Yesterday, forensic accountant and investor Harry Markopolis dropped a bombshell report which argues over the course of 170 pages that accounting fraud at General Electric is larger in scale than we saw with Enron, that the company is effectively out of operating capital, and will be unable to meet a $13 billion insurance reserve requirement in Q1 2021.
Caveats: Reports similar to this are released all the time. It’s not an uncommon tactic of short-sellers to spin rumors and arguments so that the price of companies they have shorted go down, and many times corporations will make the argument that this information is released precisely to make the stock go down. And, the report discloses that it was written by an unnamed hedge fund, so Markopolos and his team aren’t doing this out of the goodness of their hearts. And, yes, the share price of GE has gone down. But it’s been going down for years (check the 5-year trend).
Caveat to the caveat: However, (1), Harry Markopolos is the guy who discovered the Madoff fraud… in 2002, 6 years prior to Madoff going down (the SEC ignored his repeated requests for investigation), (2) he specializes in insurance fraud and has not been wrong since the Madoff call, and (3) if the bad news isn’t there to begin with, the shorts couldn’t report it, pp&s.
All right, let’s get down to what this report says… and if GE collapses, this can be the discussion thread as well.
My guess: Markopolos is right. And we may not know for another year or so. But… I think not.
One last thing: There are two sides to this report - the insurance stuff and the Baker Hughes acquisition stuff. I’m much stronger on the insurance stuff, so if someone wants to step up on the M&A part of the report, that would be greatly appreciated.
Going to finish this off with some quotes from the summary, then respond with my view about the insurance side of it.
*Quick explanation: “Long-Term Care” is an insurance policy which pays you (and providers) for out-of-hospital assisted living expenses when you have lost the ability to perform 2 (of 7) regular daily activities (going to the toilet, feeding yourself, washing yourself, etc), which occur as you get older.
The argument is effectively this:
- GE needs to reserve $29 billion cash against future projected insurance claims as per regulations. They will be required to take a $10 billion hit in Q1 2021, but are still $18 billion short.
- GE also has hidden a $9.5 billion loss on its Baker-Hughes acquisition, which will need to be realized.
- When these losses/reserves hit the balance sheet, GE’s debt-to-equity ratio shoots up from $3 of debt to $1 of equity, to $17 of debt for every $1 of equity.
- When this hits, many covenants in currently unknown contracts will have heretofore unfathomable calls - “GE’s in financial trouble, therefore according to page 42 of our agreement under the debt-to-equity provisions, we have the right to our money back. Pay by 5pm as per page 43. And I’m sorry to do this, but I’m responsible to my shareholders. It’s how the game is played.” Multiply this X an unknown number and you have AIG, Lehman, Enron, etc.
Anyway, for us money and financial nerds, this is very fascinating and worrisome. And, from the insurance side, it’s completely expected. More on that later.