Hey, who’s up for burying consumers in ridiculous loans and selling them off as securities on Wall Street? I mean, it’s not as is this has worked out badly in the past, is it? Well, okay, it didn’t work out so well when Fannie Mae and Freddie Mac pulled this stunt with home loans, but it should work out wonderfully for automobiles. After all, they never lose value on the market. My dad’s 1978 green Pinto station wagon would be worth around $123,000 today, I’m sure, so at least the collateral would be worth it (via Ed Driscoll and Jim Hoft):
The Fed’s program, while aimed at bolstering the U.S. housing and labor markets, has also steered billions of dollars into riskier, more speculative corners of the economy. That’s because, with low interest rates pinching yields on their traditional investments, insurance companies, hedge funds and other institutional investors hunger for riskier, higher-yielding securities – bonds backed by subprime auto loans, for instance.
Lenders like Exeter have rushed to meet that demand. Backed by Wall Street banks and big private-equity firms, they have been selling ever-greater amounts of subprime auto loans in the form of relatively high-yield securities and using the proceeds to fund even more lending to more subprime borrowers.
Expansion of the subprime auto business was chronicled in a 2011 Los Angeles Times series. Since then, growth has continued apace. Consider that in 2012, lenders sold $18.5 billion in securities backed by subprime auto loans, compared with $11.75 billion in 2011, according to ratings firm Standard & Poor’s. The pace has continued so far this year, with $5.7 billion of the securities issued, compared with $4.4 billion for the same period last year, according to Deutsche Bank AG. On Monday alone, three deals totaling $1.6 billion of subprime auto securities were announced by Wall Street banks.
I wrote about this almost exactly a year ago. By the end of last year, subprime auto loans have risen 18% to 6.6 million borrowers, but the amount of securities sold in support of them rose 63.5%. That suggests that the loan amounts are inflating, too, which means that these aren’t just people looking to get a low-end car for simple transportation purposes.
But at least the Dodd-Frank law and its new Consumer Financial Protection Bureau is on the job to protect consumers from bad deals of their own making. Right? Er … not really:
To make up for the risk of taking on increasing numbers of high-risk borrowers, subprime auto lenders charge annual interest rates that can top 20 percent.
The Exeter loan Nelson and his wife got, for example, carried a 21.95-percent rate. Exeter, which is majority-owned by private-equity giant Blackstone Group, assumes that one in four borrowers will default on their loan, according to an Exeter investor pitch book reviewed by Reuters.
That 21.95% rate would be what you’d expect to pay if you put a new Chevy Volt on your MasterCard and then missed a couple of payments. It’s an insane rate for auto financing, almost guaranteeing that the borrower will end up in bankruptcy and the holder of the loan will end up with a wreck worth cents on the dollar. Why would either party willingly involve themselves in this kind of transaction?
Just like in the 1998-2008 housing bubble, two reasons — desperation and greed:
Critics of the Fed say the growth in subprime auto lending is just one of several mini-bubbles the bond-buying program has created across a range of assets – junk bonds, subprime mortgage securities, and others. The yield chase delivered big windfalls to some Wall Street firms and hedge funds holding securities that soared in value. But so much money has flowed into these assets, the critics say, that the markets for some are beginning to resemble the housing boom in the run up to the financial crisis.
“It’s the same sort of thing we saw in 2007,” said William White, a former economist at the Bank for International Settlements. “People get driven to do riskier and riskier things.”
There’s no indication that the Obama administration is actively pushing this effort, but they’re not doing much to slow it down, either. They want the big numbers in car sales as badly as Detroit does, thanks to their politically risky decision to bail out GM and Chrysler four years ago. The White House needs those sales numbers to push their claims of a steady recovery, and for at least the past couple of years have turned a blind eye to the ridiculous and unsustainable bubble forming in subprime auto loans. Instead of Cash for Clunkers, we’re heading for a Crash With Clunkers.