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Thanks For The Corporate Bond Bubble, Fed

Tyler Durden's picture




 

Submitted by David Stockman via Contra Corner blog,

Once upon a time businesses borrowed long term money - if they borrowed at all - in order to fund plant, equipment and other long-lived productive assets. That kind of debt was self-liquidating in the sense that it usually generated a stream of income and cash flow that was sufficient to service and repay the debt, and to kick some earned surplus into the pot as well.

Today American businesses are borrowing like never before - but the only thing being liquidated is there own equity capital. That’s because trillions of debt is being issued to fund financial engineering maneuvers such as stock buybacks, M&A and LBOs, not the acquisition of productive assets that can actually fuel future output and productivity.

So it amounts to a great financial shuffle conducted entirely within the canyons of Wall Street. Financial engineering deals invariably shrink the float of outstanding stock among the companies visiting underwriters. Likewise, they invariably leave with the mid-section of their balance sheets bloated with fixed obligations, while the bottom tier of shareholder equity has been strip-mined and hollowed out.

At the same time, none of this vast flow of capital leaves a trace on the actual operations—-such as production, marketing and payrolls—of the businesses involved. Instead, prodigious sums of debt capital are being sold to yield-hungry bond managers and homegamers via mutual funds and then recycled back into windfall gains for stock market gamblers who chase momo plays and the stock price rips that usually accompany M&A, LBO or stock buyback announcements.

Needless to say, central bank financial repression is responsible for this destructive transformation of capital market function. It has made the after-tax cost of debt tantamount to free for big cap corporations——while fueling equity market bubbles that makes stock repurchases and other short-term financial engineering maneuvers irresistible to stock option obsessed inhabitants of the C-suites.

In this context, today’s WSJ saw fit to herald the $21 billion of quasi-junk bonds (BBB-) issued by Actavis PLC to fund its $66 billion acquisition of Allergen, a company which famously supplies Botox and similar life-enhancing products. Whether this mega-merger will result in any sustainable economic efficiency gains only time will tell, but the odds are not high. The overwhelming share of today’s red hot M&A deals fail to earn back the huge takeover premiums invariably paid. And, not infrequently, they are subsequently reborn as equally trumpeted corporate restructurings, spin-offs and other “value unlocking” maneuvers a few years down the road. It’s Wall Street’s version of “you stab ‘em and we slab ‘em”.

Yet there can be no doubt that funding the Allergen deal with $21 billion of freshly minted debt did accomplish the actual purpose of the financial engineering maneuver in question. Namely, it enabled Actavis to pay a bountiful premium to the selling shareholders without diluting its own shares.

And why not? The after-tax cost of the new debt will amount to a miniscule 2.4%. Consequently, the C-suite at Actavis acquired what amounts to a quasi-free option on the spread-sheet merger synergies and economies of scale postulated for the deal by Wall Street and its in-house financial engineers.

If these projected profits do not materialize or, as in the more usual case, if they are off-set with diseconomies of scale or operational and commercial dysfunction, the carry cost of the acquired assets will be negligible until they can be disposed in a “restructuring” event. No wonder CNBC celebrates Merger Monday and gets giddy when CEOs purportedly exhibit “confidence” in the future by launching new M&A deals.

Does this imply that the overwhelming share of M&A deals in this age of central bank financial repression amount to pointless financial engineering ploys designed to goose stock prices and stock option values, while substituting for genuine organic growth strategies? Yes it does.  And the systematic resource misallocations and anti-growth consequences are profound.

Since yesterday’s Actavis deal was the second largest bond deal ever, it induced the WSJ to trot out the historical statistics. And they scream financial engineers at work.

As shown in the graphic below, the granddaddy of debt deals was last year’s $49 billion Verizon issue. This colossal obligation most definitely had nothing to do with the acquisition of plant, equipment and technology assets or even other people’s second hand assets.

Instead, it amounted to an internal LBO in which the parent company bought in the stock of its own subsidiary. That’s right—–a cool $49 billion of holding company debt was issued to change exactly nothing at Verizon except to shower public shareholders of a second tier subsidiary with a 50% windfall against their pre-deal trading price.

It goes without saying that no one except Wall Street analysts has lately mistaken Verizon for a  value-producing enterprise. It is actually a serial deal machine—– a place where corporate value goes to die.

At the end of 2007, for example, it was already well down the slippery slope with tangible net worth at negative $10 billion. Today that figure stands at nearly negative $95 billion. Destruction of $85 billion of tangible equity value in just seven years is no mean feat——-even for a giant lumbering utility that has roughly 80 million quasi-captive customers to gouge.

