Resurrection of the subprime mortgage mess-this time in car loans

In the run up to the 2008 financial crisis, investment bankers were telling us they were flush with cash. In a real estate boom fueled by easy availability of credit, even buyers with poor credit histories could get mortgage loans, often with exotic terms and overstated income or values put onto credit applications by less than scrupulous mortgage brokers. The whole thing was fueled by securitization, in which large bundles of questionable loans were created for investors, with the risks hidden by overstated appraisal values and credit rating agencies that for one reason or another did not expose the risk.

The result was the crash in real estate and the crisis in financial markets that started in late 2008. The real estate market is only now starting to recover.

But subprime credit targeting the most vulnerable borrowers has come back. In a  July 21, 2014 report in the New York Times, In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates  we learn that in the past 5 years, auto loans to borrows with tarnished credit have gone up 130 percent, and that these loans are 25% of the total of auto loans being made. The Times investigation found loan rates as high as 24%, with the amounts borrowed typically about double the value of the car being purchased. The borrowers frequently default and the cars are repossessed. Many of the borrowers have a previous bankruptcy that prevents them from discharging the resulting deficiency debt.

As the Times reports, the money to make these loans is fueled by same process of loan securitization and investors looking for high rates of return in a difficult investing environment. Indeed, in some respects, auto loans are less risky that mortgage loans. A car can repossessed and sold in many states in a small fraction of the time to foreclose on a mortgage and sell the home at Sheriff Sale.

The victims of this process are the most vulnerable of borrowers. Most need reliable transportation in order to get to work and to feed themselves and their families. Without access to a ready chunk of cash, they have to borrow the money to buy a car.

We constantly counsel our bankruptcy clients to start with and keep a budget, and to accumulate cash for important needs such as auto repairs. But even the most diligent often find themselves backed into a financial corner, where getting an auto loan is the only option.

So availability of credit for this purpose is not necessarily bad. What is deplorable is the way that used car sellers and lenders are pawning off overpriced vehicles of questionable value on those who seek credit.

For the regulators, some controls on the credit industry and its used car seller partners is called for. For those who need to borrow money for basic transportation, the lesson is that “buyer beware”, and to borrow money for these purposes carefully and with full knowledge of the traps that unscrupulous dealers and lenders have lying in wait for them.

 



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