This Also Happened the Last 2 Times Before Stocks Crashed…”Financial Engineering Backfires”

Monday, April 18, 2016
By Paul Martin

by Wolf Richter
April 18, 2016

Something that happened just before the prior two market crashes, and the recessions that accompanied them, including the Great Recession, is happening again: the boom in financial engineering is starting to backfire against the companies doing it.

Their credit ratings are getting slashed, and their borrowing costs are therefore rising, even while they need newly borrowed money to buy back even more shares to keep the charade going. Until the music stops.

Downgrades ascribed to “shareholder compensation,” as Moody’s calls share buybacks and dividends, have been soaring, according to John Lonski, Chief Economist at Moody’s Capital Markets Research. The moving 12-month sum of Moody’s credit rating downgrades of US companies, jumped from 32 in March 2015, to 48 in December 2015, and to 61 in March 2016, nearly doubling within a year.

The last time the number of downgrades attributed to financial engineering reached 61 was in early 2007. It would hit its peak of 79 in mid- 2007, a few months before the beginning of the Great Recession in Q4 2007. At the time, stocks were on the verge of commencing their epic crash.

And there’s a reason for the link.

Companies buying back their own shares, often with borrowed money, are a big force in pushing up stock prices. Unlike other buyers, whether humans or algorithms, corporations are trying to be the high bidder. Their goal is not to buy low and sell high. Their goal is to push up their share prices. In this ingenious manner, they have become the relentless and dumb bid with near limitless means (borrowed money) – exactly what a stock market needs in order to soar beyond all reason.

The Rest…HERE

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