Corporate Cash, Not Buybacks, are Hurting the American Economy

From my background in the business school and my pursuit of an economics minor, I consider myself a lucky individual who is able to stand at the intersection of the two related fields. I can utilize one school of thought to aid the other, and vice versa, providing me with a unique insight to the connection between financial and economic events. And, as I am finding exceedingly more important, I can understand when the connection breaks down or the facts are presented in such a way to make the two stand at odds.

This is exactly what Nick Hanauer attempts to do is his article Stock Buybacks Are Killing the American Economy. Hanauer attempts to explain how the diversion of corporate profits to share buybacks has been destroying the "real economy" and contributed to the income inequality present in the United States today. While the points that he makes regarding income inequality may be valid, I take contention with his complete disregard of financial theory when explaining how buybacks are destroying the economy. Hanauer explains:

In the past, this money flowed through the broader economy in the form of higher wages or increased investments in plants and equipment. But today, these buybacks drain trillions of dollars of windfall profits out of the real economy and into a paper-asset bubble, inflating share prices while producing nothing of tangible value.

I would like to first take issue with the idea of corporate profits flowing through to higher wages. While it may be true that highly profitable companies can afford to pay its employees more, Hanauer completely ignores the effect of rising stock prices on households' wealth. Outside of real estate investments, the second largest asset individuals hold is their retirement accounts; as a result of increasing share prices, as he himself pointed out was an outcome of share buybacks, these retirement accounts can see appreciation in value. While higher wages may be a positive for the economy, rising household wealth can have the same desired effect.

The other portion of his argument deals with possible increases in investments coming from corporate profits. According to financial and economic theory, investments in these types of projects are only profitable as long as they are the "best" or most "efficient" use of resources (that is to say the opportunity cost is taken into account). Hanauer argues that these investments are the best use of resources but more and more CFOs seem to be disagreeing with him—as evidenced by the increased amounts of buybacks. Hanauer is failing to recognize that there are significant benefits of these buybacks, namely decreased cost of capital, tax benefits, and satisfied shareholders (which is important for the stock market as a whole). For Hanauer's argument to hold, CFOs who themselves are very educated and well versed in the needs of their companies, must be incorrect about capital allocation on an increasingly large scale. If the CFOs are correct, to do anything else would be economically inefficient and actually destroy value.

While share buybacks may not be hurting the American economy, exploring a different area of corporate balance sheets reveal a significant area that could be causing problems: cash. The Wall Street Jounal in conjunction with Deloitte, published an article titled How Record Cash Reserves Influence Corporate Behavior. In the article, they point out that not only large companies, but increasingly small companies, are holding more and more cash:

Between 2008 and 2013, [large companies] nearly doubled their cash reserves from $1.61 trillion to $2.88 trillion, and at the same time, the small cash holding companies kept accumulating at an even pace and increased their reserves from $433 billion to $656 billion.

While these record amounts of corporate cash may have benefited companies during the tough economic times of the recession, but as the economy continues to recover, cash piles are becoming a large inefficient use of resources. With yields across the yield curve near historic lows, the return that cash is currently seeing is paltry. It seems increasingly likely that companies would be able to find profitable investments to take on or, if none exist, they can distribute that cash to shareholders so they themselves can be rewarded for holding the company's stock and be able to find worthwhile investments themselves.

Opposites Attract? Changes in Marriage Economics

While I initially took the course to fulfill my social science, my Economics 323: Gender Economics class has been distinctly interesting. Thinking about such qualitative social issues such as marriage and childbearing by attempting to grasp each concept with some sort of logical model has shifted my prospective and opened my eyes to a new way of thinking. One particular issue that we uncovered in class was the answer to the question: do opposites attract in marriage? We uncovered, using a gains from trade model, that opposites should—economically speaking—attract as there will be larger gains from trade when each individual in a couple specializes in the production of a good in which they have a comparative advantage. By the use of complete or partial specialization in the individuals allows the couple overall to reduce opportunity costs and maximize combined output.

This economic model is discussed in the John Shoven textbook Demography and the Economy. In chapter 3, Shoven summarizes Gary Becker's work Treatise on the Family:

Gary Becker's 1981 Treatise on the Family proposed an economic theory of families based on "production commentaries," in which husband and wife specialize in the market and domestic spheres, respectively, and hence, are more productive together than apart...By having one person specialize in domestic responsibilities, while the other supports the spouse and children financially, couples are more efficient than singles.

