Chapter 17
A stranger to the history of the automobile business might wonder how it happens that General Motors owns one of the most important financial institutions in the United States, through which the corporation is engaged in consumer financing.
First as to the fact. General Motors subsidiary, the General Motors Acceptance Corporation, in the past few years has extended 16 to 18 per cent of the estimated credit given in connection with car sales in the United States. GMAC seeks business only from General Motors dealers and is in competition with banks, other sales-finance companies, credit unions, and local lending institutions. I say "in competition" because it is not a closed business; the General Motors dealer is free to use any finance service that he chooses and his retail customers may do likewise. GMAC's total annual business currently comes to about $4 billion in retail credit and about $9 billion in wholesale credit extended to dealers to finance purchases from General Motors.
We got into this business over forty years ago when the need for financing the distribution of automobiles first arose. Mass production brought with it the need for a broad approach to consumer financing, which the banks did not then take kindly to. They neglected—I might say they declined—to meet the need; and so some other means had to be found if the auto industry was to sell cars in large numbers. When GMAC was formed in 1919, facilities for consumer credit on a national basis did not exist. Merchants as far back as I can remember—and before that, I am told—granted time-payment loans for houses, furniture, sewing machines, pianos, and other articles too expensive for most people to buy for cash; and I suppose that banks must have lent to selected individuals some money that went for that purpose.
The idea of consumer finance, therefore, was not new in principle. I understand that the Morris Plan banks began financing some automobile purchases around 1910 and that the practice grew from then on. But the application of consumer finance to the automobile in a routine way was still new in 1915 when my friend John N. Willys, then president of the Willys-Overland Company—one of the most successful motorcar manufacturers at that time—persuaded me to become a director of Guaranty Securities Company, which proposed to finance the sale of Willys and other cars. This was one of the first automobile financing institutions, if it was not actually the first, to be formed to fill the vacuum created by the absence of normal credit facilities. It was also my first experience with the installment plan of purchase. At the time I did not have a direct interest in it since I was then still with Hyatt and, of course, not making or selling motorcars. John J. Raskob, as chairman of General Motors' Finance Committee, was instrumental in starting GMAC. From where I was then on the Executive Committee, I supported the idea.
The public announcement of the formation of GMAC was made with the publication of a letter dated March 15, 1919, from Mr. Durant to J. Amory Haskell, GMAC's first president. Mr. Durant said in part:
The magnitude of the business has presented new problems in financing which the present banking facilities seem not to be elastic enough to overcome.
The constantly increasing demands for our products, particularly the passenger cars and commercial vehicles, has correspondingly increased the difficulty of our dealers in commanding at the seasons of the year when most needed the banking accommodation necessary properly to handle the volume of business which their ability as salesmen and the merit of our product as merchandise has developed. This fact leads us to the conclusion that the General Motors Corporation should lend its help to solve these problems. Hence the creation of the General Motors Acceptance Corporation; and the function of that Company will be to supplement the local sources of accommodation to such extent as may be necessary to permit the fullest development of our dealers' business.
A few words about the difference between the banking and the manufacturing mentalities at that time. The bankers, I suppose, must have had their minds on Barney Oldfield and Sunday outings in landaus along the boulevards then in existence; that is, they thought of the automobile as a sport and a pleasure, and not as the greatest revolution in transportation since the railway. They believed that the extension of consumer credit to the average man was too great a risk. Furthermore, they had a moral objection to financing a luxury, believing apparently that whatever fostered consumption must discourage thrift. Consequently, automobiles were sold to consumers mainly for cash.
Distributors and dealers, too, had to develop their own sources of financing, largely out of their own capital supplemented with customers' cash deposits and bank credit. This phase of automobile credit worked all right in the early days when distributors had wide territorial contracts and were able to make their sales for cash. It was not too difficult for them to cope with their financial requirements. As the business grew, however, and manufacturers continued to require cash on delivery, dealers simply did not have the funds to finance inventories, not to mention retail installment sales.
Thus in 1915, about eight years before the automobile industry was to become the largest American business in volume of sales, its distribution system had no routine retail credit structure outside of normal banking channels, and those channels were pretty narrow. The automobile industry had to develop this credit structure itself.
Today a very high proportion of dealers' stocks are financed, and about two thirds of all new and used automobiles in the United States are bought at retail on the installment plan. The anxieties of those who doubted the soundness of consumer credit have proved groundless.
