GMAC Bailouts Show Limits of Bank Reform

Theo Francis BusinessWeek October 29, 2009

Posted by: Theo Francis on October 28

The talk about a third bailout for GMAC couldnâ??t come at a much more awkward time for the Administration or Rep. Barney Frank (D-Mass.): They have just unveiled a package of regulatory reforms billed as the toolbox for solving the â??too big to failâ? conundrum.

Unfortunately, GMAC highlights its weak point all too clearly.

Thatâ??s not to say that the proposed legislation is useless. Even critics of the approach tend to agree that the federal government needs to do a better job of watching for financial-sector risks that could shake the economy, and needs better tools to do that, as well as to dismantle big and complex firms before they threaten serious harm. Systemic-risk monitoring and resolution authority are by most accounts badly needed.

But in the end, the question isnâ??t just whether the government is vigilant enough, or has the right tools at hand, but also whether it will have the political will to use them â?? and to stick out the consequences. Thatâ??s where GMAC comes in.

You'll recall that GMAC became a bank in the thick of the financial crisis, making it eligible for cash infusions under the Troubled Asset Relief Program, and that it was among those singled out for stress-testing in the spring.

It didn't do so well. In fact, it was the only firm unable to raise enough capital in the marketplace to satisfy regulators. So Uncle Sam pitched in, bringing the public aid GMAC had already received up to $13.5 billion. Now reports suggest it could be heading to the trough a third time, to the tune of another $2.8 to $5.6 billion.

A Treasury spokesman says the agency is "in discussions" with the company over the capital needs identified last spring, and that they don't expect the talks to "result in any needs beyond the identified stress test needs in May." In other words, this is still the same problem, not a new one.

Still, the legislation proposed Tuesday is meant to prevent this kind of corporate-welfare triple-dipping. With a new systemic-risk monitoring structure in place -- a council including the Treasury secretary, Fed chairman, bank regulators, and chairmen of the SEC and CFTC -- regulators could keep an eye on big, complex institutions, or those that are tightly woven into the fabric of the economy. Then, before any firm needed a bailout, the regulators could tighten the leash, forcing the institution to ratchet down the risk and pulling it back from the brink.

Should all else fail and a major financial firm begin to fail, the government would be able to step in with its new resolution authority and -- presto -- dismantle big insurers, financial holding companies and any other company threatening to topple the financial system, just as the FDIC currently does with banks and thrifts. (Various regulators would have primary authority here, largely by industry, with the Fed intervening if they move too slowly.)

That's a big shift from the current state of affairs: No agency in particular has the responsibility to look for systemic risk generally, across industries and markets, or the authority to coerce overly risky firms into better behavior. And the government only has speedy-resolution authority for banks, under the FDIC's Great Depression mandate -- not their holding companies or other kinds of financial firms.

All well and good. But regulators have presumably been watching GMAC like hawks since before it received its first dollop on the dole. Presumably they have also asked it to rein in whatever risky business it was pursuing -- apparently to no avail.

Moreover, GMAC is already a bank -- and therefore, the FDIC already has the power it needs to dismantle it. Yet it seems the will is lacking to actually do it.

That's understandable. Whether GMAC's hypothetical failure truly poses a systemic risk was debated hotly around the time of the auto bailouts. It certainly poses a political threat to lawmakers: GMAC's failure could shake the auto-financing market and dry up credit for car-buyers, in the process threatening auto dealers and potentially crippling the comebacks of General Motors and Chrysler. Something along those lines loomed when GMAC was unable to get private-sector funding during the credit crunch. A repeat isn't very appealing to lawmakers -- nor, likely, to the public -- during an ugly recession, or even in its final throes.

So with the new legislation in place, would the political will suddenly be there? If by some twist of fate and markets, lawmakers were facing the rapid decline of Citigroup, Bank of America, Goldman Sachs or Wells Fargo -- just to name a few at near-random -- would regulators hesitate to step in, take them over and dismantle them? Or would they be tempted to make an exception and prop them up for fear of the consequences?

To some degree, these questions aren't quite fair: GMAC began to fail in the bad old days, before regulators had resolved to try harder, and Treasury had no problem letting the smaller CIT fail; after promising to keep the stress-tested banks afloat, the government more or less has to stick by its word. The Administration is also proposing fatter capital cushions to keep financial firms -- particularly big and important ones -- from getting close to the brink; think of it as an air-bag to supplement the anti-lock brakes of systemic-risk monitoring.

And yet, the problem is a real one: The reason institutions become too big to fail is that everyone fears the consequences of letting them do so. When it comes to GMAC, regulators have had the powers they want for other kinds of companies. It hasn't helped.

Bravo. Well put, and fantastic article.

Washington Bureau Chief Jane Sasseen and other BusinessWeek writers peel back the curtain on the economy, business and money matters at the White House, Congress, and federal agencies.

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GMAC Bailouts Show Limits of Bank Reform

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