Thursday, August 12, 2010

GM and AmeriCredit: How Our Economic Obesity is Dependent Upon Fiction and Predation

GM's recent $3.5 billion dollar purchase of subprime loan company AmeriCredit barely caused a ripple in the news. I blame no one for this; personally I was far more concerned with how many days Lindsay Lohan would spend in jail! Still, this was big, wasn't it? It was not long ago that GM was teetering on the verge of collapse, rescued only by a massive government bailout.

It is now owned, nominally, by the People. So let's have a look at our investment.

Why would GM buy a subprime loan company?

A few pundits did offer their thoughts, most poignantly the New York Times' Andrew Ross Sorkin, who explained, "G.M. plans to prod sales of its vehicles by using AmeriCredit to extend loans and leases to automobile customers with questionable credit. (That’s why they are called subprime loans.) These are the same customers who could very well be denied a loan by other lenders." He then asks the question of the hour: "Did we really spend $50 billion of our money just to revive the kinds of practices that led to the credit crisis?"

Yes, we did.

But why?

I believe the answer belies a deeper, more fundamental and possibly fatal flaw in our economy.

"If you liked our first-quarter financial results, stay tuned for our second-quarter financial results!"
- GM Chief Edward E. Whitacre

Before I digress into this cheerless topic let us first examine why it is in General Motor's interests to buy subprime lender AmeriCredit. The answer should be very simple: subprime loans expand the consumer market base by loosening restrictions to lending. New markets are good; they provide the growth necessary for the company's vital return to profitability.

That's it! Right?

Were it only so.

AmeriCredit's Business Model is Inherently Predatory
It is terribly ironic that despite so much retroactive moralism (we seem to excel in this), we apparently have no issue with a government-owned (or private!) company adopting a method of profitability that embraces the very practices that - not long ago - we ostensibly found abhorrent.

The fact is, consumer failure is at the heart of the AmeriCredit business model. In order to offset the risk/loss of defaults, the model is dependent upon the very significant percentage of consumers who fail to keep up with payments or are only able to make a minimal payment, thereby either incurring serious financial penalties or effectively making no impact on the principle. Profit is thus derived from the exorbitant fees, penalties, and high interest added to the purchase price, resulting in revenue far above and beyond the actual market value of the car.

Fortunately (and for reasons I cannot reveal here), I happened to be hiding under the table in the GM board room when the AmeriCredit epiphany transpired, eavesdropping while G and M discussed their evil plan. Transcript as follows:

M: (looking glum)

G: What's the matter, M?

: (sighs) We've run out of people to sell cars to.

: Bummer.

(a brief, melancholic silence
, pregnant pause, etc., follows)

: Wait, I have an idea.

: Do tell.

: Let's loan money to people that really shouldn't have money loaned to them.

: Sounds intriguing, I like it already.

: Here's how it will work: We'll advertise like hell, bring poor credit types on the lot, blow a lot of smoke up their ass, then dangle our carrot in front of them - a new car!

: A new car!

: Once we've hooked them in, we'll seduce them into agreeing on an absurdly overvalued purchase price by breaking down the elusive total cost (which we will only reveal at the point of death) into 'affordable monthly payments'.

: Affordable monthly payments. Nice ring.

: There's more! We'll assure them they won't have to pay a penny today. Zero down! 'Worry about it tomorrow!' we'll tell them.

: Never do today what you can do tomorrow!

: Next we'll employ psychology. Right when they think the car is theirs, we deliver the dreadful news: their loan might not be approved! Their credit is dubious, after all. We leave them in a small room, let them sweat a bit, peer in anxiously from time to time, and then: bingo! Approved!

: But who in their right mind would approve the loan?

G: We would! We own the loan company! AmeriCredit!

: You're good. But I'm afraid you have a little problem.

: Impossible.

: When you loan money to people you really shouldn't be loaning money to, very often they don't pay you the money back.

: But that's the whole idea, M!!!

: What?

: If they don't pay, we threaten to repossess that brand new car they've been driving around.

: I see. So then they pay?

: No, of course not! They couldn't afford the car in the first place! Remember? They have bad credit!!! And now they're behind with late fees, penalties, compounded interest, all of it!

: We've backed them into the proverbial corner. I love it.

: Yes, all they can do is make a minimum payment. If that!!! Ha, ha!!! They can't even put a dent in the principle! A vicious cycle! We'll make a fortune! Money from nothing! And in the end, we might even get the car back after all! Or sucker them into another one!

: Come to my arms! Genius!

Forgive me, a brief, ill-advised attempt at levity; sadly we now return to the grim topic at hand.

The point: the AmeriCredit model is inherently predatory. Without these penalties, late fees, exaggerated interest rates, etc. embedded in its profit model, it falls apart. It thus cannot be rationalized or regulated or manipulated to look like anything other than what it is. We are, in effect, generously rewarding the swindler.

I find all this highly problematic.

But what is the alternative?

A Healthy Economy Should Derive Profit from its Products and Services
In the case of GM, their product, a motor vehicle, has a value. That value, very simply, should be sufficient to create profitability for the company. If it can't create profitability on its own, then it follows that there is a serious flaw with the company and/or product itself.

