Making Money the Old-Fashioned Way (Not)

Remember the old Smith Barney commercial? "We make money the old-fashioned way," a dignified John Houseman solemnly asserted to the camera, "we earn it." He enunciated with such gravitas (we UHR-RN it!) as to signify peerless professionalism and unstinting performance--earnings into eternity. You just knew that it was safe investing with him.

He may just as well have been speaking for General Electric, a veritable icon of American ingenuity and industrial engineering. But the U.S. economy has evolved during the years since the Houseman ad. This morning we got a reminder that GE, like so many American companies, has been juicing earnings by straying from its roots. It doesn't just make stuff anymore; it also plays with its excess cash, hoping to boost the bottom line with vigorish. It has become a financial company in drag.

GE's first-quarter earnings came up light. Net income fell by 5.8% compared to a year ago even though revenue grew by 7.8%. How can that happen, you ask? Answer: only through a markdown in paper assets--or, in the words of Chairman and CEO Jeff Immelt, "higher mark-to-market losses and impairments" in the financial-services side of the business. In truth, GE's global infrastructure business peformed admirably, with revenue up 23% and operating income up 17%. But when your betting operation turns south, you suffer.

GE's stock is getting hammered today, off over 10%, largely because of its tepid guidance for coming quarters. But it is not just GE investors who should be concerned here. If a triple-A credit like GE is struggling, then imagine what will happen to other companies who made money by financial legerdemain and not by earning it. Profits will vanish, as will the corporate tax payments they generate. State governments used to receiving their piece of the action will continue to see revenue shortfalls. Taxpayers will have either to ante up or to lose programs.

Meanwhile the Wall Street firms who specialize in financial alchemy are still at it. The Wall Street Journal reports this morning that Lehman Brothers has repackaged $2.8 billion in unsold debt--stuff that no one wants--into a collateralized loan obligation called "Freedom." The new debt securities issued by Freedom have been given investment-grade ratings by Moody's and S&P, qualifying them to be offered to the Federal Reserve as collateral in exchange for U.S. Treasuries through the Fed's new Primary Dealer Credit Facility. That's the way to do it, as Mark Knopfler sings in Money For Nothing.