Saturday, February 28, 2009

As goes GE . . . reports on General Electric's dividend cut announced yesterday by focusing on its CEO, Jeffrey Immelt, in "Jeffrey Immelt Faces More ‘Hours of Doom’ With GE Dividend Cut".

From the GE website:

GE traces its beginnings to Thomas A. Edison, who established Edison Electric Light Company in 1878. In 1892, a merger of Edison General Electric Company and Thomson-Houston Electric Company created General Electric Company. GE is the only company listed in the Dow Jones Industrial Index today that was also included in the original index in 1896.

GE has paid dividends continuously since 1899 and last cut its dividend during the Great Depression.

Like America, GE has changed. From

More than 50 percent of GE’s profit in recent years has come from its GE Capital unit, which includes private-label credit cards, real estate, bankruptcy financing and mid-sized company lending, making it a competitor to most banks.

So, GE has for some years been a financial company in drag, despite a very different public image. The company that lit up America morphed into nothing better than a lender of money.

Before this bear market started in 2007, GE sold for about 10 times its tangible book value, even though neither other financial companies nor mature industrial companies merited that valuation. Could it be that GE was so highly rewarded because it rewarded the financial industry? Here's the evidence:

Since 2003, GE has shed more than $50 billion in businesses and acquired more than $100 billion, eliminating divisions like plastics and adding to health care. Before the credit crisis began in 2007, he sold the U.S. sub-prime mortgage business, which catered to the least creditworthy borrowers. Early in his tenure, he shed all of GE’s insurance divisions.

Basically, the thesis here is that there was an unwarranted love-in between GE and the "analysts". GE did deal after deal, paying large premiums for not-so-profitable medical companies, and the brokerage firms took their fees for arranging the deals and didn't look too hard at how GE could be a perpetual growth machine.

A GE spin-off, the insurance and financial products company Genworth, was spun off to shareholders in 2004. What started as a $20 stock is now around $1. Genworth, like GE, has roots that go back to the 1870s.

What has happened in America?

I have just finished reading Wall Street Under Oath, published in 1939 by Judge Ferdinand Pecora, who led the Senate Commission in 1933 that investigated the Crash.

It's clear that what happened, starting in the 1990s, was that the financial community set out to defraud investors. Everyone on Wall Street knew there is never a "new era" of stock valuations, no matter how exciting a new technology appears to be. However, equity losses suffered by gullible investors were equalled by equity gains by insiders, so all that happened was that some people got rich or richer, and some people lost their investment.

What was new about the 1990s was not the old stock game of "pump and dump", which has occurred over and over again. What was new was that the economic expansion was the first one in American history in which the financial health of the average American company declined. In other words, companies were already leveraging up to buy back their own stock so that they could report a meaningless improvement in Earnings per Share, or in other ways companies were using borrowed funds to leverage their earnings.

Everyone in finance knows that leveraged earnings are riskier than unleveraged ones and deserve a lower price-earnings ratio; yet the Street ginned up a mania that brought P/E's to record levels not far below where Japan's got at the peak of its financial bubble in 1989.

When the 2001 recession and bear market hit, the financial community doubled down. P/E's bottomed at levels where they usually peaked when a bull market ended, rather than where a bear market ended. In other words, the New Era of stock over-valuation was made to persist via stimulative fiscal and monetary policy and greed on the Street.

The financial community created the illusion of stability with a 2003-7 stock market climb that set a record for being the longest bull market without even a 7-10% correction. Might that have been a result of stock manipulation, one wonders in retrospect?

This time, unlike the 2001-2 bear market, the action was in debt, not equity. To keep it simple, a lender values a loan as an asset, but if the loan defaults, both the borrower and lender are losers. Lending is riskier to a society than a straightforward sale, such as a share of stock or a kitchen remodel paid for in cash. It is also more difficult to value a loan than a kitchen remodel, a light bulb, or an aircraft engine. The remodeled kitchen has a value and has a use; the loan can become worthless and has no intrinsic use to the lender that owns the loan. 

At the peak of the economic cycle two years ago, it is said that 40% of the S&P 500's earnings were financial in nature. We now know that most or all, or more than all, of those financial earnings were not earnings at all: the loans just hadn't had enough time to go bad.

GE is thus a close example of America's financial status: old, misunderstood, over-financialized, and in a tailspin.

GE has let its shareholders down in a big way.

America, the owner of the world's reserve currency, has let the world down big-time, as well.

For that reason, serious people are accumulating a much older currency called gold.

Copyright (C) Long Lake LLC 2009

1 comment:

  1. Good work DoctorX


    keep it coming, people must read to understand