General Electric Breaks Up, Symbolizing Decline of American Manufacturing and the High Price of Financialization
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Even though General Electric will continue in name after yet more downsizing and a breakup of the rump company into three pieces, the image of General Electric as paragon of American management started to unravel after the tenure of Jack Welch, and accelerated after the financial crisis.
As we’ll explain, contrary to fawning media accounts, much of what went wrong with General Electric started on Jack Welch’s watch. But his success in becoming a celebrity CEO helped goose the stock price, making it risky for any sharp-eyed analyst or commentator to even mildly question what Neutron Jack was up to.
First, an overview of the dismemberment, from the Wall Street Journal:
General Electric Co. said it would split into three public companies, breaking apart the more than century-old company that was once a symbol of American manufacturing might and has struggled in recent years.
The plan is being unveiled three years after Larry Culp took over the troubled company and tried to stabilize its operations by selling off business units and paying down the company’s debt load. But GE’s stock price, despite a 1-for-8 reverse split, has lagged behind the S&P 500 and rivals.
GE shares have lagged behind rivals and the?S&P 500 since Larry Culp was named CEO
Cumulative change since Oct. 1, 2018
The move is the culmination of a yearslong process of shrinking the company. GE has already sold off its locomotive and home appliances business. It spun off its oil-and-gas business operations. It has also sold most of its once massive financial services arm, which hobbled the company after the 2008 financial crisis. It also slashed its quarterly dividend to a token penny per share.
What remains today are three businesses—aviation, healthcare and power. The company will now spin them off into separate publicly traded companies.
Aviation, as in jet engines, will keep the GE name. Healthcare consists of making MRIs and other hospital equipment. The power company will inherit a hodge podge of doggy operation in turbines for utilities and wind farms and its “remaining digital division.”
The split-up is widely depicted in the financial press as General Electric capitulating to the new reality of how to run manufacturing firms, that being diversified by product and geography is no longer a good formula.
But perhaps the real question ought to be how General Electric managed to defy the logic of the 1980s, when leveraged buyout artists preyed on overly diversified conglomerates, breaking them up and selling the pieces for more than the value of the former whole, and companies have continued to be under pressure to make themselves look like pure plays, or alternatively, to sell narrowly focused operations when valuations were favorable.
Part of it was that General Electric was impregnable in the 1980s, even if deep financial spadework were able to make a case that its well-valued stock still represented a discount from breakup values. But General Electric, even though its activities extended across a large product range, its industrial operations were run on more integrated basis. And unlike cobbled-together conglomerates, it also had strong positions in particular product/industry categories. It seems hard to remember that GE brand washers and refrigerators were once seen as solid products; if you now encountered them, say in a prospective rental, their presence would be a red flag.
In other words, in the 1980s, it would have been business blasphemy to put General Electric in the same category as the businesses targeted by takeover artists. It had long been one of the very best managed companies in the world; Welch’s predecessor Reginald Jones was toasted as the best CEO of any public company. Even if any financial entrepreneur would have been so deluded as to attempt a run at General Electric, its reputation was an obstacle even more difficult to surmount than its massive size. Recall that the financial establishment recoiled from Saul Steinberg’s late 1960s plan to take over Chemical Bank. Having a go at General Electric would have produced an even more violent slap-down, potentially including Congressional hearings and actions to rein in raiders.
My harsh take on Jack Welch isn’t just due to his destructive expansion into financial services and his cultivation of “CEO as celebrity” which was extremely successful for him and General Electric during his tenure but long-term destructive to management practice in the US. It is also that Welch’s success as a manager has been exaggerated, but it will be well nigh impossible to ascertain to what degree due to the cheerleading and a code of omerta among departing execs. One colleague who worked under Reg Jones and later under Welch, and turned around a manufacturer that remains a top player in its niche, has said that Welch ran on Jones’ brand fumes. And some of his touted practices, such as Six Sigma, were all PR.
Jack Welch and General Electric were lucky enough to ride the great financial markets boom, triggered by a long-term secular trend of declining interest rates. Welch also inherited a superbly run company at a time when America was still a manufacturing powerhouse, despite Japan and Germany making inroads.