In the case of GMAC, the retail loss ratio on installment paper from 1919 to 1929 was approximately one third of 1 per cent of the retail volume purchased. I speak of the GMAC ratio and not of any losses by dealers after a car had been repossessed. In 1930 this ratio rose to one half of 1 per cent; in 1931 to six tenths of 1 per cent, and in 1932 to five sixths of 1 per cent. By 1933 the loss ratio was equivalent to approximately one fifth of 1 per cent. Thus, in the worst of the depression the rate of loss never reached 1 per cent of volume—a remarkable indication of the safety of the system and the integrity of the purchasers.
When we first undertook the systematic financing of the distribution and sale of General Motors' products, we had no notion that this system of credit would be subjected to a test as severe as the depression or that it could survive such a test so well. We were convinced, however, that if we exercised ordinary care in the risks assumed, financing wholesale and retail distribution and sale of our products would promote a sound demand for automobiles which lack of credit was restricting.
GMAC today operates directly or through subsidiaries in the United States and Canada and in a number of overseas countries. GMAC was started and still operates specifically to meet the credit needs of General Motors dealers and distributors, and it has always limited its activities to financing the distribution and sale of new and used products by those dealers.
GMAC provides financing plans for both wholesale and retail transactions. Its wholesale plans provide a service for General Motors dealers whereby they may stock General Motors products under trust receipts or other security documents. The dealer obtains title to the product upon payment of the corresponding obligation and the item may then be sold at retail. Should he fail to pay his obligation upon demand, or to comply with other agreed-upon terms and conditions, GMAC has the right to take back the product.
From 1919 to 1963 GMAC financed for distributors and dealers, as distinguished from consumers, over 43 million new cars, in addition to other products of the corporation. In the same period GMAC financed a total of over 46 million cars for consumers, 21 million new and 25 million used.
Its method in retail financing, known as "the GMAC Time Payment Plan," is to buy approved, retail time-sales contracts from General Motors dealers, after they have been concluded between the dealer and the retail purchaser. GMAC is not, however, obligated to buy every contract a dealer submits to it. Nor is the dealer required to offer the contract to GMAC for purchase. For both parties the transaction is voluntary. GMAC has the right to refuse risks it does not wish to assume. The dealer may place his paper elsewhere if he thinks that is to his advantage. If the dealer does submit the contract to GMAC, and all credit factors prove satisfactory, GMAC purchases the obligation. GMAC, and not the dealer, then undertakes collection of all payments from the customer.
Outside the United States, local laws and other circumstances may dictate that the technical forms of GMAC financing plans and operations differ somewhat from those in this country. With this exception, the U.S. pattern with respect to retail and wholesale plans is followed closely in other parts of the world. It is our experience that prudent financing of wholesale and retail sale and distribution of our products works as well abroad as it does in the United States. On the record, the average consumer at home and abroad is a remarkably good business risk in the field of automobile financing.
GMAC's basic policies were formulated and refined between 1919 and 1925. In the beginning we had two primary motives, to establish the validity of the system, and to crusade for reasonable rates for the customer. We were interested in making a paying business out of it, and we were also interested in the long-term good will of our customers, and in protecting them from high rates.
The risks in consumer financing centered around default, repossession, and the used-car market. Hence the importance of the down payment and the length of time over which repayment was to take place, the ability of the purchaser to make payment, and the need in the credit structure of the repossessed car's being worth the balance due. To the dealer, as an endorser of the purchaser's obligation, it was most important that there be collateral which, if necessary, could be repossessed and resold at a fair price. In the absence of such collateral, the financial burden on the dealer was very heavy.
We were encouraged by a study of consumer credit along these lines made over a period of years under our sponsorship by the eminent economist Professor E. R. A. Seligman. His two-volume work, The Economics of Installment Selling, the culmination of this study, published in 1927, became a standard work in the field. It had a strong influence, I believe, in bringing about an acceptance of installment selling among bankers, businessmen, and the public.
Professor Seligman drew some conclusions that are accepted as axiomatic today but then were novel. Installment credit, he said, not only strengthens the motive to save but increases the individual's ability to do so. It not only advances the time of demand but by interaction with the economy actually increases purchasing power. It both stabilizes and increases production, so the cost of financing is outweighed by the advantages gained.
One early question we had to answer was how much of the financial burden the dealer should carry. We had little experience by which to gauge the magnitude of the risk which dealers would actually assume under their unrestricted endorsement of the purchaser's obligation. In addition to the risk of resale loss on repossessed collateral, there was also the hazard that the collateral, the car itself, might disappear through conversion by the purchaser or confiscation by the government, or become worthless through total or partial collision loss.