There is no mystery to how Verizon navigated its way to the $100 billion negative (tangible) equity club. It borrowed itself silly funding “restructuring” charges and making vastly over-valued acquisitions. Thus, at the end of 2007 it had $31 billion of debt and today that metric stands at a staggering $113 billion.

What did Verizon get for the $82 billion in incremental debt that was on offer at bargain rates in the casino?  It certainly wasn’t any explosion of current earnings; since 2007 its EPS has only inched forward at about 3.3% per year. And it wasn’t an old-style burst of investment capable of turbo-charging future profits. Its CapEx  amounted to $140 billion over the last seven years, but 90% of that was needed to cover the DD&A charges on existing assets.

Viewed more broadly, Verizon and Actavis are at the top of the list, but they are merely super-sized versions of the generic syndrome. As shown below, the Fed’s massive money printing spree since the September 2008 crisis has fueled a massive increase in corporate debt issuance—–funds which have overwhelmingly been absorbed by non-productive financial engineering maneuvers.

The five largest debt deals of all-time shown in the graphic total $104 billion, for example, but every penny went to financial engineering and tax ploys. Sitting on $180 billion of cash, Apple most surely did haul coals to Newcastle with its $17 billion debt offering last year; and the other deals were more of the same debt financed M&A.

So far this year corporate bond issues total $241 billion. That’s a staggering $1.4 trillion annualized run rate—-or nearly double the run rate prior to the financial blow-off in 2008. Yet virtually all of this massive debt issuance has been cycled into after-burner fuel for the rocketing stock market. During the month of February alone, stock buybacks for the S&P 500 were a record $104 billion.

Is it any wonder that Wall Street threatens a hissy fit upon even a hint that the Fed’s rotten regime of ZIRP might be ended after 80 months? After all, it has amounted to free money for carry trade speculators and a cattle prod driving bond fund managers into corporate debt.

 

But here’s the thing. This entire massive capital market deformation appears to be invisible to the paint-by-the numbers Keynesian apparatchiks who run the Fed and their fellow travelers and cheerleaders in Washington and Wall Street. And the reason for this egregious blindness is not all that mysterious.

These folks do not understand capitalism nor the true ingredients of wealth creation and sustainable economic prosperity. They are simply glorified econometric modelers who pay no attention to balance sheets, economic history or enterprise level economic efficiency and investment. Accordingly, all borrowed dollars are the same; they are assumed to fuel the fires of “aggregate demand”, whether they are used to fund pyramids or machine tools.

Likewise, as long as the seasonally adjusted rate of spending—in this case for business CapEx—-during the current quarter is measurably higher than the prior period all is well. Never mind if it is merely a upward blip in a longer trend of decay or that the “spending” components of GDP do not even capture the ingredients of true wealth generation.

US household consumption spending surged during the housing and mortgage boom between 2002 and 2008, for example. Yet upwards of $3 trillion of that “spending” boom was funded with “MEW”. Needless to say, “mortgage equity withdrawal” was not a sustainable ingredient of economic growth or main street prosperity—even if it did temporarily flatter the quarterly GDP figures.

Indeed, at least the mortgage debt explosion during the Greenspan housing bubble did confer some transient prosperity on the middle class. By contrast, the corporate bond bubble this time around has been strictly a boon to the top 10% of households, which own 85% of equities, and especially the top 1%, which are heavily invested in the hedge funds and family offices which capture a lions share of the deal-driven windfalls in the stock market.

Here are the baleful facts. Total corporate and non-corporate business debt outstanding has been on a tear since the pre-crisis peak in late 2007. At that time, business credit outstanding totaled $11 trillion—–a figure which has now ballooned to $14 trillion. So despite the propaganda about a healthy post-crisis deleveraging, its been full steam ahead with debt issuance in the business sector.

But the overwhelming share of that $3 trillion has gone into financial engineering including trillions of stock buybacks during the last six years. By contrast, business CapEx has been tepid at best, and a downright disaster in reality.

Thus, during Q4 2007 the annualized rate of business spending on structures and plant and equipment totaled $1.447 trillion in constant dollars. Seven years later in Q4 2014—after massive monetary stimulus and endless Wall Street cheerleading about a rebound in CapEx—– the figure was $1.496 trillion at an annual rate. If you do not have a hand calculator, that miniscule difference amounts to a 0.4% annual rate of gain. Given the dubious inflation measures embedded in the governments price deflators, the “real” rate of gain since 2007 could easily be zero or even negative.

