Summary: Let’s look at the small and large implications of the auto loan boom. It’s an example of our inability to learn, resulting in our credit-driven business cycles. Corporations profit from more sales and interest charges. People suffer from excessive debt burdens, and bankruptcies. Governments run deficits from the eventual busts. So it goes cycle after cycle since the New Deal era regulations were removed. Perhaps eventually we’ll learn, and a new era will begin.
Contents
- Auto lending
- Larger lessons
- For More Information
(1) Auto Lending
Madness is the failure of bankers and regulators to learn from the bankers’ imprudent greed that caused the housing bubble — and bust. With results we see today in auto lending.
… average automotive loan term reached an all-time high of 66 months … loans with terms 73-84 months grew to 25% of all loans originated during the quarter. …
The average amount financed for a new vehicle loan also reached an all-time high of $27,612 in Q1 2014, up $964 from the previous year. In addition, the average monthly payment for a new vehicle loan reached its highest point on record at $474 in Q1 2014, up from $459 in Q1 2013.
… Market share for nonprime, subprime and deep subprime new vehicle loans in Q1 2014 rose to 34%.
— Experian Automotive, 2 June 2014
A seven year car loan! Long-life loans to subprime borrowers is a recipe for defaults. Fortunately lenders have another line of defense: the equity of the collateral — because the Loan to Value (LTV) ratio of the car is well below 100%. That’s just common sense. Except in mad 21st century America, as seen in this data from the Semiannual Risk Perspective, Office of the Comptroller of the Currency, Spring 2014 (red emphasis added):
Across the industry, auto lenders are pursuing growth by lengthening terms, increasing advance rates, and originating loans to borrowers with lower credit scores. Loan marketing has become increasingly monthly-payment driven, with loan terms and LTV advance rates easing to make financing more broadly available. … Average LTV rates for both new and used vehicles are above 100% for all major lender categories, reflecting rising car prices and a greater bundling of add-on products such as extended warranties, credit life insurance, and aftermarket accessories into the financing.
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Long new car loans to subprime borrowers, made with loan/value ratios over 1. The car is deeply under water as it rolls off the lot, and for many years following. At least subprime mortgage bankers expected home prices to rise; these lenders cannot even hope for that. So what happens when these loans go bad?
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The average loss per vehicle has risen substantially in the past two years, an indication of how longer terms and higher LTVs can increase exposure.
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(2) Larger lessons
(a) It’s late in the business cycle
When vendors exhaust their market, they often extend credit to uncreditworthy borrowers to maintain their sales. It’s a valuable “tell”, because it so often happens at the end of business cycles. Tech vendors did this in the last stage of the tech bubble. Subprime home mortgage lending dominated the last stage of the housing bubble — eventually providing “liar loans” with “no docs” required, and no downpayments (some even allowing capitalizing the 15% closing costs). And now we see subprime auto loans on crazy-easy terms.
(b) Regulators are still owned by the banks
The same mistakes, time after time. Lending, bubble, burst, bailout. It’s a feature, not a bug, for modern banks. But this dance requires partners. In the tech and real estate bubbles entire sectors became partners in the easy credit game (often to their regret). But bank regulators are essential partners.
This does not surprise anyone paying attention. Bank regulators exist to support bank profits, and facilitate the inevitable bailouts from their imprudent lending (as has happened every decade, on an ever-larger as the banks slowly slipped the leashes put on them during the New Deal. Free markets! Freedom! Ayn Rand!
(c) It’s evolution in action
Money flows from stupid to smart. Bankers have built siphons to fill their pockets with America’s wealth. Their political power defeats all attempts to contain them. Both Left and Right agree on this. The Tea Party was born in opposition to bank bailouts — but worked to elect bank-friendly representatives to Congress. The Occupy Wall Street movement was the biggest mobilization of the Left since the Vietnam War; it left less behind than last winter’s snow.
“In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.”
– Spencer Bachus (R-AL), Chairman of the House Banking Committee, The Birmingham News, 9 December 2010
(3) For More Information
- Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
- Please read this. For the sake of yourself, your children, and their children, 25 June 2009 — About Goldman Sachs
- FDR explains one dimension of our problem: bankers own the government, 23 November 2011
- Rising consumer debt driving the recovery: boon or bane?, 10 November 2013
- Auto loans are a driver of the expansion, but might be running out of gas, 1 April 2014
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At least autos don’t (yet) cost as much as houses did in 2006. That will probably delay/mitigate the inevitable “unforeseeable” disaster.
