Some Questions about GMAC

I’m a little late to the GMAC bailout story, but after reading all the newspapers and blogs I usually read, there are still some things I don’t understand. I’m particularly confused about the announcement that GMAC will start lending to anyone with a credit score above 620, down from their previous minimum of 700. (The median credit score in the U.S. is 723.)

1. What is the relationship between GM and GMAC? I know that Cerberus owns 51% of GMAC and GM owns the other 49%. I also know that, in order to become a bank holding company, both were forced to reduce their ownership stakes. In any case, GMAC is an independent company that should not be run for the benefit of GM. Its obvious that GM benefits if GMAC reduces its lending standards. But how does GMAC benefit?

2. If a loan to someone with a credit score of 621 was a bad idea on Monday, why was it a good idea on Tuesday? The only theory I can think of under which this makes sense is that GMAC thinks that loans to people with credit scores of 621 are profitable, but they couldn’t get the capital cheaply enough until they got their government bailout money.

3. Who is going to pay the bill when these loans go bad? It looks to me like GMAC is making a big gamble by trying to pump up its lending volume with higher-risk borrowers, right in the middle of the worst recession since . . . 1981? the 1930s? (In any case, it won’t be able to get anything like the lending volume it used to have, simply because fewer people are buying cars.) Isn’t this a situation where a company is choosing a high-risk strategy because its only option is to watch its revenues shrink away to nothing because the demand for credit has plummeted? But if that’s the case, how smart is it to go chasing after high-risk borrowers because the low-risk ones are suddenly saving their money? And now that GMAC has gotten the Henry Paulson seal of approval (remember, TARP money was not supposed to go to unhealthy “banks”), I think there’s a fair chance they are counting on Treasury to bail them out of their next round of bad loans.

Of course, it could be said in GMAC’s defense that they are just doing what Congress wants them to do: take TARP money and use it to make loans more available to consumers. But this goes back to the fundamental schizophrenia of TARP: it was conceived to keep banks from failing, but most people think its purpose should be to increase credit. And in this case I suspect GMAC’s taxpayer money is being used to sell GM cars that people wouldn’t buy otherwise, and when it runs out GMAC will be back for more.

4 responses to “Some Questions about GMAC

  1. Obviously, the government dictated the reduction in FICO standards as a quid pro quo for the FED’s approval of GMAC’s application for a banking license despite the failure of their recap plan.

  2. A friend tells me that a person with a credit score of 660 or below is considered a subprime borrower. Is this correct? If so, how is this a sound policy move?

  3. Perhaps someone can explain how this fits into another GMAC news item, reported on WSJ.com this morning: http://online.wsj.com/article/SB123089885294248867.html

    GMAC and GM have announced a change in an exclusivity agreement between them. The change is described as

    “. . . allowing GM the option to offer auto financing incentives through a third-party financing source for two years under some circumstances.

    “Under the original 2006 agreement, whenever GM offers financing incentives such as lower interest rates than market rates, it was obliged to do so through GMAC. GM received an annual fee from GMAC for granting the exclusive right . . .”

    Do I understand correctly that GMAC was willing to pay for the privilege of making below market loans? I would have thought that the subsidy would have run the other way, i.e., GM would pay GMAC a buy-down fee to subsidize customers and move product.

  4. Scott E. Pace MD

    According to the Boston Globe:

    “The US Treasury said it will purchase a $5 billion stake in GMAC LLC, the financing arm of General Motors Corp.”

    “The Fed order says GM will reduce its stake to less than 10 percent of the voting and total equity interest of GMAC. GM’s remaining equity interest in GMAC will be transferred to an independent government-accepted trustee who must dispose of the equity held in the trust within three years of the trust’s creation. Cerberus, which led an investment group that bought a 51-percent stake in GMAC from the automaker for $14 billion in 2006, will reduce its stake in GMAC to no more than 33 percent of the lender’s total equity.”