By on July 23, 2010

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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18 Comments on “GM’s AmeriCredit Deal: Awaiting Approval...”

  • avatar

    what people fail to realize and what is not reported is that the whole program is really driven by the M&A fees generated to the investment banks that put these deals together. the banksters stripped GM of assets, cashed in everything that wasn’t nailed down, then rinsed thru BK, and will now take it back off the hands of the taxpayers. gee, aren’t we lucky? remember John Byran, long serving member of Red Ink Rick’s Board of Bystanders? he also served on the Boards of Goldman Sachs and British Petroleum, two fine and upstanding institutions. also serving was Stan O’Neal whose company, Merrill Lynch (another pillar of purity?) received billions in GM stock after it was funneled thru the Fiat Fiasco. there are more games played than the public realizes…at it gets fleeced.

    in the meantime, these guys have bills (hey the Hamptons aren’t exactly cheap you know).

  • avatar

    Wasn’t one of the terms of GM’s bailout that purchases over a set amount had to be approved by someone in the government?

    I would think $3.5 billion would certainly qualify for some form of governmental scrutiny in any case.

  • avatar

    GM screwed up by selling GMAC. It was a profitable business. Their manufacturing business was unprofitable, and that was the one they should have sold.

    • 0 avatar

      The biggest problem with GMAC was that they got into….sub-prime home loans. Those loans are stinkers. Yes, the car business loans aren’t doing fabulous but the home loans sunk them.

    • 0 avatar

      Selling GMAC was the smartest thing they ever did!!! Period!!! Probably the smartest move in all of business ever. GMAC had untold billions of losses coming with all the sub-prime loans ResCap (a sub of GMAC) had on the books. They got $2 Billion from Cerberus for a business that has incurred over $10 Billion in losses in tha past couple years (not sure the exact amount but I think I’m pretty close).

  • avatar

    I don’t care how it’s financed…I want a 21st Century La Salle!

    • 0 avatar

      or how about a new Oldsmobile or Pontiac?

    • 0 avatar

      LOL, I showed my 26 year old girlfriend a picture of a 1982 Oldsmobile 98 coupe on an eBay auction. She actually said; “Oh that’s pretty.” She whole heartedly endorses the idea of me possibly picking up a 1991 Fleetwood too.

      This from a woman who drives a Pontiac Vibe and wants an SUV as her personal vehicle once the kids start arriving. I want a new Oldsmobile too, make mine a loaded 1979 98 Sedan with the 403V8, I know it’s strangled with smog equipment but I love big blocks.

  • avatar

    Much as I hate to agree with Grassley….this stinks.

  • avatar
    Mike Kelley

    Anyone who questions this deal is a racist.

  • avatar

    GM had been trying to work with GMAC/Ally, but they don’t want to finance the subprime cars. Since GMAC/Ally doesn’t play ball, it only makes sense for GM to find a new player, and they have.

    Honestly, this will be good for GM’s IPO. GM will be able to move more metal now. The whole this needs to be paid back to the taxpayer doesn’t make a lot of sense. That is what the IPO is for. Anyone know how long it would take to figure out how much equity GM gets to buy back for 3.5B? It isn’t as simple as paying back a percentage of the total bailout. If the dates are correct and GM is going IPO in Aug, it wouldn’t make much sense to try to negotiate with the gov’t on how much it would be buying back anyway.

  • avatar
    John Horner

    “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.”

    Bzzzt, not true at all. The captive finance arms of the Japanese brand auto makers are all significant sub-prime auto loan originators.

    “The nation’s highest-volume subprime and nonprime auto lenders based on market share for the 3rd quarter of 2009:

    1. Wachovia Dealer Services 6.90%

    2. Capital One Auto Finance 5.70%

    3. Toyota Financial Services 5.60%

    4. Chase Auto Finance 5.50%

    5. GMAC Financial Services 3.70%

    5. Ford Motor Credit 3.70%

    7. American Honda Finance 2.90%

    8. Nissan Infiniti Financial Services 2.10%

    9. CitiFinancial 1.50%

    10. Credit Acceptance Corp. 1.20%

    Source: Experian Automotive ”

    Also, it isn’t MOST auto companies which have captive finance arms, it is (or was until the GMAC/Chrysler Financial spin-offs) ALL.

  • avatar

    How does Guido the Neck keep that BIG roll of cash supplied despite regularly loaning money to working stiffs in the ‘hood?

    Maybe the legit BIG firms need to take lessons from Guido.

  • avatar

    Grassley has a point – the deal has a certain rot to it.

    Worse, by overstimulating new sales at the expense of resale and residual values, it hurts the GM brand.

    I like the takes from the more market based observers. The tone of many in the MSM suggests that downsizing to an apartment or driving a used vehicle is the near equivalent of waterboarding.

  • avatar

    I have a mortgage with GMAC (and most definitely _not_ subprime in my case) and I gotta say- most of my dealings with them have been frustrating at best. Conversations with their customer service folks remind me of the “Our amplifiers go to 11” scene in the Spinal Tap movie and “I don’t understand- why male models?” from Zoolander. Surreal.

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