Immelt, GE Capital, and the Financialization of Manufacturing.

Joe Klein:

Gotta admit I’m not too pleased by the departure of Paul Volcker from Barack Obama’s circle of adviser. He was one of the few, along with Elizabeth Warren, in the current administration who had a proper perspective on the outrageous behavior that the financial community considers business as usual. And while the appointment of his replacement Jeffrey Immelt, of General Electric, signals a desire to snuggle up to the business community–at least Immelt comes from the manufacturing sector. He has experience actually making products, a skill notably lacking among every one of Obama’s other economic advisers.

Again, I’ll repeat: the important distinction here is between the business community, which should be encouraged to create more jobs, and the financial community, which should be shamed for its casino-gaming shenanigans and kept away from the inner circles of economic policy-making.

I agree with all that except the part about GE not being part of the casino-gaming shenanigans sector. That part, ummm, no. Before anything else, the idea that we have 15 million unemployed because of our “competitiveness” is just wrong, lacking any real substantial evidence. But the idea that GE can, as Joe Klein puts it, point a way forward from a financialized economy is also wrong. Two points.

1. As Raj Date cleverly put it, to understand the bailouts, you need to understand “the Killer G’s”: Goldman Sachs, GMAC, and GE Capital.

GE Capital, the major subsidiary of GE, is a major shadow bank. It used GE’s high-quality credit rating to become a major player in the capital markets, much in the same way AIG FP used the boring insurance high credit rating.  GE Capital  was the single largest issuer of commercial paper going into the financial crisis.

GE Capital received major bailouts during the crisis, including having the FDIC guarantee more than $50 billion dollars of unsecured debt that was issued.  To put that in perspective, only about $24 billion of GE Capital’s funding comes through deposits, allowing a shadow bank with massive unsecured debt obligations and only a small depository base to be carried through the financial panic.  Both graphs from Date:

2. Next I want to go to the book Financialization and Strategy: Narrative and Numbers (authors: Froud, Sukhdev, Leaver, Williams, 2006), which does an extensive case study of General Electric and the financialization of the manufacturing business model from 1980 onwards:

Our analysis of the undisclosed business model is relatively straightforward and focuses on seven principles of GE’s cost recovery under Welch:

1 run the industrial business for earnings;
2 add industrial services to cover hollowing out of the industrial base;
3 buy and sell companies through acquisition and divestment to achieve returns and
growth objectives;
4 rely on large-scale acquisition to prevent like-for-like comparisons and to increase
opacity and the power of narrative;
5 grow the financial-services business up to the limit of the company’s credit rating;
6 accept the balance-sheet costs in terms of return on capital but focus on managing
return on equity and cost of capital;
7 add financial engineering to smooth earnings and manage growth….

The story of GE Capital is a story of upward mobility, as GE has found growth of sales revenue by moving beyond captive finance into many other lines of financial business. GE has sold financial services since the 1930s, starting with domestic credit for refrigerators, a classic form of captive finance. Up to the late 1970s, GE was arguably not so different from other US corporates, such as GM or Westinghouse, with a financial-services division whose central activity was captive finance. However, through the 1980s and 1990s, GE Capital greatly expanded and increased its offering in everything from LBO finance to store cards. GE has stayed away from retail banking and, after its problems with Kidder Peabody, moved out of securities dealing. But, in general, its expansion has been as a general supplier of consumer and commercial financial services, while also developing niche areas, such as mortgage insurance. The company’s expansion into financial services is neatly summarized by Fortune: ‘GE Capital pours wealth into the corporate coffers by doing just about everything you can do with money except print it’ (21 February 1994). Hence, GECS overtook General Motors Acceptance Corp. (GMAC) in terms of total assets in 1993 and was twice as large by 1997 (Forbes, 21 April 1997)….

In all this, the GE Capital board was engaged in high-stakes risk management where misjudgements about a class of business would have undermined GE’s financial record. By way of contrast, Westinghouse, GE’s conglomerate rival, had its finance arm liqui- dated by the parent company after losing almost $1 billion in bad property loans in 1990 (The Economist, 30 April 1994). GE Capital’s expertise in making acquisitions is acknowledged by S&P as one of the factors that supports its triple-A rating: ‘GECC (GE Capital Corp.) tends to be a very savvy buyer, understanding the various business risks and pricing the acquisition appropriately’ (S&P 2002: 2).

If the expansion of GE Capital rested on judgement and controls, it also reflected the structural advantage of the triple-A credit rating, which effectively made the financial business (as user of the credit rating) dependent on the industrial business (as credit-rating generator), and this in turn set limits on how much GE could expand without risking reclassification by credit-rating agencies. GE Industrial may be a low-growth business but it has high margins, is consistently profitable over the cycle and has funded almost all of the dividends that GE Consolidated has paid out, as well as providing the funds for acquisitions and repayment of debt. This solid industrial base is the basis for GE’s triple- A credit rating, which allows GE Capital to borrow cheaply the large sums of money that it lends on to consumers and commercial customers…

If there’s demand, we can dig into the huge debate in the analyst community about what was going on with GE and earnings management, a worry that hit an explosive moment post-Enron and Worldcom, during the Sarbannes-Oxley debates.

GE has been at the forefront of blurring a “financial services”-centric model of business onto the remains of a hollowed out manufacturing base, one kept in a minimal state just strong enough to qualify for high credit scoring. Marcy Wheeler has written about how that manufacturing part of the company is driven by outsourcing. In his recent, excellent book Cornered, Barry Lynn talks about how GE’s manufacturing business model becomes focus on business lines with government buyers (defense) and with government regulators and industry standard setters that can be worked (health care). They use the ratings agencies to only look at those business lines when determining the ratings they get, and lever up in the shadow banking network off that. Success!

This is not a big win for the notion of Jobs and Competitiveness.