By on August 7, 2014

subprimechart

The topic of subprime auto loans has been a hotly contested one at TTAC, with numerous commenters defending both the practice and the stability of recent run-up in subprime lending.

Over at the Autos and Economics blog (operated by contributor Mike Smitka), David Ruggles (better known as “ruggles” around here) provides a well-reasoned defense of subprime lending, and why he thinks we are not headed for a subprime lending bubble. Despite that, other voices seem to think we are heading for one, if not in subprime then in the broader market.

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63 Comments on “A Contrarian View Of Subprime Auto Loans...”


  • avatar
    Pch101

    The contrarian view of subprime lending is maintained by this website, not by Mr. Ruggles and the rest. They’re defending the status quo of an established and perfectly legal industry of lenders and their institutional investors.

    As far as bubbles go, let’s separate the sales from the lending side. The topic of the Reuters article is not the prospect of a loan default bubble, but of a sales and production bubble for the OEMs. The questions are whether the current growth in sales and transaction prices is sustainable, and what would happen to the OEMs if it isn’t.

    • 0 avatar

      Actually, it isn’t my view that is “contrarian.” Sensationalistic pieces written by those with an agenda, like the NYT reporters, who avoid the facts, don’t make me the contrarian.

      • 0 avatar
        Pch101

        “it isn’t my view that is ‘contrarian.\'”

        That’s what I said.

      • 0 avatar

        Yes, and TYVM for that observation.

      • 0 avatar
        Big Al from Oz

        @ruggles
        Why blame the NY Times?

        This concern over the sub prime lending was initiated in Wall St, by some analyst.

        I do think there will be an issue and a downturn in vehicle manufacturing in the US.

        How much longer can the US sustain the very low interest rates by the Fed?

        When they do rise what impact will it have on the US vehicle manufacturers?

        Also, start to trend some data. US wages are moving laterally. The workforce is becoming smaller as a percentage of the population.

        Also, here a significant figure that the US auto manufacturers should investigate. What was the population in the US in 2008 and what is the population now?

        So, what should the increase be in vehicles?

        Sub prime and lengthened loans will reduce production.

        This short term gain game at the expense of the future will come back to haunt the motor vehicle industry in the US.

        • 0 avatar

          Actually, the NYT piece was triggered by an Equifax report. They cherry picked the report and came up with bogus conclusions.

          For example, they said that sub prime had risen 132% since the Great Recession. Well, there was a time when there wasn’t any subprime lending taking place. Credit had dried up and there was no money to lend. It had ground to a screeching halt. Why would you select an anomaly unless you were looking for a number like 132%, which isn’t representative of what is and was going on at all UNLESS you were looking to sensationalize?

          Of course there will be another downturn at some point. Who knows what might trigger it. The discipline at the OEMs and their captives isn’t perfect, but it is light years ahead of where they were pre GR.

          There is still tremendous pent up demand. The scrappage rate alone means there are many vehicles that need replaced and millions rebuilding their credit score and net worth. After all, households lost 38% of their net worth almost overnight.

          There ARE higher interest rates on the horizon. It is unavoidable. But I think they will rise slowly and OEMs have mostly priced in subventions so the impact on consumers will be minimal. However, higher floor plan rates will cause dealers to sell more aggressively, not that they haven’t been already. Despite some false pieces about broad “days supply,” new vehicle inventory has been short for dealers. They are in a game of “earn and turn.”

          Also, the price of inventory for BHPH/LHPH dealers have gone through the roof. Cash for Clunkers crushed vehicles these guys call “inventory.” The shortage has kept values high. It has also helped keep down their deficiencies, the other side of the coin.

      • 0 avatar
        CapVandal

        Thanks R.

        Every time I swear that I won’t waste another nanosecond posting my view of reality, I get suckered into it again.

        Glad to let you carry the ball. And — I don’t know why I give a fuck, but the comments on TTAC’s aren’t all that dissimilar to a lot of partially informed buzz.

        I will say that as long as ordinary people are worried about it, it CAN’T be a bubble.

  • avatar
    kvndoom

    Lose your house, you can still get a roof over your head (apartments, relatives, etc).

    Lose your car, you lose your ability to get to work, school, stores, so many parts of your very livelihood.

    Cars are easily resold. Houses are not. SOMEBODY will buy a repo’ed car if it’s in good shape.

    It’s much easier to get another car after a repo than it is to get into another mortgage after a foreclosure.

