I am told that print media outlets are in real trouble.  That’s too bad, because it means that relatively few people were able to join me in the unintentional hilarity that was Ally Bank’s full-page, color newspaper ads last week.  Among various pronouncements that it is a better, more customer-friendly bank (perhaps too low a bar in the first place) Ally helpfully points out that “we never forget it’s your money, not ours”.

You can say that again.

As it turns out, Ally Bank is the new name for GMAC Bank, the firm that was waved into the banking system by an uncharacteristically jolly Federal Reserve last Christmas Eve, and soon thereafter was showered with a $5 billion capital infusion under TARP, plus a variety of taxpayer-backstopped funding alternatives.  Now that the “stress tests” have predictably found a still-yawning capital shortfall of $11.5 billion at GMAC, taxpayers are ponying up an additional $7.5 billion in capital and $7.4 billion in debt guarantees.

In fairness, the Treasury Department is coming off a few real successes, some of them -- like the “stress tests” -- helping to undo the worst excesses of the frenzied Paulson-era bailouts. 

The continuing life support extended to GMAC, though, is a major mistake:  It creates enormous risks to taxpayers; it is a needlessly indirect subsidy of auto sector jobs; and, worst of all, it re-animates perhaps the most dangerous “zombie bank” in the industry.

Taxpayer Risk:  Defeat from the Jaws of Victory

Oddly, before this latest twist of bailout fate, federal regulators (the FDIC, anyway) had more or less dodged a bullet with GMAC. 

GMAC is a huge institution.  It has some $179 billion in assets (plus $136 billion in off-balance sheet loans), the vast majority of which are auto and mortgage loans.  As you might imagine, this is a difficult time to own an enormous portfolio of consumer loans and leases. 

And GMAC’s portfolio seems especially bad.  This is a firm that for years appeared to provide below-market, medium-term loans “secured” by fast-depreciating cars and trucks; when -- surprise, surprise -- that seemed insufficiently profitable, GMAC sought to fuel growth through subprime and non-traditional mortgages originated, for the most part, through brokers.  The inevitable result of that disastrous foray is well documented:  GMAC’s far-flung mortgage operations have lost $9.2 billion over the past two years.  (To put the enormity of those losses in context, the FDIC reported this week that the entire banking industry made only $7.6 billion in profits last quarter).

The good news, from the public’s perspective, was that the FDIC had kept the taxpayer’s exposure reined in -- even today, only 13% of GMAC’s consolidated assets are funded by deposits at its subsidiary bank.  Given that relatively small exposure, the bank subsidiary’s (relatively) clean asset base, and the fact that depositors rank higher in the capital structure than, say, unsecured creditors or equity holders, it seemed that the FDIC had managed to keep taxpayers out of danger.

Unfortunately, Treasury and the FDIC have managed to snatch defeat from the jaws of regulatory victory.  Since last Christmas Eve’s surprise gift of bank holding company status from the Fed, GMAC has managed to secure $12.5 billion in capital from the taxpayer, plus $7.4 billion in debt guarantees from the FDIC.  In other words, after years of the FDIC’s ensuring that taxpayers were insulated from the inevitably disastrous results of GMAC’s lending practices, the government has now reversed course and intentionally put taxpayer money at risk.

And the magnitude of that risk is breathtaking, as a few data points will underscore.  First, the sheer size of GMAC is troubling.  Its on- and off-balance sheet assets are considerably larger than the sum of the assets of all 305 banks on the FDIC’s “problem bank” list at the end of Q1.  The sum of committed taxpayer equity investments in GMAC -- $12.5 billion -- is 2.5 times the cost of last weekend’s BankUnited failure.  Worse still is the prospect that GMAC’s “Ally Bank” marketing scheme might actually succeed, thereby generating incremental FDIC-insured deposits to support GMAC’s dubious loan portfolio.  If GMAC were to achieve an industry-average deposit mix, it would mean an incremental $95 billion in deposits.  If it were to fail at that point -- which would be deeply unfortunate but not especially shocking -- it could mean a $20 or $30 billion hit to the deposit insurance fund.  To calibrate, recall that healthier banks, which of course would be saddled with replenishing the fund, last week screamed bloody murder at new FDIC assessments that will raise only $6 billion for the fund.

