Saturday, November 5, 2016

How are subprime auto loans like subprime housing loans?

From Doug Holtz-Eakin's characterization of the financial crash of 2009:
Excess liquidity, combined with rising house prices and an ineffectively regulated primary mortgage market, led to an increase in nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay.

Now we get the FT's characterization of the subprime auto loan industry:

...lenders have relaxed lending standards, offering bigger loans to consumers and giving them more time to pay the loans back, resulting in borrowers taking on debt that they may not be able to repay. The auto loan market has grown from $750bn in 2011 to $1.1tn at the end of June, according to data from the US Federal Reserve. 
The issue is particularly acute for the subprime ABS market, where issuers take loans from less creditworthy borrowers and package them up into bonds that are then sold to investors. 

But maybe this time will be different:
..so far, the risks have not turned to reality in the ABS market. Wells Fargo notes in a recent report that there have been 435 ratings upgrades across the subprime auto sector this year, and no downgrades. Borrowing costs for issuers across the subprime spectrum have also reduced through 2016 as investors continue to clamour for the relatively high returns offered by the products.

4 comments:

  1. If past is prelude, then the past housing bubble should be a lesson to auto loan companies. According to the FT article, the current auto loan defaults this year are projected to be 1.7 million this year. This is surprising as auto loan defaults peaked between 1.8 million to 1.9 million respectively between the years of 2008 to 2009, which was during the housing market crash. Now that subprime auto loans are being packed as bonds, investors are more interested in the high returns that the bond products offer. The bigger issues are the same issues that contributed to the housing bubble, lack of regulation. More and more non-bank institutions are creating loans that have longer repayment periods than usual which makes borrows able to buy vehicles that they could not normally afford. This is compounded by the fact that these non-bank institutions are not regulated like banks, so essentially there is a lack of regulation as they use securitization markets or private equity firms. Competition is good but in this case, companies want to get as many of their vehicles out to consumers in the subprime sector as they can to keep their profits up. I guess greed pushes aside the lessons learned during the housing market crisis when some firms went out of business and ruin many people’s lives. Essentially greed is driving contempt.

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  3. If you don’t know your history, you’re bound to repeat it.

    The lessons that should have been learned after the subprime housing bubble burst appear to have been forgotten now that subprime auto loans are gaining popularity. As a result of the housing crisis, various regulations were created to, in essence, save us from ourselves. The same type of regulations were not created in other financial sectors. It’s almost as if regulators and the public don’t believe that the markets can be impacted in the same fashion as in the previous financial crash.

    This election cycle candidates attempted to address issues related to regulations. Unfortunately, I think that so many people don’t understand how regulations can impact their daily lives and future. Also, since regulations are often stigmatized as causing businesses unnecessary costs and labor, many fail to see the value of regulations.
    I wouldn’t be surprised if auto subprime loans are the next sector cause a financial crash. I personally know a 78 year old man who took a loan out to buy a new $40,000 car. This man has no discretionary income or pension but yet he was approved for the loan. Homes and cars have always been used as barometers of wealth. Maybe now that it’s more difficult for potential homebuyers to get their desired homes, they’ll use cars as their main status symbols.

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