Becker's analysis aligns perfectly with the gains from trade theory and for a significant period of time founded the basis for much analysis within the marriage economics field. However, as our class discovered, this theory poses a problem when applied to modern data on marriage patterns. Research done on recent marriage patterns reveal that opposites may not actually attract and factors outside of production skills are increasingly relevant to the marriage decision. 

One particular factor, friendship, is discussed in the New York Times article Study Finds More Reasons to Get and Stay Married. The article discusses the impact on friendship between spouses on marriage utility:

One reason for [benefits of marriage persisting] might be the role of friendship within marriage. Those who consider their spouse or partner to be their best friend get about twice as much life satisfaction from marriage as others, the study found...But in recent decades, the roles of men and women have become more similar. As a result, spouses have taken on roles as companions and confidants, particularly those who are financially stable, as the economists Betsey Stevenson and Justin Wolfers have discussed.

This seems to contradict what the initial gains from trade model that was proposed. Factors that would likely drive friendship in a relationship, namely similar education levels, similar interests, etc., are also those likely to reduce the comparative advantage between the individuals from a trade prospective. This research suggests there is a confounding factor other than these production factors that go into the overall utility (satisfaction) of marriage, and this factor is increasingly becoming more and more important.

But what caused the shift in the importance of the "friendship" factor. People across the United States did not just wake up one day and begin to increasingly think "gee, I should really marry someone that I am really friendly with".

The answer comes down to one word: cohabitation, or living with a "partner" without a formal marriage. According to the analysis of Neil Shah, writer for WSJ, on a Pew Research Center study:

For many Americans, staying single, cohabiting or raising children out of marriage increasingly looks like the best available option. Nearly 25% of young adults 25 to 34 who have never been married were cohabiting last year, up from under 22% in 2007, Pew says. Roughly 7% of adults 30 to 44 were cohabiting in 2010, too, according to a different analysis, up from 3% in 1995.

The increased importance of friendship within marriages flows directly from cohabitation. Individuals are taking longer to determine whether or not to marry another person, utilizing cohabitation to make this determination. These "couples", who often will not pool resources (specifically finances) and will not make the normal gains from trade decisions. As a result, they have had to look to other factors (similarity, friendship, etc.) to provide utility in a marriage.

Revised Post: Super Bowl Ad-conomics

As part of my Econ 411 class, we are required to revise 5 of our previous blog posts, refining the ideas that we present. I chose to revise my analysis of Super Bowl economics, focusing solely on what I call "Ad-conomics":

The entertainment of Super Bowl night does not end on the field; plenty of people remain focused on the action between the action: advertisements. It is no secret that advertisers go all out for the Super Bowl. They sink some of their greatest ideas into a 30 second clip which costs $4.5 million (that's $150,000 per second plus the costs of actually producing the ad), all to reach what is the largest audience in the United States. With costs so great, it makes you wonder if the value is actually worth it.

An article by Matthew Yglesias on Vox entitled The unsustainable economics of Super Bowl ads attempts to answer to that question, and his answer is a resounding "no". The article begins with a discussion of a common measure of value in the advertising industry:

The easiest way to look at this question is to start with industry-wide CPM statistics. That stands for cost per mille, the price an advertiser pays to reach a thousand viewers (advertisers love Latin, apparently). The average CPM for 2015 so far is $37.35 which makes a $4.5 million Super Bowl ad worth the cost if it gets 120.5 million viewers.

Clearly the Super Bowl advertising did not live up to its "value" as described by the author as only 114.5 million people watched the Super Bowl, as was reported by Nielsen. Further building to the authors point in the article, Yglesias explains how advertising cost has outgrown viewership increases, such that now advertisers are "paying a premium in CPM terms."

