Dividends are an umbrella.

Here’s an essay from Robert Samuelson on the risks of global finance, and there isn’t one proposed government intervention. I’m impressed. That’s refreshing.

“Liquidity” is a common, but confusing, economic metaphor. Financial markets (say, stock and bond markets) are said to be “liquid” when it’s easy to buy and sell. Transactions flow smoothly. By contrast, either buyers or sellers are scarce in an “illiquid” market. Prices move sharply, up or down. Markets can also have too much liquidity: Investors may take increasingly large risks to put their abundant funds to use. “Bubbles” can form. Losses may follow.

We now have evidence of that.

Mr. Samuelson offers recent subprime mortgage losses as an example. It’s true enough, but I would take his idea a step further and explain the reasonable alternative when corporations get into “excess” liquidity. When in doubt, return it to shareholders. What makes executives believe they’re significantly better at finding uses for those funds? The new dividend doesn’t need to be permanent, just an acceptance from management that they can’t always find investments with a risk-return ratio suitable for their business.

Sure, those subprime mortgages will work out well for some mortgage companies. But if the company offering them isn’t normally in the subprime market and is now offering loans simply to utilize excess cash, it ignores risk relative to what its business deems reasonable. That’s unwise and bad for shareholders. It would be better off giving the money to them. It’s their money, after all. Let them judge how they want to invest (or spend or whatever).

I’ve oversimplified, of course, because there is nuance here. While Mr. Samuelson is correct that “‘excess liquidity’ often evaporates through losses”, it doesn’t have to be that way. Take the next step. How do we utilize excess liquidity without seeing it end in losses?

One thought on “Dividends are an umbrella.”

  1. “The new dividend doesn’t need to be permanent, just an acceptance from management that they can’t always find investments with a risk-return ratio suitable for their business.”
    This is one of the first things they teach you in any managerial finance class. Anywhere.

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