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Will the Obama administration's reforms of the financial system hurt retailers and manufacturers with lending arms?
Economist Staff, The Economist
June 26, 2009
The talk had become so fevered that on June 22nd Jeffrey Immelt, General Electric's embattled boss, sent out a memo to all staff to quash it. "GE is and will remain committed to GE Capital," he insisted. These words of reassurance were prompted by the financial-reform plan the Obama administration had unveiled earlier in the month, which many saw as heralding the dismemberment of America's biggest conglomerate, with interests from nuclear power to financial services.
GE is not the only company in the line of fire. An array of retailers and manufacturers that provide customers with loans for purchases, from Target to Harley-Davidson, also face threats to their business if the proposed legislation makes it through Congress. That, as Mr. Immelt pointed out in his memo, is a big if: "it is very early in the process, and Congress will now spend months reviewing and drafting legislation." During that period, GE will doubtless deploy its huge lobbying clout to argue that it should be left alone.
The administration's proposals pose two main concerns for GE, of which much the greatest is the implication that GE Capital, the firm's vast finance arm, would be considered a "Tier 1" bank, meaning one that is so big and systemically important that it should be subjected to especially thorough scrutiny and tight controls. Restrictions on the industrial activities of such banks might force it and the rest of GE to part company.
Mr. Immelt rejects this prescription on the grounds that the combination of commerce and finance within the firm played no part in the financial crisis. Indeed, GE argues that the strong cash flow from its industrial businesses-aircraft engines, power-supply equipment, and so forth-actually protected its financial operations during the credit crunch, when stand-alone financial firms suddenly found they could no longer raise funds.
But GE did have difficulties raising money, which led it to turn in October for (expensive) help to Warren Buffett, a celebrated investor. The firm says it did not need assistance obtaining short-term commercial loans, and only took part in the Federal Reserve's emergency scheme to provide such lending to demonstrate its support for the concept. But its struggles certainly added to the general sense of panic at the time. Had GE failed, it would have done significant damage to the financial system and the wider economy. If companies such as General Motors and Chrysler are "too big too fail," then so is GE Capital, let alone the conglomerate as a whole. And it makes little sense to regulate GE Capital differently from any other big, risk-taking nancial business.
It is not clear, however, that GE's industrial businesses added to the systemic risk posed by GE Capital, or to the difficulty of regulating it. Nevertheless, given the way the political wind is blowing, GE Capital should expect to feel a heavier regulatory hand on its shoulder in future. It is also likely that GE Capital will find it more expensive to borrow for some time to come. That may well make being in financial services less attractive to its shareholders, who have already successfully pressed for a paring down of GE Capital, partly in response to the firm's plunging share price during Mr. Immelt's eight-year reign. Some want GE to get out of finance altogether.
GE is also concerned, along with a host of other companies, about the administration's proposal to put an end to a category of financial firm they have all set up called an "industrial loan company." These are state-regulated outfits, based mainly in Utah, which can take in federally insured deposits from savers, make loans and issue credit cards, but are subject to less onerous regulation than banks. They have proliferated in recent years as non-financial firms such as Target, BMW, Pitney Bowes, and UnitedHealth have created ILCs as a cheap and profitable way to steer credit and other financial services to their customers.
The administration wants to subject all consumer-finance firms to the same regulations to prevent a gradual migration to the most lax form of oversight. That fear is not unreasonable, and the response sensible enough. But it is likely to be undermined by the boundless ingenuity of businesses looking for a way around supposedly comprehensive regulations. Moreover, there is no evidence that the ILCs of non-financial companies played any part in the financial crisis, or that they pose any systemic risk.
Harley-Davidson lending money to fifty-somethings in the midst of mid-life crises so that they can buy its "hogs" is unlikely to bring capitalism to its knees. Indeed, since the 19th century, when firms such as Singer started extending "dollar down, dollar a week" loans to help people buy sewing machines, such financing has been a routine feature of business life. It is unlikely to go away even if regulation makes it more expensive. Instead, those firms that depend on providing such loans will presumably accept the stricter oversight that comes with owning a bank.
The crackdown on ILCs, more than anything, is testimony to the phenomenal lobbying power of America's banks, which have long railed against the growth of cheaper, more lightly regulated competitors. Back before the financial crisis, the banks protested so furiously against an attempt by Wal-Mart to obtain a license to start its own ILC that the giant retailer backed down. But whatever the regulatory category, the sort of competition that a firm as large and well-run as Wal-Mart would bring to consumer banking might be just what bloated incumbents such as Citigroup desperately need.