A recent wave of articles suggests that the next subprime crisis will ensue in the form of auto loans1. The fundamental issue is whether subprime auto loans are a real basis for concern or much ado about nothing.
Just as the securitisation of home mortgage loans was not previously widely known outside those operating in the financial markets, many today may not realise that auto loans are also securitised. Investors seeking a higher rate of return are turning to securities backed by subprime auto loans, which are offered to less creditworthy borrowers at higher interest rates (often 20 percent or higher as compared to 5 percent for prime borrowers).
According to the financial press, the major concern is that "[t]he explosive growth [in subprime auto loans] is being driven by some of the same dynamics that were at work in subprime mortgages."2 A recent New York Times article noted that "[m]any subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers" and that "lending practices in the subprime auto market ... demonstrate that Wall Street is again taking on very risky investments just six years after the financial crisis."3 For example, during the second quarter of 2014, US borrowers obtained USD 101 billion in new auto loans.4 Total outstanding auto loan balances rose to USD 905 billion. Subprime auto loans – defined as loans to borrowers with credit scores below 620 – made up 22 percent of new auto lending in the second quarter.5
Other commentators are not so alarmed. They note that the percentage of subprime auto loans make up a smaller proportion of total auto loans than before the "Great Recession" (i.e., the period from 2000 to 2004) and that overall lending to subprime borrowers is still below normal levels from before 2008.6 Moreover, some contend that subprime auto loans are not as risk-laden as subprime mortgage lending because automobile loan payments are smaller and more manageable for borrowers than mortgage payments. Auto loans are scheduled to be repaid faster, and, as noted, loan collateral is more easily seized and recouped than houses.7
Notwithstanding the debate in the press, regulators have taken notice. To date, two institutions, GM Financial and Santander Consumer USA, have received subpoenas from the US Department of Justice requesting certain documents relating to their subprime auto loan contracts.8 The subpoenas were issued in contemplation of a civil proceeding for potential violations of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), which served as the government's main weapon against thrifts during the S&L crisis over two decades ago.
Even with the increased securitisation of subprime auto loans and heightened regulatory attention, we concur with the commentators who are not alarmed. As many of them note, automobile loan payments are smaller and somewhat more manageable. Additionally, defaults are less likely because people scrimp to make their car payments so they have a means to commute to work. Finally, unlike houses, cars rarely appreciate; conversely, a "bubble" in the car market is unheard of.
For all of these reasons, subprime auto loans are more likely to be a bump in the road than a disaster.
Footnotes
1 See, e.g., Silver-Greenberg, Jessica et al. In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates, The New York Times, Jul. 19, 2014.
2 Id.
3 Id.
4 Quarterly Report on Household Debt and Credit, Federal Reserve Bank of New York (Aug. 2014).
5 Id. See also, Rugaber, Christopher S. New York Fed: US auto loans rise tohighest level since 2006, U.S. News & World Report, Aug. 14, 2014.
6 Weise, Karen. Three Charts on America's Not-So-Bubbly Subprime Auto Loans, http://mobile.businesweek.com/articles/2014-08-14.
7 Ally Financial Bets on Risky Car Loans, Reuters, May 31, 2011.
8 U.S. Auto Loans Soar to Highest in 8 years, http://newyork.cbslocal.com/2014/08/18 , Aug. 20, 2014; Corkery, Michael, et al. Santander Consumer Gets Subpoena in Subprime Car Loan Inquiry, The New York Times, Aug. 20, 2014.
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