Self-evidently, whether the seven year trend of CapEx growth is 0.4% or even lower it reflects at drastic deterioration from prior business cycles—-notwithstanding the Fed’s massive financial repression designed to jump start investment spending, and the incremental $3 trillion that US businesses actually borrowed during this period.

During the 7-years after the business cycle peak of 2000, by contrast, real spending on structures and equipment increased by nearly 2% per annum or at 4X greater rate than during the current so-called recovery. And during the 1990-1997 cycle, the annual rate of gain in real business CapEx was 4.3%. Stated differently, during that seven year period, cumulative real business investment rose by 31% compared to the tiny 3.4% gain during the equivalent cyclical period since 2007.

Once upon a time in the pre-Keynsian world, economists and practical men of finance knew something else, as well. Namely, that what counts for long-term growth and genuine prosperity is the level of the capital stock, not merely the gross rate of business investment spending in any given quarter or other short-run period.

The fact is, our Keynesian GDP accounts do not account for capital consumption or depreciation of the existing capital stock in the famous reckoning of GDP. But if new CapEx does not replace current depreciation the productive capacity of the macro-economy is falling—notwithstanding the positive number for the “I” (investment) component in the GDP equation.

In fact, business sector depreciation is currently running at a $1.1 trillion annual rate for the US economy, meaning that gross spending on structures and plant and equipment barely covers the capital resources used up in current production.

Here is where the record boom in corporate debt issuance hides the true decay of productive capacity in the US business sector. During Q4 2007, real net investment after capital consumption in the US business sector was about $400 billion at an annual rate. By contrast, during Q4 2014 the comparable number was about $300 billion.

That’s right. Real net investment in the US business sector is now 25% smaller than it was before the crisis; and before it was “solved” with massive money printing, false interest rates at the zero bound and the explosion of corporate borrowing that resulted therefrom.

This drastic shrinkage is something totally new under the sun, and not in a good way at all. During the 7-years after the 1990 peak, for example, real net business investment expanded by 50%.

In fact, during Bill Clinton’s last year in office, the balance sheet of the Fed totaled $500 billion and real net business investment that year came in at $450 billion.

Let’s see. The Eccles Building has grown its balance sheet by 9X since the turn of the century, but real net investment in the business sector has plunged by 33%!

So thanks for the corporate bond bubble, Fed. Its just one more nail in the coffin of capitalist prosperity in America.

 

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Thu, 03/05/2015 - 15:31 | 5858462 J J Pettigrew
J J Pettigrew's picture

They win.

This is why no one is concerned about the deficit anymore...

it fuels the buybacks..

Fake rates, fake asset evaluations

Thu, 03/05/2015 - 15:35 | 5858478 Babaloo
Babaloo's picture

1.  Can't blame 'em for taking (almost) free money

2.  Cutting corporate tax rates will fix this...

Thu, 03/05/2015 - 15:41 | 5858506 kaiserhoff
kaiserhoff's picture

Like water, humans will take the path of least resistance.

Thu, 03/05/2015 - 15:48 | 5858533 max2205
max2205's picture

They squeezed the turnip and it is almost dry.

Thu, 03/05/2015 - 16:00 | 5858573 Manthong
Manthong's picture

OK, so what’s the wealth transfer scam after the next crash?

Bail out the broke corporations and bail-in the savers and depositors?

 

Sounds like a plan to me.

Thu, 03/05/2015 - 18:30 | 5859109 Niall Of The Ni...
Niall Of The Nine Hostages's picture

Suck America dry.

Everything of value---oil, metals, foodstuffs, manufactured goods---to be exported to pay off America's debts to her creditors, in gold and silver coin, of course, not Fed-confetti. Only banksters get to stiff people on their debts. The proles won't have that luxury.

The US will go through ten years of living hell. GDP down 40 percent, at least. Wages by 60 per cent, for those who still have a job of any kind and are getting paid somehow. Imports down to nearly nothing.

For seven years, minimum, most people who aren't banksters or their flunkies will be living on whatever food they can find. Think of the worst muck passing for food you've ever seen on sale at the nastiest, most ghetto dollar store you've ever been in. Now imagine three-quarters of the shelves are empty. That'll be your food shopping experience every day, and you'll be glad that they have anything at all.

Unless you're very wealthy or have relatives in the countryside, real food will be a luxury. Meat will be something you eat at Christmas, maybe at Thanksgiving. Rest of the year you'll eat mac and cheese and you'll like it. (Not real cheese, of course---yellow-coloured starch.)

