General Motors and the Subprime Crisis
General Motors (GM) was one of the most unexpected casualties in the subprime mortgage crisis. This was because of the fact that General Motors (GM) had nothing to do with the mortgage business. It was one of America’s and the world’s oldest motor companies. However, the crisis had many casualties which were not related to the financial services business. Perhaps, the biggest of such casualties was the General Motors (GM) fall.
The reason behind this fall was that in 2008, the outbreak of the subprime mortgage crisis had caused a financial catastrophe in the United States. Most people were foreclosing their homes due to unavailability of funds. A lot of people were out of work. As a result, the automobile sales in the United States had faced a nosedive. On year on year basis, the sales of General Motors (GM) had fallen by 30%. As a result, General Motors (GM) found itself out of cash.
To top it up, the usual source of funding for General Motors (GM) i.e. the banks were also out of cash. The subprime mortgage crisis had absorbed all the liquidity out of the market, and the banks had nothing left to lend to General Motors (GM).
General Motors (GM) also made an attempt to offload some of its assets. However, the market for loans was tight. Hence, no company in the United States found itself interested in purchasing General Motors (GM) assets within the required time frame at the given price.
To top it up, General Motors (GM) had many liabilities. For instance, its newly negotiated agreement with United Auto Workers i.e. the labour union in Detroit had cost the company a lot in terms of pension and retirement benefits. Estimates stated that these benefits were increasing the prices by as much as $1500 per car produced further reducing their effectiveness in front of Japanese imports. Also, the price of gasoline had risen as much as $4 per gallon. This was further discouraging people from buying automobiles and was further causing a drop in the level of automobile sales.
It is for these reasons that General Motors (GM) was not left with any option. The company was in a complete financial mess. Its operations were perfectly solvent. However, the firm was highly leveraged, and as a result, a seasonal fluctuation in sales had caused the fall of this United States behemoth.
General Motors and Federal Assistance
General Motors (GM) received a variety of loans from Obama as well as Bush administration during the crisis. The government was basically of the view that if the auto industry were allowed to collapse, several thousand people would be unemployed and as a result, the US Treasury will have to pay a lot for unemployment benefits. It is for this reason that the government decided to bail out General Motors (GM) as well as Chrysler Corporation.
The first loan that was received by General Motors (GM) was for a massive $13.4 billion. This loan itself was a controversial investment for the government. However, this turned out to be a small portion of the total loans. A few months later the government loaned out an additional $2 billion to General Motors (GM). Just another couple of months later, the government had to raise its investment by $4 billion again! Despite so many efforts, General Motors (GM) filed for bankruptcy protection in 2009.
It was during the bankruptcy proceedings that General Motors (GM) received the biggest bailout of $30 billion dollars. This bailout was aimed at providing General Motors with the early cash required to re-start its operations. An interesting point to be noted is that over half the money out of the $30 billion final instalments was never used. Over $16 billion were lying in an escrow account idle, unused!
The US government never intended to gain ownership of General Motors (GM). However, post the bankruptcy they had become one of the largest shareholders of this corporation. General Motors (GM) has paid back all the debt that it received from the Troubled Asset Relief Program (TARP). It has also acquired most of the equity back from the government. In less than a decade, General Motors (GM) is back on its feet and is turning in billions of dollars in profits once again.
The Aftermath: General Motors
- A New Company: Post the bankruptcy filing of the old General Motors (GM), a new age General Motors (GM) Corporation was created in the United States. This corporation was relatively financially smaller i.e. it had shorter turnaround. Another interesting point to note is that the company had a smaller United States presence. However, its overseas presence was still noteworthy. The new age General Motors (GM) decided to focus its strategy on emerging markets like India and China instead of saturated markets like the United States.
- Brands: The newly formed General Motors (GM) Corporation had a good hard look at its brands. Some of the divisions which were not performing well were sold off whereas others were simply shut off. It is because of this that Saab was sold off to a Dutch company whereas Pontiac, Saturn and Hummer were simply shut down. The company wanted to focus all its attention towards the cash cows. It is this lack of cash that had caused the bankruptcy in the first place, and General Motors (GM) had learnt its lesson, it now wanted to be a cash rich company.
- Operations: The new age General Motors (GM) had significantly ramped down its operations. The number of workers working in General Motors (GM) took a drastic hit after the subprime mortgage crisis. Worldwide General Motors (GM) let go off close to 40,000 workers whereas in the United States close to 16,000 jobs were cut. In the process of this sudden and forced cost cutting, General Motors (GM) had to shut down 13 out of its 47 plants. This also caused major damage to the local economies where these plants were situated.
However, General Motors (GM) took the difficult steps that were required. As a result the corporation still survives in some form today. The new General Motors (GM) cleared all government debt within a few years and stood tall even though subprime mortgage crisis had wreaked havoc on its balance sheet.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Subprime Mortgage Crisis: An Introduction
- Dot Com Bust: Starting Point of Subprime Mortgage Crisis
- Political Incentive for Home Ownership
- The Case Of Freddie Mac, Fannie Mae and Ginnie Mae
- Advantages to Freddie Mac, Fannie Man and Ginnie Mae
- Types of Mortgages
- Types of Mortgages from Borrowers Point of View
- Mortgage Products - Negative Amortization & Home Equity Line of Credit
- The New Mortgage Landscape
- The New Mortgage Landscape: Conflict of Interest
- New Age Financial Securities - Mortgage Backed Securities & Credit Default Swaps
- Collateralized Debt Obligations and Tranching
- Benefits of Collateralized Debt Obligation (CDO’s)
- Subprime Crisis: Problems Caused by Accounting
- The Self Reinforcing Housing Loop
- Integrated Financial Systems
- Credit Market Freeze
- Borrower Approach vs Collateral Approach
- How Reverse Mortgage Works ?
- Reverse Mortgage: Pros and Cons
- The Big Bust – Washington Mutual (WaMu)
- General Motors and the Subprime Crisis
- The Return of Subprime Mortgages
- The Big Subprime Bust
- Executive Compensation and Sub-Prime Mortgage Crisis
- The Big Fall: Lehman Brothers
- The Big Fall: Bear Stearns