Are you ready to party like it’s 2008? The lending institutions seem to be, as subprime lending has reached a peak not seen since the year of the near-collapse of the financial industry. Nearly 40% of all auto loans are now subprime, and it’s as bad in the unsecured credit arena as well, the WSJ’s Alan Zibel reports:
Loans to consumers with low credit scores have reached the highest level since the start of the financial crisis, driven by a boom in car lending and a new crop of companies extending credit.
Almost four of every 10 loans for autos, credit cards and personal borrowing in the U.S. went to subprime customers during the first 11 months of 2014, according to data compiled for The Wall Street Journal by credit-reporting firm Equifax.
That amounted to more than 50 million consumer loans and cards totaling more than $189 billion, the highest levels since 2007, when subprime loans represented 41% of consumer lending outside of home mortgages. Equifax defines subprime borrowers as those with a credit score below 640 on a scale that tops out at 850.
The good news is that this is not taking place in the mortgage industry at all — at least not yet. By 2008, 20% of all mortgages were subprime; today, as the Wall Street Journal notes, it’s 0.3%. That figure includes home equity lending, a form of secured loans that got distorted by government incentives into a way to turn the equity bubble into ATM machines for homeowners rather than opportunities to invest back into the property itself through home improvement and repair.
Outside of mortgages and student loans (which are handled by the federal government now), though, the percentage of lending to riskier borrowers went up to $189.3 billion in 2014, not far off from 2008’s total in the low $200 million range. Loosening up credit can help boost economic development and growth, but it can also lead to more bubbles and the potential for collapse, depending on how that credit is structured and whether the resources to back it are solid.
As we saw in the bubble, though, new firms are entering the subprime field to offer loans that banks won’t. They claim to be more cautious than before the crash, but … we’ve heard that in the past:
Nonbank lenders catering to subprime borrowers said they are seeking to fill a void left by large banks, which have pulled back from riskier lending due partly to greater regulatory scrutiny. …
Many lenders said they are making loans only to borrowers at the top end of the subprime credit-score range, and they are reviewing additional borrower history such as bank-account transactions and income. This type of due diligence wasn’t as thorough with some lenders in the past.
Simon Constable is not impressed:
The key here is how that risk is secured. Do these lenders have the assets to cover their own potentially bets? If so, then it’s no problem except to their own shareholders. If they are securitizing these loans and spreading the risk into the bond markets in the way that Fannie and Freddie did, then a significant failure could pull down financial institutions in the way that we saw in 2008. That’s not an academic question, either; late payments and defaults are rising in the auto loan industry, and the economy isn’t expanding so fast as to raise the levels of these subprime lenders rapidly enough to save their bets.
If we had solved the Too Big To Fail problem after 2008, this would be much less of a public-policy concern. Instead, though, Dodd-Frank took us in exactly the wrong direction, which means the risk is more concentrated than it was in 2008:
According to a new study by the Harvard Kennedy School of Business, the attempt to end Too Big to Fail backfired – in a big way.
One problem that led to TBTF was industry consolidation, which had been steadily reducing the number of smaller community banks that made lending much more accessible to small business owners, farmers, and middle and working-class families. Over the past twenty years, the share of US lending handled by community banks has fallen by half, from 41 percent to 22 percent, while the share handled by large banks more than doubled from 17 percent to 41 percent.
One of the factors driving that consolidation was “economies of scale,” the GAO found in an earlier study. The FDIC noted that was a particularly strong factor for banks that did more than $100 million a year in lending. Dodd-Frank actually made this worse, thanks to the massive amount of new regulation and its attendant compliance costs. …
If the point of Dodd-Frank was to eliminate TBTF, it’s clearly failed. Instead, what it has done is prove the point of conservatives, who have consistently argued that regulatory expansion disproportionately impacts smaller players in any market. Larger players know this and leverage their influence to get legislators to expand regulation in a way that burdens their smaller competition. Eventually, it incentivizes them to either leave the market or get swallowed up by consolidation.
That means that any large-scale failure would be more likely to result in a bailout. That means that we should all be concerned with the rate of subprime lending, especially in the unsecured loan sectors.