THE PEOPLE OF GE Capital kept a wary eye on Jeff Immelt.
The division’s financial profits had fueled two decades of furious growth at GE. Welch had known how central the Capital machine was to his company’s performance. Though his own financial knowledge was deep, Welch had also understood his limits when it came to the intricacies of the business. He had entrusted his all-important earnings machine to a trusted CEO, Gary Wendt, and his CFO Dennis Dammerman. When he took over, Immelt would stay fully briefed on what they were doing.
But to the people within GE Capital, Immelt was still an unknown quantity. He had never worked in their division, and from the sound of things, he seemed less interested in finance than in marketing big ideas out of the industrial businesses and expanding GE to other corners of the world.
Welch had chosen a salesman, not a banker, on purpose. Immelt’s sales chops, the company believed, would position him perfectly as GE moved deeper into a new century that would require aggressively ferreting out opportunity in new markets as global trade barriers fell, opening new frontiers. But some of those watching from the perspective of GE Capital weren’t sure Immelt truly knew how the money got made in the division that had sustained Jack Welch’s operation—or if the new boss even really cared.
The focus on marketing throughout the organization led to less risk management, according to people who worked at GE through the transition. One trend that seemed to take hold inside GE Capital was a greater tolerance for increased risk if it was offset by higher sales volume. The idea was that the impact of a few bad deals would be diluted by the greater number of deals being made. Huge profits would outshine mistakes. As a rule, however, higher investment returns only arrive on the back of increased risk. To old-timers, the idea seemed naive at best and downright dangerous at worst. This type of flawed logic had destroyed many companies, especially in the financial services industry.
The early problems at Capital, including the scrutiny from Bill Gross, and the aftermath of the Enron collapse, along with the slowed economy, led Immelt to take the ax to Capital. He cut ten thousand workers within his first year and completely reorganized the division.
Denis Nayden was pushed out as leader of the division, which was then split into four separate operations: commercial finance, consumer finance, equipment management, and insurance. New leaders in those groups would report directly to Immelt and Dammerman.
As part of his campaign to persuade Wall Street that GE wasn’t in trouble or hiding anything, Immelt was now sending it the message that Capital would have more oversight. His assertion that he had long wanted “more direct contact” with the team sent a clear message: I’m the boss now.
The Capital veterans bristled. They were being punished for demonstrating ongoing success while the industrial side of the company continued to depend on their strength. To them, GE had changed the minute Immelt sat in Welch’s seat. And not in a good way.
He either didn’t understand, or didn’t care, that GE Capital was an elite finance organization that was outgunning Wall Street at its own game. It could be stood up next to JP Morgan & Company and Goldman Sachs. This purge only solidified the perception that Immelt wasn’t in their corner.
Although he brought a new approach to Capital, Immelt still depended on it. In fact, in his first years as CEO, the operations grew bigger. Like Welch, he found it hard to resist the siren song of the money that could more easily be made from financial services. More than ever as GE’s commercial results and stock price sagged, GE Capital was providing the grease that kept the earnings machine running.
To honor GE’s handshake agreements with the credit rating agencies, Welch and his team had pledged to limit the company’s reliance on Capital, capping its contribution to 40 percent of GE’s earnings. Welch himself had no strong desire to set a limit, but the approval of these agencies was critical to the whole enterprise. GE could churn out huge returns only because rating agencies sustained its triple-A debt rating.
Under Immelt, the cap flew out the window. That decision was made partly out of necessity in the early difficult years. More Capital profits were needed to shore up GE’s overall earnings. But to skeptics, the rising share of earnings from Capital signified that Immelt wasn’t sure what he was doing with a massive financial services business. If too much profit came out of the finance side, GE could face pressure from credit rating agencies to address the risk in its structure. The secret sauce of Capital—receiving a stellar credit rating that let it borrow cheaply because it was viewed as an industrial company, not as a bank—could have been at serious risk.
Immelt’s fans thought the criticism was unfair. The CEO was leaning on Capital because of a major drought in the market for power equipment, GE’s biggest industrial product line, after years of booming growth. It was slowness on the industrial side, they argued, that made the growth of Capital seem outsized.
At the same time that there was less oversight of GE finance operations, Immelt quietly reduced the board’s involvement with financial complexities. In 2002, he disbanded the finance committee of the board, which had been tasked with oversight of “retirement plans, foreign exchange exposure, airline financing and other matters involving major uses of GE funds.” He gave no reason.
Indeed, there was no notice of the disbanding of the committee, which had included directors with significant experience managing risk, including former JP Morgan & Company CEO Sandy Warner and the billionaire race car driver and entrepreneur Roger Penske. Listed in the 2002 annual report, the finance committee was simply gone the next year.
Despite all the new transparency, GE still needed to use complex maneuvers to keep earnings buoyant. The playing field for business in the years after fraudulent practices caused the meltdowns of Enron, Tyco, and Worldcom was a perilous environment. New accounting rules took hold, and more frequent public disclosures were required by the SEC. Immelt and GE chief financial officer Keith Sherin, unlike their predecessors, now had to sign their own names to GE’s financials, attesting to their accuracy.
More worrisome to the company than the new pressure from regulators, however, was a growing unease among a group they took even more seriously: investors. Patience for the financial engineering that had papered over short-term hiccups in the industrial business was now wearing thin.
In the fall of 2002, it was dawning on executives at headquarters in Fairfield, Connecticut, that sales and profits were going to come in slower than projected in most of GE’s core businesses. In a straightforward accounting of the quarter, the result would have been simple: a slew of expenses and charges were due to hit GE’s bottom line. The company would have to report a smaller profit for the three-month period than investors had expected. Almost certainly, some of GE’s investors would sell their shares in disappointment and the all-important stock price would go down.
But GE didn’t accept such a result without a fight. And conveniently, it had a piggy bank to break: there were gains scattered around the company, including an unexpected tax refund and cash back from customers that wanted to cancel orders. The biggest boost was a $300 million benefit from the sale of GE’s e-commerce unit. That deal would give GE the gain it needed to hit its earnings targets and avoid annoying Wall Street, but the bankers were struggling to get the deal closed by the end of the quarter. Into this breach stepped GE Capital. When the buyers couldn’t raise the needed funds, Capital bought $235 million worth of bonds to get the deal done.
GE got its gain and hit its targets. It was the sort of gambit that under Welch had earned GE a reputation for creativity and financial guile.
But these moves didn’t play that way anymore. What was this, skeptics asked, but the company financing a private investor to take one of its own units away? To the investors who graded GE now, this just looked risky and raised questions about how long GE could make such moves before running out of runway. Immelt simply couldn’t haul out the same tools that Welch had used with impunity, at least not without suffering the criticism of analysts and pundits.
Even large investors were raising their eyebrows. CalPERS, the largest pension fund in the country, moved to file a shareholder challenge to GE’s executive compensation. The fund wanted leaders to be paid in accordance with their performance.
The party, it seemed, was ending.