Make GE Great Again

General Electrics (GE) hit the headlines several times with its plan to sell off GE capital, the company’s financial arm. The sell off was a strategic move as GE is restructuring to return to its roots as an industrial company. However, unpredictable market conditions have put major obstacles in GE’s path. These market conditions include tough regulations, plunging oil prices, and slow growth in emerging markets.

Tough Regulations

The most urgent problem that GE faces now is tough regulations. Regulatory bodies are watching GE very closely because its large market share allows it to have significant impacts on the market. The restrictive market environment becomes increasingly problematic for GE as it tries to consolidate its core industrial businesses. Sean Ross, an expert financial writer and consultant, shared his concerns on GE’s regulation issues in his published article. In 2015, GE planned to acquire a huge power unit from the French energy company Alstom SA in Europe as part of the restructuring effort. However, EU regulators halted the deal due to antitrust concerns. GE gained approval only after it agreed to sell parts of Alstom to Ansaldo Energia, a rival Italian company. Again, in July 2015, U.S. regulators invalidated a $3.3 billion sale of GE's appliances operation. The argument was that the sale would give rise to monopoly.These are just two instances. Going forward, we know that similar regulation obstacles will continue to hinder GE’s effort to restructure.

Plunging Oil Price

Even if GE eventually overcomes regulatory restrictions, another immediate problem that GE will face is the plunging oil price. This obstacle is just as significant as the regulatory restrictions for a newly consolidated industrial company. After restructuring, the $19 billion Oil division has become GE’s third-largest division, accounting for 20 percent of GE’s industrial sales. However, being reliant on oil is highly risky when oil price has been in free-fall. According to the Wall Street Journal, revenue from GE’s drilling and surface division indeed fell 10% in 2015. The falling oil price has posed a huge growth impediment for GE since its oil division is a key industrial growth driver. In addition, GE’s shift to focus on oil with such a bad timing has also shaken investor confidence drastically. Some investors are worried that GE’s share price will fall even more than the 35% share price drop since the current CE, Mr. Immelt, took over. If GE’s management team does not address such sentiments well, further share price drop might be a self-fulfilling prophecy when investors start panic selling.

Slowing Emerging Economies

GE’s problems are not limited to these immediate obstacles in its path of restructuring. One of the company’s long-term problems is the sustained slow growth in emerging markets. The slowing growth is going to put GE’s revenue on a downward trend. GE has traditionally relied on the emerging market’s strong growth to offset sluggish demand in developed economies. The emerging markets were the sole driver of GE’s revenue growth. For the past decade, GE's total revenue growth rate has been only 1.1%, but the Pacific Basin and the Middle East region have achieved 8% and 13% annual growth respectively. Keith Sherin, GE’s chief financial officer, publicly stated during an interview that GE was shifting its focus to these markets with higher growth. However, the recent slow growth in these economies has caused GE’s revenue to drop by 11% in 2015. As the emerging economies continue to slow down, GE’s revenue is likely to decrease as well.

With all these obstacles, GE’s future seems more uncertain than ever. The key to solving these problems lies in having an effective management team that will devise the right strategies at tough times. GE has made miracle happened once under Jack Welch whom was deemed to be “Manger of the Century”, but the investors are rather pessimistic that the new CEO Jeffery Immelt will have the same caliber to lead GE to new heights.

A Messy Breakup

It’s one of Democratic presidential candidate Bernie Sanders’ most ringing taglines about reforming the financial sector – “if a bank is too big to fail, it is too big to exist.” If elected, he claims, he would immediately establish a list of banks whose collapse would “pose a catastrophic risk to the US economy” and break them up within 365 days. But what are the broader economic implications of dismantling some of the nation’s largest financial institutions, and would seeing his plans through truly benefit the country?

           America today, still reeling from the financial crisis,

bears striking resemblance to the America of the early 1930s. In response to widespread economic collapse following the stock market crash of 1929, Congress spat out the Glass-Steagall Act, which mandated the separation of commercial and investment banking activities in an effort to reduce commercial over-speculation. The GSA was perhaps one of the earliest recognitions that risky banking activities must be closely regulated to avoid potential catastrophe.

But like much of American politics, it didn’t work – the GSA was finally repealed in 1999 by the Gramm-Leach-Bliley Act after decades of lax enforcement. No longer facing regulatory firewalls between their various banking activities, financial institutions rapidly expanded their range of services, oftentimes through aggressive M&A activity. Since the early 1990s, 37 banks have become just four – Citigroup, JP Morgan Chase, Bank of America, and Wells Fargo – that now control $6.5 trillion in assets.

        The crisis of 2008 was an indication that the financial

services industry has once again grown to a dangerous size. Banks were ramping up leverage and opacity through the proliferation of increasingly complex derivatives, and the degree of banks’ interconnectedness ensured that if one were to fall, others would surely feel the impact. To this day, banks assert that the riskiness of their positions is overstated as many of their derivatives strategically offset each other. But as the world has seen, a single wrong bet with enough leverage (i.e. the housing market) has the potential to drop the economy into free-fall.

        Few substantive measures have been taken to prevent such a

catastrophe from reoccurring. As part of the convoluted and painfully inefficient Dodd-Frank Act, the Volcker Rule attempted to restrict banks from risky prop trading; however, the infamous JP Morgan “London Whale” incident in 2012 that resulted in a massive $6B trading loss proved that such legislation has been largely ineffective. Now the financial industry once again sits precariously on the same precipice that it did before the crisis, but this time the stakes may be even higher – the derivatives market is currently valued at roughly $700 trillion, more than 10 times the size of the world economy, and another mishap like 2008 would once again send the economy plummeting.