Unnecessarily Indirect Subsidy

Given the risks attendant to the bailout, a reasonable person might question why taxpayers at large (or, perhaps more accurately, their children and grandchildren) should be forced to subsidize GMAC and its corporate parents -- the odd couple of the teetering-on-bankruptcy General Motors and the monstrously successful private equity firm Cerberus Capital Management (whose Chairman just happens to be a former Bush Treasury Secretary). 

More cynical observers might suspect a case of bipartisan political patronage.  But I don’t think so.  I believe the taxpayers’ elected representatives in the Congress and the last two Administrations honestly think they are saving systemically critical U.S. auto sector jobs by bestowing continuing economic benefits on private, politically entrenched special interests.

I would humbly suggest, however, that it might be more straightforward and less damaging simply to create a direct subsidy.  After all, the entire point of propping up GMAC, presumably, is that it will continue to provide consumer and dealer financing at below-market rates, to such a degree that consumers will buy American-made cars that they otherwise appear unwilling to purchase. 

If that is the market distortion we are trying to achieve, there is a simpler way.  Simply hand auto buyers a check (or, more likely, a refundable tax credit) of $1000 or $2000 to buy an American car.  Given the magnitude of the GMAC bailout, the government can hand out rather a lot of $1000 checks and still be ahead of the game.

I am no particular fan of taxpayer giveaways.  But at least with a direct subsidy, it’s obvious what Congress is doing.  And, more importantly, we would avoid resurrecting GMAC, which is quite possibly the worst of the “zombie banks.”

The Trouble with Zombies

There are two breeds of zombie bank, both of them dreadful for the broader economy.  GMAC manages to be dreadful in both ways.

The first, garden-variety zombie is a bank with unrealized losses that dwarf its capital position.  Such a bank stumbles around the financial landscape, unwilling to lend actively, because it is desperately trying to husband capital ahead of the inevitable realization of embedded losses in its credit portfolio.  As the “stress tests” made clear, GMAC is certainly fits this zombie definition, with capital levels fully $11.5 billion short of that required under the tests’ adverse scenario (a scenario that, as unemployment levels continue to climb, looks less adverse all the time).

Indeed, even after being stuffed with taxpayer-supplied capital, GMAC will still not be able to serve as an efficient credit intermediary.  This is, quite simply, a bank with no credible track record as a lender.  Indeed, it is almost precisely the opposite of what policy-makers should want in a bank:  it has shown the ability to make astonishingly bad credit risk-return decisions, in multiple asset classes, through comically bad distribution channels, for many years in a row.

GMAC is a zombie in a second, even more dangerous way.  Recall the real problem with zombies in movies is not so much what they do to themselves, but what they do to the living.  The same is true with zombie banks like GMAC.  

Given its track record, GMAC is unlikely to raise significant funding without a government backstop (either through FDIC-insured debt, or FDIC-insured deposits).  But by consuming investor appetite for such bonds and deposits, and indeed by driving up the cost of such funds because of its own desperation, this zombie bank leaches out profitability that would otherwise be captured by more strategically viable enterprises.  Consider, for example, that “Ally Bank” is, today, advertising 1-year CD rates at 2.80%, which is roughly double the cost of funding earnings assets for other large banks during Q1. 

Competing with desperation pricing like this is especially problematic for community banks, which rely on deposit funding far more than their larger brethren.  Competing with zombies will, on the margin, drive down community bank net interest margins, and thereby reduce their rate of organic capital generation. 

In other words, by keeping zombies like GMAC alive, we are slowing the pace at which troubled but viable institutions heal themselves.   That slows the banking recovery, and the broader economic recovery as well. 

GMAC has done enough damage; it is time to let it fend for itself.

Raj Date is the Chairman and Executive Director of the Cambridge Winter Center for Financial Institutions Policy.  He is a former McKinsey & Company consultant, bank senior executive, and Wall Street managing director.