Fact and Fiction Behind Too Big to Fail

The Hidden Underbelly of the Auto Bailout

Candidates for President from both parties play to voters’ disgust for bailouts. On February 24th the Detroit News reported that President Obama’s campaign launched an ad in Michigan claiming the Republican candidates had turned their backs on GM. Mitt Romney has frequently publicly criticized the government auto bailout. In his January State of the Union speech President Obama defended the auto bailout while claiming he would support no more bailouts. While ordinary citizens are reading about inconsistencies in all candidates’ positions, they haven’t been told one of the hidden secrets behind the auto bailout.

At the time of its bankruptcy GM owned its financing arm, GMAC. GMAC got its start providing financing of GM customers’ car purchases. No news there.

However, in GMAC’s 1999 annual report on SEC form 10K (the detailed, official annual report for investors), GMAC described its active nationwide involvement not only in residential mortgage origination and servicing, but also its major involvement in mortgage securitization through its subsidiary, Residential Funding Corporation (RFC). RFC “is the number-one issuer of private-label mortgage-backed securities in the U.S.” “In addition to prime residential mortgages, RFC also purchases and securitizes subprime residential mortgages, home equity lines of credit and home improvement loans.”

In GMAC’s 2005 10K the financing arm of GM stated that “sales by GMAC’s mortgage subsidiaries of mortgage loans through whole loan sales or securitizations require GMAC to make customary representations and warranties about the mortgage loans to the purchaser or securitization trust.” In fact GMAC stated that the “remedies available to a purchaser of mortgage loans may be broader than those available to GMAC’s mortgage subsidiaries against the original seller of the mortgage loan. If a mortgage loan purchaser enforces its remedies against GMAC’s mortgage subsidiaries, GMAC may not be able to enforce the remedies it has against the seller of the loan or the borrower.” GMAC, and therefore GM, was deep into residential mortgage securitizations shoulder to shoulder with other big banks. While legal settlements involving multi-billion-dollar claims on the biggest banks arising from their promises made when selling mortgages hit the news, one wonders how much GMAC, now Ally Financial, is protected from these claims by the bankruptcy process.

Maybe the bailout would have happened sooner if not for GMAC’s mortgage operations masking the auto side’s decline. In 2005 the mortgage operation made $1.3 billion in net income, over half of GM’s financing arm’s $2.4 billion in net income. Despite the profits on financing and particularly mortgage financing, GM still showed a consolidated net loss in 2005 of $10.6 billion.

GM recently told the Wall Street Journal it targeted $10 billion in profits. Its 2005 10K provided the profit targets set in 2004. The income target for GMAC was “greater than” $2 billion. This was a higher goal than that for its North American auto segment, which had been set at $1.0 to $1.4 billion.

Once made a bank holding company by the Federal Reserve, facilitating GMAC’s access to financial bailout dollars, GMAC (and now Ally Financial) had to file the same reports to the Fed as the other big banks. The most widely-followed report is the FR Y-9C. GMAC’s June 30, 2009, form FR Y-9C showed that 16% ($29 billion) of GMAC’s balance sheet was comprised of residential mortgages and construction loans. It was no doubt very helpful to the Fed’s management of the mortgage crisis not to have GMAC’s large portfolio of mortgage loans put up for sale.

A policy angle adds color to this story. While testifiying before Congress in support of eliminating the Glass-Steagall barriers between investment and commercial banking in June 1998, Fed Chairman Alan Greenspan stated that the U.S. would continue to separate banking from commerce. Clearly he wasn’t familiar with the contents of GMAC’s 1999 annual report.

After the bailout, GMAC was essentially spun off and renamed Ally Financial Inc. It is the 16th-largest bank holding company on the Fed’s list, ranked by year-end 2011 assets.

Fairy Tale Capitalism: Fact and Fiction Behind Too Big to Fail

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Was the mortgage debacle the sole cause of the financial bubble's collapse? Do you believe those who say the elimination of Glass-Steagall barriers didn't contribute to its building? Fairy Tale Capitalism: Fact and Fiction Behind Too Big To Fail places the mortgage mess into a broader perspective. It explains how the Federal deposit guarantee was married to investment banking's trading intensity, why the Fed had no choice but to bail out the biggest banks and how derivatives played a poorly-understood, but equally important role in the crisis. In simple terms Emily Eisenlohr walks with those who live on Main Street down Wall Street's darker alleys.

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