Is GE Capital a Dodd-Frank Victim?
Here's an interesting question following General Electric’s announcement this morning that it’s going to sell the vast majority of its financial-services business: Is this a GE thing, or a large-opaque-financial-institution thing? That is, is it just one corporation making a bold statement about its future, or is it the beginning of the dismantling of the U.S.'s financial giants?
For GE, this is the kind of big, bold move that investors had been pining for. The company has changed a lot since Jeff Immelt took over as chief executive officer -- by his estimate, he had already sold 65 percent of the businesses he inherited from Jack Welch in 2001. But the changes usually felt incremental, and often reluctant.
This time, though, the company took markets by surprise. It was already spinning off its credit-card unit, and Immelt said in last year’s Letter to Shareowners that his goal was to get GE Capital’s share of the company’s operating earnings down to 30 percent (it was 42 percent last year). Now the company has committed to get it less than 10 percent by 2018, and already taken a major step in that direction by selling $26.5 billion in real estate assets to Blackstone Group, Wells Fargo and four other buyers. It also announced a share buyback of as much as $50 billion.
The immediate market reaction was overwhelmingly positive, with the shares up about 8 percent as I write this. From Richard Clough’s Bloomberg News story:
GE’s moves are an “overwhelming positive,” Steven Winoker, a Sanford C. Bernstein & Co. analyst who rates the shares as outperform, said in a note to clients. While Winoker said he was counting on GE to eventually divest more of GE Capital, “what we did not expect was the speed with which management would move to undertake this transformation.”
That transformation means that now GE really won’t look like Jack Welch’s company anymore. A few months after he took over as CEO, Immelt described GE as “a diverse portfolio of leading businesses.” The most profitable of those businesses, by far, was the huge, bank-like Welch creation known as GE Capital. Now GE is a “focused infrastructure leader” and the bank is going away -- all that will remain are the operations that help customers finance their purchases of GE's gas turbines, jet engines, locomotives and such.
You could reasonably depict this as “exorcising the financial demons of Jack Welch,” as Rob Cox of BreakingViews did, and you might think Welch would be irked, or at least saddened, by this repudiation of his finance-fueled growth model for GE. But here’s what Welch wrote today to CNBC:
I like the package. It looks like a smart move and right for the changing financial landscape.
Now, maybe Neutron Jack is just being diplomatic. While quite outspoken on other matters he has generally been a model ex-CEO in discussing his hand-picked successor’s decisions. It could also be, though, that he’s just telling the truth. The financial landscape has changed. The 1980s and 1990s were a great time to be a financial business, especially a sprawling, diversified financial business. Now, not so much. From GE’s announcement today:
[T]he business model for large, wholesale-funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward.
The most obvious change is that since the financial crisis the Federal Reserve has been making life difficult for large, wholesale-funded financial companies -- even if they’re not technically banks. 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.
Of the six Fed-regulated bank holding companies even bigger than GE Capital, only two -- Goldman Sachs and Morgan Stanley -- are similarly financed mostly with wholesale funds. But Citigroup, JPMorgan Chase and Bank of America all get 40 percent or more of their funds from sources other than deposits (Wells Fargo, where deposits make up 78 percent of liabilities, is the exception). If it’s going to be increasingly difficult for large, wholesale-funded financial companies to generate acceptable returns, then it's not just GE that will be under pressure to divest and shrink. In other words, maybe the framers of the Dodd-Frank legislation that forced many of these regulatory changes really did know what they were doing.
GE already had plans to reduce its financial operations, and it has a gigantic industrial business to flee to. For the other major bank holding companies, finding a new business model is going to be more difficult. This could be a signal, though, that they’re going to have to try.
So is this a GE thing, or a large-opaque-financial-institution thing? How about both?
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