If not in US dollar notes under Warren Buffet’s mattress, what is Berkshire Hathaway’s “$104bn cash pile invested in?

Sir, you conclude that “Regulators and governments would do well to study whether the huge increase in repurchases has damaged business growth and capital formation” “Record share buybacks should be raising alarms” November 8.

Of course they should but let us be very clear, since that has been going on for quite some time so, if they have not done it yet, then shame on them.

For instance in July 2014 Camilla Hall, in “Bankers warn over rising US business lending” wrote, “Charles Peabody, a bank analyst at Portales Partners in New York, has warned that while it is hard to extrapolate what is driving commercial and industrial lending, if it is to fund acquisitions or share buybacks it may not indicate a strengthening economy. “It is loan growth, just not sustainable,” he said.” 

And therein Hall also wrote, “A banking lending executive at a large regional lender said ‘Traditionally banks have been very cautious of that’.”Of course, you and I know Sir that banker should not be throwing the first stone, since bankers too have morphed, thanks to the risk weighted capital requirements, from being savvy loan officers into being financial engineers dedicated to minimizing the capital their bank is required to hold.

Also, in 2017, when discussing IMF’s Global Financial Stability Report, John Plender wrote: “Low yields, compressed spreads, abundant financing and the relatively high cost of equity capital, it observes, have encouraged a build-up of financial balance sheet leverage as corporations have bought back equity and raised debt levels…Rising debt has been accompanied by worsening credit quality and elevated default risk.”

But what really caught my attention today was your reference to Berkshire Hathaway’s “$104bn cash pile [it holds] keeping its powder mostly dry for future deals — if, say, the market correction continues.”

How do you keep that powder dry? Since most probably it is not in dollar notes under Warren Buffet’s mattress, what is it invested in? We know that in accounting terms “Cash” includes a lot of investments, but in the real life, “Cash” does not always turn out to be real cash. In Venezuela you could now fill a whole mattress with high denomination bolivar notes, and still not be able to buy yourself a coffee with it. 

In a world in which regulators have assigned a 0% risk weight to for instance the already $22tn and fast growing US debt, which, if nothing changes, would doom that safe-haven to become very dangerous, is not Cash just another speculative investment?

@PerKurowski

Just wait until the music stops playing the low interest rate tango building up corporate balance sheet leverage

Sir, John Plender, when discussing IMF’s latest Global Financial Stability Report writes: “Low yields, compressed spreads, abundant financing and the relatively high cost of equity capital, it observes, have encouraged a build-up of financial balance sheet leverage as corporations have bought back equity and raised debt levels…Rising debt has been accompanied by worsening credit quality and elevated default risk.” “Beware the curse of buybacks that destroy shareholder value” October 31

Clearly this is another music that keeps bankers dancing, even when they know they shouldn’t, not for their own or for the economy’s sake.

In July 2014, commenting on an article by Camilla Hall on this subject I wrote: “Ask any old retired banker what was his first question to a prospective borrower and you would most probably hear him say: “What do you intend to do with the money if I lend it to you?” The banker would not have liked to hear “To pay a dividend or buy back some shares”.

Not any longer. Now his first priority is to think about how he can construe the operation in such a way as to minimize the capital needed, so that he could max out leverage too… and pay dividends and buy-back shares too.

But why should we assume only bankers are to behave responsibly? It takes two to tango. The regulators, with their risk weighted capital requirements clearly indicate they do not care one iota about the purpose of banks, and the central bankers, they just keep on kicking the crisis can down the road with QEs and low interest rates.

https://teawithft.blogspot.com/2017/05/low-interest-rates-cause-buy-backs.html

@PerKurowski

Current bank swimwear does not stop some to be caught swimming naked when the tide goes out, just the contrary.

Sir, Mohamed El-Erian ends his discussion of “the challenge facing those looking to generate high risk-adjusted returns.”, citing Warren Buffett’s observation that “only when the tide goes out do you discover who’s been swimming naked”. “How the great bull run can have a constructive end” May 23.

We already know a couple of those who will be caught swimming naked.

Sovereigns building up debt assisted by QEs, low interest rates and regulations that forces public debt down the throat of banks and insurance companies.

Corporations, because of low interests rates taking on high levels debt in order pay dividends and buy back shares.

Millennials and those following them believing there is something real out there that will take care of their older days.

Students who took on debt based on illusions about finding a good full-time job, those that are disappearing by the second.

How has all this happened? Regulators said “We have risk-weighted the oceans so there are no more tides.”… and the whole world believed their mumbo-jumbo.

But on the contrary, the risk weighted capital requirements for banks which distorted the allocation of bank credit to the real economy, helps only to guarantee that the tides will be stronger and more destructive than ever.

