The Federal Reserve bank gave an early Christmas present to General Motors' finance arm, allowing the ailing provider of auto loans to qualify for the government's $700 billion rescue fund.

The Fed announced late last Wednesday that it had approved GMAC Financial Services' request to become a bank holding company. That designation makes GMAC eligible to receive a portion of the bailout fund and get emergency loans directly from the Fed. The plan also significantly reduces the ownership stakes of GM and Cerberus Capital Management, LP, in GMAC.

Analysts had speculated that without financial help, GMAC would have had to file for bankruptcy protection or shut down, dealing a serious blow to GM's own chances for survival. The Fed cited "emergency conditions" in justifying its decision.

Before the Fed's decision, GMAC was facing a crucial deadline Friday to complete a deal with its bondholders that would allow it to exchange debt for equity.

Struggled to convince investors

GMAC was struggling to convince investors to provide the capital that it desperately needed to win approval to become a bank holding company. The US central bank acted before the debt deal deadline, which stood until Friday.

The Fed's move to provide government aid to one of America's biggest suppliers of auto loans was just the latest extension of the federal bailout programme, initially designed to shore up ailing banks. As the credit crisis kept ballooning, the programme expanded to include insurers, credit card companies, and the automakers themselves. Just last week, President George W. Bush ordered an emergency bailout of the industry, offering $17.4 billion in rescue loans, and citing imminent danger to the US economy.

"To make the auto package complete they had to do something with the financing," said David Cole, chairman of the Center for Automotive Research. "It's really tied to the whole survival of the industry."

Huge impact

"GMAC was basically frozen," he said. The Fed's move "has a huge impact on dealers and consumers. ... The Fed wanted to avoid a disaster in the automotive sector very, very badly for the cascading factor it would have on the overall economy."

In a statement, GMAC praised the Fed's action.

"This is a very significant positive step for the company, and it marks a key turning point in our 89-year history," said spokeswoman Gina Proia. "GMAC believes becoming a bank holding company is the best long-term solution to provide automotive and mortgage financing to consumers and business,including auto dealers."

She said the change in status would provide the company with "improved access to funding".

GMAC provides financing for both GM dealers and customers as well as home mortgage loans through its Residential Capital LLC division. If forced to file for bankruptcy, funding would have been cut off to roughly 85 per cent of GM's North American dealers.

The company is 51 per cent owned by Cerberus. General Motors Corp. owns the remaining 49 per cent. But because those companies' businesses are mainly outside banking, they must cut their ownership so that GMAC qualifies as bank holding company.

GM has committed to reducing its ownership in GMAC to less than 10 per cent. Cerberus was ordered to reduce its stake to 33 per cent of total equity in the company.

The Fed's decision was announced after the close of a shortened trading day on Wall Street. GM shares closed up more than 8 per cent earlier Wednesday.

The Fed said the plan will "benefit the public by strengthening GMAC's ability to fund the purchases of vehicles manufactured by GM and other companies and by helping to normalise the credit markets for such purchases."

Earlier last week, analysts suggested that the government was working behind the scenes to save GMAC, as the company struggled to get bondholders to convert 75 per cent of their debt into equity of the company, a prerequisite for becoming a bank holding company.

Future uncertain

Meanwhile, the future of Chrysler Financial, Chrysler's financing arm, is also uncertain. Earlier this month, the company that provides financing for 75 per cent of Chrysler dealers said it could be forced to temporarily suspend funding for showroom inventories if dealers keep pulling large amounts of their money out of an account used to fund those loans.

Ford Motor Credit Co, which expects to report its first year of losses in 2008, has applied for an asset-backed securities loan facility administered by the Federal Reserve. It has already drawn on 25 per cent, or $4 billion under the commercial paper funding facility.

Ford Motor Credit spokeswoman Brenda Hines said the company has no intentions of going through the process to become a bank holding company.

"We just don't think it's necessary from our standpoint," she said.

The decision to change the status of GMAC to a bank holding company follows the Fed's action on Monday granting the request of CIT Group to become a bank holding company so that it could qualify for federal rescue funds.

Bank-holding status

The Fed also has granted bank-holding status to Goldman Sach's Group Inc, Morgan Stanley and American Express Co, all of which have changed their status in an effort to get access to more support after the financial crisis erupted with force in September.

Congress approved the bailout programme on October 3 with the original intent of buying up troubled mortgage assets.

That part of the programme has never been implemented. Instead, Treasury Secretary Henry Paulson switched course. He began an effort to use $250 billion of the $700 billion fund to make direct purchases of bank stock, to inject more funds into financial institutions and fight the most severe financial crisis in seven decades.

But the effort has come under attack from critics who say that the Bush administration is not overseeing the programmeme sufficiently to make sure that the banks actually increase their lending.

Many lawmakers are also upset that the programmeme has already obligated half of the $700 billion total without making a serious effort to help troubled homeowners avoid a rising tide of mortgage foreclosures.