “commercially reasonable efforts,” which Jeremy C. Stein, chairman of the Harvard University economics department and a former Fed governor, called a welcome watering-down of expectations that the central bank would dictate employment policies to borrowers.
And while Stein said that it was “smart of them to weaken that”, what ended up happening is that companies entirely sidestepped preserving employees and rushed to cash out – guess who – shareholders once again.
But in keeping with the Fed’s overarching directive – that its programs are about lending, not spending in the words of Powell – once the Fed has triggered a new debt bubble with its explicit interventions in the secondary market, the Fed has no control over what companies do with the source of the virtually free funds:
“For the Fed to second-guess a corporate survival strategy would be a step too far for them,” said Adam Tooze, a Columbia University history professor. Putting explicit conditions on program beneficiaries would make the central bank “a weird hybrid of the Federal Reserve, Treasury, BlackRock and an activist stockholder,” he added, clearly unaware that we now live in a world in which this “new normal” Frankenstein monster is precisely who is in charge of capital markets, as the helicopter money resulting from the unholy merger of the Fed and Treasury is precisely what BlackRock is frontrunning, in its own words. But heaven forbid some of the trillions in new debt are used for emplyees…
And while tens of millions of jobs have been lost since March – today’s laughable and fabricated jobs report, in the BLS’ own admission – notwithstanding, there has been one clear beneficiary: the S&P 500 has jumped 38% since March 23, the day the Fed intervened; on Friday, the Nasdaq just hit an all time high. Observers of the stock market wonder how it could be so bullish at the same time as the country faces an avalanche of joblessness unsurpassed in its history.
The choices companies are making – choices which we correctly predicted back in 2012 – provide an answer.
Since selling $4 billion in debt on March 30, Sysco has amassed $6 billion of cash and available liquidity, enabling it to gobble up market share, while cutting $500 million of expenses, according to Chief Executive Officer Kevin Hourican. Sysco, which is based in Houston, will continue to pay dividends to shareholders, Chief Financial Officer Joel Grade said on a May 5 earnings call.
Countless other companies are also splurging on debt-funded dividends, while some – such as Apple and Amazon – are now issuing debt to fund their next multi-billion buyback program.
Of course, it’s not just investment grade debt: the Fed notoriously is also active in the junk bond space, buying billions in high yield ETFs (that now hold bonds of bankrupt Hertz).
Movie theaters were one of the first businesses to close during the pandemic. Cinemark, which owns 554 of them, shut its U.S. locations on March 17. Three days later, the company paid a previously announced dividend. It has since said it will discontinue such distributions. Cinemark borrowed $250 million from the junk-bond market on April 13, the same day it announced the firing of 17,500 hourly workers. Managerial staff were kept on at reduced pay, according to company filings. Cinemark, which is based in Plano, Texas, said it plans to open its theaters in phases starting June 19.
The theater chain opted to go to the bond market over seeking funding from the government because “it didn’t come with any of the strings attached that government-backed facilities can include,” CEO Mark Zoradi said on the April 15 earnings call. It “was really no more complicated than that.” And why did Cinemark find no trouble in accessing the bond market? Because with the Fed now buying both IG and HY bonds, there is no longer any credit risk, which is why spreads have collapsed back to all time lows; in effect the Fed is forcing investors to buy Cinemark’s bonds, which then uses the proceeds to pay shareholders either a dividend or to buyback stock. As for the company’s employees? Why they are expendable, and in a few month there will be millions of unemployed workers begging for work at or below minimum wage.
Win win… for Cinemark’s management and shareholders. Lose for everyone else.
Actually, win win for all corporations: like Cinemark, Omnicom issued $600 million in bonds in late March. In an April 28 conference call to discuss quarterly earnings, CEO John Wren said the company was letting employees go but didn’t say how many. He said the company was extending medical benefits to July 31 for employees furloughed or fired.
Wren added: “Our liquidity, balance sheet and credit ratings remain very strong and we have no plans to change our dividend policy.”
And once again, Dividends 1 – Employees 0, because everything will be done to prevent shareholders from dumping the stock.
Toyota borrowed $4 billion from investors on March 27. Three days later, the Japan-based car company said it would continue paying dividends to shareholders. Eight days after that it said it would drop roughly 5,000 contract workers who helped staff its plants in North America.
And so on, and so on, as companies issue hundreds of billions in debt without a glitch – now that the Fed has taken over the bond market – and use the proceeds to fund dividends, while laying off millions.
In a March 24 letter, 200 academics, led by Stanford University Graduate School of Business Professor Jonathan Berk, called lending programs aimed at corporations “a huge mistake.” Better to focus help directly on people living paycheck to paycheck who lost their jobs, it said.
“Bailing out investors who chose to take high-risk investments because they wanted the high returns undermines capitalism and makes it an unfair game,” Berk said in an interview. “If you don’t have a level playing field in capitalism, it doesn’t work.”
Why dear, misguided Jonathan: whoever told you the US still has “capitalism”?
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Author: Tyler Durden
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