GM's AmeriCredit Deal: Awaiting Approval
Now that GM’s acquisition of the subprime lender AmeriCredit has had 24 hours to sink in, howls of protest are starting to surface. The charge is being led by Senator Chuck Grassley, who has requested a review of the deal from the SIGTARP, saying
If GM has $3.5 billion in cash to buy a financial institution, it seems like it should have paid back taxpayers first. After GM’s experience with GMAC, which left GM seeking a taxpayer bailout, you have to think the company and, in turn, the taxpayers would be better off if GM focused on making cars that people want to buy and stayed clear of repeating its effort to make high-risk car loans.
And though Grassley’s criticism could be read as mere partisan gamesmanship from a leader of “the party of no,” there are a number of very good reasons for opposing the deal.
A look around the blogosphere reveals that opposition to the AmeriCredit deal largely falls into three categories: one camp, led by Grassley, believes that GM is burning cash on the deal that should be going to taxpayers, another worry is that the deal is an excuse for GM to fall back into bad habits, while a third objection concerns the deal’s effect on GM’s former captive lender GMAC (now known as Ally Financial). Each of these criticisms has its own valid points, and together they form a solid basis for opposition to the deal for government overseers, taxpaying citizens and potential IPO investors alike.
Grassley, who was a leading critic of GM’s “payback” ads frames his criticism of the deal by holding up full taxpayer payback as the deal’s opportunity cost. Though Grassley is on the right track with his criticism of GM’s profligate spending, $3.5b would hardly make a dent in GM’s obligations to the taxpayer. The Treasury’s stake in GM currently stands at about $43b, or over 12 times the amount GM spent on AmeriCredit. Though paying back taxpayers would likely help GM’s sales by eliminating the sense of obligation to taxpayers, the idea of GM buying back equity from Treasury is nothing short of laughable given that its cash pile stands at about $30b (or about $14b short of what it needs).
But even if you remove the taxpayer angle from the equation, there are still good reasons for sharing Grassley’s misgivings about the deal. Perhaps the best-articulated criticism of GM’s deal from a cash-management perspective comes from the NYT’s Deal Professor Steven Davidoff, who argues
With more than $35.7 billion in cash and marketable securities on its balance sheet as of the end of the first quarter of this year, G.M. is paying cash for AmeriCredit, something it certainly could not have done without the tens of billions of dollars that it received in government assistance. G.M. is also paying a 24 percent premium to AmeriCredit’s closing stock price on the day before the deal was announced.
If I were an owner of G.M., and I suppose I am in part as a taxpayer, I would wonder if that cash might not be better used as a special dividend to G.M.’s shareholders. Certainly, the fact that G.M. is spending $3.5 billion will be noticed by its unions and seen as a sign that there is cash available for them too.
Taken with TTAC’s latest analysis of the GM IPO, it’s clear that GM still doesn’t understand that its government-supplied cash pile paints a huge target on its back. Given the political overtones to anything related to subprime lending, it’s hard to imagine the UAW not seeing this deal as a sign for it to start pushing concession rollbacks. Meanwhile, $3.5b might not be enough to make an impact on taxpayer ownership, it does represent a healthy amount of R&D spending, or most of the amount needed to rescue GM’s European division, Opel, or enough to affect any of the other cash outlays that GM will not be able to get away from over the next five years. Instead of looking at looming medium-term costs, GM jumped into AmeriCredit because, as Davidoff points out
Managers with too much cash to burn will burn too much cash. If you want a real-life example, simply read the beginning of “Barbarians at the Gate” and Ross Johnson’s epic struggle to spend all of the money that RJR Nabisco was throwing off in the 1980s.
If GM could expect a serious improvement in its business by acquiring a subprime lending arm, these criticisms might be easy to dismiss. Unfortunately, the “bad habits” critique offers strong evidence that this is not the case. Davidoff lays out the case thusly
First, when G.M. owns a captive lender, it subsidizes the plants, labor unions and dealers. Captured finance means nonmarket financing for buyers when they receive a loan. Think zero percent financing. In connection with the acquisition, AmeriCredit will also re-enter the lease financing business, raising similar issues. Lease financing for automobiles usually results in artificial residual pricing for the buyout price at the end of the lease. All of this helps empty dealer lots and keeps plants running. But it oversupplies cars. The problem of artificially oversupplying new cars (like new houses) is put off for another day.
