In the article, The quarter-century buyback era draws to an end, I announced the demise of the dominant role of stock buybacks in the economy, although there has been no official death certificate and the body has not yet been found.

The buyback era began in 1982 when the US Securities and Exchange Commission promulgated Rule 10b-18, granting “safe harbor” to corporations that wished to use equity repurchases to boost market prices in order to give value to executive option schemes.

The justification given by the SEC, at the time, displayed a breath-taking irrational naiveté that demonstrated the government’s total lack of concern for the interests of small investors. Here is what they said when issuing Rule 10b-18 in 1982:

The Commission has recognized that issuer repurchase programs are seldom undertaken with improper intent, may frequently be of substantial economic benefit to investors, and, that, in any event, undue restriction of these programs is not in the interest of investors, issuers, or the marketplace. Issuers generally engage in repurchase programs for legitimate business reasons and any rule in this area must not be overly intrusive.

It should be noted that the Securities Exchange Act of 1934 includes broad general anti-fraud and anti-manipulative prohibitions meant to protect investors.

The SEC, in Rule 10b-18, without an Act of Congress, abrogated these investor safeguards, allowing corporations to fraudulently manipulate the price of their stock whenever they wished, barring investors from satisfaction in the courts and protecting corporate fraudsters from criminal prosecution.

Nevertheless, as the fraud unleashed by Rule 10b-18 robbed investors of trillions of dollars of value, the SEC continued to mouth pious platitudes about “protecting investors”, while most people, like the victims of Bernard Madoff, were happily unaware of what was going on.

How big was the buyback movement?

The impact of stock buybacks on the US economy can be measured from Federal Reserve Flow of Funds table F.102: Nonfarm, nonfinancial corporate business.

This table shows the net change of corporate financial assets and liabilities from one period to the next. The line item, Net equity issues, is expected to show a positive number, indicating that the corporation has issued more new shares than it has redeemed. However, since Rule 10b-18, net equity issues have generally been negative, reflecting the fact that US nonfarm, nonfinancial corporations have been buying back more stock than amounts raised through initial public offerings.

	SEC Rule 10b-18 opened the door to the buyback era

Total net buybacks of corporate equity from 1983 to 2008, according to Federal Reserve flow of funds table F.102, was $3.6 trillion.

However, we know that even in years with negative net new equity issues, there have been initial public offerings. The amount of these IPOs must be added back to the flow of funds figures to measure the size of the buyback phenomenon.

Also, there has been steady erosion of the value of the dollar since the Reagan years. To evaluate the impact of buybacks in terms of 2008 dollars, we must re-inflate the historic date in terms of today’s money.

	Negative equity flows, adjusted for IPOs and inflation

Using Flow of funds table F.102, adjusted for inflation by the CPI index, and estimates of yearly IPOs (from Renaissance Capital data and Wolter Kluwer’s IPO Vital Signs ), we are able to put a value on the total amount of corporate buybacks since SEC Rule 10b-18, in 2008 dollars, at $5.77 trillion.

This is a very big number, even compared to the size of the Obama administration’s “stimulus” plans. It is more than 100 times the size of Bernard Madoff Ponzi scheme — and no one will go to jail.

Where the money came from and where it went

The mechanics of a stock buyback are quite simple. A company uses money that should belong proportionately to all shareholders, to buy back stock on a non-proportionate basis from a relatively few shareholders. Most stockholders get nothing from a corporate buyback, except the right to own part of a company with less cash.

As the SEC admitted, way back in 1982 when it issued Rule 10b-18, the purpose of buybacks is to manipulate the price of a stock upwards. This is good news for corporate executives who happen to be holding stock options (for which they paid nothing). It is also good news for mutual fund managers who earn fees based on the market value (not intrinsic value) of the portfolios they manage.

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