That's assuming you still have a job of some kind to pay for food or can find some scam or other quickly after losing yours. Not everyone will. Homelessness, panhandling, prostitution and petty theft will become a way of life for much of what was once the middle class.

If you still have a place to live, you might get electricity for three hours a day. Over the air TV for maybe two hours a day, with little to watch that isn't "news" or tacky reality shows, because producing any other programming costs too much. The Internet? Forget it.

Forget driving to work too (if you still have any work to go to). You'll walk or cram into buses or gypsy minivans, as often as not in dangerous disrepair (spare parts cost money the gypsy cabbie has better uses for, like bribes to keep cops and tax officials off his mudflaps). Only the very wealthy will still swan about in private cars, or rather bullet-proof limos.

Pensions will be defaulted on or hyperinflated away. Anybody over 60 without a rich son or daughter who can afford to pay all their expenses will face more or less complete financial ruin. Life expectancies will plunge, suicides skyrocket.

(Mom and Dad needn't bother hiding a stash of gold or silver. Someone will notice Mom and Dad eat real food and put two and two together. Someone else will kick in the door, take the gold and kill Mom and Dad. Nobody will see anything. Police will have no suspects.)

Social services will essentially collapse. One day your kid's teacher will stop coming to work and never come back because nobody's paid her in months. (Trust me, your wife won't be able to stay home and home-school your kid.)

At your local hospital your relatives will have to bribe a nurse with food or alcohol to change your bedpan, never mind get a doctor to treat you---and they'll have to feed you too, because the hospital won't.

Thu, 03/05/2015 - 16:24 | 5858655 daveO
daveO's picture

Right. I actually read an article, on another site, that said the market could continue to rally into 2018, no kidding. The ability to borrow 'market gains' has it's limits. A lot of folks will lose their jobs and pensions from this insanity.

Thu, 03/05/2015 - 16:50 | 5858763 JRobby
JRobby's picture

A lot of folks have lost their jobs and pensions from this insanity.

Thu, 03/05/2015 - 20:31 | 5859432 Mr. Ed
Mr. Ed's picture

Employees of these companies always get screwed.

But, executives and shareholders of public companies stuff their pockets with bonuses and capital gains as buybacks push share prices to the sky.  The expensive cash used for the buy backs goes right into the exec's and shareholder's pockets, once removed.

Why is this not routinely and openly described as looting of the company's future profits and current assets (since they become collateral)?  Why isn't it a white collar crime for that matter?  Where's the SEC in all this?  I honestly don't get it.

The SEC and CFTC don't mind sticking their noses into everything else... like when it comes to my trading...THAT? - THEY'RE ALL OVER IT!  I can't trade this, I can't trade that with leverage... with all their damned rules, I can't open an acoount outside the country anymore...etc, etc.

Thu, 03/05/2015 - 15:44 | 5858518 LawsofPhysics
LawsofPhysics's picture

LOL!!!  No it won't.  liabilities are unfundable as it is... default on the BAD debt already!!!  Nothing else will fix shit and only lead to a complete fucking "free-for-all".  Fine by me, bring it alredy!!!

Thu, 03/05/2015 - 15:42 | 5858507 LawsofPhysics
LawsofPhysics's picture

The destruction of capital will be felt, eventually...

 

Economically speaking, if you don't have any real capital, you are not going to actually build or do  shit.

Thu, 03/05/2015 - 15:31 | 5858463 Itchy and Scratchy
Itchy and Scratchy's picture

In the long run we are all dead! - Einstein

Thu, 03/05/2015 - 15:36 | 5858483 KnuckleDragger-X
KnuckleDragger-X's picture

Capex is soooo 20th century. The cool thing is borrowing piles of money to buy back stocks inflated by Wall St. so top executives can sell their options for top dollar and get huge bonus's for doing it THIS is how you create a great company in the new millenium.

Thu, 03/05/2015 - 19:13 | 5859258 sun tzu
sun tzu's picture

What does it cost to manufacture tweets, facebook posts, and electronic stock certificates?

Thu, 03/05/2015 - 15:43 | 5858485 Thirst Mutilator
Thirst Mutilator's picture

Well, as long as nobody is hurt by money counterfeitting, then let's keep doing it!!! Oh WAIT!!!

<--- Hey CH1 ~ Insteada droppin' us one of your canned "Fuck DHS" liners here, why don't you grace us with your exquisite knowledge as to why my comment is patently FALSE?