    The overall figure of 46.2B is just a big number to spread FUD and doesn’t tell the whole story. The auto industry has recovered at a much better pace than the housing industry since the meltdown.

    I’m with Ruggles on this one.

    • 0 avatar
      PandaBear

      Excuse me?

      It is much easier to afford a car than an apartment. And you can always get a cheap ride that only cost $3000 and run like poop once in a while, until your financial situation is better and trade it for a more reliable ride.

      • 0 avatar
        hreardon

        Panda –

        Ask anyone in auto lending: people will default on their mortgage, stop paying the landlord, switch to a raman noodle diet and donate plasma before losing their car to a repo.

        The process of repossessing a house and of evicting a tenant can take months, if not years, if you know how to work the system. Not so for an automobile.

        • 0 avatar
          ect

          My father was a banker, spent a number of years in consumer credit, and that was exactly his view of the safety of auto lending.

          I recall him telling me once that the Bank figured out that the cost of registering the liens they took was significantly higher than the total value of car loans that went bad. So, they decided to keep taking the liens, but to stop registering them (without telling the borrowers, of course), which increased profits.

  • avatar

    Derek,

    I am having a difficult time making out the colors on the legend BUT, YOY? 2013 to 2014? That isn’t clear. Am I missing something?

    This looks like it came from Experian, perhaps the deck I sent you?

    Some additional resources:

    http://www.marketwatch.com/story/why-the-auto-loan-bubble-is-just-hype-2014-08-05

    http://www.autofinancenews.net/subprime-lending-nears-pre-crash-levels-sp/

    The headline says “sub prime lending nears pre-crash levels” as if that had something to do with the crash of the Great Recession. It didn’t. Many Americans need subprime to get a vehicle to go to work and to rebuild their credit score.

    http://www.thecarconnection.com/news/1093499_americans-owe-902-2-billion-in-car-loans-a-record-high-and-most-are-re-paying-on-time#src=10065

    http://www.autoremarketing.com/subprime/afsa-ally-cps-refute-claims-recent-times-article?utm_source=Listrak&utm_medium=Email&utm_term=http%3a%2f%2fwww.autoremarketing.com%2fsubprime%2fafsa-ally-cps-refute-claims-recent-times-article&utm_campaign=Defending+the+Subprime+Market

    • 0 avatar
      3Deuce27

      Reg; “The headline says “sub prime lending nears pre-crash levels” as if that had something to do with the crash of the Great Recession. It didn’t. ”

      Thanks for that, David. Mental clarity is sorely lacking on this site, but I can always count on you for it.

      Sub-prime ‘housing’ lending also didn’t cause the collapse of the economy, but that idea was effectively sold to the public by the corporate noise machines, and the public bought wholly in to it.

      • 0 avatar

        TYVM! It was easier for Republicans to say, “Liberals made lenders make risky loans” than to explain how they blocked regulation of CDSs and wrote into the Commodities and Futures Modernization Act a paragraph that said, Credit default swaps are not insurance and will not be subject to regulations requiring reservation of capital to pay potential claims.”

        Besides, most folks have no clue what a CDS is and don’t want to learn. After all, didn’t “Liberals” push risky loans on lenders via the CRA?

        But this is a discussion for another board, and only came up here because some are trying to equate auto lending and the mortgage industry.

  • avatar
    DC Bruce

    People who should know better keep drawing a false parallel with subprime home mortgages. The implosion in subprime mortgages was caused by the mistaken belief that the collateral (the real estate) would protect the lender against the default risk created by a borrower with lousy credit scores. The belief being that residential real estate would not lose value, so even a 100% loan-to-value ratio loan was relatively safe, regardless of the creditworthiness of the borrower. Consequently, the loans were much more risky than believed.

    Car loans don’t have that problem. The value of the collateral (the car) is very well known. The market for used cars is much more liquid than the market for used residential real estate, so it’s possible to know pretty accurately what the value of the car will be 1, 2, 3, 4 years out. Not only that, a non-performing car loan is going to retain that status for a lot less time. Much more quickly than a house can be foreclosed on and re-soled, a car can be repo-ed and sold. We’re talking months, not years.

    With a car loan, because the car is always depreciating, the default risk from the borrower is far more important. Consequently, subprime car lenders are going to charge accurately for the default risk they are assuming (unlike subprime residential real estate lenders in the early 2000s). What’s driving money into subprime car loans is the search for yield. With the fed keeping interest rates very low, investors are aggressively chasing higher yields. That requires them to assume more risk, but most of them understand that. As a result, the subprime car loans are priced accordingly.