Admittedly, General Electric, like many American manufacturers, was in the financing business by virtue of lending to buyers. But it had greatly expanded its role by the late 1980, to the degree that it took big hits from LBO lending (I knew the ex-McKinsey partner who ran its workouts. He had two conference rooms, one that he named “Triage” and the other “Don Quixote”.)
But even as of the early 1990s, GE Capital was celebrated for accounting for 40% of General Electric’s activities, doing everything from venture capital to private label credit cards to credit guarantees. And General Electric got the best of both worlds. It avoided the taint of being seen as a stodgy old economy manufacturer; by the time Jack Welch left, in 2000, it was classified in the Fortune 500 as a diversified financial firm. Yet got to borrow at industrial AAA rates, which were more favorable than any bank or insurer rated AAA.
The enormous GE Capital operations gave Welch more luster than he deserved a second way: they enabled General Electric to play earnings games, so they alway met their quarterly guidance to the penny. Admittedly, GE Capital unwisely continued its expansion after Welch left, in the low interest rate dot-bomb era, including increasing its leverage level and re-entering the subprime mortgage business in 2004.
Then CEO Jeff Immelt kept reassuring investors in 2007 even as the foundation was starting to crack. From Fortune in 2008:
GE is known for seeing changes ahead of time….Home prices peaked in June 2006, yet it wasn’t until a year later, with the subprime crisis on the front page of every newspaper, that GE Capital finally decided to bail out. [Subprime lender] WMC lost almost $1 billion in 2007 before GE dumped it in December. A Japanese consumer-lending company called Lake was another lousy business, but GE Capital again didn’t face the music until it was too late. GE took a $1.2 billion loss on it last year after deciding in September to sell it – but by then consumer credit was deteriorating so fast that unloading it (to Shinsei Bank) took another year….
Despite its stumbles, GE has a long history of strict financial discipline. Immelt told shareholders in February , and repeated to employees recently, that GE had no exposure to collateralized debt obligations (CDOs) or structured investment vehicles (SIVs). It uses derivatives for hedging, which is relatively safe, but prohibits speculating in them, which is dangerous. It subjects its financial positions to shock tests – for example, assuming that interest rates rise a full percentage point across the board and stay there for a year; if that happened in 2008, Immelt said at the beginning of the year, GE’s positions were so well hedged that the effect on profits would be negligible. His upbeat conclusion in February: “Our financial businesses should do well in a year like 2008.”…
Making matters worse, Immelt had assured investors only 18 days before the quarter’s end that everything was on track. GE’s just-released annual report was titled “Invest and Deliver,” significant because inside GE “deliver” is a special word. You deliver on commitments – always. As Welch said on CNBC, “Just deliver the earnings. Tell them you’re going to grow 12% and deliver 12%.”
So Immelt committed the ultimate GE sin and failed to deliver. How come? That’s easy. He reassured investors on March 13, and the quarter ended on March 31. But something unimagined happened in between: Bear Stearns failed, causing credit markets nationwide to freeze up. GE had been counting on GE Capital to do its usual end-of-quarter rescue act, but this time it couldn’t.
This is even more damning than it appears. It effectively says that Immelt didn’t understand that General Electric was a financial services firm, and therefore wasn’t minding that store.
Bear went bust on March 14, a mere day after Immelt gave shareholders another happy talk. Admittedly the run on Bear took only about ten days, but anyone paying attention knew the financial markets were in crisis mode the week before. For instance, our March 6 headline was Credit Markets “Utterly Unhinged”. The post reported that the agency securities market (Fannie and Freddie bonds and mortgage securities with their guarantees) had seized up, a white-knuckle development for a market nearly as big as Treasuries and until recently regarded as just as safe.
And the wheels came off Bear that very March 13 evening. Many of its counterparties stopped trading with it on Monday, March 10. Bear had skimpy cash reserves compared to other investment bankse, as we explained in our March 14 post, Bear Death Watch: Why It Failed. As we wrote:
Bear concluded that it was in trouble as of 4:30 pm on Thursday; it called James Dimon at JP Morgan at 6:00 pm., who immediately called the Fed, which then sent a team of examiners over to Bear that worked through the night.