        It’s time to take real action, and both consumers and the

government agree. Many top banks currently have PB ratios below 1, an indication of wavering investor confidence. The Federal Reserve has recently required banks to reserve a certain percentage of their total capital to cover their risk. And even some companies on “the fringe of Wall Street,” i.e. GE and MetLife, have begun divesting core business segments of their own accord.

        There is not yet clear evidence that breaking up the banks

would be a better solution than simply restructuring them or setting additional regulations to limit the amount of risk they can take. After all, many assert that overall domestic economic growth is inextricably tied to the growth of the financial sector. But as it currently stands, I believe that steps of some form must be taken to limit banks’ power and risk before another financial crisis breaks out. -- Brendan Wu B.S. in Finance and Statistics Leonard N. Stern School of Business New York University | Class of 2018 bsw258@stern.nyu.edu | 732-379-8088

Pfizer and Allergan Announce Merger

Pfizer announced today its decision to acquire Allergan in a $160 billion deal. This is the largest deal in a long list of healthcare deals that have been closed in recent years. The healthcare industry has made moves to consolidate, especially among smaller-cap companies, but this deal shows that even large-cap companies are participating in this trend as well. Not only does this deal add to the list of healthcare deals, it also adds to the growing list of inversion deals. Inversion deals are mergers where a U.S.-based company will acquire a company based in a foreign country in order to reincorporate overseas to take advantage of lower tax rates. By doing so, Pfizer expects to decrease its corporate tax rate from approximately 25% to 17%. For a company that generates billions in pre-tax income, this 8% savings represents a substantial increase in net income. Allergan, based in Ireland, will legally become the parent company, but Pfizer will technically be the lead company post-merger. The transaction price represents a 30% premium to Allergan's share price before rumors of a potential merger emerged and were priced into Allergan's stock price.

The combined company, called Pfizer Plc, will be able to recognize significant cost synergies equalling $2 billion within three years after the deal closes. Together, the two multi-billion dollar companies will sell over $60 billion worth of pharmaceutical products every year. Despite recent outrage and criticism over large pharmaceutical companies acquiring smaller ones and spiking up prices on their products, this pricing strategy is not expected to be a concern as the two companies expect to achieve accretion through cost savings and tax savings rather than demanding price premiums on specialty pharmaceutical products.

Eric Chao

Cracking Down on Fantasy Sports

On Tuesday, DraftKings and FanDuel were sent cease-and-desist letters for their daily fantasy sports operations in New York. State attorney general Eric Schneiderman declared their operations to constitute illegal gambling—although season-long leagues involve skill, daily wagers are largely based on chance. Members of these sites place bets on events outside their control, which is considered gambling in this state, and because neither company holds a casino license, this kind of operation is illegal. In Schneiderman’s opinion, the gambling that occurs on DraftKings and FanDuel causes the same kinds of problems as other forms of illegal gambling, luring in individuals with the promise of easy money and enabling gambling addictions.

The attorney general’s actions come shortly after Nevada’s attorney general and Gaming Control Board ruled that daily fantasy sports met the requirements for sports gambling, requiring a license to operate. Both companies ceased operations in Nevada soon after. However, they are unlikely to do the same in New York, given that the state has the most daily fantasy participants in the US with over 500,000 players.

Regulators only began scrutinizing DraftKings and FanDuel in early October, when a DraftKings employee released internal betting data and then won $350,000 in a contest on FanDuel. The possibility that employees could use proprietary information to win on other sites spurred 34 lawsuits in the past month, in spite of both companies immediately banning their employees from playing on other sites for money. In the wake of Schneiderman’s cease-and-desist orders as well as Nevada’s decision, many other states are taking a closer look at how the daily fantasy sports industry operates, and whether regulations should be instituted. A grand jury in Florida has subpoenaed records of the fantasy sports trade group, and a dozen more states are now considering fantasy sports legislation. Both DraftKings and FanDuel have some battles ahead if they want to continue dominating the multi-billion dollar fantasy sports industry.

  • Wendy Chao

To Raise or Not to Raise

The Federal Reserve, tasked with the dual mandate of price stability and maximum employment, is increasingly looking ready to raise rates. With NFPs coming in at 271,000 versus an expected 177,000, the headline unemployment rate and the U6 rate (which includes discouraged and marginally attached workers) both decreasing, and hourly wages up 2.5% over the last year, the case has never been stronger for the Fed to raise rates. This goes along perfectly with the narrative that they have laid out over the past year of remaining data dependent and trying to act by December.

However, while Fed Fund futures may be pricing in a nearly 70% chance of a rate hike in December, perhaps the optimism is somewhat misplaced. There are two key metrics that have yet to fall within the Fed’s desired range and will likely drive discussions in the coming meetings: labor force participation rate and inflation. The labor force participation rate has failed to decline significantly over the past year and thus may signal continuing labor market slack. Similarly, inflation is still much below the 2% target set by the Fed. Raising rates too early could actually potentially diminish the Fed’s credibility – it has long maintained that they are looking for an inflation rate of 2% and acting early may convey an adverse signal to the market that the 2% target is a ceiling rather than target level.

Thus, the upcoming meeting will definitely be an important one to watch and the Fed’s actions will likely define the future trajectory of the US economy

--Aditya Garg