    Subprime residential real estate loans were mis-priced: that is, the interest rate being demanded did not correspond to the increased risk the lender was actually assuming.

    It would be unfortunate if so-called “well-meaning” consumer protection agencies shut down subprime car loans in the interest of “protecting” either the investor or the consumer (who has to pay a high interest rate). The alternative is to be frozen out of the credit market.

    25 years ago, it was almost impossible to get a loan for a used car, even one 6 months old. Typically, when available, those loans were for two years and carried a high interest rate. Everyone has benefited from the availability of car loans for used cars. In fact, one could say that a used car loan is, in some sense, safer than a 100% financed new car loan, since the used car will not be underwater in the first year.

    • 0 avatar
      hreardon

      DC Bruce – well put. Thanks.

    • 0 avatar
      Pch101

      “The implosion in subprime mortgages was caused by the mistaken belief that the collateral (the real estate) would protect the lender against the default risk created by a borrower with lousy credit scores.”

      It wasn’t just subprime that hit the wall. The entire mortgage industry imploded. It was never just a subprime problem.

      The securitization problem comes from the disconnection between origination and holding. When those who make the loans don’t keep them, then they became more interesting in selling off loan portfolios for profit than in managing risk.

      The underestimation of risk comes from the credit enhancement aspect of the security. In essence, pooling stronger and weaker assets together is regarded as a way to hedge the risk. The problem is that it doesn’t take much for the entire portfolio to weaken during a downturn. The systemic risks don’t go away just because there is credit enhancement.

      • 0 avatar
        hybridkiller

        “The securitization problem comes from the disconnection between origination and holding. When those who make the loans don’t keep them, then they became more interesting in selling off loan portfolios for profit than in managing risk.”

        +1

        This was at the core of the mortgage industry meltdown. Mortgage lenders were bundling loans into CDOs and selling them out the back door as fast as they could get them in the front door. It’s no surprise they lowered lending standards to increase volume.

        It’s also true that the collapse of the credit markets in general was largely due to unregulated derivatives like CDSs. ruggles is right – for anyone who cares anything about financial markets, credit default swaps are scary things indeed. I know what they are and I almost wish I didn’t.

    • 0 avatar
      ellomdian

      ^This.

      The ‘implosion’ was the result of 3rd and 4th-order derivatives falling apart because the initial security… wasn’t. Notes were written to Sub-prime borrowers with the expectation that the value of the home would continue to increase. The issue wasn’t that the borrowers were risky, it’s that when the risky borrowers defaulted, there wasn’t anything worth selling left over.

    • 0 avatar
      krhodes1

      @DC Bruce

      I agree with you 99.9%, and very well said.

      The .1% being that it was certainly not a problem to get a used car loan 25 years ago, and interest rates were not THAT bad. I took out a bank loan to buy a ’85 Jetta 2dr in ’88 ($4500 with 17K on it), at the tender age of 19. My folks co-signed, of course, but it was a no money down loan at ~10% for four years. My first mortgage in ’01 was at 8.75%…

  • avatar
    hreardon

    I’m solidly with Ruggles as well. I have two sources that I use to base this one, both of which are clients:

    1. Bankruptcy law firm who handles automotive BKs for the likes of Ford, Nissan, Honda, etc. This part of their otherwise massive practice is small because the number of repos is relatively small overall. Late pays, fines and penalties, but repos are still less than 2%.

    2. Auto Title Loan company. They report similar numbers: slightly less than 2% default rate on loans. People will hock their underwear on the street corner before losing their wheels.

    So is there still cause for concern? Sure there is, because cheap credit helps push up the price of new cars. But will the subprime auto market cause the same ripple effects and catastrophe as the housing market? I’m dubious of that claim.

  • avatar
    dwford

    There is nothing wrong with subprime lending in the auto industry. There are, however, 2 areas of abuse than can hurt the industry.

    1. Fraud at the dealer level. Finance managers can inflate income levels, adjust work history, and “powerbook” cars – i.e. lie about what equipment a vehicle has to secure a larger loan from the bank. These practices can put people into loans that they simply cannot repay. Typically the finance manager will lie to the customer who balks at the high payment, saying that they can refinance in 6 months once their credit gets better.