Second, the subsidy ensures that people who may not otherwise qualify to buy new cars do so. They overconsume and overspend as they shift their buying from used cars to new cars. This may be an immediate net gain for an economy in distress, but it may be a drag as well, as consumers divert income that could be used for other things that would perhaps create more wealth over all.
And, as the Peridot Capitalist points out, fueling another boom-bust cycle through lax standards is a recipe for, well, another bust.
While I am sure those in the industry will praise this deal as a way for GM to maximize unit sales, we need not completely forget how cyclical economies work. Subprime lending pays off when the economy is improving but when the business cycle inevitably turns (as every economy does), the loans turn sour, the losses are crushing, and the cycle starts all over again. To me this highlights one of the core problems our domestic economy has developed over the last 10 or 20 years. We continue to follow the path of loose credit when things are going great and at the first sign of a downturn, credit standards increase dramatically. Once things stabilize, we hear that banks are slowly reducing their standards and loan volumes increase again.
Of course, this line of reasoning is vulnerable to exaggeration. The Atlantic’s Daniel Indiviglio notes that
The auto market also doesn’t really have to worry about the kind of bubble that struck the mortgage market, specifically because autos are a depreciating asset. Millions of people are going to hope to get rich quick by flipping their cars, for example. There’s an old industry adage that most people will keep paying their auto loan even after they’ve defaulted on their mortgage, because they need their car to get to work. They can default on their mortgage and rent, but they probably don’t want to have to walk if they lose their car. Moreover, if times really got tough, and they did lose their home, they could always live in their car temporarily.
Indiviglio’s defense of subprime auto lending is cogent and well-argued, but even that isn’t enough to convince him that the AmeriCredit deal was a good idea. He concludes
Of course, none of this means to imply that it makes sense for GM to purchase Americredit. While most other auto companies, particularly foreign ones like Nissan and Honda, have found it sensible to keep a captive finance company in-house, none of those are subprime. They generally cater to people with very strong credit so they don’t have to worry about strategy and can simply earn interest on loans that are a very safe bet. So it’s puzzling that GM wouldn’t just focus on building up a new prime borrower-driven captive unit instead. And it’s even stranger that the government wouldn’t raise its eyebrows when GM is making an acquisition rather than engaging in additional divestitures to try to pay back the billions it still owes Uncle Sam.
Underlying these criticisms are the obvious incentives that GM has to improve its short-term performance even at the expense of its long-term health. IPOs are notorious pressure-cookers, focusing an entire company on projecting a certain image for one discrete moment. Given GM’s history of overproduction and volume-boosting tricks that inevitably must be paid off in either falling resale or diminished profit margin, this line of criticism can’t be ignored. Especially because we already know that much of GM’s cash is essentially spoken for over the medium term.
The final criticism of GM’s AmeriCredit acquisition involves The General’s former captive finance unit Ally Financial. The criticism is a simple one: though Ally will continue to provide floorplan financing to GM dealers as well as some retail loans, AmeriCredit will inexorably grow closer to GM once its credit rating improves on the strength of its consolidation to GM’s balance sheet. Already losing out on GM retail loans, Ally could find itself replaced by AmeriCredit as GM’s main floorplan lender, dealing Ally a devastating blow. The WSJ [sub] puts the relationship between Ally and GM into context
Ally financed 33.5% of GM’s U.S. customers in the first quarter, compared with 30.3% as of Dec. 31. It financed 87.7% of the inventory in GM’s U.S. dealerships during the same period, compared with 90.9% in the fourth quarter.
The problem is that Ally still owes taxpayers $16.3b, and by buying AmeriCredit instead, GM may have doomed Ally to a much longer payback timeline, effectively increasing its impact on taxpayers. After all, GMAC might not have been rescued from its subprime mortgage mess had it not enjoyed its close relationship with GM, which the government was set on rescuing. It’s galling enough that GMAC was rescued as a “stealth bailout” for GM, but the fact that GM is now throwing Ally to the wolves is one serious twist of the knife.
On the other hand, had GM bought Ally, it would have been doing a great disservice to its balance sheet. Not only would buying GMAC have been expensive, it would have brought more government debt on board, and would have faced regulatory issues as well, as Ally is a bank holding company. Ultimately, it’s impossible to fault GM for not going with Ally… the blame belongs to the auto task force, which saw GMAC/Ally’s importance to GM without facilitating their long-term cooperation. Both GM and Ally insist that their relationship remains strong, but it’s hard to imagine GM acquiring a lender and not moving aggressively to consolidate its credit business with that lender. And once again, the taxpayers will be left holding the bag.
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