GMAC: Too Important to GM to Fail

Late yesterday I finally finished going through the TARP Congressional Oversight Committee's new report (.pdf) on GMAC. It's totally fascinating. Reading the report was like witnessing one of those horrible car accidents where you don't want to look, but you can't look away. It's pretty clear that the Congressional Oversight Committee deeply disapproves of how the GMAC bailout was handled. I do too, so I was eager to read what they had to say. The report is informative, thorough, sensible and revealing.

But it's also long. I can't possibly sum up its entire 170 pages here, but I'll do my best to provide some highlights. If you want the whole story, you can find all the gory details here (.pdf).

A Taxpayer's Nightmare

Who should be concerned with the GMAC bailout? The U.S. taxpayer. This diagram explains why. You're the little building with columns on the left:

(TruPS are "Trust Preferred Securities"; MCP is Mandatory Convertible Preferred Stock)

$17 billion might not seem like much (ya know, in context), but it amounts to a 56% ownership stake in the lender. According to the Office of Management and Budget, the taxpayer loss will be at least $6.3 billion. And that doesn't take into account the $7.4 billion of FDIC guaranteed debt GMAC issued. Or the $7.8 billion credit line ($5 billion utilized) from the Fed's Term Auction Facility. Or the $3.1 billion obtained through the Fed's Term Asset-Backed Securities Loan Facility.

Its financial performance makes pretty clear why a big loss is likely:

As you can see, GMAC is doing horribly in pretty much every aspect of its business. Its Global Automotive Finance (GAF) is near breaking even, but its mortgage portfolio is just awful.

Why Was It Rescued?

So if GMAC was so far gone, then why was it rescued? Not because it was systemically important to the U.S. economy -- according to the Treasury. The report says:

Treasury has never argued that GMAC itself was systemically important, although in 2008 some Treasury staff members believed that GMAC's failure at that time - independent of its effects on the domestic automotive industry - could have thrown an already precarious financial system into further disarray during the depths of the financial crisis.

GMAC, however, was no Bank of America or Citigroup. It wasn't that interconnected like a Goldman Sachs either. It wasn't too big to fail: it was too important to GM to fail.

Why was the lender so vital to the automaker? Not so much because of its auto loans -- GM's customers probably could have got those elsewhere. It had more to do with a different type of loan GMAC and other captive auto lenders provide: dealer floorplan loans. The report explains:

Floorplan financing is a vital cog in the U.S. automotive market, as it allows dealers to offer cars to consumers. Floorplan financing is crucial for dealers because of the significant cost associated with financing their entire inventories via wholesale automobile purchases from the manufacturers. The average floorplan loan is $4.9 million, and collectively U.S. automobile dealers hold about $100 billion worth of inventory. Floorplan loans provide dealers with a revolving line of credit that allows dealers to maintain their inventories for sale to customers. This also helps manufacturers manage their inventory, facilitating the transfer of automobiles from the plant to the dealer. For the lender, the generally low profit margins in floorplan financing are balanced by an attractive credit profile and gateway business opportunities to other, potentially more lucrative product lines (e.g., consumer auto and dealer real estate lending).

Without floorplan loans, dealerships would fail. Without dealerships, GM couldn't sell cars. Without selling cars, GM would fail. And as we know all too well, GM's failure was not an option the federal government was willing to consider. So, really, the big picture shows that GMAC's rescue was just a backdoor bailout of GM. In order to keep GM going, GMAC had to be saved. (I should note that GMAC also provided lending to Chrysler, so the other troubled U.S. automaker was part of that equation too.)

Could Bankruptcy Have Accomplished The Same Task?

So GM needed floorplan loans, but did GMAC necessarily have to be the provider of those loans? The oversight panel isn't so sure. In the executive summary, they write:

Moreover, the Panel remains unconvinced that bankruptcy was not a viable option in 2008. In connection with the Chrysler and GM bankruptcies, Treasury might have been able to orchestrate a strategic bankruptcy for GMAC. This bankruptcy could have preserved GMAC's automotive lending functions while winding down its other, less significant operations, dealing with the ongoing liabilities of the mortgage lending operations, and putting the company on sounder economic footing. The Panel is also concerned that Treasury has not given due consideration to the possibility of merging GMAC back into GM, a step which would restore GM's financing operations to the model generally shared by other automotive manufacturers, thus strengthening GM and eliminating other money-losing operations.

Indeed, other options could have been seriously considered. The Treasury also could have empowered other lenders to provide floorplan financing to GM through guarantees. That wouldn't have been as costly as you think. As the report rightly notes, "Floorplan financing is a low-risk business, particularly in comparison to consumer automotive." I find it a little difficult to believe that other lenders wouldn't have eagerly stepped in to provide already low-risk loans to GM if government guarantees were also in place. That would have been better for moral hazard and would not have forced taxpayers to cover GMAC's enormous mortgage losses.