    2. Fraud at the securitization level. This is what happened in the housing industry. Mortgages were bundled and sold as prime, and lazy investors just bought the bundles without truly looking at what was in them. If this happens in the auto loan securitization industry, the result will be the same – losses for those investors.

    There is a definite need for subprime loans, and done correctly they can help people reestablish their credit going forward.

    • 0 avatar

      All true, although there is additional technology in place to minimize “power booking.”

      I’d like to see regulators send out “mystery shoppers” to look for fraud. Those of us in the industry despise the fraudsters.

      Another thing that needs to happen is for additional regulation to come down hard on BGPH/LHPH dealers in states where they can garnish wages. Some of the things they are doing are legal, but shouldn’t be.

    • 0 avatar
      hreardon

      dwford – agreed. Fraud is the probably the biggest threat to any market and was one of the key drivers in destroying the mortgage market.

    • 0 avatar
      87 Morgan

      Power Booking has largely subsided, thanks to the online VIN ratings. Really the only thing left to power book with is approved modifications such as lift kits etc.

      Most of the lenders are doing customer interviews these days on sketchy deals to eliminate this further.

      As for this bubble nonsense. I am 100% with Ruggles that it does not exist. Too many factors are at play. Primarily, there is always a market for affordable used cars. Factor in the amount of used cars heading overseas in the gray market, I.e. A lot less salving title cars here as they can be packed up and sent to Africa for example and repaired to road worthy levels with no or little government intervention. Somehting has to fill that void, enter the abused repo. It gets cleaned up and resold in lieu of the buy here pay here salvage titled car. From a consumer level this is better as they have a better shot if having an airbag deploy in the event of a wreck than they did with the salvidge titled car that may or may not have an airbag.

      I spent five years in the sub prime mtg business, the loans that went bad were not priced according to the underlying risk associated, as the assumption, falsely was the asset would not go down in value. Sub prime auto securitazation factors asset depreciation into the pricing model.

      • 0 avatar

        Lift Kit? If you want to ruin a truck’s value to a dealer, put a lift kit on it. I wouldn’t even take one in on trade unless it was put back to stock. A dealer carries HUGE liability for selling altered vehicles. I’m a cautious type and wouldn’t even take in a vehicle with wheels and tires that didn’t match what the vehicle was designed for.

        But that’s another issue.

        Another thing not mentioned in the sensationalistic articles is the fact that with a BHPH/LHPH vehicle, the dealer generally fixes anything that keeps it from functioning and adds that in with the auto loan. People who aren’t driving ain’t paying.

        • 0 avatar
          FormerFF

          That was my observation when I was in the car business. Most modifications reduced the car’s value by 100% – 200% of their total installation price.

          About the only exception was a quality set of alloy wheels in a near stock size installed on a car that had steel wheels, those added a little value.

        • 0 avatar
          danio3834

          “Lift Kit? If you want to ruin a truck’s value to a dealer, put a lift kit on it. I wouldn’t even take one in on trade unless it was put back to stock.”

          Depends on the location of the dealer. In some places, a dealer has a hard time moving a truck without a lift kit. It’s all about what the customers demand, caution comes second to profit.

  • avatar
    FormerFF

    The car market and the real estate market are fundamentally different. Real estate is supply constrained, the auto market is not.

    • 0 avatar
      28-Cars-Later

      The auto market can become supply constrained depending upon production and economic conditions.

      • 0 avatar
        FormerFF

        In theory, it could, like after World War II. In our current environment, with a surplus of global capacity, it won’t.

        • 0 avatar
          28-Cars-Later

          The 2011 Tokai earthquake was a prime example, as the tsunami severely impacted the Japanese auto industry. The lack of spare parts created a supply constraint on US and JDM market sales.

          “TORRANCE, Calif. — Toyota says its U.S. sales dropped 7 percent in 2011, hurt by supply problems from Japan’s earthquake and tsunami.

          The Japanese automaker sold 1.6 million vehicles during the year, down from 1.8 million the year before. For December, sales edged up less than a percent to 178,131.

          The March earthquake and tsunami hampered Toyota’s supply of critical parts for several months, reducing the number of vehicles it could stock at dealers.”

          http://www.huffingtonpost.com/2012/01/04/toyotas-sales-2011_n_1184306.html

          “Like Kuramoto, the rest of Japan’s auto industry was caught off guard by last spring’s unprecedented earthquake-tsunami double punch. But one year later, lessons from the March 11, 2011, disaster have piled deep for automakers, suppliers and dealers alike.

          And it has changed the way they do business.

