Friday, March 27, 2009

How GM Blew it With GMAC

April 3, 2006 is the Day the Music Died, the day GM agreed to sell 51% of GMAC to Cerberus, a hedge fund. The sale was completed in November 2006. For $14 billion spread over 3 years, it lost control of its future. GM’s fate was ordained.

Having previously sold off its non-automotive assets (Hertz, appliances, busses, locomotives, and heavy equipment), GMAC was the last crown jewel in the shrinking GM Empire. The thirst for capital was so great that GM ceded control of GMAC.

GMAC was not just a subsidiary of GM; it was the key to GM’s viability, more critical than Chevy, Cadillac, Buick, Pontiac, Saturn, Saab, Hummer, Adam Opel, Vauxhall, or Holden. These divisions would be worthless without GMAC to finance GM’s dealers and retail customers while GMAC earned a consistent profit. GMAC was a license to make money.

GM’s desperate management forgot how critical GMAC was. Oldsmobile was expendable, but GMAC was not.

The rising GM founded GMAC in 1919 as a captive finance company to facilitate the sale of GM products. Credit was essentially non-existent then for individuals; the consumer finance industry did not exist. Banks did not deal with individual consumers.

GMAC would finance wholesale sales to dealers (“floor financing”) and then the retail sales and leases to consumers. The plan was brilliant. GMAC would borrow funds using GM’s capital strength and low interest rates, and then lend the borrowed funds at higher rates to dealers and consumers. The steady, almost risk free profit would come from the spread on the borrowed funds.

By 2006 GM’s credit rating had shrunk to junk bond status, substantially raising the borrowing costs of GMAC and cutting into its profits. Even so, GMAC earned $2.8 billion in 2005.

In good times and bad times GMAC had the funds to finance the sale of GM products. GMAC was always there to facilitate sales and keep the assembly lines rolling.

Without GMAC, GM would not have become the world’s largest corporation. Without GMAC, GM would have collapsed decades earlier.

Good times or bad times, popular or unpopular models, high quality or poor quality vehicles, high or low mpg vehicles, GMAC financed the sales and leases of GM products.

GMAC helped GM survive the Great Depression, and Cadillac, previously an also ran, rose to the top of the luxury car market while competitors, such as Pierce Arrow and Packard lacked the capital to compete. In 1979 when President Carter drove the prime rate to 19.5%, GMAC had funds available, albeit at 9.75%.

GM’s problems were compounded because it was seduced by the quick, easy, seemingly risk free profits in the subprime mortgage market. GMAC dove headfirst into the subprimes without looking.

GMAC wrote off billions from subprime mortgages last year, and was no longer able to finance its operations. It hemorrhaged $7.5 billion in 2007-2008.

Cerberus’s interests and those of GM are inconsistent. Cerberus’ primary goal is to earn a profit. GM’s is to sell GM vehicles.

Cerberus made a bad investment, and cut its losses by refusing to invest additional funds into GMAC. Cerberus looked to Washington for a bailout.

GMAC normally financed 45% of GM’s new vehicle sales and leases, but was down to 14% in October. GM was in the tank.

GMAC had no money to lend, and GM lost 45,000-50,000 sales monthly as willing buyers were unable to obtain financing. Cerberus raised the minimum credit score for GMAC financing to 700 and above, cutting off many of GM’s traditional customers as the recession set in.

GMAC’s response was to convert itself into a bank holding company in December and issued $5 billion in preferred stock to the Treasury Department for TARP funds, and received an additional $1 billion in loans.

Indicative of GMAC’s problems is that Cerberus appointed the prominent investor Ezra Merkin to be GMAC’s Chairman. Ezra may have been prominent, but shrewd he was not. His funds lost at least 2.4 billion in the Madoff scandal and he facilitated the investments of others into Madoff. The once proud, but now chastened, if not bankrupt Merkin, resigned from GMAC in January.

Madoff, Merkin and GMAC - How the mighty have followed!


GMAC announced on May 5, 2009 that it lost an additional $675 million in the first quarter, of which $125 million came from (subprime) real estate loans. It has now lost money in 5 of the most recent 6 quarters.

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