General Motors Fights Uphill Battle with Double Edged Sword

Shortly after the U.S. government lent the Big Three $17.4 billion, we learned Monday that an additional $6 billion of taxpayer money is headed to GMAC, the large General Motors (GM) finance arm. Where will this money go? Well, GMAC said Tuesday that it will immediately resume automobile financing for “a broader spectrum of U.S. customers.” That is code for “we are going to lend money to people who probably should not be getting it right now.”

If you think this sounds awfully strange given the current economic situation, you would be right. GMAC got into trouble in the first place by giving out loans to sub-prime borrowers for not only car loans, but mortgages as well (Ditech is owned by GMAC, for example). To stem bad loans, earlier this year GMAC increased its minimum required credit score to 700. This compared to the median credit score nationally of 723, so more than half the country qualified even after lending standards were tightened considerably.

Not surprisingly, auto sales sank after the new minimums were implemented, but I think it is unreasonable to attribute all of that decline to the new credit standards. The economy is bad, people are cutting back, and unemployment is soaring, so there are simply fewer people who can afford to buy new cars, regardless of what their credit score is.

As car inventories build and GM’s losses mount, the only way to boost sales is to lend to less creditworthy borrowers. GMAC said Tuesday it will modify its credit criteria to include buyers with a credit score of 621 or higher.

This appears to be a slippery slope. Lending to borrowers with bad credit as a means to increase profits is exactly how we found ourselves in a sub-prime mortgage meltdown in the first place. With the economy worsening, this hardly seems like the time to loosen credit standards. Not only that, but doing so almost ensures that increased profits earned from higher car sales volumes will be offset by higher credit losses because GM funds the majority of its car sales through GMAC, its own financing division.

While I do not own GM stock, what is going on here should matter to all of us because taxpayer money is being used. We essentially just gave GMAC $6 billion which it is using to lend to borrowers with credit scores as much as 100 points lower than the national average. Such a plan can’t possibly increase the odds that the government gets its money back on these emergency loans. Since Uncle Sam will be first in line to collect its money, GM shareholders are likely to be left with very little unless the company sincerely changes its ways. As this week’s news is more of the same, I have no interest in going near GM stock.

Full Disclosure: No position in General Motors at the time of writing, but positions may change at any time

Comments

[the details:]

Dear SA editors, have we read this story before? take a look at yesterday's SA article by Chris Krasowski

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happy new year

2008 Dec 31 05:27 AM

[bs_o_meter:]

lowering credit score to 621 in a recession where the blood is still spilling on the streets is a hail mary play. another reason to stay away from GM.

2008 Dec 31 05:36 AM

[777john777:]

if gm dose not try 2 get things moving. who will? the banks seem 2 be happy 2 sit on the 700 billion. it's not HELPING!!!!!!!!!

2008 Dec 31 06:19 AM

[Firat Ünlü:]

>Not only that, but doing so almost ensures that increased profits earned from higher car sales volumes will be offset by higher credit losses

.... in the future. That's the key point, they need as much superficial data as possible that could convince Washington to keep the lifeline, thus pushing sale numbers high by lowering credit standards even makes sense in a weird way. Why care about the future when survival is at stake?

2008 Dec 31 06:57 AM

[Detfan:]

All GMAC has done is gone back to its lending standards of a few months ago. This is not a loosening of credit for "high risk" candidates. However the person qualifying with a 631-650 score will certainly have a higher interest rate than someone at 750, as it should be. GMAC's underwriting of automobile loans is bread and butter for them. Their sub-prime mortgage loans is what got them in trouble. GM's ability to sell vehicles has been greatly enhanced by the return of GMAC. I look for GM's sales to be 20% higher than Novembers.

2008 Dec 31 07:56 AM

[John D:]

BRAVO!!! ... GM (GMAC) lending money to start sales moving and people are buying cars !! Perhaps those old fella's in Washington will note what is happening and push Wall St. to do something constructive with the $350 billion they got instead of bonuses for the #^%%$&^'s that caused the CRISIS like use the money for what it was intended like get the economy in a forward motion again.
They really didn't have to pay bonuses to have them straighten out the mess, the government just needed to show them that if they would like to face prosecution for mismanagement the alternative would seem much less attractive - then of course there are people in the government that were put in place to control this as well that should have been doing a song & dance for Detroit and the rest of the country instead of burying the heads of the Big 3 in a smoke and mirrors show.
Now lets just hope that they look at

2008 Dec 31 09:14 AM

[John D:]

BRAVO!!! ... GM (GMAC) lending money to start sales moving and people are buying cars !! Perhaps those old fella's in Washington will note what is happening and push Wall St. to do something constructive with the $350 billion they got instead of bonuses for the #^%%$&^'s that caused the CRISIS like use the money for what it was intended like get the economy in a forward motion again.
They really didn't have to pay bonuses to have them straighten out the mess, the government just needed to show them that if they would like to face prosecution for mismanagement the alternative would seem much less attractive - then of course there are people in the government that were put in place to control this as well that should have been doing a song & dance for Detroit and the rest of the country instead of burying the heads of the Big 3 in a smoke and mirrors show.
Now lets just hope that they look at EQUAL trade as opposed to FREE trade and fix a few other issues as well !!

2008 Dec 31 09:16 AM

[axelrod608:]

I would choose a different title for your article, something like "GM commits suicide with double edged sword".

2008 Dec 31 10:03 AM

[mcl_mixer:]

The reason GMAC stopped lending to people with credit scores below 700 was that they were running out of money. If you only had a limited amount of money, who would you loan it to? Also, 621 is Alt-A, not sub-prime.

I'll bet you're one of those people who think that auto workers making $28 an hour are overpaid, but a secretary or administrative assistant at Goldman Sachs making $200,000 per year is well deserved.

2008 Dec 31 12:03 PM