          Automakers and suppliers are double-sourcing more parts, reinforcing factories, moving facilities from flood plains and improving emergency plans. They are even stockpiling bigger inventories — anathema to believers in Japan’s just-in-time manufacturing ethos.

          Japan’s car industry has spent decades quake-proofing its operations. But last year’s turmoil showed just how far they have to go. Rolling out new, improved measures has only begun and will take years. Meanwhile, executives warn it’s a matter of when, not if, another big temblor will rock the manufacturing heartland between Tokyo and Nagoya.

          “We have just started to discuss how to deal with it,” says Fumihiko Ike, senior managing officer and disaster task force chairman at Honda Motor Co. “All we can do for the time being is pray another problem won’t happen again.”

          http://www.autonews.com/article/20120312/OEM01/303129960/tsunami:-the-aftermath

    • 0 avatar
      Pch101

      The supply constraints or lack thereof don’t really matter for this.

      The difference is that the collateral value of a car is less relevant to the borrower’s decision to pay or not pay than is the collateral value of a house.

      Houses are often purchased with the expectation that they will become more valuable, while cars rarely are. A decline in housing prices will encourage some borrowers to default, while car pricing trends won’t have much influence on the choice to make car payments.

      • 0 avatar
        hreardon

        Great point about valuations, PCH.

        Important distinction here: whenever an object/asset becomes seen as an appreciating item there is potential for speculation: land in Florida, tulips, beanie babies, heck, even some bourbons these days.

        Outside of collector cars (arguably in their own bubble at the moment), vehicles simply aren’t seen as appreciating objects and are priced accordingly.

        I don’t see a near or medium term future where hot money flows into automotive speculation like it did into housing or any number of other asset classes.

        • 0 avatar
          Pch101

          I should have also noted that unlike the car, the home becomes a source of spending power (or more to the point, debt capacity) in a way that the car does not.

          When the house loses value, the family that was inclined to leverage it loses significant spending power, which contributes to the economic slowdown and feeds the downward spiral. Declines in home values have broad economic implications that car values largely lack.

          • 0 avatar

            TRU DAT! Households experienced a sudden evaporation of net worth, about 38% as I recall. That has a chilling impact on consumption. Add to that the fear of unemployment and a frozen credit market and one has the Great Recession and slow recovery. Damaged credit scores contribute to lethargic consumption, and they aren’t rebuilt overnight.

            I am amused at those who complain that the recovery has been slow. Of course it is slow. And obstruction by the opposition party hasn’t helped. They seem to be the ones complaining the loudest, as if they could fix it better because they broke it in the first place.

            I say this as a lifetime Republican, currently embarrassed.

    • 0 avatar
      PandaBear

      Real estates cannot be transported to another location (with higher income level) but vehicles can.

  • avatar

    Written for Autofinance News:

    “A recent report from Equifax Inc., which noted that originations and total outstanding balances for subprime auto loans have hit recent highs, triggered an alarmist article on subprime lending in The New York Times. In the July 19 piece, authors Jessica Silver-Greenburg and Michael Corkery cited anecdotes that leave the impression that fraudulent practices are widespread. They castigate the “high” interest rates on subprime loans without mentioning the high rate and expense of default and repossession. Repos in Buy Here Pay Here, a LARGE part of the sub prime business, can reach a third of originations, and collection practices ― which are expensive to begin with ― are a challenge on these loans.

    Through April, 2.6 million subprime loans were originated, representing 32% of all auto loan originations, according to Equifax. The outstanding balance of those subprime loans totaled $46.2 billion, an eight-year high. Equifax defines “subprime” as loans to customers with credit scores of 640 or below. As a matter of record, though, in some circles, a loan is deemed subprime only when the credit score drops to 580.

    The American Financial Services Association and other industry professionals have since weighed in on the NYT article, noting that it enflames already-riled regulators. And Derek Kreindler, managing editor of TheTruthAboutCars.com blog, writes: “Don’t expect that 32% figure to let up anytime soon. The glut of credit available for auto financing ― driven by securitized subprime auto loans being sold as investment-grade instruments ― is going to keep the auto financing business alive and kicking for the foreseeable future.”

    Just curious, but where is the evidence that sub prime auto loans are being sold as “investment grade.” What is the definition of “investment grade?”

    I have seen many articles trumpeting the danger of the expansion of subprime without proper context. It is one thing to have data, but quite another to interpret it properly. In the Equifax report, Deputy Chief Economist Dennis Carlson called the increase in subprime lending “good news,” adding that “a fully functioning second-chance market is essential for a healthy economy.”

