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My view: Subprime auto loan market headed for disaster

By Kyle Scott

For the Deseret News

Published: Friday, Aug. 8 2014 12:00 a.m. MDT

Updated: Saturday, Aug. 9 2014 8:42 a.m. MDT

Car dealers catch a bad rap, and sometimes justifiably so. But in this instance it is the large lenders far away from the daily grind of selling cars who are wreaking havoc in the used car market.

Rich Pedroncelli, Associated Press

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The subprime auto loan market has seen a growing amount of investment from large institutional investors. This influx of cash has made it easier for car dealers to get loans approved for customers who would otherwise not qualify. The result has been riskier loans on the books of lenders. While the housing crash was only six years ago, it seems like the effects have worn off, as this is a similar scenario that preceded the 2008 collapse. Not only are large banks like Wells Fargo and Bank of America entering into the market, but the loans they are funding are being packaged as securities and sold to investors with the blessing of credit rating agencies; the same credit agencies that gave their blessing to the toxic debt sold in the run up to the Great Recession. The scenario would be comical if it wasn’t so frightening.

As recently reported in one of the nation’s largest print media outlets, there has been a 130 percent growth in subprime auto lending in the past five years, fueled primarily by banks and private equity firms who see the subprime auto loan industry as an untapped revenue stream. The result is people getting loans on vehicles they cannot pay for, and the amount owed on the vehicle far exceeds the actual resale value. This puts subprime borrowers, who are usually borrowers with fewer options to begin with, in a situation in which they will almost inevitably default on the loan. The 2014 first-quarter reports show banks have written off 15 percent more auto loans as unrecoverable this year over last, and repossessions this year are up 78 percent over last year. All this while one of the largest lenders, Wells Fargo, has increased its lending by nearly 9 percent this year over last. The rate of return is getting worse and the lending is increasing. This is a formula for disaster. But it’s not a disaster that can be avoided by tinkering at the margins. The core of the problem must be attacked.

Selling people a more expensive car than they can afford is indeed a problem. However, the answer is not to infantilize the borrowers or demonize the dealers, but to understand the fundamentals. People without much money and even less credit need a vehicle. Car dealers need to sell vehicles. Banks and Wall Street-backed lenders capitalize car dealers who can then supply their product to the consumer. This means, in many instances, the dealer is not the one financing the vehicle but instead acts as a middleman between buyer and lender. So, if the influx of capital from corporate investors were eliminated, and thus forced dealers to "in house finance,” lending would be done more responsibly as dealers have less risk tolerance than a large backer. Banks can take greater risks because they have greater resources and the backing of the government if things get too bad. This is a comfort most other businesses do not enjoy.

Large finance companies understand how to assess balance sheets, but in this instance they do not understand the industry behind the numbers. The numbers are mere abstractions, or representations of, a more detailed and nuanced industry. Lending money to people who have almost no chance of paying it back, as is now the case, is a recipe for disaster.

Car dealers catch a bad rap, and sometimes justifiably so. But in this instance it is the large lenders far away from the daily grind of selling cars who are wreaking havoc in the used car market. This potential spillover of a collapsed used car market into the rest of the economy is something we should all be concerned about.

Kyle Scott, Ph.D, teaches political science at the University of Houston and has written previously on public policy in Deseret News and elsewhere. This piece was published previously at UK Progressive.

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