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Subprime Auto Loans: The Next Shoe to Drop?
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Booming auto sales have more to do with low rates and easy financing than they do with the urge to buy a new vehicle. In the last few years, car buyers have borrowed nearly $1 trillion to finance new and used autos. Unfortunately, much of that money was lent to borrowers who have less-than-perfect credit and who might not be able to repay the debt. Recently there has been a surge in delinquencies among subprime borrowers whose loans were packaged into bonds and sold to investors. The situation is similar to the trouble that preceded the Crash of 2008 when prices on subprime mortgage-backed securities (MBS) suddenly collapsed sending the global financial system off a cliff. No one expects that to happen with auto bonds, but story does help to illustrate that the regulatory problems still haven’t been fixed.

In a recent article in the Wall Street Journal, author Serena Ng uses the performance of a bond issue called Skopos Auto Receivables Trust to explain what’s going on. She says:

“The bonds were built out of subprime auto loans and sold in November. Through February, about 12% of the underlying loans were at least 30 days past due, a third of which were more than 60 days delinquent. In another 2.6% of loans, borrowers had filed for bankruptcy or the vehicles had been repossessed.” (“Subprime Flashback: Early Defaults Are a Warning Sign for Auto Sales“, Wall Street Journal)

Check out those dates again. If a loan, that was issued in November, is 60 days delinquent by February, it means the borrower never even made the first payment on the debt. How can that happen unless the lender is deliberately fudging the underwriting to “slam the sale”?

It can’t, which means that dealers are intentionally lending money to people they know won’t be able to pay them back.

But why would they do that?

It’s because they know they can offload the crappy loans on Mom and Pop investors looking for a slightly better rate of return than they’ll get on ultra-safe US Treasuries. That’s the whole nine-yards, right there. Selling vehicles is just a cover for the real objective, which is creaming big profits off toxic paper that will eventually sell for pennies on the dollar. Ka-ching!

The problem is NOT subprime borrowers who pay much higher rate of interest on their loans than more creditworthy customers. The problem is dodgy lenders who game the system to line their own pockets. That’s the real problem, and the problem is getting more serious all the time. According to the WSJ:

“The 60-plus day delinquency rate among subprime car loans that have been packaged into bonds over the past five years climbed to 5.16% in February, according to Fitch Ratings, the highest level in nearly two decades. The rate of missed payments is higher for loans made in more recent years, a reflection of more liberal credit standards and the larger number of deals from lenders serving less creditworthy customers, according to Standard & Poor’s Ratings Services…

“What’s driving record auto sales is not the economy, but record auto lending,” said Ben Weinger, who runs hedge fund 3-Sigma Value LP in New York and who has bearish bets on some auto lenders. He said demand for auto debt has led lenders to systematically loosen underwriting standards, which he predicts will result in higher loan delinquencies.” (WSJ)

“Liberal credit standards”?? Is that what you call it when you lend thousands of dollars to someone who someone who doesn’t have a job, an address or a credit card?

Sheesh.

While it’s true that delinquencies are rising, it’s not true that subprime borrowers don’t pay their bills. They do, in fact, subprime lending can be extremely lucrative provided lenders do their homework. But when a lender is merely the middleman in a larger transaction, (like when the debt is bundled into a bond and sold to Wall Street) he has no incentive to make sure that everything checks out. His goal is to grind out as many loans as possible and let the investor worry about the quality. After all, what does he care if the loan blows up or not? It’s no skin off his nose.

Keep in mind, the auto dealers really clean house on these garbage loans too. The average rates on these turkeys exceed 20 percent while loan duration typically lasts for about 6 years. That’s a serious chunk of money drained directly from the paychecks of the poorest and most vulnerable people in society; the same people who are stuck forever in low-paying service sector jobs that barely pay enough to keep food on the table or gas in the tank. These are the victims in this loan-sharking swindle, the people who desperately need a car to get to work to feed their kids, and then find themselves shackled to a long-term obligation that just makes matters worse. Here’s more from the WSJ:

“Before making loans, Skopos said it verifies information, including borrowers’ employment and whether they actually made cash down payments. For those with no credit score, it looks at alternative metrics, like how they pay phone bills. “We interview every customer before we fund the loan,” Skopos CEO Daniel Porter said, adding that individuals with no credit histories are often young working adults who are more motivated to keep making payments.”

They check to see if they pay their phone bills? That’s what they call “underwriting”? What a joke!

By now you’re probably wondering how this whole subprime nightmare resurfaced just 8 years after Wall Street blew up the financial system? Wasn’t Dodd-Frank supposed to fix all that?

Sure, it was, but the powerful auto lobby in Washington managed to carve out a special exemption for themselves that allows them to shrug off the new reforms and continue the same risky behavior as before. That’s why this auto-loan scam has morphed into a ginormous Hindenburg-like bubble that poses a looming threat to financial stability. It’s because the big money guys twisted a few arms on Capital Hill and got what they wanted. Money talks. Here’s more from the WSJ:

“Banks had $384 billion of auto loans on their books at the end of last year, but households had auto-loan balances of over $1 trillion, according to Federal Reserve data. Indeed, Fitch Ratings warned last week that delinquencies of over 60 days on securities backed by subprime auto loans hit almost 5% in January. That is the highest since September 2009 and close to the record peak hit that same year.