    I would be pleased if people would stop acting like subprime auto financing had a damn thing to do with the global economic meltdown in 2008. It didn’t. Subprime auto financing is nothing like the subprime home lending issues of the past decade, and $46 billion of total outstanding balances on all subprime loans is miniscule compared with the size of the overall economy and a drop in the bucket compared with the mortgage market.

    Meanwhile, the ratio of subprime auto originations, including the buy-here, pay-here sector, has hovered around the 30%-to-35% mark for more than a decade. After all, more than a third of the population has a credit score below 640. Kind of makes sense, right? People need cars, and those originations include new and used loans, although they are mostly used.

    To be clear, despite the sky-is-falling tone of the NYT piece, Equifax said “serious” delinquencies of 60-plus days remained near all-time lows, and represented less than 1% of total outstanding balances.

    A quick call to Melinda Zabritski, director of auto finance at credit bureau Experian, revealed the following:

    First, the Great Recession caused the average credit score of U.S. consumers to take the hit one would intuitively expect.

    Second, when credit dried up, many people ― except for the highest credit score consumers ― turned to BHPH or subprime finance, as one might expect. The stat cited in the NYT article compared subprime originations today with the dark days of the credit crisis, when capital for that kind of lending was completely dried up. Why pick a point in time that is obviously an anomaly, if one is trying to tell a story in real context?

    Third, lenders are looking at the near-prime and subprime markets in a search for yield unavailable in the highly competitive prime lending space.

    Fourth, fast-track credit ― the point at which a dealer can send a contract to a lender without first calling it in for formal approval ― is now 720, up from 690 pre GR. There are more strict debt-to-income and loan-to-value parameters in place, as well.

    Fifth, and perhaps most importantly, millions of consumers have been able to rehabilitate their credit through subprime financing ― and there will be millions more. An accurate portrayal of the Sub Prime market would have at least mentioned this.

    There are some who equate subprime auto lending to with mortgages made under the Community Reinvestment Act. Nothing could be further from the truth. CRA mortgages are NOT inherently “Sub Prime.” According to the Federal Reserve, CRA mortgages have outperformed the mortgage market overall.

    Also, as a matter of record, most of the mortgages that soured during the mortgage crisis were not subprime. Many people with excellent credit walked away from mortgages where they were paying off, for example, $450,000 on a $250,000 home. Yes, their credit score took a hit, and they might have had to get a subprime auto loan to buy a car. It will take some time to repair all the damaged credit. This has played its own part in the slow economic recovery.

    Despite the NYT piece, clearly fueled by a desire to create controversy where the facts don’t indicate controversy exists, it’s time for everyone to take a deep breath and keep both feet firmly planted on the ground.

    There is no subprime bubble.”

  • avatar

    Tony and Guido of Kneecap Auto Sales and Lending are itching to get back into the business. Let’s CLOSELY regulate the sub prime business, especially BHPH, but don’t kill it off. We’ll be sorry if we do.

    BHPH is now under the eye of the CFPB. CFPB would do well to spend their resources on stuff that is really going on rather than trying to make a big deal out of certain protected classes being charged 1/3 of a percent more than the overall population…… IMHO.

  • avatar

    RE: “The securitization problem comes from the disconnection between origination and holding. When those who make the loans don’t keep them, then they became more interesting in selling off loan portfolios for profit than in managing risk.”

    Absolutely true, HOWEVER, securitization was working well when Wall Street securitized mortgages for Fannie and Freddie. Securitization created the capital to make more mortgages. There were STRICT guidelines in place. Then credit default swaps enabled the Wall Street securitizers to get in the game and buy loans far more risky than what F&F were empowered to buy. After all, enabled by the unbacked CDSs, they could get the same AAA rating as mortgages “Guaranteed by the full faith and credit of the U.S. Government, even though the loans weren’t up to F&F standards.

    Interesting, before it was over, F&F were buying AAA rated MBSs from Wall Street that contained mortgages so risky they couldn’t have purchased themselves.

    What cratered the MBS business was when the collateral on the collateral they held didn’t come close to supporting the money they had out. And there were no reserves to pay the credit default swap claims because the issuers had never been required to reserve any capital to pay claims.