However, the author fails to realize two key facts about Super Bowl advertising costs. First is just the simple economics of demand for advertising space. The $37.35 average CPM is based on all advertising so far in 2015, including normal shows and shows that are competing for viewership. No one event can compare to the Super Bowl, which dominates ratings and faces almost no competing programs. Simple economics say that advertisers would demand this program in greater proportion to the "average", increasing the amount that they are willing to pay. The second point that the author fails to recognize is the increase engagement that consumers have to these ads. Plenty of consumers remained glued to the television during advertising spots, as opposed to possibly turning away from the TV during normal programming. In addition, millions of Americans take to Twitter, YouTube, and Facebook to continue to view/analyze the ads. This often leads to people voicing their opinions and voting for the ads that "won" and "lost", further driving advertising engagement. Clearly, again, advertisers would be willing to pay a premium for this economic feature.

A recent Forbes article attempts to elicit exactly how much this premium would be for all of these extra economic features related to the Super Bowl. Part of their article directly responds to Yglesias's use of an average CPM figure. The author, Chris Smith, cites a comparable major TV event, the Academy Awards, and its CPM figure of $42 to estimate an effective audience ad cost of $8 million for this year's Super Bowl. However, Smith agrees with my analysis of even higher premiums for Super Bowl ads: "nobody tunes into the Academy Awards to watch the commercials."

The full analysis of the Forbes article details a slightly higher price tag based on the statement by NBC executive Seth Winter, who estimated that a price tag of $10 million would still be worth it for companies to advertise:

"We did an analysis around last year's Super Bowl that Fox ran, and our analysis showed that with all of the video distribution pre- and post-game, the value of the PR, the value of that which advertisers used to activate around their investment that it reached a very solid good foundation number of $10 million."

The article then goes on to challenge this $10 million figure based on four main components: basic television viewership, social media, media coverage of the game's commercials, and increased brand awareness. Two of the ideas, TV viewership and social media, were highlighted above and the article further breaks them down quantitatively: 54% higher brand recall for a Super Bowl ad and an average of 19 million additional impressions via social media. The other two components, media coverage and increased brand awareness, are both based on studies performed by market research firm Repucom and researchers at the University of Wisconsin-Eau Claire, respectively.  When combined, all of these components of "value creation" add to $10 million.

Federal Reserve Meeting: January 2015

The United States Federal Open Market Committee concluded its first meeting of 2015 this past Wednesday, releasing a statement that was highly analyzed and scrutinized given the anticipation over the Fed raising interest rates. While there was no clear indication of the Fed's future moves, analysis of the statement and some of the key points can bring a more solid understanding of the Fed's actions going forward.

One of the most interesting analytic tools available to understand the FOMC's statements is the Statement Tracker Tool provided by the Wall Street Journal. This tool takes a direct comparison of two statements, using red highlights and strike-throughs to indicate verbiage that has been removed and green highlights to indicate points that were added. For this most recent statement, I analyzed the change between the January statement and the directly preceding it (December 2014). One of the most prominent changes between the two statements occurs in the third paragraph:

The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time...especially if projected inflation continues to run below the Committee's 2 percent longer run goal, and provided that longer term inflation expectations remain well anchored.

As indicated by the red highlight and the strike-through, the FOMC had chosen to omit this portion of the December 2014 statement in their statement released this past Wednesday. This change is important on two levels: first, it takes away the "considerable time" clause from the Fed's statement. This clause was cited by Federal Reserve officials as showing a commitment to near zero short term rates for an extended period of time. With the removal of this clause, it gives a pretty clear indication that the Fed will adjust the target range within the coming months. The second piece of information that is taken away from the Fed's statement is concerning keeping the target rate low given lower inflation. This, I feel, is a more striking development, as it more explicitly states that these rate hikes will in fact happen, even if inflation remains under their 2% target. The removal of this key policy point shows that changes will be made, and they will be made (almost) regardless of what the data shows.

Upon analyzing the Fed statement, the Wall Street Journal published an article entitled 7 Takeaways From the January Fed Statement: 'The Committee Judges That It Can Be Patient'. In this article, several WSJ writers analyze seven of the key points that can be taken away from the January statement. For his analysis, Pedro Nicolaci da Costa analyzed the meaning behind one added word in the third paragraph:

The Fed added a single word to its policy statement which may actually have a lot of meaning. In a sentence saying it was monitoring inflation and market trends, the Fed now notes it is monitoring "international developments." That's about as close as Fed officials will ever get to hinting that movements in the dollar, which has been rallying steady, may affect their thinking.