I swear, bad-luck weighted capital requirements for banks would take care much better of the real dangers, namely the unexpected.

PS. Here are some interesting questions to ask regulators, but only for those who would dare to hear the answers.

@PerKurowski

Just as there is room for higher taxes, there is also room for much lower margins for the redistribution profiteers

Sir, Rana Foroohar writes: “It is likely that companies would put any extra money from a lower rate on repatriation of foreign cash into share buybacks. The 2003 dividend tax did not increase investment, but the 2004 repatriation holiday bolstered buybacks 21.5 per cent.” “The case for higher taxes” May 22, 2017

What? Does she mean that the “foreign cash” is in cash (stashed away under a mattress) and not already deployed in assets like for instance US Treasury Bills?

What? Does she mean that was has bolstered the immense buyback we have seen over the last decade has more to do with repatriation than with the low interest rates imposed on markets by the Fed, by means of QEs and bank regulations?

Clearly there is room for higher taxes, but never ever crazy 83% ones, and not those that enrich the redistribution profiteers, but those that would allow to initiate the payment of a Universal Basic Income, perhaps starting at only $300 per month, and then taking it from there.

That could help growth and that could help reduce inequality.

@PerKurowski

Low interest rates cause buy-backs, meaning less equity controlling assets and higher leverages. How will it play out?

Sir, you write: “the relationship between rates and the valuations of assets such as stocks is not simple. Ironically, if there is a bubble in stocks right now, excessive faith in and misunderstanding of the power of low rates might be a contributing factor. Central bankers keen to avoid crashes might explain this more clearly.” “Central bankers cannot blow bubbles alone” May 6.

In a sort of veiled way, IMF in its Global Financial Stability Report’s, “Where Are the U.S. Corporate Sector’s Vulnerabilities?” reports on this, when it states:

“The corporate sector has tended to favor debt financing, with $7.8 trillion in debt and other liabilities added since 2010. Bank lending to the corporate sector has continued to recover and could well rise further in response to more favorable market valuations. In contrast, equity finance has traditionally been outstripped by share buybacks and has recently leveled off. A drop in the cost of equity capital may stimulate equity financing, but it could coincide with higher corporate debt—particularly if additional share buybacks are financed through debt.”

That begs three questions:

First: How much of the recent increase in the stock markets is the result of buybacks; that which helps earnings per share to get a sort of artificial boost; that which results in less equity controlling the corporations?

Second: Do the recent stock-market prices increases duly reflect the increase riskiness derived from much higher corporate debts? 

Third: Have Central Banks therefore, with their low interests rate policies, dangerously lowered the capital (equity) requirements of corporations?

On the first two questions I have no answers, though just having to ask them should suffice to at least raise some eyebrows.

On the third the IMF seems to clearly respond, “Yes!” when on that same page, under the subtitle “High Leverage Combined with Tighter Borrowing Conditions Could Affect Financial Stability” it writes:

“As leverage has risen, so too has the proportion of income devoted to debt servicing, notwithstanding low benchmark borrowing costs. Although the absolute level of debt servicing as a proportion of income is low relative to what it was during the global financial crisis, the 4 percentage point rise has brought it to its highest level since 2010, which leaves firms vulnerable to tighter borrowing conditions. The average interest coverage ratio—a measure of the ability for current earnings to cover interest expenses— has fallen sharply over the past two years. Earnings have dropped to less than six times interest expense, close to the weakest multiple since the onset of the global financial crisis.”

Holy Moly! And interest rates have not yet returned to something more "normal"; and the Fed's balance sheet is still so huge it leaves little space for any future QE assistance...and not to speak of the already too large public debts. 

How will this all play out? I don’t know. Perhaps I’d better, like most, stick my head in the sand.

@PerKurowski

Old banking: “What do you intend to do with the money?” New banking: “How do I minimize the capital the bank needs to hold?

Sir, Camilla Hall quotes a bank officer in that “loan growth [in the US] doesn't seem to be driven by the underpinning of an economic recovery” and then she reports that “much of the corporate lending is going to fund payouts to shareholders, finance acquisitions and fuel the domestic energy boom”, “US banks cautious over growing levels of lending” July 9.

Ask any old retired banker what his first question to a prospective borrower would be and you would most probably hear him say: “What do you intend to do with the money if we lend it to you?”, and the banker, as Camilla Hall writes, would not have liked to hear “To pay a dividend or buy back some shares”.

What is the first question a banker nowadays makes? Most probably “How can I structure this loan so that the bank needs to hold the least capital against it?”

And I ask you FT… what do you believe leads to healthier banks and a sturdier economy, the old or the new banking?