    The story about how proposed regulation of CDSs was squashed is interesting in and of itself. During the massacre, Long Term Capital Management melted down and Greenspan and crew, the same people who squashed the CDS regulation attempt, coerced Wall Street into bailing them out. After looking CDS disaster in the eye, they went ahead a blocked needed regulation.

    • 0 avatar
      05lgt

      Mr. Ruggles thank you for the concise summary that holds up when compared to the many books I’ve read on the topic. The cruel irony of handing over the rescue using taxpayer funds to the same team who prevented all efforts to avert the predictable tragedy is the ugliest thing in the whole calamity.

  • avatar
    seth1065

    I would be more worried about the length of car loans for the sub prime and reg market, with loans going 6 years are people gonna have the cash for the note and the repairs or maintenance for their cars when they are needed, just replacing tires is pricy these days with everyone “needing 20 wheels” ( to be fair maybe you car only comes with 17 in wheels from the OEM) , They may pay the note and be driving around on bald worn out tires.

    • 0 avatar

      I recall when auto loans went from 24 months to 36 months, and the predictions were dire. Regardless, I prefer to see a lot of balloon or lease financing to shorten terms. People rarely pay their car off before trading. Why not take that into account when getting a new vehicle and make someone else guarantee the value at end of term? Its not for everyone, but is for most.

      • 0 avatar
        hreardon

        Agreed, ruggles, but I do think that there is a tipping point to the auto finance game, I just have no idea where/when it is. A two, three or four year note pretty well assures you’re under a manufacturer’s warranty and with a decent product should get at least that much, if not longer, without any catastrophic failures or major maintenance items biting you in the rear.

        Six years and longer – well, now you’re at the point where maintenance items start to get more costly (again, depending on make+model).

        I wouldn’t be surprised to see extended warranty ‘insurance’ start to get bundled more frequently into some of these loans. Tack an additional $15-$25/mo on to the payment for 6 year coverage. Hmmm…

        • 0 avatar
          krhodes1

          People already do this with extended warranties. I think it is foolish, but for many people the peace of mind is priceless. I prefer to hold onto my money rather than pre-pay for repairs that may not actually happen.

          Favorite example, friend of mine bought a gold plated extended warranty on a ’08 Accord. He’s looking to trade the car now, has the new car itch. The warranty is not transferable and he has not had a single claimable expense. What a waste of money. And he bought the car on only a 3yr note!

  • avatar

    RE: “The lack of spare parts created a supply constraint on US and JDM market sales.”

    It was the lack of assembly line parts that constrained supply. But PCH has this one right. It just isn’t a valid to equate car loans with mortgages. They are two different animals.

    Imagine if a Chrysler BK had taken down the auto industry suppliers. The same suppliers also supply aerospace and military procurement. There was good reason Alan Mulally came to D.C. to plead for his competitors. The heads of Honda, Toyota, Mazda, Nissan, MB, BMW, etc. should have been there too.

    the Joint Chiefs made their own visit to the Bush 43 White House. There was NEVER any doubt the the Feds would do whatever they needed to to keep things functioning. The only question was how.

  • avatar
    dude500

    Remember that the catalyst for the mortgage collapse was the reset of the adjustable rate, interest-only and “pick-a-pay” mortgage. People who thought they could continuously refinance when the variable rate period ended (and were underwritten by banks with the same thinking), suddenly couldn’t refinance, and so the mortgage market collapsed.

    This isn’t a problem for autos, which are all fixed rate (so far). Borrowers 1) know exactly what the monthly cash outflow will be, and 2) don’t have an assumption that the value of the collateral is increasing. Unless poorly underwritten, the catalyst for an auto loan default will likely be a life event (loss of job, health issues, etc).

  • avatar
    Mullholland

    I believe that this kind of reporting by the NYTimes and others on subprime auto loans are merely diversionary tactics designed to focus people’s attention on anything other than the two more real and threatening financial bubbles in student loan debt and corporate junk bonds.

    • 0 avatar

      The real Sword of Damocles is Credit Default Swaps with no reserves to pay potential claims, other than the net worth of the issuer. Aboput $50 TRILLION. By contrast, there are about $7 TRILLION in insurance contracts in place around the globe with actual reserves established to pay claims. This makes other issues seem like small potatoes, don’t you think?

      • 0 avatar
        hybridkiller

        I’m glad that you continue to emphasize the CDS issue – as you said, if more people only knew…

        Reminds me of that old bumper sticker, “If you’re not outraged, you’re not paying attention”.