Rock-bottom interest rates and record-breaking car sales have combined to put auto lending into overdrive, making some skids inevitable. While those should be more than manageable for the banking system, individual firms that went too fast into the curve by lowering underwriting standards may have a rougher ride.” (“Why Auto Lenders Are in for a Rougher Ride“, Wall Street Journal)

You know what comes next, don’t you? The delinquencies start piling up, the finance companies begin to creak and groan, the banks and other counterparties hastily selloff assets to try to stay afloat, and, finally, the Fed rides to the rescue with another batch of emergency loans to prevent the whole wobbly, over-leveraged system from crashing to earth.

Of course, we could just pass legislation that made it a criminal offense to intentionally issue loans to anyone who fails to meet strict, government-approved underwriting standards. But then we’d never have these excruciating economy-busting financial crises anymore.

And what fun would that be?

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at [email protected].

(Republished from Counterpunch by permission of author or representative)
 
• Category: Economics • Tags: Banks 
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  1. What about the idea of forcing car dealers to repurchase loans in default? Years ago, I think the financing arm of Deere and Co. had a policy of forcing a dealer to repurchase the “paper” (note and associated security interest documentation) from the financing company when a purchaser went into default. Deere & Co would help with the repossession, but the bad loan went back onto the dealer’s books. If dealers knew that bad loans would come back to haunt them, their incentive to lend to very risky borrowers would be reduced. Of course, Deere didn’t securitize the loans but i don’t think a version of the Deere system would be impossible.

    • Replies: @Big Bill
  2. You can criticize these loans without defending the losers who take them out.

    Nobody needs a new car. $5,000 is the most anyone needs to spend for reliable transportation, and you can easily get away with a lot less.

    The people who take out subprime auto loans for new cars are irresponsible dipshits.

    That said, a sensible financial system would prevent dipshits from harming themselves this way.

    • Replies: @Heymrguda
    , @tbraton
  3. Heymrguda says:
    @Thorfinnsson

    Right you are. In 2010 we were in temporary $ difficulties & got an ’04 Mercury sable wagon for $5000. Still runs like a rr locomotive.
    You can get a good car for $5k or even less if you’re patient and have some mechanical knowledge.

    • Replies: @Grandpa Jack
  4. @Heymrguda

    What you say is true, but how much mechanical knowledge do most buyers have?

    Maybe you buy a 7 yr old car that runs like a finely-tooled Swiss watch for the next decade, or maybe you buy one that starts going to crap 6 months later, and costs you more every few months than what you’d be shelling out in car payments for a better ride. Not to mention that you’d better have a forgiving boss (and a forgiving girlfriend) if your transportation is unreliable. Even having a mechanic look it over before buying is no guarantee. I’ve bought used cars that have gone both ways, even with getting a mechanic to check them out ahead.

    That being said, a lot of poor people do go for more wasteful “bling” in their cars than people who are more financially secure.

  5. Big Bill says:
    @Diversity Heretic

    Deere became a “bank holding company” in the last desperate days of 2008. I have a feeling they may have gone full ‘tard since then. They have been investing in stock buybacks ever since. Money that has not gone into R&D for improved products.

  6. Alfa158 says:

    I remember about ten years back Mitsubishi had a brilliant idea to give cars to college students who had no credit, jobs, or permanent addresses, presumably because they could build brand loyalty among young educated adults. As I remember, the deal was that the payments would be deferred for the first year with the idea that once the kids graduated and got jobs they would catch up on the payments. There was a TV commercial for the offer depicting a diverse group of hipster looking kids riding around in a Mitsubishi listening to hipsterish music.
    Needless to say it was a fiasco. A lot of kids leave college with no real jobs and don’t always leave any forwarding address. In thousands of cases, the company not only never collected a payment, but Mitsubishi could not even track down the cars to repossess them. Ended some careers at Mitsubishi USA and helped further drive their US auto business into the dirt.

  7. Wally says: • Website

    Of course, we could just pass legislation that made it a criminal offense to intentionally issue loans to anyone who fails to meet strict, government-approved underwriting standards.

    Hellooo.

    All we’ll get is more hollow claims of “racism” and “discrimination”.

    Those issuing the loans are simply doing what Big Government Left is demanding of them.

  8. tbraton says:
    @Thorfinnsson

    I agree. It’s amazing how much you can save simply by buying an older, used car. I was talking to a friend a few weeks back, and he had just bought a used van for use in his business. The van had a lot of mileage on it, but he paid just $500 for it, figuring he could get at least three to five years out of it before buying a “new” vehicle. The same applies to boats. Only a fool would buy a new boat, when you can buy a relatively new boat with few miles on the engine(s) for roughly 1/3 the price of a new boat. When I heard that Marco Rubio had shelled out $80,000 for a new 24 foot boat, I concluded he was a total fool since he could have bought the equivalent used boat of the same size for about a third of that price. The problem is that it takes a little time and a lot of brains to locate the real bargains, either in cars or boats.

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