The idea that the government might well break up the nation’s largest financial companies has always seemed far-fetched, in part because the lending industry has some 3,000 lobbyists in D.C. But now one of the world’s largest financial organizations has decided to break itself up and leave the mortgage arena.
It makes you wonder: Will it be the last?
General Electric has been one of the most important companies in America since its founding in 1892, the only organization continually on the Dow Jones Industrial Index from its start in 1896 through today. In 2014, GE generated a profit of $15.2 billion.
GE is among the most-diversified companies in the world with products ranging from light bulbs, to locomotives and jet engines, and on to financial services. Those financial services are largely under the umbrella of the General Electric Capital Corporation, but not for long: General Electric has just announced that it will sell off “most GE Capital assets,” setting in motion one of the most important exits from the mortgage industry in a long time.
GE Capital and Systemically Important Financial Institutions
“Back in the early 2000s,” explains John Rubino at DollarCollapse.com “General Electric — previously known as the world’s biggest, best managed maker of cool, useful things like jet engines and wind turbines — discovered that it could make even more money by exploiting its AAA credit rating to borrow cheap currency and lend it out at higher rates. It ramped up its vendor financing, enabling customers to buy more of its stuff, and built a real estate empire that spanned the globe.
“It took a while for people to figure out that the company, via its GE Capital division, had in effect become one of the world’s biggest, most highly-leveraged banks. But eventually they got it, and when the real estate/derivatives bubble burst in 2008, being a major bank was like being a dot-com in 2000 or a silver miner today: a very bad thing in the eyes of shell-shocked investors.”
By 2014 GE’s financial division had approximately 47,000 employees and accounted for roughly 42 percent of the company’s earnings, meaning it generated about $6.4 billion in profits.
This isn’t a fire sale, so why is GE selling a hugely-profitable business at a time when the American economy appears to be firming up? The company says the sale was motivated by a desire to focus on “continued investment and growth in its world-class industrial businesses.”
In other words, part of the answer is money — the sale is expected to generate $35 billion in dividends and is coupled with a $50 billion stock buy-back. With fewer shares, earnings-per-share can rise, something which if it happens should be good for both share values and executive bonuses.
But another part of the answer is Dodd-Frank. Under the 2010 legislation the government can label a super-jumbo non-bank company as a “Systemically Important Financial Institution” or SIFI. When a company has the SIFI tag it’s subject to stricter regulation and tougher capital requirements, standards which make the company less risky but also hold down potential profit levels.
According to the Treasury four nonbanks have been labeled as SIFIs to date: MetLife, the American International Group (AIG), General Electric Capital Corporation and Prudential Financial. MetLife has sued the government to be removed from the list while GE is taking a different approach: By selling GE Capital the company will reduce its “ending net investments” or ENI from $538 billion in 2008 to about $363 billion now with another $75 billion soon to be lopped off with the sale of Synchrony Financial, thus creating grounds to get the SIFI designation removed.
GE says it “has discussed this plan, aspects of which are subject to regulatory review and approval, with its regulators and staff of the Financial Stability Oversight Council (FSOC). GE will work closely with these bodies to take the actions necessary to de-designate GE Capital as a Systemically Important Financial Institution (SIFI).”
Translation: GE is engaging in a voluntary downsizing with the hope that a smaller-but-more-targeted company with less regulatory oversight can generate higher returns. The GE effort to be SIFI-free may well encourage other Wall Street behemoths to follow a similar strategy. For those who would like to see the leading financial goliaths broken up, the GE strategy offers a pathway to smaller size without the need for congressional action or lengthy court battles.
Could it really happen that some of the nation’s big banks might divide like a bunch of financial amoebas?
GE is doing it and consider this: JPMorgan Chase Chairman and CEO Jamie Dimon said in the 2014 annual report to shareholders that “our stock performance has not been particularly good in the last five years. While the business franchise has become stronger, I believe that legal and regulatory costs and future uncertainty regarding legal and regulatory costs have hurt our company and the value of our stock and have led to a price/earnings ratio lower than some of our competitors. We are determined to limit (we can never completely eliminate them) our legal costs over time, and as we do, we expect that the strength and quality of the underlying business will shine through.” (Parenthesis his)
No doubt a lot of companies, shareholders and regulators are going to see what happens with GE. If stock values rise and perceived risk to the public declines then pressure to divest will surely grow. In effect, it could happen that some major financial services companies may go back to something like the Glass-Steagall standard, the legislation which between 1933 and 1999 required banks and securities brokerages to be separate.