No Strategy

Another big concern of the oversight panel is that all this money was provided to GMAC without the firm first providing a clear strategy for recovery:

Treasury's previous and current support is not underpinned by a mature business plan. Although GMAC and Treasury are working to produce a business plan, Treasury has already been supporting GMAC for over a year despite the plan's absence. Given industry skepticism about GMAC's path to profitability and the newness of the non-captive financing company model, it is critical that Treasury be given an opportunity to review concrete plans from GMAC as soon as possible.

The report mentions such plans had generally been required when the Treasury involves itself in other seemingly unconditional rescues, like those of GM and Chrysler. Why not GMAC? Indeed, a year later, its losses are still incredibly deep.

Stress Test Debacle

GMAC was one of the 19 bailout recipients to be subjected to the government stress tests. It failed. Along with 9 other banks, it was required to acquire capital by November. It was the only bank that failed to do so from the private market. That's why it needed three bailouts, instead of just one. The Treasury felt compelled to provide GMAC with capital due to its participation in the stress tests. I don't understand this why; neither does the oversight panel:

There was no specific contractual obligation to GMAC either as a result of the stress tests or as a result of previous injections of capital. At the time of the May 2009 investment, Treasury and GMAC executed the May Stock Purchase Agreement (SPA), which described the terms under which Treasury would provide capital to GMAC should it be unable to obtain additional capital from private sources. The term sheet appended as a schedule to the May SPA, however, only stated that Treasury stood ready to commit "up to $5.6 billion" in additional capital. Treasury clearly retained the legal flexibility to provide less than that amount - even zero - if circumstances warranted.

My analysis here is that the Treasury a) didn't want to lose its initial $5 billion investment (the 1st bailout) and b) had an essentially unlimited commitment to do whatever it took to keep GM afloat. That's what drove it to use the stress test as an excuse to provide GMAC with more money. So it just kept throwing good money into the furnace to keep GMAC going.

Treasury's Lenience

This point gets into the weeds a little, but when the Treasury established the stress tests, it created the "Capital Assistance Program" (CAP) to recapitalize banks that failed, if it chose to do so. And the requirements of firms obtaining money from the CAP were different from the general the TARP requirements -- the CAP was stricter. The report explains:

An institution that received funding under the CAP would be subject to several restrictions, including restrictions on executive compensation, increased disclosure requirements, and a requirement that the institution provide information regarding how it would use the CAP funds to increase lending.

Treasury's rationale for disregarding the CAP? Since GMAC would have been the only firm to utilize the CAP, officials didn't feel that it made sense to bother with the program just for GMAC's funding. After all, it could just give GMAC more all-purpose TARP money. But wasn't there a reason they created these stricter rules for the CAP? Receiving additional bailout funds was an exceptional situation that deserved exceptional treatment.

Other Concerns

WTO Worries

Another interesting worry from the report: trade implications. It says:

As discussed above, although GMAC is no longer a subsidiary of GM, the TARP funds provided to GMAC have been cited by at least one trading partner as giving rise to subsidy concerns under applicable WTO rules. Thus, another consequence of the GMAC/GM model, in which GM and GMAC (whether captive or otherwise) are almost inextricably entwined, is that funds provided to GMAC have also been viewed as a subsidy to GM itself. The Panel takes no position on whether funds provided to either GM or GMAC could in fact constitute a subsidy under WTO rules. However, one trading partner has included the aid to GMAC in that analysis, raising the question as to whether any trading partner could be successful in arguing that support for GMAC could constitute an actionable subsidy under World Trade Organization (WTO) rules.

China, in particular, was not amused.

CEO Salary

I've already commented on the GMAC CEO's salary. It was pretty sizeable:

That deferred stock vests immediately, but its payout is deferred.

Conclusion

I don't know that I can conclude any better than the final paragraph of the report:

Viewed from the vantage point of March 2010, or even December 2009, the decision to rescue GMAC is one of the more baffling decisions made under the TARP. A company that apparently posed no systemic risk to the financial system, that did not seem to be too big to fail, too interconnected to fail, or indeed, of any systemic significance, was assisted to the extent of a total of $17.2 billion of taxpayers' money and became one of the five largest wards of state. The decision to save GMAC was not, however, a December 2009 decision. It was made in the turbulent early months of 2009 as an intrinsic part both of the rescue of GM and Chrysler and of the stress tests, and can only be understood in that context. Within that context, Treasury's objectives become clearer, and within that context, it is also clear that there are lessons to be learned.

And let's hope those lessons are learned. But for now, it looks like GMAC will continue to enjoy unconditional government support as long as GM does.

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