GMAC Financial Services is seeking to become a bank holding company, so it can receive a capital infusion from the Treasury's Troubled Asset Relief Program.
Approving the application would be a terrible mistake, because it would create a fundamental breach in the legal barriers that separate banking and commerce. There are compelling reasons to preserve those barriers.
GMAC is a deeply troubled company. It has reported almost $8 billion of losses since the end of 2006, and it is burdened by more than $60 billion of debt. This year it narrowly avoided bankruptcy by restructuring its debt. Now it must restructure its debt again, and it wants the Treasury's help.
The problems have been created by its auto finance unit and by Residential Capital, a big subprime mortgage lender. GMAC's auto finance unit has provided low-interest loans to risky customers for many years to subsidize the sale of General Motors products. ResCap was established in 2004 to diversify GMAC's sources of revenue, but it targeted lower-income, high-risk borrowers and effectively doubled the risks its parent already faced from its subprime auto loans.
By exploiting a loophole in the Bank Holding Company Act, GMAC acquired an industrial loan company with Federal Deposit Insurance Corp. coverage in 2004. Two years later GM sold a 51% interest in GMAC to an investor group led by Cerberus Capital Management, a big private-equity firm. At that time the FDIC maintained a moratorium on all transactions involving ILCs. However, it bowed to intense political pressure and approved the transaction, because GM desperately needed the funds offered by Cerberus.
GMAC's predicament illustrates the dangers of allowing commercial firms to control banks. It has never acted as an impartial provider of credit. Instead, it has provided preferential loans to GM customers, and it has incurred excessive risks in doing so. It probably took additional risks with ResCap because it wanted to offset the problems created by its auto loans. Instead, it compounded those problems.
The application seeks a further extension of a federal safety net that has already been stretched thin by the global financial crisis. When Congress passed the Gramm-Leach-Bliley Act in 1999, I and others predicted that the law would cause federal guarantees to be extended beyond banks to cover securities firms and insurance companies. That has now occurred. The Fed and the Treasury have orchestrated massive bailouts of Bear Stearns, American International Group, and Citigroup.
The safety net now supports the entire financial sector of our economy.
Providing Treasury funds to GMAC would extend the safety net to the commercial sector of our economy. Other troubled commercial firms would undoubtedly seek to acquire banks, so that they could qualify for federal help.
Our nation's time-honored tradition of ensuring the impartial and objective allocation of bank credit would be lost. Our economy would be dominated by commercial-financial combinations similar to those that prevailed in Germany and Japan after World War II. Such combinations would wield extensive political influence and would become frequent recipients of government largesse.
Moreover, the Fed and the Treasury would become regulatory czars exercising unprecedented control over industry and commerce. Currently the FDIC does not have authority to exercise consolidated supervision over parent companies of ILCs.
In contrast, under the Bank Holding Company Act, the Fed would become the consolidated supervisor of GM and Cerberus by approving the GMAC application. Similarly, the Treasury would exercise significant control over any commercial bank holding company receiving a capital infusion from the government.
In view of the manifold challenges facing the Fed and the Treasury, regulating big commercial firms is the last thing they should do. This is not the first time our nation has been tempted to allow commercial-financial conglomerates. During the 1830s and the 1920s such conglomerates were established and engaged in extensive commercial, industrial, and real estate development activities. Massive booms occurred during each decade, followed by devastating busts in which those conglomerates failed with disastrous consequences.
Our nation has already suffered great harm from the enormous risks created by financial conglomerates during the past decade. We should not create even bigger dangers by allowing commercial firms to combine with banks.
One of the most prudent things we could do would be to close the ILC loophole, because it is the only way commercial firms can acquire FDIC-insured institutions.