  • avatar
    tankinbeans

    I’m curious how BHPH, who price used cars at well over 2 times their value, and then charge sky high interest rates. I understand that the riskier the buyer the more the bank is going to charge, but charging twice the value plus a high interest rate seems like it’s just itching to take a person to the cleaners.

    Case in point, my brother’s wife just walked and left him without a car. He went to CarHop (not sure if they’re national or not) where they had a 12 year old Alero for $7k and wanted to charge 20% interest. They don’t put prices on the windshield because they split their cars up and have a range of prices depending on the credit of their customers. He didn’t go through with it, but wow.

    • 0 avatar
      danio3834

      They’re able to price the total cost higher than the value of the car because many buyers shop based on monthly payments. The total cost is easy to conceal with a long loan period making the monthly payment low. Many BHPH customers barely give a thought to the cash price of the car, they’re only interested in what comes out each month (or even bi-weekly).

    • 0 avatar

      Regarding BHPH pricing – It is against the law to not price your vehicles and I’m just the kind of asshole to rat out a dealer who doesn’t post prices. BUT I also know the costs involved with BHPH/LHPH. A third end up repossessed. That’s a lot of deficiencies. The squadron of collectors ain’t cheap either.

      • 0 avatar
        krhodes1

        @Ruggles

        Is that federal law or local to you? Not doubting, I’ve never remotely dealt in that realm and am curious. VERY few used car dealers near me do anything remotely like posting prices – I am pretty sure they just size you up and ask what they think the market will bear!

  • avatar
    05lgt

    DK, thanks for pointing us to Ruggles other work.

  • avatar
    TW5

    The bubble is basically a foregone conclusion, but bubbles aren’t really the issue. Everyone wants to know how its going to end. Undramatic deflation or cataclysmic pop?

    • 0 avatar
      hreardon

      As long as the rules barring the discharge of student loan debt stick and the belief that everyone needs to go to college remain, this will become a serious long-term albatross around the necks of many millions.

      Take away government protection for lenders and you’ll see an immediate repricing of a college education. Contrary to what many think – this isn’t a bad thing.

    • 0 avatar
      hybridkiller

      “The bubble is basically a foregone conclusion, but bubbles aren’t really the issue. Everyone wants to know how its going to end. Undramatic deflation or cataclysmic pop?”

      Bubbles, by definition, usually end with a dramatic pop -otherwise it’s just a cyclical trend.

  • avatar

    RE: “Depends on the location of the dealer.”

    Actually, it depends more on whether or not the dealer is an inexperienced independent or a franchise new car dealer.

    RE: “In some places, a dealer has a hard time moving a truck without a lift kit.”

    I wouldn’t have any problem moving them because I wouldn’t inventory them.

    RE: “It’s all about what the customers demand, caution comes second to profit at most dealers.”

    No, its about what a dealer can reasonably insure and the risk he/she wants to take. Any altered vehicle that a dealer sells is a potential lawsuit if it is in an accident. There are specific paragraphs in dealer’s coverage on the issue. Most inexperienced independents aren’t aware of it. After all, their area of expertise isn’t insurance. They probably never read their policy. In some cases there are limitations on what a lender will finance. After all, the vehicle is collateral.

    I can’t tell you how many times I’d have someone with an altered truck come to me complaining about their tire wear. I’d sell the truck stock and the consumer would replace the wheels and tires and put a lift kit on it, and expect their warranty to still apply. Sorry. It doesn’t work that way.

  • avatar

    A key statistics from the American of Financial Services Association conference, according to TransUnion and confirmed by many sources. Subprime outstandings are running at about 14% to 15% of total outstandings, about where they’ve been for a decade. Everyone had a good laugh about the alarmist articles. The people attending are looking for risk to be concerned about. Subprime auto loans aren’t a point of concern.

    Even extended term financing received a good discussion. No one likes it, ESPECIALLY extended term on pre-owned vehicles. But on new vehicles, OEM rebates seem to be the way out for a consumer who wants to bail on a negative equity trade. The problem is, for them to “get out” they need to buy a vehicle with big incentive money which may or may not be what they actually want to buy. But no one said life would be a series of first choices. If you have serious negative equity, you might end up in a particular RAM truck with $9200. in rebates, even though you don’t want a truck. OR, your other choice is to come up with cash or pay down your current vehicle by making some more payments. You might be better off to lease your next vehicle, if you have negative equity. That way at the end of the lease term, the negative equity you rolled into the lease is resolved and you’re back to sea level again.


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