The fact that this is happening yet again would seem to suggest that choosing not to hold the financial industry accountable for their role in the housing crisis was a very grave mistake on the government’s part. By allowing them to dodge responsibility and avoid facing the consequences of their actions for the most part — and both parties are guilty of that — they sent the message that the wealthy are essentially above the law and the financial industry need not bother to conduct its affairs ethically (and certainly not as long as the politicians can profit from all the contributions to their campaign coffers, which in many respects have become little more than a bribe). For pity’s sake…the American people were roped into bailing out many of the companies that helped create the crisis last time, and *this* is how the financial industry chooses to repay them????? If this were a marriage in which one spouse was choosing to behave like this, there is a good chance that the other spouse would have placed a phone call to a marriage counselor — or a divorce lawyer — by now (assuming that the other spouse has any sense).
Of course, the fact that this is happening again would also seem to suggest that the American people have allowed themselves to become little more than greedy and gullible idiots who have lost whatever sense they might have once possessed and are practically issuing an engraved invitation to the banks asking them to exploit us (an invitation that they’re clearly not going to pass up). Fool me once, shame on you — fool me twice, shame on me.
“the American people were roped into bailing out many of the companies that helped create the crisis last time”
I don’t have a cite right now, but my understanding is that virtually all of the “bailout” money has been repaid.
There was a cost, but not in the dollar amount of the bailouts… it lies in the fact that the bailouts patched things up enough to allow us (or rather, the important 1% of us) to return to business as usual and forget about our more fundamental problems.
Perhaps we could have prevented this auto loan boom, and the student loan boom, and… whatever else will come next… but then we would no doubt have killed what little “recovery” Main Street has.
Hardly anyone wants to think about how deeply dysfunctional our economy is; because once you start to do that, you realize that no one (yet) knows how to fix it. We prefer to argue over which pre-fabricated ideology would solve all problems, if only the ignorant everyone else would see the light.
Coises,
The cost of the bailouts is large.
“Perhaps we could have prevented this auto loan boom, and the student loan boom, and… whatever else will come next… but then we would no doubt have killed what little “recovery” Main Street has.”
Totally false. Bank bailouts have een a commonplace of western economies for two centuries. There are two proven solutions.
(1) Bagehot’s Rule: lend rapidly only good collateral at a penalty rate. No bailouts. The Bank Of England has perfected this.
(2) The government puts the bank into bankruptcy, re-opens it, later sells it off. This has been done many times, by nations from Sweden to Russia. No bailouts.
With all due respect, Coises, the fact that all the bailout money has been repaid is not (and should not be) enough to minimize what the banks did — especially not given the signs which suggest they’re getting ready to do it all over again. The banks screwed the American people over at least twice…once with the role they played in the housing crisis, and twice by getting a bailout which allowed them to avoid “taking personal responsibility” (which evidently only the “little people” are required to do) and escape facing the consequences of their actions while most of the rest of America suffered, including many people whose behavior did not contribute to the crisis.
I’ve used the analogy of a marriage on this website before because even though a country’s economy is not quite like a marriage, it’s not quite as far removed from one as some people think it is either given that an economy reflects a social contract of sorts in much the same way that a marriage does on a much smaller scale. Unfortunately, many of the same dynamics appear to be at play in the relationship which the American people have with their political and financial leaders as someone whose relationship with his or her spouse is afflicted by a serious problem which jeopardizes the first person’s physical or emotional well-being — whether that problem is addiction, an extramarital affair, domestic violence, or what have you.
As an illustration, the fact that a domestic violence victim’s injuries may have healed does not in any way lessen his or her spouse’s wrongdoing for choosing to believe that physical assault is an appropriate way to resolve a marital dispute. However, a person who chooses to allow or even facilitate this behavior by minimizing it or making excuses for it cannot expect that this behavior will somehow stop on its own because the chances are very good that it will not — the main reason being that the wrongdoer has no motivation to stop, whether internal or external. In order for it to stop, the person who is being injured needs to put his or her foot down and make it clear that behavior of this kind will no longer be tolerated in future. If the other person wishes to continue the contract, he or she must put an end to this behavior — and if he or she does not or cannot, the injured person will take steps to dissolve the contract which keeps the two of them together. This by no means implies that the solution to this problem will be easy, because it will definitely not be…but it will not be done at all unless the person who is suffering most forces the issue and demands that a solution be found and implemented,
For me, I am not convinced that the bailout has really proven to be the lesser of two evils since (as you point out) the 1% have largely succeeded in recovering whatever they may have lost and are simply going right back to their old ways without showing the slightest signs that they feel any regret or remorse or learned anything from the experience. And why should they, when the bailout more or less taught them that they can do what they please when they please to whom they please and will not really be punished for it? If there had been no bailout, the banks would have failed and there is a very good chance that everyone would have suffered…with emphasis on the word *everyone*. The 1% would not have suffered as much as everyone else, of course, but that would have been true in either case. Granted, speculating about what would have happened without the bailout is a bit like locking the corral after the cattle have already been rustled…but I think there’s at least a fair to middling chance that denying a bailout might have taught everyone (Main Street as well as Wall Street) a lesson which might have proved valuable in the long run. Sometimes the lessons which are the most valuable are the ones which demand the most from us…if they were easy, everyone would learn them and they wouldn’t be quite so valuable!
