FacebookTwitterGoogle+RedditEmail

Subprime Auto Loans: the Next Shoe to Drop?

shutterstock_280510289

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?

Screen Shot 2016-03-17 at 5.07.13 PM

More articles by:

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 fergiewhitney@msn.com.

January 16, 2019
Patrick Bond
Jim Yong Kim’s Mixed Messages to the World Bank and the World
John Grant
Joe Biden, Crime Fighter from Hell
Alvaro Huerta
Brief History Notes on Mexican Immigration to the U.S.
Kenneth Surin
A Great Speaker of the UK’s House of Commons
Elizabeth Henderson
Why Sustainable Agriculture Should Support a Green New Deal
Binoy Kampmark
Trump, Bolton and the Syrian Confusion
Jeff Mackler
Trump’s Syria Exit Tweet Provokes Washington Panic
Barbara Nimri Aziz
How Long Can Nepal Blame Others for Its Woes?
Cesar Chelala
Violence Against Women: A Pandemic No Longer Hidden
Kim C. Domenico
To Make a Vineyard of the Curse: Fate, Fatalism and Freedom
Dave Lindorff
Criminalizing BDS Trashes Free Speech & Association
Thomas Knapp
Now More Than Ever, It’s Clear the FBI Must Go
Binoy Kampmark
Dances of Disinformation: The Partisan Politics of the Integrity Initiative
Edward Curtin
A Gentrified Little Town Goes to Pot
January 15, 2019
Patrick Cockburn
Refugees Are in the English Channel Because of Western Interventions in the Middle East
Howard Lisnoff
The Faux Political System by the Numbers
Lawrence Davidson
Amos Oz and the Real Israel
John W. Whitehead
Beware the Emergency State
John Laforge
Loudmouths against Nuclear Lawlessness
Myles Hoenig
Labor in the Age of Trump
Jeff Cohen
Mainstream Media Bias on 2020 Democratic Race Already in High Gear
Dean Baker
Will Paying for Kidneys Reduce the Transplant Wait List?
George Ochenski
Trump’s Wall and the Montana Senate’s Theater of the Absurd
Binoy Kampmark
Dances of Disinformation: the Partisan Politics of the Integrity Initiative
Glenn Sacks
On the Picket Lines: Los Angeles Teachers Go On Strike for First Time in 30 Years
Jonah Raskin
Love in a Cold War Climate
Andrew Stewart
The Green New Deal Must be Centered on African American and Indigenous Workers to Differentiate Itself From the Democratic Party
January 14, 2019
Kenn Orphan
The Tears of Justin Trudeau
Julia Stein
California Needs a 10-Year Green New Deal
Dean Baker
Declining Birth Rates: Is the US in Danger of Running Out of People?
Robert Fisk
The US Media has Lost One of Its Sanest Voices on Military Matters
Vijay Prashad
5.5 Million Women Build Their Wall
Nicky Reid
Lessons From Rojava
Ted Rall
Here is the Progressive Agenda
Robert Koehler
A Green Future is One Without War
Gary Leupp
The Chickens Come Home to Roost….in Northern Syria
Glenn Sacks
LA Teachers’ Strike: “The Country Is Watching”
Sam Gordon
Who Are Northern Ireland’s Democratic Unionists?
Weekend Edition
January 11, 2019
Friday - Sunday
Richard Moser
Neoliberalism: Free Market Fundamentalism or Corporate Power?
Paul Street
Bordering on Fascism: Scholars Reflect on Dangerous Times
Joseph Majerle III – Matthew Stevenson
Who or What Brought Down Dag Hammarskjöld?
Jeffrey St. Clair - Joshua Frank
How Tre Arrow Became America’s Most Wanted Environmental “Terrorist”
Andrew Levine
Dealbreakers: The Democrats, Trump and His Wall
Jeffrey St. Clair
Roaming Charges: Que Syria, Syria
Dave Lindorff
A Potentially Tectonic Event Shakes up the Mumia Abu-Jamal Case
FacebookTwitterGoogle+RedditEmail