A thought on GE’s opting out of the Finance Business
Paul Krugman writes about GE’s announcement to get out of the finance business. Why are they getting out? Financial reform from the Dodd-Frank legislation that includes “greater oversight, higher capital and liquidity requirements, etc.”
Paul Krugman says…
“And sure enough, what GE is in effect saying is that if we have to compete on a level playing field, if we can’t play the moral hazard game, it’s not worth being in this business. That’s a clear demonstration that reform is having a real effect.”
Standards are tightening in the financial business to prevent moral hazard. Higher liquidity and capital requirements will go hand-in-hand with the Fed’s intent to raise interest rates. So I see a positive side to normalizing interest rates in that some socially risky shadow banks will opt out.
Less shadow banks could translate into an easier time for normalizing the Fed rate. We wouldn’t have these shadow banks doing arbitrage and such with their moral hazard to put downward pressure on interest rates.
What do the readers of Angry Bear think? Does financial reform make normalizing interest rates easier? Does the lack of financial reform cause the Fed rate to seem stuck at the zero lower bound? Can the Fed rate rise without good financial reform? How important is financial reform to the normalizing of the Fed rate?
I don’t think nominal short term interest rates have anything to do with it. Banks (or shadow banks) are in the business of pricing risk (assuming for the moment they are not a Ponzi scheme), they make profits on margin not from nominal interest rates.
GE has said that they are exiting the financial biz due to Dodd Frank and the concern that GE would be deemed a SIFI (strategically important financial institution).
So there is no question that Dodd Frank worked. It has shut down a very big lender. Many (specifically Krugman) are claiming victory.
Okay, now we must wait for a few years to see how this plays out. Will it make a difference to the real economy? I think it will.
GE is – by far – the biggest equipment lender in the world. It provides money to buy equipment for business. GECC (had) 500,000 customers and had lent out a half trillion for purchases of stuff like back hoes, bull dozers, train engines, planes and every other thing you can imagine.
Now they are gone. Will someone take their place as the largest lender of money for this bread and butter side of the economy? I don’t think so, not in the next few years.
So it WILL get harder to finance the things that companies use to make stuff. It will also get more expensive as GECC was the price leader. I think that GECC will be missed, the economy will suffer as a result.
What is going to happen to the business? It was sold to a New Zealand company financed by hedge funds and a big German bank. GE made $7B in 2014 on this biz. It paid over $2B in taxes on this revenue. It employed 35,000 people (most in USA). Post the sale many of those US jobs will be lost and all of the profits will be whisked out of the country and not taxed at all.
So Dodd Frank will hurt the economy, result in a loss of jobs and it will reduce federal tax revenues. I have a hard time calling that a success, but Krugman sees it as a huge vindication.
Like I said, wait a few years on this one. Over time people will come to understand that a very big mistake was made.
Interesting:
GE Is Creating A Smaller, More Stable And Profitable Financial Business; September 17th, 2013 by Trefis Team
Guess news travels slowly over to Wall Street? Much of what you are talking about has been taking place since 2008/2009 as a result of many of those core businesses borrowing from GE Capital defaulting on their loans. Unlike student loan, businesses can shed their loans without recourse by GE under bankruptcy. “At the time (2008-2009 me), GE Capital constituted nearly half of GE’s total earnings and thus, the financial crisis impacted the company severely.”
The big mistake made was the sell out by the President in budget negotiations to allow TBTF to keep risky ventures rather than force TBTF spin them off into smaller companies non reliant upon them to finance losses incurred from those risky ventures. A big, big mistake as Main Street is again on the hook.
Bkrasting:
GE is keeping the business financing segments related to financing sales of their own equipment. They are (and have been) disassembling the portions of their financing business that are not related to making and selling their own equipment.
They’re selling off 200 billion in loans and keeping 90 billion. They’ve already sold off something near 200 billion in the last decade after the embarrassment of taking the TGLP bailout when the commercial paper market dried up.
JG you understand the history of this. You are correct about the TGLP financing. It was an embarrassment, and it does signal that GE is in the group of “too big to fail”.
But you also know that that this occurred at the same time as a massive global meltdown that rivaled anything seen since 1929. It was a panic, plain and simple.
Not long after GE was able to again access the capital markets. The CP borrowings under the program were all paid back. This was never a question of GE being insolvent, it was a question of the money pipeline that came to an an abrupt halt.
If those steps did not happened then GE, Citi, BoA JP-Chase, Wells Fargo and a bunch other would have failed in a month. What was a very deep 6 month recession would have become a very long term depression.
Yes we have Dodd Frank today, and that does make things “safer”. But it also creates different types of risk. Like I said, wait two years before claiming victory on this one.
Edward: “Does the lack of financial reform cause the Fed rate to seem stuck at the zero lower bound?”
No. The FED wanted low interest rates and they produced them over the last 7 years. When the FED decides to increase the FED Funds rate, the banks will have to pay each other that rate for overnight un-collateralized loans. That increase will directly influence all other bank interest rates and indirectly influence all other lending rates.
