The collapse of GE’s house of debt was 130 years in the making

Genius, the inventor Thomas Edison once said, is 1 per cent inspiration and 99 per cent perspiration. He might have added: In business, it’s also almost 100 per cent commercialisation.

That’s a final lesson for General Electric, the industrial conglomerate Edison helped found that’s being split into three after nearly 130 years — as well as for Toshiba, once effectively GE’s Japanese unit and now also considering a division into three separate businesses.

GE had always liked to think of itself as a hotbed of research and development in the model of Edison’s Menlo Park laboratory. From the start, though, the company drew as much from the financial brilliance of its co-founder, John Pierpont Morgan, as from Edison’s engineering prowess. A failure to keep up with how equity and debt markets changed in the 21st century is at least as important an element in its downfall as industrial missteps.

GE’s history can be seen as a series of credit innovations. The company was put together as a rescue merger by Morgan to bail out Edison’s disastrous bet against alternating current as the future of electricity distribution. Morgan, the archetype of a Gilded Age “robber baron” industrialist, saw the business as a vehicle to dominate the new market in electricity in the same way John D. Rockefeller’s Standard Oil controlled the US petroleum industry. It was a trick Morgan later repeated in building US Steel from Andrew Carnegie’s empire.

Getting monopolistic control of an entire industry requires colossal volumes of capital. That wasn’t easy at a time when the storekeepers and farmers who dominated the US bond market preferred to extend finance to municipalities, railways and public utilities rather than industrial businesses.

Morgan’s solution was to take control of his customers, establishing the Electric Bond & Share Co. to acquire shares in power companies, who could then borrow at low rates and in turn purchase GE’s generating equipment. When the Great Depression of the 1930s left households without the cash flow for consumer appliances such as refrigerators, the company repeated the trick by setting up GE Credit with the same purpose: provide finance for customers to buy its products.

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In that sense, the roots of GE’s downfall came long before Jack Welch, the chief executive officer in the 1980s and 1990s, allowed its financing arm to grow into a behemoth. GE Capital was the fifth-largest lender in the US on the eve of the 2008 financial crisis, with about 4 per cent of the entire market in short-term commercial paper loans. Bloated it was, but GE Capital wasn’t an aberrant development in the company’s history. Instead, it was the final flowering of an ideal of credit-driven growth that had run through the business since it was built by America’s greatest financier.

Even the conglomerate structure that current chief executive Larry Culp’s split will finally dismantle was in some ways a response to credit conditions. When debt is scarce, lenders are unwilling to provide cash to foster new and innovative businesses — but they’ll happily fund a blue-chip giant, a factor that once gave industrial conglomerates a crucial advantage over smaller businesses. By borrowing using its enormous balance sheet, GE could funnel cash at below-market rates into riskier ventures, helping to innovate faster and perfect the many inventions that emerged from its Research Laboratory: lightbulbs, power stations, X-ray machines, electric cookers, radios, televisions, lasers, jet engines and nuclear power.