Auto loans are a driver of the expansion, but might be running out of gas

Summary:  Modern history consists to a scary extent of boys with toys. Powerful tools used irresponsibly: Atomic weapons, nuclear power plants, debt, and (God help us, genetic engineering). The decades of the Cold War featured several terrifying close calls with nukes. Now we’re suffering the effects of imprudent debt accumulation, and are likely to for another decade. Today we look at auto loans (a follow-up to our November post). Along with student loans they’re a hot front in the household debt crisis.

Consumer debt head volcano

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Contents

  1. The secret to rising auto sales
  2. The bad news about those loans
  3. Perhaps the slowdown has already begun
  4. For More Information

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(1)  The secret to rising auto sales

November’s post pointed to a disturbing Bloomberg article about auto loans: “Good Job Is Good Enough as Subprime Car Buyers Lift Sales“.  Car loans are being made with an average maturity of 62 months and high loan-value levels (80%), so that a high fraction will have no equity if they default. And to make that more likely, lenders were boosting sales by increasing lending to sub-prime buyers. During the past 5 months the problem has grown worse.

Why is this important? Because auto sales have been one of the major drivers of the recovery. As shown by Atif Mian and Amir Sufi in “Another Debt-Fueled Spending Spree?“, at their website, 31 March 2014:

House of Debt: auto sales
House of Debt: auto sales, 31 March 2014

With little growth in real wages for most Americans since 2009, how have we managed to splurge on new cars? Mian and Sufi show the answer: a surge in auto loans:

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House of Debt: auto loans
House of Debt, 31 March 2014

(2)  The bad news about those loans

Auto loans, like all debt, serve a valuable purpose unless improperly used.  As they are today.

(a) More car loans exceed 6 years as prices rev“, USA Today, 12 March 2014 — Excerpt, describing the madness (car loans of 72 – 84 months!):

That came as the average amount financed for a new car was the highest since 2008, averaging $27,430 in the quarter, Experian says, with an average monthly payment of $471. Long-term loans make costlier cars seem more affordable, but leave buyers with higher overall costs for the car and more time owing more than it is worth.

J.D. Power’s Power Information Network (PIN) found the long-loan trend continued into last month with a record 33.1% of loans at 72 months or longer, with 84 months or longer at 3%.

PIN also found more cash-strapped buyers getting lower payments by leasing, which hit a record at 26.5% of new-car transactions last month.

Both trends point to how expensive new vehicles have become. The transaction price — what customers actually paid — was $32,319 last month, 2% higher than a year ago, Kelley Blue Book reports.

(b) Out of Gas: Most Americans Can’t Afford New Cars“, NBC News, 25 March 2014 — Excerpt:

For many Americans, new cars are driving out of reach. Jose Hernandez, 24, lives in East Los Angeles and makes $26,000 a year working the front desk at a clinic. After trading in his previous car with $6,000 in negative equity, he financed a 2013 Civic EX for $25,000 at 2.3% for 6 years, paying $379 in monthly payments, plus $100 per month in insurance.

… Car ownership has long sat at the core of what it means to “make it” in this country. If you want to get to and around the suburbs, you’ll need to drive.

It’s an aspiration that’s slipped from the grasp of most, as a new report finds the average new car unaffordable for the average American family in 24 of the 25 largest U.S. metro areas. Except for Washington, D.C., median-income households in those areas fell shy of the $32,086 in annual salary required to buy an average new car, the Interest.com analysis found.

(3)  Perhaps the slowdown has already begun

Large numbers of subprime loans on cars with negative equity, driven by people who need a car but cannot afford new cars (often, cannot afford even recent used cars). It’s a song similar to one we heard before, and one that does not end well. Without gains in jobs and wages, this trend cannot continue much longer.

These loans might not default in large numbers, even in a recession. But car sales driven by rising subprime loans suggest that economists’ rosy forecasts for auto sales might be disappointed — eliminating a major driver of US economic growth. If subprime growth slows, instead of the widely expected “Red, White, and Boom” taking the US economy to “escape velocity” after years of slow growth, 2014 might give us another year at stall speed (that’s 2%; GDP in 2013 was +1.9%).

The new subprime boom might already have played out. From “Subprime Auto Loan Performance: The Best Is Behind Us“, Amy S Martin and Naveen C George, Standard & Poor’s, 26 February 2014:

In our opinion, we’re at a turning point with respect to subprime auto loan performance, similar to where we were in 2006 (at the peak of the previous expansion).

The numbers support their conclusion.

  1. The 60 Day Delinquincy rates are rising. The rate on prime auto loans is at a 2 year high. The rate on subprime auto loans has risen strongly since the early 2012 trough, and are now at the highest since early 2010.
  2. Net Loss Rates (below): Both prime and subprime made a trough in early 2012. Both are now rising; subprime is the highest since early 2010.
  3. Recovery Rates (below): Prime hit a peak in early 2012 and are now the lowest since early 2010. Subprime is at the lows since early 2010.

Graphs from “US Auto Loans ABS Tracker”, S&P, 25 March 2014

S&P: automobile loans
“US Auto Loans ABS Tracker”, S&P, 25 March 2014

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S&P: automobile loans
“US Auto Loans ABS Tracker”, S&P, 25 March 2014

(4)  For More Information

Carrying a debt burden

Posts about debt:

  1. Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.
  2. A picture of the post-WWII debt supercycle, 26 September 2008
  3. Debt: the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  4. A look at our government’s debt – rising because we like to spend, 29 December 2009
  5. Rising consumer debt driving the recovery: boon or bane?, 10 November 2013

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13 thoughts on “Auto loans are a driver of the expansion, but might be running out of gas

  1. A few months ago, I read an article about the increase of passenger traffic in the USA. This actually fits these stories about subprime auto loans: people are squeezed dry by the crisis, but must still travel to go to work. So it is either going back to using public transport, or go into massive debt to have a car.

