Can We Avoid Another Cataclysmic Meltdown Of The Global Financial System?

Chapter 5 We’re All Bankers Now

Chapter 5 describes what can happen when corporations undertake a strategy to emulate banks and stray too far from their core businesses and are then forced to reclaim their roots in the industry they had once excelled. The story of how American businesses operating in the real economy  came to emulate financial institutions is told using GE as an example. The purpose of telling this story is to provide more evidence as to the adverse impact these financiaization strategies have had on American industry and what is likely to happen in the future if we continue down this path. This chapter includes a discussion of GE’s recent change in strategy to return to its core business of innovating and making products and the promise this new strategy has for restoring the American industrial base that had been eroded by financialization.

The GE Story in Industrial Financialization (a.k.a. Bank Emulation)

Although this chapter presents in summary form a number of examples of businesses that are emulating banks,  there are too many to discuss. Accordingly, emphasis is placed on discussing GE as a good example of a company that decided to emulate a bank and the lessons learned from its emulation. These lessons provide insights as to what  may have to change, if we are to reign-in industrial financialization and rebuild businesses that serve the real economy, not just Wall Street.

As explained, GE was founded 120 years ago, and it has always been considered a bellweather for the American industrial corporation. Up until the 1980’s GE  was considered as one of America’s most successful conglomerates, capable of manufacturing a wide range of industrial and consumer products. The vast majority of GEs sales  came from building “big-ticket” industrial products such as jet turbines, nuclear power reactors, mining equipment, X-ray machines, electronics.Its product mix had expanded into manufacture of complex materials, and plastics  as well as consumer products  such as lightbulbs, consumer electronics and household appliances. GE  had also received a modest share of revenue from financial activities in the 1950s 1960s and 1970s but such activities had increased five-fold by the late 1980s. GE major profit center for these financial activities was called GE Capital and starting in the 1980s GE redefined itself under Jack Welch its legendary CEO. He dramatically expanded GEs financial business. GE Capital emerged as one of the world’s largest financial service companies, providing financing, and equipment leasing, engaging in leverage buyouts and  as a bundler and seller of sub-prime mortgages.

Leading up to the financial crisis of 2008, GE Capital had become America’s largest “nonbank” financial services firm.  It became heavily engaged in borrowing  money to conduct its daily operations and it focused more and more on  manipulation of capital rather than on using its capital to help GE in creation of truly innovative products and services.

By the time of the 2008 financial crisis, the assets of GE Capital had reached $700 billion. The 2008 collapse of real estate market inflicted huge losses on GE Capital, requiring $139 billion in FDIC guaranteed loans as GE was considered  to be a Too Big to Fail entity by US Treasury officials. In addition, GE had to raise cash quickly and was forced to attract private sector investors by offering its shares at bargain prices. Jeffrey Immelt, Jack Welch’s successor as GE CEO then decided that GE would reverse course back toward  its basic business of making things and backing away from all of the financialization activity it had been engaged in. As explained, this is a work in progress at GE, and time will tell if GE can re-invent itself to the extent that is needed.

GE like so many other American corporations became obsessed with the business of finance for a myriad of reasons. But the basic one was the belief that it is easier to make money on financial services  than it is on manufacturing, as the financial services business requires less investment, incurs lower overhead and offers higher profit opportunities than does manufacturing.

This trend toward financialization  reflects the broad shift in the US economy from manufacturing to services over the last several decades and in spite of the 2008 melt-down and the 8-year long anemic economic recovery, is still ongoing. It is helped along by lax regulatory environment that favor pursuit of more volatile financial investments over safe less profitable real-economy investments. And perversely, as more and more investment is drawn out of the real economy and used as passive investments in financial assets, the more these financial assets become over-valued and their rates of return are perceived to become higher that rates of return on manufacturing assets, thereby compromising potential investment in real economy manufacturing.

In short, it appears that there is no quick fix to the problem of under-investment in job creating manufacturing that is needed, if the incentives for making passive investments in financial assets remain.