GE and The Secondary Market
Real estate assets worth about $26.5 billion are being sold off to funds controlled by Blackstone, Wells Fargo and other investors, but that’s not all: One has to wonder what will happen with the secondary market.
GE Capital has long been a significant player in the secondary market, the electronic arena where mortgages worth trillions of dollars are bought, sold and insured each year.
“The General Electric Credit Corporation (GECC),” said HUD in the early 1980s, “is the nation’s largest diversified finance and leasing company. Through its various departments and subsidiaries it provides financing for first and second mortgages, homebuilder construction, manufactured housing, and commercial real estate loans. GECC has been positioning to move fully into the private secondary mortgage market over the past three years. Through its subsidiaries it buys and underwrites mortgages and provides mortgage and title insurance.”
Long dominated by Fannie Mae and Freddie Mac — so-called “government-sponsored enterprises” or GSEs — secondary market activities can be very profitable, and they would surely be more profitable for private-sector firms with less Fannie Mae and Freddie Mac participation or — even better — no Fannie Mae and Freddie Mac participation.
This is the thinking behind several bills offered on Capitol Hill during the past few years. For instance, the proposed Residential Mortgage Market Privatization and Standardization Act of 2011 “gradually reduces Fannie Mae and Freddie Mac over the course of 10 years by forcing the institutions to guarantee the credit on a decreasing percentage of the mortgage backed securities they issue. It also takes steps to bring uniformity and transparency to the housing market so that private capital can gradually replace the GSEs.”
None of the various bills dedicated to GSE “reform” have been enacted and the cherished goal of eliminating Fannie Mae and Freddie Mac — and capturing their profits — is now effectively off the table. Indeed, there is some motion to assure the continued operations of the two GSEs. As an example, in March Sens. Bob Corker (R-TN) and Mark Warner (D-VA) proposed legislation which would “prohibit the sale of Treasury-owned senior preferred shares in government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac without congressional approval.”
The government wants to hang on to Fannie Mae and Freddie Mac because they’re a fountain of wealth. The two GSEs were forced to borrow $188.4 billion from Uncle Sam and so far have paid back $228.2 billion, a net addition to the Treasury of $39.8 billion with more to come because in a so-called “sweep amendment,” the government now claims that it has the right to all future GSE profits. Not surprisingly, shareholders are suing.
What About Mortgage Lending?
Part of the reason for GE’s new approach may well be because the mortgage business is hardly a source of guaranteed profits.
In 2004 GE bought the California-based WMC Mortgage Corp., a leading subprime lender. WMC was then sold by GE in 2007 with a loss of more than $1 billion, according to investigative journalist Michael Hudson with the Center for Public Integrity.
By 2007, said Hudson, “WMC Mortgage was effectively out of business, dead after having pumped out roughly $110 billion in subprime and ‘Alt-A’ loans under GE’s watch, according to industry data tracker Inside Mortgage Finance.”
It’s possible that additional WMC claims — perhaps large claims — remain outstanding. GE says it continues to face “pending and future mortgage loan repurchase claims and other litigation claims in connection with WMC, which may affect our estimates of liability, including possible loss estimates.”
The New GE
There’s little doubt that shareholders will be happy with the buy back and dividends but what about the company’s future direction?
GE says it wants to “create a simpler, more valuable company by reducing the size of its financial businesses through the sale of most GE Capital assets and by focusing on continued investment and growth in its world-class industrial businesses.”
If this statement means GE wants to bulk up industrial productivity and production within our borders then it will be wildly applauded. But what if that’s not the case? What if GE merely wants to increase profits by manufacturing more abroad?
“Even as employers have created nearly 10 million U.S. jobs over the last 4 ½ years,” says USA Today “giant multinationals haven’t added many. In fact, new data from the Commerce Department’s Bureau of Economic Analysis(BEA) show that multinational companies, which account for one out of every five U.S. private-sector jobs, reduced their U.S. employment by 875,000 from 1999 through 2012 while adding 4.2 million jobs abroad.”
Moving production overseas might sound like a good idea to bottom-line capitalists, but it’s hardly foolproof. According to the International Business Times “investors fear continued strength in the dollar will slow U.S. earnings growth. A prolonged period of dollar strengthening would hurt U.S. multinational corporations once they convert foreign revenue to dollars as nearly half of the S&P 500’s revenues are derived from overseas.”
And how is the U.S. dollar doing?
With weak economies in Europe and Asia and outright warfare in much of the Middle East the dollar is looking awfully good these days so maybe building more stuff in the United States is really the way to go. If that’s the GE strategy then it will set a good precedent for many other companies and greatly enhance the U.S. economy.