A while back, I wrote about one unintended consequence that causes a peculiar market distortion. In the news this week, we have another prime example, one that few people outside the industry will understand. Here’s the crux of the gist: GE to sell bulk of finance unit, return up to $90 billion to investors
(Reuters) – General Electric Co will shed most of its finance unit and return as much as $90 billion to shareholders as it becomes a “simpler” industrial business instead of an unwieldy hybrid of banking and manufacturing.
The company on Friday outlined a restructuring plan that includes buying back up to $50 billion of its shares, selling about $30 billion in real estate assets over the next two years and divesting more GE Capital operations. GE stock jumped 8.5 percent.
Now, for an inside baseball moment: What’s really going on here is that GE, over the decades, built up a large and highly profitable set of finance businesses. Many of them, probably a majority, were developed to help sell GE manufactured products, everything from locomotives and jet engines to MRIs. It’s just like when you go buy a car – the dealer doesn’t want to send you off to find financing, he wants to make sure you can get it right there before you change your mind. So, the car manufacturers provide financing in order to help the dealer move product.
So far, so good, and not very different than what lots of other manufacturing companies do. GE Finance has succeeded very well – too well, in fact. A couple decades ago, the success of the equipment leasing operations in structuring deals so that they were able to offset taxable income with depreciation allowances resulted in GE paying little if any taxes, which, while perfectly legal (and, frankly, good for the economy, as each of those leases represents equipment deployed someplace trying to make money), nonetheless offended the tender sensibilities of the mathematically soft-headed. So we got AMT – Alternative Minimum Tax – a patch sewn onto a kludge of a Rube Goldberg machine: the tax depreciation regulations. See the essay linked above for details, if you’ve got the stomach for them.
GE’s business model is quite hands-off for a conglomerate. The mother ship sets return goals, such as a 2% return on assets or such, and then lets the subsidiaries figure out how to do it. Fail, and they very unsentimentally cut the subsidiary loose by selling it to somebody else. Succeed, and management gets bonuses. This is a process they have perfected over decades, with the result that GE is consistently one of the most profitable companies in the world.
One oddity: they don’t limit what their subsidiaries do in order to make the required returns. Generally, conglomerates don’t really want their units competing against each other head on – seems inefficient, on the surface, at least. GE, on the other hand, says ‘have at ’em’. So a GE subsidiary can conceivably put another GE subsidiary out of business. Life is tough. Further, if a subsidiary sees a chance to expand outside its core business, they have the green light – just so long as they meet the return target.
Thus we arrive at the state we are today: GE’s financial arm had become the largest source of income for GE, but had also started to cause headaches for the mother ship. It had originally fallen under greater political scrutiny because of the ‘tax dodge’ of depreciation. Then, after the late economic unpleasantness, GE Finance got classified as a ‘too big to fail’ bank. Never mind that it had played a relatively minor role in the whole mortgage debacle, and has always been managed conservatively – because the subsidiaries had long expanded into financial realms other than just equipment finance, the unassailable logic of Barney Frank (he’s dead, no use assailing now. Oops – a reader corrects me – Mr. Frank is not dead. Somehow, I thought he was. My apologies, on the vanishingly slight chance he reads this.) as codified in the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 said that *consumers* needed to be protected from Wall Street – and that, because GE has a toe-hold in consumer finance and knows people on Wall Street, consumers need to be protected from GE as well.
Now, I have little sympathy for GE – they are ruthless company that lays people off at the drop of a hat. They play political hardball, they know the game. But they are not by any stretch a consumer bank. The vast bulk of their business is business to business – they finance equipment for other companies. But Dodd-Frank is requiring them to behave – and keep records, issue reports, file filings and follow processes – designed to protect *consumers* from shady dealings. It’s made life hard, expensive and less profitable for GE Finance – and the GE Mother Ship as well.
Thus, after assessing the fall out for a couple years, GE, in its typical ruthless manner, has decided to rid itself of these troublesome finance companies. Thousands of people will be fired. And – disclosure – many of these folks are among my very best customers.
Most of these people are highly trained finance professionals, so they will probably be all right eventually. What bugs me is the pointlessness of it all: no consumers are going to be ‘protected’ by this move, tens and maybe hundreds of millions will change hands just processing all these sales, and families and communities will be disrupted. But to oppose Dodd-Frank means you’re a meanie who wants big businesses to fleece consumers with impunity, right? Sheesh.
As to the stock price going up: duh. There’s going to be a massive influx of cash from the sales of the various finance subsidiaries, and GE plans to use much of it to buy back stock, goosing the earnings per outstanding shares. So, looks great! Now, after all the dust settles in a year or two – then what? GE will have sold off its most profitable businesses, and will be relying on manufacturing to close the gap.
How do you think that will work out? How has it typically worked out over the last few decades?
And, finally, yes, this is a bit of a cheap shot, but very telling:
They could be fresh from the LA Religious Education Conference, or the Life Teen rock band at many local churches.