    So contrarily to what is often stated, things are actually not brightening for the US economy: people are now scraping the bottom of the barrel, and this means that the situation is very fragile.

    1. Guest,

      “Things are actually not brightening for the US economy”

      It depends if that is a statement about the past, present, or future.

      The economy has been growing slowly since 2009, and at only 2.2%/year for the past 3 years.

      2013 and the first quarter of 2014 were a bit slower than that.

      The future is the realm of dreams. Economists have good grounds for expecting faster growth.

      But all of that refers to “the economy”. Aggregate numbers. In fact, as you note, most people are experiencing much recovery because the gains are going to the top few percent.

      “The situation is very fragile”

      Yes. That is the significance of growth at “stall speed” (which is a theory). And the significance of unequally shared growth.

  2. Seems like neither the manufacturers, dealers or the lenders can wean themselves from subprime.

    A lot of people should not need cars to get to work. Perhaps they should live closer to where they work. At least get rid of the second car.
    But then that would trash the economy. Especially the part I feed of off.

    1. “Perhaps they should live closer to where they work.”

      If they are going into subprime loans to acquire a car, then they probably do not have the funds required to buy a house closer to where they work, or the necessary cushion to pay the initial outlays for a new house while they wait to sell the old one (it can take really long nowadays).

      Everything fits together: people are underwater with their homes, do not have buffers to sustain them when changing their life situation, barely enough money to buy a car (hence subprime loans) — when they are lucky, they use public transport.

      They have next to zero margin of tolerance for a new global or personal economic shock.

  3. dougp remarks: A lot of people should not need cars to get to work. Perhaps they should live closer to where they work.

    This is a failure in the design of American cities. For 60 years, from after WW II until around the year 2008 when oil prices spiked above $140 briefly, American cities were designed around the concept of cheap 7-cent-per-barrel oil made possible by the puppet dictatorships put in place in the middle east by the American and British military. Puppets like the Shah of Iran and the Saudi royal family, eager to sell cheap oil to their American and British protectors and happy to crush democratic middle eastern reformers like Mossadegh.

    This led to the design of cities as dense inner urban wastelands connected to vast suburbs by long freeways. No way to get from the suburbs to the cities by bicycle or by walking. Many cities do not even include sidewalks in much of their infrastructure: if you don’t have a car, you’re out of luck.

    This made sense when oil as cheap and America accounted for 80% of the world’s GDP and the U.S. military bestrode the world like a colossus. Today, America accounts for only about 25% of the world’s GDP, and the U.S. military can’t even defeat barefooted fifteen-year-old kids who are armed with bolt-action rifles in Afghanistan or Iraq.

    A good use of the largely wasted stimulus spending in 2009 would have been to knock down and rebuild American cities for the post-automobile era. Instead of suburbs located far from urban wastelands connected by giant freeways, mix housing and small businesses in the city and use light rail and trolleys and moped lanes and subways/elevated trains to enable mobility.

    That would have been a worthwhile expenditure of money. It would have kick-started the U.S. economy, created jobs, and prepared us for the end of the era of cheap oil. Instead, most of the stimulus sent to bailing out insolvent banks, which then sat on the cash to pay down their bad housing loans.

    America has not yet come to terms with the fact that large tracts of our country (Southern California and much of the American southwest, much of the midwest) are designed around obsolete infrastructure like freeways and obsolete transportation modes like the single-passenger automobile. The infrastructure of places like Los Angeles is simply unsustainable. It will either have to be torn down and rebuilt from scratch, or those regions of the United States will have to be abandoned, as the Dust Bowl was in the 1930s.

    1. Small businesses? Americans don;t shop at small businesses which support a local merchant class. They shop at big box stores and the internet. Supermarkets are now topping 200,000 square feet (Super Wal Marts and Super Targets) and even gourmet supermarkets top 50,000 square feet.

      But…of course… these require cheap oil to sustain, so….who knows what will happen. :)

    2. Thomas, I think you’re being overly dramatic about tearing down all the freeways. Even if there was no oil at all, I think LA freeways would still be congested with electric cars, just from the fact it’s an international business hub and with millions of people trying to get to and from somewhere. On the other hand, you might be happy to know that LA is in fact building a couple new light-rail and subways lines, as well as other major transit improvements to supplement what you might not realize is already a pretty extensive system that moves about a million and a half riders per day.

      I do completely agree with your other point, that building up infrastructure in our cities, especially public transit infrastructure and urban mixed-use real estate, would have been a much more productive use for those trillions of dollars in stimulus money. If you look at China’s cities now, compared with a couple decades ago, it’s pretty clear that doing exactly that is a huge part of how they pulled themselves out of the third world. Sometimes I wonder what would have happened if the Federal Reserve spent all the money from it’s Easing programs on municipal infrastructure bonds instead of T bills and MBS. My bold conjecture is that it would have been very bad for the banking sector, but pretty good for the rest of us.

    1. Mayer,

      I suspect you are unclear on the credit gig.

      (1) it is not binary (most things are not binary). It is about prices and terms.

      (2). Subprime refers to estimated ability of a borrower to replay. Credits don’t care how much the borrower needs the money.

      (3). A likely outcome is that subprime auto sales eventually will return to status pre-credit boom: lending small amounts of money at high rates with lower loan-value terms. That is, on older or beaten-up cars, not new ones –except at low loan-value ratios.

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