 

The 'HYPOCRITES ANTI-DEFAMATION SOCIETY' awaits your 'thought provoking' ruminations...

Thu, 03/05/2015 - 15:37 | 5858490 Hohum
Hohum's picture

Creating wealth is a drag; creating faux wealth is fun!

Thu, 03/05/2015 - 15:38 | 5858492 all-priced-in
all-priced-in's picture

Which industry doesn't already have excess capacity?

 

Only a fool would expand capacity when they already have excess capacity.

 

 

 

 

Thu, 03/05/2015 - 15:57 | 5858559 RockyRacoon
RockyRacoon's picture

That's a fair observation.  And with each quarter having to be bested by the next quarter, there are only a few convenient and "cheap" ways to do it:  stock buy-backs and M&A pretty much being the only large scale options.

Thu, 03/05/2015 - 15:38 | 5858493 SuperVinci
SuperVinci's picture

No Bushs

No Clintons

 

ever again will help slightly.

Thu, 03/05/2015 - 15:38 | 5858497 buzzsaw99
buzzsaw99's picture

there own???

Thu, 03/05/2015 - 15:47 | 5858530 venturen
venturen's picture

WINNING!

Thu, 03/05/2015 - 15:55 | 5858551 disabledvet
disabledvet's picture

So 90% of the current US economy is being rendered uneconomic?

Sounds like Wall Street again.

Once the whole edifice comes crashing down again I'm sure they'll have another product to sell.

I do think the failure of Detroit is a problem. That is in fact the capital base being eroded.

Throw in Puerto Rico and Chicago and this really could be the worst recovery ever.

Thu, 03/05/2015 - 16:03 | 5858584 Berspankme
Berspankme's picture

but...but....Obie says the shadow is gone. the US is well on it's way to recovery. This can't be true. Obie has at least a 2nd grade understanding of finance

Thu, 03/05/2015 - 16:37 | 5858703 daveO
daveO's picture

You're being too kind.

Here's his white brother.

http://cdn.pastemagazine.com/www/system/images/thumbs/www/articles/howdy...

Thu, 03/05/2015 - 15:56 | 5858555 d4pwnage
d4pwnage's picture

If Stockman is bearish on stocks and Goldman is bearish on gold, does that mean Bondman is bearish on bonds and Realestateman is bearish on real estate?

Thu, 03/05/2015 - 16:00 | 5858572 Itchy and Scratchy
Itchy and Scratchy's picture

Only this guy know for SURE! ;

https://www.youtube.com/watch?v=mlCiDEXuxxA

Thu, 03/05/2015 - 16:06 | 5858598 Seal
Seal's picture

The Fed's only purpose has been to enhance bank balance sheets - never to address its supposed mandate of full employment

Thu, 03/05/2015 - 16:12 | 5858625 Greenspazm
Greenspazm's picture

Another great rant, Dave. Now what?

Thu, 03/05/2015 - 16:47 | 5858747 daveO
daveO's picture

Prepare for the inevitable collapse.

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

Quote from here; http://en.wikiquote.org/wiki/Ludwig_von_Mises
Thu, 03/05/2015 - 16:53 | 5858776 JRobby
JRobby's picture

"a final and total catastrophe of the currency system involved"

It will be involuntary. They will not do it voluntarily. They don't even consider an orderly wind down. They will not accept defeat in even small increments.

Thu, 03/05/2015 - 16:50 | 5858758 Doug
Doug's picture

Nothing will come of what he writes, but so what?  I hope he keeps writing.  His blog is the best chronicle of our downfall. 

Thu, 03/05/2015 - 16:19 | 5858641 kahunabear
kahunabear's picture

What it really amounts to is the fed forcing all personal savings into financing of risky corporations at extremely low rates. Those corporation's executives have then used the money to raise their compensation instead of investing in the business.

Thu, 03/05/2015 - 17:53 | 5858983 scubapro
scubapro's picture

 

 

so if stock prices is being buoyed by corporate buying, funded by corporate debt issuance.....is there a schedule of debt issuance for 2015 so we can see where the cliff is?     but a new round of issuance by a firm doesnt have to be planned out that far.     perhaps we can discuss if interest rates were to rise to X% then corps would not want to issue more debt???

 

seems like a combo of lower margin debt as % of total equity  AND less bond issuance would probably be THE bell.   But bond issuance is a driver of bond liquidity and price 'discovery'.    right now we are seeing more issuance which in and of itself can drive rates lower....if it stops/slows rates go up, which slows new issuance which pushes rates (spreads at least)  higher.   

first a little bit, then all at once.

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