The addition of another policy variable, "international developments", is an interesting shift from the FOMC. This shift takes into account the rapid appreciation of the dollar as compared to numerous currencies, especially the Euro. While the Fed will never directly state that it makes policy decisions based on movements in the market, the addition shows that the Fed is cognizant of the headwinds that the US economy could face given international instability: namely, decreasing amounts of exports.

ECB Decision in the Details

This past Thursday, the European Central Bank made a historical decision in announcing its first ever quantitative easing program. This decision to undertake a QE program was highly expected by the markets, but the pace and size of this program, €60 Billion per month for a total size of €1 Trillion, sent stock markets across the globe rallying. While the headline numbers were often the most discussed, much of the important features of this bond purchase program comes from the details buried further down the page.

One of the most important details of this program comes from the loss sharing provision, or the small size of it, that is in the QE program. In an article posted to Medium in the Bull Market page, Karl Whelan breaks down exactly how and how the risk will not be shared:

As flagged, any risk from the "additional asset purchases" will not be shared apart from the 12% of purchases used to buy debt issued by European institutions. The ECB will also be making 8% of the purchases under the program and it is jointly owned by the NCBs, so effectively this means 20% of the purchases will feature risk sharing. However, the vast majority of the purchases-national sovereign bonds bought by NCBs-will not have risk shared. Thus, if a national government defaults, the NCB that purchased its debt will not be compensated by the other central banks.

This feature of the QE program was critical for the larger countries, such as Germany and France, to agree to this deal. While 20% of the program will be risk shared, these countries whom have significantly safer debt ratings will not have to be overly concerned about the increased risks associated with the more risky countries in the Euro Zone. In addition, making each NCB responsible for holding their sovereign debt removes most of the possibility for moral hazard, as it does not incentivize governments to default if their loss sharing would have been shared equally.

An additional detail of the ECB's decision to begin a QE program was the handling of Greece. As the results of this weekend's election, the controlling party in Greece is now one of anti-austerity philosophies. This brings a complication to the QE program, which was described by Nektaria Stamouli and Selios Bouras in their WSJ article Greek Austerity Review Needs To Be Completed for ECB QE:

The review of cutbacks and reforms in Greece must be completed to receive the next installment of international aid...Greece needs to stick to the terms of its bailout, footed by the European Commission, the European Central Bank and the International Monetary Fund, to be included in the ECB's bond-buying program.

As the outcome of the election is now clear, we can see that the anti-austerity party could cause a double hex to be placed on the Greek economy. First, as promised in their campaign, the Syriza party will push to end austerity measures as imposed as part of their bailout. With this push, they could compromise the continuation of receiving their bailout funds, leading to an eventual default and negatively impact their economy. Second, the ECB's decision to include Greece in the bond buying program is dependent on their continued bailout; again being involved with this program, which can aid in pulling down bond yields, is at risk with the Syriza party in power.

2014: A Year in (Economic) Review

2014 was an interesting and transformational year for the United States economy. Now that the year has come to a close, it is important to take a look back on the past twelve months to keep track of our economic progress. 2014 saw a brief economic contraction in the first quarter, the end of the Federal Reserve's third quantitative easing program, and a changing of the guard at the head of the Federal Reserve. Taking a comparative look at the reaction to the first quarter's GDP report and the anticipated fourth quarter GDP report can show the metamorphic story of the US economy last year.

When Chair Yellen took office in the beginning of 2014, the economy was in the midst of only the second economic contraction since the end of the Great Recession. A CNBC article and accompanying video highlight the reaction to the first estimate of US Gross Domestic Product in the first quarter. While the final estimate of Real GDP growth was only revised downward (twice) to -2.9% from the 0.1% growth initially reported, the reaction to the weak data nevertheless holds. In the video, CNBC reporter Rick Santelli offers his reaction: "so to summarize: weak. Let me summarize again: weak." The article goes on to further discuss the "weak" initial report saying:

While the harsh weather could partially explain the weakness in growth, the magnitude of the slowdown could complicate the U.S. central bank's message as it is set to announce a further reduction in the amount of money it is pumping into the economy through monthly bond purchases.

The added backdrop to this initial reaction is that, as I said before, the final number came in significantly worse than what was originally reported. If this number had been reported to begin with, I would have been curious to see if there would have been greater questioning within the Fed about the speed of their tapering plan. I would have expected that Chair Yellen, who is considered to be an monetary "dove", may have pushed for an ease of the tapering plan.