In 1925, as a result of a thorough study by A. L. Deane, then a vice president of GMAC, a modification was adopted which limited the risk on the part of the dealer. Under this revised plan, GMAC agreed to absorb any losses on retail transactions if the collateral could not be returned to the dealer in reasonable condition within ninety days after the first default of the customer. Further, it provided that a certain percentage of the GMAC finance charge would be placed to the credit of the dealer to establish a reserve fund against which any losses on the sale of repossessions could be offset. Thus, to a large extent, the profits of the dealer on all sales were freed from the hazard of being reduced by credit-sale losses.
Insurance protection against fire, theft, and collision hazards was made available at the same time by the organization of another General Motors subsidiary, General Exchange Insurance Corporation. This company offered insurance to customers who requested it, against physical damage to the car (not against such risks as public liability and property damage). This was important to the dealer since companies insuring automobiles were, in those days, highly selective and the purchaser could not always get the insurance that was often a prerequisite to financing. The idea of finance companies offering physical-damage insurance became broadly accepted, with some modifications, as a standard pattern for finance company relations with dealers. Today the company that offers the physical-damage insurance to installment purchasers is Motors Insurance Corporation, a subsidiary of GMAC.
At that time some finance companies relieved the dealer from responsibility for the unpaid balance of the retail credit transaction when the customer defaulted. This "non recourse" system had the disadvantage of reducing the dealer's interest in checking the soundness of the original credit. Also, it was more expensive to operate for a number of obvious reasons. Not the least of these was the fact that the finance company was not in a position to sell repossessions at as good prices as a franchised dealer. The purchaser eventually paid for the additional cost involved through a higher finance charge.
At first GMAC chose not to follow the so-called non recourse route. There were a number of reasons for this. Among them was this matter of cost to the consumer. GMAC felt it undesirable to relieve the dealer of all obligation on retail installment transactions. It felt that its plan, with its guaranty of the return of the collateral, would provide the necessary protection to the dealer at the lowest cost to the purchaser. Experience has proved this to be correct. However, because of competitive pressure, GMAC added a non recourse plan to its service.
The finance charge itself is an important element of the cost of a car. Throughout the years, both General Motors and GMAC have emphasized this fact. GMAC has pointed out that additional and unnecessary costs are incurred by the purchaser if the repayment time is unnecessarily long and the down payment lower than is justified. GMAC has campaigned against excessive financing charges— I think it fair to say it took the leadership in this matter. The man whose name is associated with GMAC more than anyone else's is John J. Schumann, Jr., who joined GMAC in 1919 and was its president for twenty-five years, from 1929 to 1954. He was a strong leader for sound practices and he put the stamp of his personality on the organization. In uncompromising terms he advanced policies and practices that were guided by the time-tested formula of honesty and square dealing.
In General Motors' annual report for 1937, in support of Mr. Schumann's policies, I wrote:
. . . charges to consumers in excess of an equitable minimum are not consistent with the policy of the Corporation in providing services to the end that the public may be adequately served by its dealers, at the lowest sound price.
History took some interesting turns in this connection. In 1935 GMAC announced the so-called "6% Plan." This told the public that they could get financing for 6 per cent per annum on the initial unpaid balance—the conventional form of computing finance charges and therefore a comparative basis for measuring the charges of competing finance companies. The actual rate on the money advanced, calculated on a true interest basis, was of course higher; but GMAC followed the convention and advertised it. GMAC believed that the "6% Plan" gave the customer a convenient, publicly known yardstick for measuring his actual finance charges. Competition did not like the GMAC "6% Plan." There were complaints to the Federal Trade Commission that this was an "unfair trade practice" which misled the public into believing that the stated finance charge was a simple interest rate. I thought it was made perfectly clear when we said in the advertising that the "6%" was a multiplier (i.e., not an interest rate), but the commission ruled that GMAC must discontinue using the term "67c"—in my opinion, to the advantage of high-rate finance companies and to the disadvantage of the consumer.
In 1938 the government attacked General Motors and GMAC, charging that General Motors dealers were required to use GMAC's financing service. General Motors denied that it had made such a requirement, and urged that our interest was confined to protecting the customer and to persuading our dealers to follow our policy of low customer rates.
The government, however, commenced criminal proceedings in South Bend, Indiana, against General Motors Corporation, General Motors Acceptance Corporation, two subsidiary companies, and eighteen executives. The trial was held in the fall of 1939 and terminated in an unusual and apparently inconsistent verdict acquitting all the personal executive defendants and finding the four corporate defendants guilty. Thereafter, the government commenced a civil action against General Motors and GMAC and the same two subsidiary corporations, based on the same charge that General Motors dealers were required to accept GMAC's financing services. In 1952, after a long contest with the Antitrust Division of the Department of Justice, we entered into a consent decree which set ground rules for the relations of General Motors and GMAC with the dealers. We have operated satisfactorily under these rules. Under them GMAC still conducts its business independently in competition with other financing organizations.
