Wall Street's Bitter Lessons For GeTim Smart
No surprises. That's what General Electric Co. Chief Executive Officer John F. Welch Jr. expects from his troops. But in April, Welch received a surprise on a par with Pearl Harbor. That's when lieutenants at GE's Kidder, Peabody & Co. unit brought the bad news that an errant trader, Joseph Jett, had rolled up, over 30 months, such a huge volume of fictitious trading profits in government securities that GE had to report a $350 million pretax loss.
On Aug. 4, an 85-page report by former Securities & Exchange Commission enforcement chief Gary G. Lynch that was commissioned by GE concluded that Kidder suffered from "lax oversight" and "poor judgments." Virtually all of the senior executives, including CEO Michael A. Carpenter, have been forced out and replaced by GE operatives.
That's a far contrast from the image GE likes to project: a tightly run ship that fosters high performance while maintaining rigorous controls. Release of the report raises questions about the much-vaunted GE management system, the paradigm of consultants and business-school profs. GE has suffered black eyes in the past, such as a bribery scandal involving the jet-engine division. But the Kidder fiasco clearly shows that GE is just as capable as any other big American company of making colossal errors in judgment.
DIFFERENT CLOTH. Just as Kidder's top executives didn't understand Jett, GE couldn't get a handle on Kidder. Like Exxon Corp. before it with office equipment and Eastman Kodak Co. with pharmaceuticals, GE erred in believing that management success in one business would automatically transfer to another. It thought that controlling the people who make up Wall Street's freewheeling trading culture was as simple as controlling manufacturing processes, in which GE has long specialized. "There was never anybody in the company who came out of that world and understood it," says gne former top GEer.
Back in 1986, when GE acquired Kidder, the move seemed to fit a master scheme to achieve dominance in financial services. A brochure that GE's crack marketing folks put together at the time talked of building synergy with GE Capital Services Inc., GE's hugely profitable financial-services arm, that would yield a "force in the world's financial marketplaces second to none."
Wishful thinking. GE repeatedly bungled the job. To begin with, Welch, who declined comment on the Lynch report, picked Carpenter to lead the effort. Carpenter had no securities-industry experience, having come to GE from a career in management consulting. He never got along with GE Capital head Gary C. Wendt, an engineer turned finance whiz. As a Welch favorite, Carpenter reported not to Wendt, who ran the company Kidder was nominally a part of, but to Welch. Wendt kept his distance from Kidder. What's more, Kidder's top personnel seemed cut from different cloth than the nuts-and-bolts managers who run GE Capital. Says Harvard University business school Professor Francis J. Aguilar: Kidder "has never really fit, and they've never really folded it into GE Capital."
There is a vast difference between the worlds of finance in which GE Capital and Kidder operate. GE Capital is focused on Main Street: It leads in such businesses as auto leasing, mortgage insurance, and equipment financing. These are also businesses where the assets tend to be real, not paper.
HUMBLING? Kidder, by contrast, is part of a world where a few superstars acquire enormous power, where a trader like Jett, with no formal training, could make $9 million in a single year. That's a far cry from the thousands of highly skilled credit analysts and managers at GE capital who lease railcars and process mortgage-insurance applications. With few exceptions, such as Merrill Lynch & Co., firms on Wall Street have long lacked the kind of tight management structure that is common in Corporate America.
Kidder, among the most poorly run firms when GE bought it, has also been a lackluster producer of profits, GE's chief barometer of success. But Welch was never able to fix the problem. He recently said that Kidder has earned about $250 million since 1986. That's on an investment of $1.4 billion. Not the kind of performance one expects from GE, where such mundane businesses as gas turbines make that much money in a single year. Welch, for some reason, tolerated those results for a while, but in recent years he has been trying to unload the firm.
In the long run, some good could come of GE's Kidder mess. Maybe the episode will humble a company that had begun to believe it was infallible. It can serve as a reminder that no matter how well you are doing--and certainly GE has performed as well as any large company of late--you can't eliminate surprises. It's how you deal with them, and what you learn from them, that are the true measures of a good manager.