Is this a failure of the labor market? Or is it a rerun on a smaller scale of the financial crash that created the Great Recession? According to the Federal Reserve of New York, a record number of Americans are three months or more behind on their car payments — even worse than during the crash in the previous decade:
A record 7 million Americans are 90 days or more behind on their auto loan payments, the Federal Reserve Bank of New York reported Tuesday, even more than during the wake of the financial crisis.
Economists warn that this is a red flag. Despite the strong economy and low unemployment rate, many Americans are struggling to pay their bills.
That seems incongruous in an economy where growth has spread out across the spectrum. Job creation has picked up, wages have increased in real terms at the best rate since before the Great Recession, and the overhang of discouraged workers finally appears to be evaporating. Still, the New York Fed blames this on a lack of widespread impact from the economy:
“The substantial and growing number of distressed borrowers suggests that not all Americans have benefited from the strong labor market,” economists at the New York Fed wrote in a blog post.
Maaaayyyyybeee, but there’s something else going on here too. In the same blog post, the NY Fed also notes that the delinquencies are mainly coming from subprime loans:
The flow into serious delinquency (that is, the share of balances that were current or in early delinquency that became 90+ days delinquent) in the fourth quarter of 2018 crept up to 2.4 percent, substantially above the low of 1.5 percent seen in 2012.
In the chart below, we disaggregate the delinquency rate by the borrower’s credit score at origination. The relative performance between each credit score group stands out immediately; but the increase in delinquency is most obvious among the loans of the two groups of lower-score borrowers, shown by the blue and red lines in the chart below. Borrowers with credit scores less than 620 saw their transitions into delinquency exceed 8 percent in the fourth quarter (annualized as a moving sum), a development that is surprising during a strong economy and labor market. Meanwhile, the delinquency transitions among those with the highest credit scores have remained stable and very low. In aggregate, the increasing share of prime loans has partially offset the deteriorating performance of the subprime sector.
That increase in the percentage of prime lending as a hedge against subprime risk has only happened recently. Over the last several years, subprime lending increased significantly, including in the auto-loan market. By 2013, subprime auto lending had increased 18.8%, while subprime auto-loan securities had grown 63.5%. Many of those loans carried high interest rates, sometimes as high as revolving credit-card rates. Did people expect to marry credit risks to high interest rates and not get defaults?
The Washington Post buries the scope of that risk towards the end of their article:
He noted that non-prime and subprime auto loans increased from 28 percent of the market in 2009 to 39 percent in 2015, a reminder of how aggressively lenders went after borrowers who were on the margin of being able to pay. More lenders are giving people six or seven years to repay now vs. four of five years in the past, according to Experian, another tactic to try to make loans look affordable that might not otherwise be.
That’s a more accurate look at the aggressive nature of subprime lenders, which also has echoes of the housing bubble and its 2008 collapse. The NY Fed blames this mainly on “auto finance reporters,” but this chart shows a more nuanced picture:
Half of all auto-finance reporter loans are subprime, which accounts for $75 billion in outstanding debt. However, 25% of all auto loans written by large institutions are also subprime — and that accounts for over $97 billion in outstanding debt. Those “too big to fail” institutions apparently didn’t learn any lessons, and neither did the investors who are buying securities based on subprime debt. And how much backstop are the auto finance reporters getting from the large banks?
The only potential good news is that auto-loan debt isn’t large enough to knock out financial institutions — on its own, anyway. Does anyone want to bet that subprime lending in the housing markets hasn’t followed along in the same manner, though?