12  When Large Corporations Play Solitaire


You may believe that the subprime scandal will effect only gambling banks who have loaded up with syndicated debt diced and packaged to "manage risk." But "managing risk" is the elusive goal of every gambler, and these stock market gambles go on from one area of the economy to the other until it will take years to sort them out. For the "sorting out," in fact, the government is likely to step in and bail out what portion of the badly prepared mortgage with the greater "efficiency" of the mortgage company’s agents replaced the examination of credit and tax records.

This basic birthmark of a card game for endlessly big stakes crops up all over. The latest can be found in The Wall Street Journal (27/11, "Big Buybacks Begin to Haunt Firms" by Peter A. McKay): "Driven by billions of dollars in share buybacks, record-setting buyouts and a wave of mergers, the amount of stock in the market shrank by hundreds of billions of dollars in share buybacks, record-setting buyouts and a wave of mergers, the amount of stock in the market shrank by hundreds of billions of dollars in the past four years.

"With the supply of stock down and demand strong, the market rallied. However, now as the market slows and credit buckles, high-profile companies are cutting back on buy-backs, and some wish they held on to the cash they gave back to shareholders.

"‘In an environment like this, stock buybacks take second place,’ said James Dimon, CEO, J.P. Morgan Chase & Co., in a conference call last month.

"Yesterday, shares of Freddie Mac fell 29% on the word that the mortgage company may halve its dividend and seek a capital infusion amid a record loss. Freddie might not be in this position if it hadn’t bought back at least $1 billion of common stock and replaced it with preferred shares. Fannie Mae, the largest US house-funding company, has tapped the market more recently, raising $1.5 billion in less tan two months by selling preferred stock. Fannie shares fell 25% yesterday and are at their lowest level since May 1996.

"In recent weeks, Countrywide Financial Corporation, which spent $2.4 billion in the past year to repurchase its shares, was forced to resell a chunk of its stock to raise money. Office Depot Inc., which bought back 5.7 million shares at an average price of $35 a share, said on its earnings call yesterday said that it would like to buy its shares back at the current price of $17.49M but can’t. Office Depot fell 7% yesterday.’

"Home Depot Inc. said it will delay the rest of its massive stock buyback plan, while investors in Citigroup Inc. have turned nervous about the health of the bank’s balance sheet and capital levels, prompting management to say it isn’t in the position to repurchase shares.

"The reversal of the trend exposes a flow in the buy-back strategy – many companies bought high and are selling low.

"From the third quarter of 2002 to the second quarter of this year, more than 1.5 trillion shares have disappeared from the stock market through buybacks, mergers or buyouts, according to the Federal Reserve. The number hit a peak during the second quarter of this year, when non-financial companies retired seasonally adjusted net 192.5 billion shares. Some of the money to buy shares came from credit markets, where companies raised $156.5 billion in the quarter.

"Now some investors worry that dividends and buybacks will go from a positive to a negative position for the market as a slowing economy put pressure on a host of companies. Investors usually embrace buybacks, even if those shares are richly valued, because they typically mean that companies are generating a lot of cash.


- from Economic Reform, December 2007