The first quarter GDP report stands in stark contrast to how the United States economy finished the year. Third estimate of the third quarter Real GDP growth currently stands at 5.0% growth, and this strong growth is expected to continue at a slightly slower pace in the fourth quarter and into 2015. In a recent publication by the International Monetary Fund, the United States economy's growth rate was revised upwards while most other developed areas were revised downwards. The IMF explains:

For 2015, the U.S. economic growth has been revised up to 3.6 percent, largely due to more robust private domestic demand. Cheaper oil is boosting real incomes and consumer sentiment, and there is continued support from accommodative monetary policy, despite the projected gradual rise in interest rates.

This report of expected healthy economic growth for the United States stands in direct contrast with the beginning of 2014. An economy that could only be described by the word "weak" now appears to be one of the healthiest economies in the developed world. It now appears the Fed was correct to continue its course of tapering, and are now even expected to begin to normalize their monetary policy.

America: A State of Political Roadblocks

I will preface this blog post by saying that, while I consider myself a Democrat (mostly due to my Keynesian view of economics), I generally abstain from promoting one political thought over another. It is my guiding political view that, during troubled economic times such as these, the country should look for proper leadership, regardless of political lines.

As the State of the Union was last night, I thought it would be proper to discuss some of the economic issues that were debated and examined by both political parties. One particularly hot bed issue that came up Tuesday night was the debate over taxes and tax reform. In the multitude of articles that came out before and after the address, two things became immediately clear: Republicans and Democrats disagree on what to do about taxes (shocker) and there seems to be almost no hope of getting a tax deal done.

The address, like this debate, will start on the Democratic side. In a front page article by the Wall Street Journal, Carol E. Lee, John D. McKinnon, and Kristina Peterson outline the President's initial proposal for tax changes. The authors highlight the talking points of the proposal, starting with a $320 billion tax hike over the next 10 years centered on high-income Americans, which would then go to pay for a $235 billion tax break for "mostly moderate-income workers". They then followed the talking points with a quote from an administration official:

"If Republicans, who now speak of poverty and income inequality with some regularity, want to defend a tax loophole of trust funds of the wealthiest of Americans, then we look forward to hearing that argument," a senior administration official said, referring to the proposal to tax additional inherited assets. "We're going to make the counter on Tuesday night. We are calling it middle-class economics."

Before the Republican Party even had a chance to respond, it seems as though the political strategy game is already being played. This official, and potentially other Democrats, seem to be salivating over the prospect of having trapped Republicans into this political corner.

On the Republican side, most of the ideas that were pushed for by President Obama were largely dismissed. Scott Neuman gathered statements and quotes in response to the address in his article Republican Leaders Dismiss Obama's Tax Proposal As 'Not Serious'. Neuman sites a spokesman for former Republican Vice Presidential candidate Paul Ryan:

"This is not a serious proposal," said Ryan spokesman Brendan Buck in a public statement. "We lift families up and grow the economy with a simpler, flatter tax code, not big tax increases to pay for more Washington spending."

While it is still early to determine what this "simpler, flatter tax code" will exactly entail, previous tax proposals have indicated that Republicans often advocate for tax breaks and a cutback in spending, which stands directly opposed to the President's plan.

Not even a day after the President's address and we are already starting to see a roadblock form on the tax issue. Economically speaking both plans have merit. Increasing taxes on those who are seen as able to "afford" it to fuel spending programs creates expansionary fiscal policy. On the other hand, continuation of tax breaks and a simpler tax code will likely stimulate consumption of goods, again expansionary. What is clearly not expansionary (or in any way economically helpful) is the political bickering that will likely last well down the road.

And while my ideals will typically agree with the President's tax plan, I am willing to advocate for a Republican plan for the sake of economic advancement. If the debate rages too long into the year, the US may miss an opportunity to take important economic steps toward recovery and, worse yet, deepen the political gridlock that exists in Congress. I concede my economic ideals to being in the minority in Congress, as both houses were recently voted into Republican control by the American public. However, that is not to say that the President should be bullied into accepting a plan that he does not believe in (as he too was elected via a public vote). It is to say that strong leadership from both the President and Republican Congress should make sure that a tax deal, albeit strongly right leaning, gets done.