We don't sidestep that problem (whatever it may be - a failure to innovate, myopia, hubris, etc.) by resorting to a means of profitability wholly unrelated to the company's primary product, particularly when that means is fundamentally nefarious. That is not to say there is anything wrong with ancillary revenue streams, even clever ones, but when they consist of precisely the same ingredients that have very recently led our economy to near ruin, we should have cause for concern.

In the case of AmeriCredit, profit is derived from failure. If money is a symbol of an exchange in social value, we should be alarmed when our system generates wealth from deception, fear, intimidation, irresponsibility, ignorance, foolishness, and the like. These are desperate means of creating wealth. These are also immoral, unethical, and potentially inhumane means of creating wealth.

We want our wealth to be derived from things like innovation, knowledge, freedom, creativity, hard work, persistence, commitment, individual empowerment, merit, the can-do attitude, etc. In short, the increasingly elusive, so-called American Spirit.

There is a great social cost to the predatory model: we reinforce our social shortcomings and problems by making them an integral component to our own economic health.

Why are we doing this? Why are we, as a people, effectively endorsing a company like AmeriCredit?

My answer should (hopefully!) disturb you.

Our Economy Relies on Predation Because it Must
To sustain our rate of affluence, our economy needs to grow. To grow, we need to find new markets. In the unlikely scenario there are no more new markets to find, then our rate of affluence will have to slow down. Pretty simple. But what if we really, really, really don't want to slow down our rate of affluence and yet still are unable to find any new markets substantial enough to sustain the very growth we require?

Well, we might make them up. We might create revenue out of the ether. We might make a fictional market.

That is precisely what recently happened. The true cause of the recession was to lose our suspension of disbelief, albeit reluctantly. Fueled by the pressing need to create new markets where there were none to be found, we simply drummed them up and pretended they were real. The difference between the true value of a house and the fictional value it was imagined to be worth (all with 'borrowed' money) created a vital revenue stream that in reality did not exist at all. No one could really afford to pay the inflated loans offered by the banks for assets that were not really worth the prices we invented for them.

Now why would we do something that dumb? Because this need to create artificial wealth is due to an unwillingness to accept a very ugly truth about our own society: we are economically obese.

Economic Obesity
We have a sickness. We are full, but we don't want to slow down. Our appetite is insatiable, and yet we are running out of real nourishment (real products, services, and new markets) to feed it. As a result we are opting to eat either a lavishly nonexistent meal or to indulge in the equivalent of economic trans-fat: predation.

Thus the fundamental problem with our economy is that our rate of affluence is so high we cannot sustain its need to grow without relying on artificial or predatory mechanisms of market creation.

In other words, houses became wildly overinflated because they had to. Predatory subprime loans are a part of the automobile industry because they have to be.

GM vehicles (the real product) are not adequate on their own to support the size of waistline our economic obesity demands. Similar to artificially bloated housing prices, the interest, penalties, fees, and so forth added to a subprime loan represents the fictional value of the automobile industry. It is not surviving on fumes, it is surviving on something that is at worst predatory, at best socially valueless. It is creating a 'market' by resorting to unethical means of obtaining wealth.

In order to sustain our own economic obesity, we must feed nefariously on ourselves!

So What?
An artificial market will, sooner or later, reveal its illusory nature, with severe economic consequences. The housing bubble crashes, etc. A predatory market, however, is indeed a viable source of nourishment to a free market, providing it is devoid of ethics.

So what's the problem?

Embedded in the predatory business model is a not-so-subtle component of social exploitation: the sum effect is to enable the rich to get richer and the poor to get poorer.

Let us take the AmeriCredit case. How the demographics of subprime car loans break down precisely is beyond me, but I suspect those with credit issues are very often those with less money to begin with. If you cannot generally afford things, you are more vulnerable to the suggestion that you might be able to have them anyway, particularly when you have been emotionally clubbed over the head that you are utterly inadequate if you don't (we call this advertising - a topic I intend to write about at length elsewhere).

What's so strange about that, you ask?

Absolutely nothing.

If you peer into history, you will find that invariably, every society gradually succumbs to severe social stratification, surviving on these very same corrupt and immoral methods to squeeze every penny of value from the poor, making them only poorer.

When we allow our own economy to become reliant on the same mechanisms from which we once fled in terrified droves (or huddled masses), we know that the destiny of this country is no different from those we have so valiantly attempted to differentiate ourselves from. And indeed, social stratification in the United States has already reached such a point that the wealthy class is entirely out of touch with just how much money they make, and just how little the poor do not.

We are recreating those societies as we speak; the sooner we all realize this, the better.

Our economy, simply because this country is so enormously, unfathomably rich, will of course recover from our 'recession', and recover relatively quickly. But (until we corral our economic obesity) we will learn nothing from it because we can't. We are dependent upon these fictional revenue streams until the system breaks down completely, which it ultimately will (if history is any guide), upon which we will suffer through a terrible recalibration of actual and imagined wealth. I shudder to think how this will play out, but again, if history is any guide, the stakes are truly life and death.

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