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I saw a commercial in my local area where the car dealership flashed on the screen the number of the lousy credit score of an ‘actual customer’ then they flashed a picture of the $30,000 car that the customer drove off in.
‘no credit no problem!’
‘your W-2 form is your credit!’
Meanwhile debt issues are tearing up households.
Another excellent article, FM. Once again I have not seen this issue covered in any depth by the mainstream media. It’s fascinating to observe the long list of issues which cannot be dealt with except in passing by major newspapers, major TV news networks, and news magazines: the out-of-control growth of police state power by our intelligence agencies (one big article a year ago by the Washington Post, but nothing else by any major media), our endless unwinnable foreign wars (confined to spot coverage of particular “crises” with no recognition of the basic problem that America is now engaged in a Forever War against the rest of the world, a war with no end and no victory condition), the collapse of U.S. infrastructure (British media like The Economist and The Guardian have done extensive articles on this crisis, but nary a peep from American media), and now the rise of crazy subprime for insanely overpriced unaffordable U.S. cars.
Increasingly this website is becoming a go-to place for important stories not dealt with in any depth by the bubble media. And by “bubble,” I mean American media that create a bubble of unreality by focusing on trivial horserace-type stories (Is Biden ahead of HIllary in the early 2016 presidential fundraising? Will Boehner lose his Speaker position soon? ) to the utter exclusion of news that really matters.
As you memorably remarked several years: “America is engaged in a war against reality — and we’re losing.” Fascinating to observe the bizarre bubble of media fantasyland within which the U.S. population now finds itself cocooned. Like something out of a Star Trek episode, your site now represents one of the last outposts of verifiable reality in a universe of self-delusion…
“So what happens when these loans go bad?”
I wasn’t sure myself so I checked Wikipedia. I think we have a pretty good idea because it just happened 2008. This is Ally Financial which was GMAC or the finance company that was linked to GM.
http://en.wikipedia.org/wiki/Ally_Financial
“The company was bailed out by the US Government during the financial crisis of 2007–08 taking over from its previous owner General Motors. On 24 December 2008, the Federal Reserve accepted then-GMAC’s application to become a bank holding company.[2] Ally returned to profitability in 2010, posting a net profit of $1.075 billion for the fiscal year.[1] Ally planned but did not execute an initial public stock offering in 2011. Ally announced plans to launch an IPO in spring 2014,[3] and the shares begin to be traded as NYSE:ALLY on Apr 10, 2014.”
If history repeats itself, this thing just implodes and they get yet another bailout. If the implosion is too massive, that is if the bond markets wake up and figure out that this is a bad bet, I expect what happens is that car loans end up like housing loans now — with many backed by government guarantees.
Here’s why ultimately I think we don’t know. The thing about the Lehman Crash, and why no one without deep private knowledge could predict the outcome was that no one knew that AIG made so many bad bets. That’s the thing. Someone can do the math and calculate whether the system can handle a car loan crash, but with the derivative contracts there’s the possibility of unexpected linkages that cause wider damage. Maybe this won’t happen with car loans, but I don’t know. I don’t think I can know. These relationships are hidden.
Cathryn,
A bit more color on this. GM’s sub, Ally Fin, was primarily a mortgage lender.
Also, total auto loans are only $900 billion, vs $10trillion in residential mortgages (pre-crash). Not large enough to bring down the system.
http://www.federalreserve.gov/releases/g19/current/default.htm
People who otherwise have good credit histories become bad credit risks when they over extend themselves. The dealerships selling autos derive a major portion of their profits from the financing and the add-ons. They have every incentive to push the consumers to the edge. The end result being that they actually turn many prime borrowers into subprime borrowers over time. I don’t think the Fed’s easy money policy is a cause of this behavior. Most of the deep subprime lending is on overpriced used vehicles, and the lender is not advancing 100% of the loan to the dealer. The dealer is in essence financing a part of the purchase price out of his profits. https://www.creditacceptance.com/dealers.aspx?id=1