Buyback Financing Helps Drive Up Interest Rates: Q1 2006

Massive issuance of bonds by non-financial corporations, largely to finance an extraordinary level of stock buybacks, helped force bond interest rates upwards in Q1 2006. (See Flow Table F212).

The annualized rate of bond issuance by non-financial corporate business rose to $240.4 billion in Q1 2006, four times the issuance rate of 2005.

The graph shows that, for years, the principal issuers of corporate bonds into the U.S. market have been the financial sectors (green bars) — mainly issuers of asset-backed securities raising funds for mortgages and consumer finance.

Principal Issuers of Corporate & Foreign Bonds
Principal Issuers of Corporate & Foreign Bonds

Non-financial Corporations Raise Money For Buybacks

The annualized rate of issuance of corporate bonds by the financial sectors rose from $679.3 billion in 2005 to $725.4 billion in Q1 2006, while the financial sector’s share of the issuance market fell from 90% to 70% due to the extraordinary level of bonds issued by non-financial corporations.

Flow Table F102 (non-financial corporations) shows that the primary reason for the substantial increase in bond issuance by non-financial corporations was to finance extraordinary levels of stock buybacks in Q1 2006 ($586.8 billion, annualized).

The purpose of these buybacks was to force up stock prices — giving value to executive options and providing unrealized capital gains that would jack up ‘performance’ figures of mutual fund managers.

Bond issues were necessary because profits after taxes and dividends were insufficient to fund the level of buybacks needed to manipulate market prices.

Corporate executives, in their own interest and against the interests of long-term shareholders, were willing to pay high prices not only to take their stock off the market, but also to raise the funds needed to do this.

So this is where the Efficient Market Hypothesis has taken us.

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