“In trouble” meant Bear did not have enough cash to open Friday. Bear wanted a $25 billion emergency loan from JP Morgan overnight. JP Morgan (not entirely unreasonably) could not get its arms around the risk assessment overnight and asked the Fed for a guarantee, which it provided in an emergency meeting Friday morning.
How could Immelt think GE Capital and hence General Electric would not get caught in the downdraft? And how could analysts be as deluded? From Fortune, on the first quarter 2008 earnings miss:
Result? Uproar and a further slide in the stock. Investors felt betrayed and disillusioned. Analyst Nicholas Heymann of Sterne Agee spoke for many when he wrote: “Investors now understand that GE uses the last couple weeks in the quarter to ‘fine-tune’ its financial service portfolios to ensure its earnings objectives are achieved. It turns out it really wasn’t miracle management systems or risk-control systems or even innovative brilliance. It was the green curtain that allowed the magic to be consistently performed undetected.”
In September 2008, General Electric had another episode of assuring investors everything was hunky dory and there would be no need to sell stock. As Seeking Alpha recounted later that year:
On September 25, with the stock trading at $25.50, Jeff Immelt lowered GE’s earnings guidance, suspended its $15 billion stock buyback plan and declared they needed no outside capital. He reaffirmed their commitment to maintaining a AAA rating with these actions.
Yet in a week, General Electric’s credit default swaps were priced at junk level just before the company announced a $15 billion stock sale, $3 billion to Warren Buffett on preferred terms and $12 billion to the general public.
General Electric also needed to avail itself of rescue facilities to roll $74 billion of commercial paper and obtained guarantees for $139 billion of debt under an FDIC program.
General Electric lost its AAA rating in 2009, dashing whatever hopes it had had of returning to its former financial services industry bezzle, um, dominance.
Now it’s easy to blame Immelt for much of this sorry performance, and Welch’s successor didn’t cover himself with glory. But a big part of the mystique Welch cultivated was as being a superstar people manager. If you look at The 8 Rules of Leadership by Jack Welch from Inc. Magazine, for instance, it’s all about cheerleading. Nothing about the hard nitty gritty, like making sure your systems (IT, financial) are rock solid, that a CEO should exhibit Andy-Grove-level paranoia in monitoring competitors and looming technology and environmental threats, or even bland but really important basics like listening to customers (and the hard part, figuring out when and how much to act on what they say).
In other words, the lameness of Immelt is the direct result of Welch’s show pony “leadership”. Management succession is one of the most important duties of a CEO and Welch blew that too.
When Welch died in 2020, the business press published encomiums as well as some reputational markdowns. For instance, from The Week:
Upon his retirement, almost 20 years ago, Welch was a legend…
Upon Welch’s death this past weekend, however, GE was a decimated shadow of its former self. And Welch’s own legacy, to put it bluntly, lies in ashes: A warning for others of the dangers in 1980s-style Wall Street financialization, and of an overwhelming focus on shareholder value above all else….
Years after his retirement, in 2009, Welch told the Financial Times that shareholder value — the corporate governance philosophy that a company should focus on maximizing returns to its shareholders to exclusion of all else — was “the dumbest idea in the world.” But while Welch ran GE, you could find few better exemplars of putting “shareholder value” into practice: It wasn’t just that Welch laid off over 100,000 workers; he closed huge swaths of GE’s domestic factory operations — up to and including the company’s famed light bulb manufacturing — and sent them overseas where labor was cheaper. “If I had my way, I’d put every GE plant on a barge,” he once declared.
To further juice General Electric’s stock market value and its returns to the ownership class, Welch took the billions he saved from all those closures and layoffs and embarked on a sweeping quest to buy up companies in sectors and industries far beyond GE’s original core competencies in manufacturing, engineering and electronics. The company became a massive conglomerate, with major stakes in health insurance, pharmaceuticals, finance, entertainment, and more. By the time Welch retired in 2001, GE’s annual revenue flow had increased five times over, and its stock market value had exploded from $14 billion to $410 billion.
Then it all fell apart.
It is sad to see the dismembering of a once great American company. But let’s not forget why.