Also the FED has power that no shadow banker can match. If raising the FED Funds rate did not raise interest rates enough throughout the economy then they could resort to other measures. For one, the FED could raise capital reserve requirements which would leave less money to available to loan.
And that is exactly what they are going to do to the largest banks.
http://www.bloomberg.com/news/articles/2014-12-09/fed-sees-big-us-banks-facing-capital-surcharge-of-up-to-45
In this case the intent is to force the largest financial institutions to reduce risk. But logically it will reduce funds for lending and indirectly raise interest rates. Perhaps this is why the FED has been publicly discussing raising interest rates?
So your other question “Does financial reform make normalizing interest rates easier?” is much better.
From Bloomberg:
“In 2013, GE Capital was designated a systemically important non-bank by the Financial Stability Oversight Council. As a result, the Fed announced plans late last year to start regulating it as a de facto bank holding company, subject to the same capital standards and stress tests as banks.”
See: http://www.bloombergview.com/articles/2015-04-10/ge-blazes-a-path-for-the-financial-giants-to-follow
Perhaps the latent risk of higher capital reserve requirements is what drove GE to sell GE Capital. Those reserve requirements are surely not written in stone yet. Perhaps they did not believe that they could predict the likelihood of increasing risk to GE Capital. And they found a buyer who did not fear that risk. Which was the wiser? I don’t know.
Dodd Frank is a good law. The sky will not fall, the sun will come up in the morning.
Bkrasting: “This was never a question of GE being insolvent, it was a question of the money pipeline that came to an an abrupt halt.”
The money pipeline came to a halt because the banking world came to understand that banks like Bear Strearns had been assuming excessive risk in residential mortgage securitization or the result thereof.
In the summer of 2007, two of Bear Stearns’ special purpose entities were in such trouble that the bank initially threatened to refuse to give them additional funding. But their reputation was on the line as other banks would treat Bear Streans as just as unreliable as their special purpose entities. (Special purpose entities was the term used by Enron and rapidly fell out of favor after Enron bit the dust but only the name changed.)
Then came the realization that Bear Stearns was NOT the only banker to make risky assumptions about residential mortgage backed securities.
As news spread throughout the banking industry, it became apparent that loaning money to any other financial institution involved betting on their prior assumptions about risk versus profit.
Most of them were afraid that their perspective borrower had been doing what they themselves had been doing. (Smiling here)
You wouldn’t have to have a lot of imagination to worry that your money could disappear and only reappear after bankruptcy, if it reappeared al all.
In short, there was money in the pipeline but very few trustworthy borrowers to be found.
It was not a panic, it was a return to virtuous risk assessment.
Ge got in cash flow trouble once before during the panic of 1893 when it had to pay high interest rates. (Maury Klein Power Makers P 354) In this case GE owed 10 million in short term debt and had only 1.3 million in cash. In addition it had endorsed the notes of a lot of power systems it had sold equipment 2. To cure this some subsidiaries were written down and some elimintated as well as the stocks of some utility customers (given to pay for equipment) being spun off In essence GE at the time sold to much on credit. (and suddenly it could not sell them as the price went to zero) Ge at the time went to a strictly cash business.
In any case, I’m not sure that the case isn’t substantially overstated that this government tag/regulation is “THE REASON” that GE is divesting finance businesses. GE buys, GE sells. At this time they’ve made the determination that they can make more money with less money by having a smaller financing arm that directly and solely supports their own production and selling efforts.
If GE really wanted to control a financing organization of this size without being subject to regulation, they could probably find some way to do that, because they aren’t just a bank.
When I joined the GE Large Steam Turbine Dept. in 1968, it made the best steam turbines in the world (ranked #1 for both reliability and efficiency by Power Magazine). They were designed using computers also designed and built by GE, and partly accessed over the Internet using terminals which dialed into the GE Time-Sharing System using phones connected to acoustical couplers. Then Jack Welch took over in 1980, got us out of the Internet, and started closing our steam turbine manufacturing plants in Charleston, S.C., South Portland, Maine, Durham, N.C., Lynn, MA, and Fitchburg, MA so he could layoff their workers. Within 10-15 years we were no longer the best nor the second-best turbine maker.
He turned us into a mostly bank/financial-services company, making profits by pushing around pieces of paper instead of making anything useful. Making money for money’s sake, not for anything one could point to with pride.
I can say with confidence still that for those reading in the continental U.S.A., some if not most of the electricity powering your computers and light bulbs comes from turbines I designed, helped build, tested, or did field service on. But it would have been a much larger percentage except for Jack Welch.
So don’t get me started on GE’s detour into financial services. There are plenty of other vultures who will descend on that business and absorb GE’s market share. The last I checked no one has put any of those GE turbine plants back into operation.
Sorry Edward:
I guess Wall Street and potentially Krugman awoke to actions taken by GE well before Dodd Frank was passed as I suggested to BKrasting below which you can reference also. Just a brief citation with site also noted in earlier comment:
I guess I wonder why this is news worthy? GE over extended, realized it in 2008/2009, and took action to minimize its losses going into the future.
This is not new for GE and has been going on well before Dodd-Frank as I noted below..