Back at the dawn of the automobile era, banks generally refused to loan money for such things as buying a car. It wasn't considered prudent. This was frustrating to companies such as General Motors, which naturally wanted as many people as possible to have the wherewithal to purchase Cadillacs and Oldsmobiles and Pontiacs and Chevrolets. So GM decided to solve the problem by, in effect, becoming its own bank. In 1919 GM created the General Motors Acceptance Corp., a financial arm of GM that specialized in offering credit to car buyers and allowing them to buy on installment plans.
GMAC was a huge success. So much so that, over the years, it gradually expanded its operations, becoming a significant bottom-line contributor to GM's profits. In 1985, GM's execs decided, hey, if we're loaning money to our customers to buy cars, why not go ahead and loan them money to buy homes as well? GM promptly purchased two large mortgage lenders and instantly became the second largest mortgage bank in the U.S.
Along the way GMAC also became an early player in the world of "structured finance" or derivatives, by taking the income streams generated by all those car and mortgage payments and turning them into bonds, through the process known as "securitization," which it then sold off to investors. All very state-of-the-art, all very emblematic of the career arc of the modern American corporation.
Why should we care about all this history? Well, with the Dow just finishing its worst week in four years, down another 120 points on Friday, it would behoove us to look for explanations as to what is continuing to spook investors. To wit: On Thursday, GM shook up Wall Street by announced that it was delaying filing its 2006 Annual Report by a couple of weeks. The reason, said analysts, had to do with GMAC's significant exposure to the ever-popular subprime lending debacle. Like so many other players in the mortgage business in the last few years, GMAC's home lending subsidiary, ResCap, apparently got pretty deep into making risky loans to homeowners with bad credit, and now is paying the price.
How bad is it? According to the Houston Chronicle, "At the end of the third quarter, ResCap, long viewed as the crown jewel in GMAC's businesses, held $57 billion of subprime mortgages for investment, or 77 percent of its total loans held for investment. Its exposure to 'residual interest' in mortgage securities -- the high-yielding slices that suffer some of the first losses if loan defaults are higher than expected -- was $1.4 billion as of Sept. 30."
There are two primary schools of thought on how the subprime lending saga will play out. One side says that financial woes are limited to just that segment of the mortgage industry that dealt with the riskiest loans, and the problems will spread no further. But the other side contends that we're only at the beginning of a chain reaction that could end up causing serious damage to some of Wall Street's biggest players.
GM, the largest car maker in the world, is a pretty big institution, and GMAC is a pretty big financial player. But due to the opaque nature of the derivatives trading business, no one, not even, apparently, GM itself, is clear on exactly what ResCap's subprime woes might mean for the larger picture. But it can't be good.
From the Chronicle:
ResCap said in January it will eliminate 1,000 positions by October to reduce costs as the mortgage lender grapples with the continued deterioration in the subprime mortgage sector. The company now has 14,000 employees worldwide. In a filing with the SEC, ResCap estimated that it would incur about $10 million in severance and related costs associated with the work-force reduction.
"We continue to believe GM equity is complacent about the potential impact of such subprime exposure," Bear Stearns auto analyst Peter Nesvold wrote in a note. He said the weakness at GMAC due to subprime problems is one of the key risks facing GM.
Last fall, GM sold 51 percent of GMAC to Cerberus Capital Management, in a cash-raising effort aimed at bolstering the company's shaky finances. But the two parties have since been squabbling over the fine print. There now appear to be some questions as to whether GMAC was properly valued at the time of the deal.
All in all, not a good week for Wall Street. Monday morning should be interesting.
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