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.
4:30 PM, Aug 13, 2010 • By CHRISTOPHER PAPAGIANIS
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.
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.
According 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.
However, it is difficult to argue that Americans are undersupplied in cars. Right now, there are almost two people for every passenger car in the U.S. In order to steadily expand automobile ownership, new credit must reach borrowers of lower and lower quality. That is, instead of simply providing a counter-cyclical buffer in the business cycle, the government’s interventions may work to deepen structural problems of loose credit that generate unsustainable patterns of demand. That, in turn, raises the chances that a future GM will have to be bailed out. The cost structure of GM requires a level of new car sales that can only be sustained through questionable lending practices. Rather than shed fixed costs and radically downsize the company into a smaller, profitable manufacturer, the government’s strategy seems to be winning back market share and boosting final sales through aggressive discounting and the easing of credit standards. GM’s second quarter earnings of $1.3 billion are a reflection of this strategy. Edmunds notes that the average discount to sticker price on GM car sales in the second quarter was 15.7 percent. This was 15 percent greater (2 percentage points) than the industry average final sale discount. Incentives to buyers averaged $3,691 per GM car, which is 38 percent more than the $2,762 average per car incentive provided by the rest of the industry.
One of the lessons from the recent crisis is that the U.S. had far too much consumption generally, and far too much of its income devoted (on a relative basis) to the specific consumption of housing and cars. As everyone knows, a big part of the problem was that it was just too easy for consumers to obtain financing for these products. With households still struggling to keep up with old debt obligations, a rational public policy would acknowledge that consumers are likely to want fewer new houses and cars in the future. Yet, the fact that the U.S. still owns the majority of GM clearly complicates what should otherwise be a fairly straightforward recalibration of resources and capital within the economy.
Rather than reviving the old patterns of demand, resources need to be reallocated into other (new) sectors to ensure a fresh and sustainable recovery. It’s hard to image how resuming the patterns of the old debt binge will lead to robust economic growth in the future. If anything, that trajectory probably increases the likelihood of us facing another financial crisis sooner.
Unfortunately, the same schizophrenic policy outlook that applies to GM also pertains to housing. If you combine the market shares for Fannie, Freddie, and the Federal Housing Administration, the federal government guaranteed roughly 97 percent of all home mortgages in the first quarter of 2010. While these agencies have been widely viewed as essential for stabilizing the housing market, their sheer dominance now raises concerns about the long-term sustainability of the housing sector, as well as the ultimate costs for the taxpayer.
Taxpayers have already committed roughly $150 billion to the bailout of Fannie and Freddie – all in the name of subsidizing homeownership. The Congressional Budget Office projects that losses could balloon to $400 billion over time, while other analysts suggest the taxpayer hit could be closer to $1 trillion, if default and foreclosure rates stay high. And there’s no ceiling on the federal government’s assistance, since the Obama administration announced last Christmas Eve that there should be “no uncertainty about the Treasury's commitment to support these firms as they continue to play a vital role in the housing market during this current crisis.”
While the projected losses from the U.S. bailout of GM are small by comparison, it’s hard to ignore that the reconstituted GM increasingly looks like the newest member of the “government sponsored enterprise” club, which means, in effect, that it is also “too big to fail.” Fannie and Freddie morphed into behemoths that profited from their special relationship with the government – and then left taxpayers holding the bag when things went sour. Now, GM is pulling out their old playbook to increase sales using an in-house subprime lender. Unsustainable revenue growth in anticipation of an initial public offering (IPO) is not likely to be in the long-term interests of taxpayers.
Until the U.S. government takes its finger off the scale for these two sectors, there can’t be a meaningful recalibration of capital and resources across the economy. This recalibration is a key part of the country’s ability to break out of its slow-to-no growth trajectory. How to enable the development of new and sustainable patterns of investment and consumption within the economy is the central challenge for policymakers moving forward.
Christopher Papagianis is the managing director of Economics21. He was previously a special assistant for Domestic Policy to President George W. Bush, working on both housing and transportation policy.
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