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GM Joins Fannie and Freddie

The opportunity to pursue private profits backstopped by an implicit government guarantee is an invitation to take on excessive risk.

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Andrew Ross Sorkin has a very interesting column this week examining the signal sent by GM’s purchase of AmeriCredit.  The short answer: GM looks like it’s trying to revive the old patterns of demand before the recession.  It’s doing so by following some of the same business practices that led to its bankruptcy filing last summer.

GM Joins Fannie and Freddie

Too big to fail?

AmeriCredit currently serves 11,000 dealerships, but only 4,000 of those are associated with GM. The company has plans to expand across all auto companies: It recently announced to investors that loan originations could total as much as $900 million over the last quarter (ending June 30), up from $175 million over the same period one year earlier.

GM’s recent purchase of AmeriCredit was designed to put the company on a level playing field with its competitors (Ford and Toyota) ahead of a planned I.P.O. filing later this year.  AmeriCredit is an auto finance company with a specialty in subprime lending.  With AmeriCredit as part of its portfolio, GM has control of a lender (once again) that can reach all types of auto buyers who need credit, including those with FICO scores in the 300-600 range (which also just happens to be AmeriCredit’s focus).  Private analysts of the acquisition have predicted that AmeriCredit will juice GM’s sales by 10-20 percent a year moving forward. 

Source: Wall Street JournalSource: Wall Street JournalAccording to Sorkin, “G.M. plans to prod sales of its vehicles by using AmeriCredit to extend loans and leases to automobile customers with questionable credit. These are the same customers who could very well be denied a loan by other lenders. But prudent lending is not at the top of G.M.’s to-do list: it needs to move its vehicles off the lot and it needs to do so quickly.”

Sorkin asks the right question: “did we really spend $50 billion of our money just to revive the kinds of practices that led to the credit crisis?”

On the upside, a successful deal for GM’s auto financing arm could help the taxpayer.  Since the government still owns 61 percent of GM, a successful I.P.O. is vital if U.S. taxpayers are going to get back at least a portion of the money that was invested in the firm over the last two years. On the downside, a GM that increasingly depends on more risky loans (through AmeriCredit) may come at the cost of a long-term recovery. Is GM heading down the same path that ultimately led to a government take-over? 

The strategic calculus that ensured this deal may have been influenced by the possibility of a future bailout (a textbook example of “moral hazard”). If GM’s bet with AmeriCredit proves wise, the company will reap private profits. If the deal turns sour, GM will likely turn again to the government for additional taxpayer assistance. The same logic that ensured the first bailout – that GM is a crucial part of the Rust Belt economy, including many swing states – will also underpin a future bailout. Put another way, the opportunity to pursue private profits backstopped by an implicit government guarantee is an invitation to take on excessive risk.

In that sense, this deal also represents the broader dilemma faced by the federal government. In order to boost demand today, the government relies on extending credit to borrowers of lower and lower quality – either directly, or through quasi-government organizations like GM.

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