Toward the end of 1955, with a number of General Motors executives, I was requested to appear in Washington at a hearing conducted by the Senate Subcommittee on Antitrust and Monopoly. During this hearing, which was largely related to the issue of "bigness," the position of GMAC was discussed at some length. Some felt that GMAC should be disposed of by General Motors. I was interested in the conclusions in the report of the staff of the subcommittee, which state that General Motors has had a competitive advantage over other manufacturers of cars because it has owned a sales-finance company, and that it should be forced to divest itself of this activity.
But why? Plenty of money is available to other sellers of cars. The advantage GMAC offers to General Motors is a sympathetic relationship, equitable to the consumer. And I am glad to say that, in providing an economical service to consumers and dealers, it has built a profitable business for General Motors.
Many others in more or less similar types of industry recognize the value of a sales-finance subsidiary—for example, General Electric Company with its General Electric Credit Corporation, and International Harvester Company with its International Harvester Credit Corporation. The suggestion that General Motors or any other company should be deprived of a sales and distribution tool operated in the interest of the consumer strikes me as very unusual in our scheme of things. To me it would seem that it can stem only from those elements which attacked, for their own gain, the earlier farsighted and public-minded activities of GMAC and the policy that the public should be treated fairly with respect to service and the cost of such service.
I subscribe to the simple truth expressed by Charles G. Stradella, then president of GMAC, to the subcommittee in 1955. He said:
In its association with General Motors Corp., GMAC may have advantages. In all probability, there are dealers who are influenced by the assurance of continuity of service, community of interest, fair treatment, et cetera, which go with the association. Lenders [to GMAC] are influenced by the assurance of adequate capitalization, sound management and conservative financial policies and practices. On the other hand, unless these advantages were supported by the record of GMAC and its aggressive pursuance of sound practices, the association would do it little good in the eyes of the parties concerned.
GMAC helped to bring consumer financing into being in the early days. It has had an influence on keeping the terms of down payments and time span on a reasonably conservative basis. Its disciplinary influence in the direction of reasonable rates to the customer is gradually being taken over by legislation; more than half the states now set maximum rates by state law. I believe the time is not far off when all the states will have rate legislation. In my personal opinion, this is the right procedure provided the states set reasonably low rate ceilings in the consumer's interest.
While legislation may be desirable to control effectively the maximum charge which the public must pay for the privilege of installment credit, I have never felt that other conditions of the transaction between the dealer and the purchaser, such as down payment and length of time, should be regulated, except in the case of national emergency. This does not mean that I have not been aware, along with others, of the dangers of over expansion of consumer credit. The record is clear that GMAC has been continually interested in discouraging unduly small down payments and in keeping the length of term within reasonable limits. I think I might add that conservative financing is essential to the health of the automobile industry. The man who pays too little down and takes too long to pay will have no equity with which to come back soon for a new car.
In late 1955 considerable concern was expressed in many quarters that consumer credit might have been over expanded and that down-payment and term control might have become too loose. In my opinion the facts did not warrant such conclusions. There was agitation for legislation to control consumer credit in order to check inflation. In his economic report of January 1956 the President of the United States raised the question whether permanent authority for standby control of consumer credit by some governmental agency would be a useful adjunct to other stabilizing measures. The study of this question was assigned by the President through the Council of Economic Advisers to the board of governors of the Federal Reserve System. We, with many others, responded to the questionnaires issued during the course of the study and stated the reasons for our belief that permanent standby controls, to be operated by a government agency, were unnecessary; that generally the control of consumer credit can safely be left in the hands of consumers and lenders until Congress identifies specific circumstances which dictate otherwise, or a national emergency calls for presidential action. A statement of the Federal Reserve Board released in 1957 found, among other things, that "fluctuations in consumer installment credit have been generally within limits that could be tolerated in a rapidly growing and dynamic economy "; that "a special peacetime authority to regulate consumer installment credit is not now advisable," and that "the broad public interest is better served if potentially unstabilizing credit developments are restrained by the use of general monetary measures and the application of sound public and private fiscal policies." I agree with these ideas
So far as GMAC is concerned, I would say in brief that it offers a sen-ice related to the product and in the interest of the consumer. The advantages to the customer, the dealer, and the corporation seem obvious to me.