Residential Capital (ResCap)

Residential Capital (often shortened to ResCap) was a massive American mortgage company and, more importantly for investors, a cautionary tale from the heart of the 2008 financial crisis. As a subsidiary of GMAC Inc. (which later became Ally Financial), ResCap was once a titan of the U.S. housing market. Its primary business involved mortgage origination (creating home loans) and servicing (collecting payments). However, its most fateful activity was bundling these mortgages into complex financial products known as mortgage-backed securities (MBS) and selling them to investors worldwide. ResCap's aggressive expansion into the risky subprime mortgage market ultimately led to its spectacular collapse. When the housing bubble burst, the poor-quality loans it held and had sold imploded, triggering billions in losses and a flood of lawsuits. The company filed for Chapter 11 bankruptcy in 2012, marking one of the largest corporate failures of the crisis. For today's investor, the story of ResCap is a powerful lesson in understanding hidden risks, the dangers of complexity, and what can happen when a company prioritizes short-term profits over long-term stability.

Before its downfall, ResCap was an engine of the housing boom. Its connection to GMAC, the financial arm of General Motors, gave it an air of legitimacy and stability. Investors and financial institutions felt secure dealing with a company backed by such a well-known corporate parent. This perception of safety allowed ResCap to borrow money cheaply and expand its operations at a breathtaking pace. Its business model seemed brilliant during the good times. It would originate a mortgage, sell it off as part of a security, and collect a fee. This process of bundling loans into tradable assets is known as securitization. The problem was the quality of the ingredients. To feed the market's insatiable appetite for high-yield investments, ResCap waded deeper and deeper into the subprime pool, lending to borrowers with poor credit histories.

The collapse of the U.S. housing market starting in 2007 exposed the rot at ResCap's core. Its failure was driven by a perfect storm of factors that investors should study and remember.

• The Subprime Bet: ResCap's profits were built on a foundation of sand. It had originated and guaranteed trillions of dollars in mortgages, a huge portion of which were subprime. When homeowners began defaulting en masse, ResCap was on the hook.
• Put-Back Demands: A critical blow came from “put-back” demands. When ResCap sold mortgage-backed securities, it often guaranteed the quality of the underlying loans. When investors (like Fannie Mae and Freddie Mac) discovered the loans were junk, they legally forced ResCap to buy them back at face value. This created a cash drain the company could not survive.
• Litigation Tsunami: Buried in worthless securities, investors, bond insurers, and government agencies all sued ResCap, alleging fraud and misrepresentation. The legal fees and potential settlements were overwhelming.

The sheer weight of these obligations forced ResCap into one of the most complex bankruptcies in U.S. history, effectively wiping out its shareholders.

The ResCap saga offers timeless lessons that go to the heart of the value investing philosophy. While you couldn't invest in ResCap directly (it was a subsidiary), its parent company, GMAC, was publicly traded. Understanding the risks within its subsidiaries was key to properly valuing the parent.

• Lesson 1: Always Look Under the Hood. A famous parent company is not a guarantee of quality. A diligent investor would have examined GMAC's financial reports and noticed the massive and growing exposure its ResCap unit had to the subprime market. Never invest in a company without understanding all its major operating parts.
• Lesson 2: Beware of “Black Box” Businesses. ResCap’s business revolved around complex, opaque securities. As Warren Buffett advises, “Never invest in a business you cannot understand.” If a company's profit source is wrapped in layers of financial engineering and jargon, it’s a red flag. Simplicity and transparency are the friends of the long-term investor.
• Lesson 3: Respect Cycles and Scrutinize Earnings Quality. The housing market is notoriously cyclical. ResCap leveraged itself to the hilt at the very peak of the cycle, a classic error. Furthermore, its massive “profits” weren't from a durable competitive advantage but from underwriting low-quality loans. Always ask: Where are these earnings coming from, and are they sustainable? The answer for ResCap was a resounding no.