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What’s Behind the Subprime Auto Loan Fiasco? (Video)

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As we reported last week, a record 7 million Americans have fallen 90 days or more behind on their auto loan payments. That’s 1 million more than the previous peak in auto loan delinquencies in 2010. But as Wolf Street points out, there is a big difference between then and now.

Serious auto-loan delinquencies are now on par with Q2 2009 when millions of people had lost their jobs and when the economy was in free-fall. But today unemployment is low and the economy appears to be humming. What gives? “

Currently, there is about $1.3 trillion in auto loans outstanding. Looking at auto loan delinquencies in terms of a percentage of the total outstanding, the number hit 4.5% at the end of 2018. This is the same percentage as in the second quarter of 2009 as the economy was feeling the full effect of the 2008 crash.

Wolf Richter of Wolf Street highlighted some of the reasons for the surge in auto loan delinquencies in a recent episode of the Wolf Street Report.

In the first place, a lot of Americans are struggling with their jobs.

While the unemployment rate is at around 4% and has been as low as 3.7%, there are many pockets of weakness in the labor market. A lot of people have gig work. A lot of people are underpaid. Their wages have not gone up with inflation. People have been discouraged and they’re not participating in the labor force anymore, and so they don’t show up in unemployment figures. So, there are many weaknesses in this labor market.”

Even so, Richter said it’s still the “cleanest dirty shirt of the labor market” we’ve had in a number of years, so the labor market itself cannot completely explain the surge in auto loan delinquencies.

A second issue is the rapidly rising cost of new cars. The average price of a new vehicle is now around $36,000. This represents a significant increase in the cost of vehicles and there has not been a corresponding rise in wages. Subprime borrowers face a double whammy. They not only have to pay the higher price; they also get hit with a higher interest rate.

A third, and according to Richter probably the most significant issue, is the number of subprime lenders who have plowed into the auto business over the last 10 years. This is an extremely profitable business for the lender, but an extremely risky position for the borrower.

These are precisely the kind of customers who can’t afford those payments, and cannot afford to make those payments based on high interest rates, and they can’t even afford that expensive of a car.”

The auto business actually looks a lot like the subprime housing market we saw blow up in the years leading up to the 2008 crash. These companies make risky loans. They use sloppy underwriting techniques. And then they package the loans together in auto loan-backed securities and sell them.

By 2018, the air was coming out of the auto bubble. A number of these specialized subprime auto lenders had already collapsed. Richter said now we’re starting to see many of these companies curtail their lending.

Of course, it’s not just specialized companies making subprime loans. According to Richter, about 25% of the auto loans on the books of big banks are subprime. Credit unions have also gotten into the business.

The big difference between the subprime auto loan market today and the subprime housing market in the years before the crash is one of scale. A collapse in the subprime auto market will cause some pain, but it won’t likely bring down financial institutions.

But that doesn’t mean this isn’t extremely problematic. The real question is how will the looming credit crunch affect the auto industry – an important part of the US economy? Richter says we’re already seeing the impact.

In 2015 and 2016, US automakers experienced record years. Since then, we’ve seen a downturn. As default ratios spike, lenders become more careful and that squeezed more and more potential customers out of the market.

As auto-loan delinquencies continue to surge, as those losses are spreading, underwriting will continue to tighten and will make it more difficult for an entire layer of customers to buy new vehicles.”

And this is the rosy scenario. The real question is what happens if the economy goes into recession? What happens if we see growing job losses?

This gives us a glimpse of the underlying rot in the US economy. The Federal Reserve flooded the country with easy money. That blew up all kinds of bubbles, including the auto lone bubble. The simple truth is economies built on debt aren’t sustainable.

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