The Next Subprime Debt Crisis Is Coming
Justin Spittler
Easy money is fueling record car sales...
U.S. car sales are on track to hit 18.3 million this month. It would be the most cars sold during any month this year. It would also be the first time in history that more than 18 million cars were sold in the U.S. for three months straight.
The mainstream media thinks high car sales are proof the economy is getting stronger. In reality, car sales are high because people are borrowing at record rates to buy them…
• Last quarter, the value of U.S. car loans grew by $39 billion...
It was the 18th quarter in a row the car loan market grew.
The value of U.S. car loans now tops $1 trillion for the first time ever. This means the car loan market is 47% larger than all U.S. credit card debt combined.
• It’s never been easier to get a car loan...
According to the Federal Reserve Bank of New York, lenders have approved 96.7% of car loan applicants this year. In 2013, they only approved 89.7% of loan applicants.
It’s also never been cheaper to borrow. In 2007, the average rate for an auto loan was 7.8%.
Today, it’s only 4.1%.
Loose lending standards and cheap credit have encouraged more car buyers to take out loans.
Nearly 86% of people who bought a new car during the second quarter took out a loan. Used car buyers borrowed 56% of the time.
• Nearly half of all people who take out auto loans have shaky finances...
Subprime loans make up 40% of the auto loan market. Subprime loans are made to people with poor credit history or no credit history at all. They’re riskier than loans to borrowers with good credit.
That’s why they come with higher rates.
Last week, The Wall Street Journal explained just how quickly the subprime market is growing.
Over the six months through September, more than $110 billion of auto loans have been originated to borrowers with credit scores below 660, the bottom cutoff for having a credit score generally considered “good,” according to a report Thursday from the Federal Reserve Bank of New York. Of that sum, about $70 billion went to borrowers with credit scores below 620, scores that are considered “bad.”
In other words, subprime loans made up 64% of new auto loans during the second and third quarters.
• The Federal Reserve is helping to stoke the subprime auto market...
In 2008, the Fed dropped its key interest rate to effectively zero and left it there. At the time, the U.S. economy was experiencing the worst economic downturn since the Great Depression. And the Fed wanted to boost borrowing and spending.
The plan worked...
Car buyers are borrowing as much as they can. The average loan for a new car purchase hit $28,524 during the second quarter, its highest level in five years.
Consumers are also taking out loans with extra-long terms. The average term for a new car loan is now 67 months. For a used car, it’s 62 months. Both are all-time records.
• An industry built on debt has a high risk of collapsing...
People with large auto loans could struggle to pay their debts if the U.S. economy runs into trouble.
Last month, Thomas Curry, U.S. Comptroller of the Currency, said today’s subprime auto loan market reminds him of the subprime mortgage market before the last financial crisis...
During the last housing boom, lenders thought the housing market would stay hot indefinitely.
So they loaned trillions of dollars to homebuyers with bad credit or no credit. As you likely know, housing prices eventually plummeted, triggering a wave of defaults and foreclosures. The mortgage market collapsed. And it almost sunk the entire global financial system.
Today’s $1 trillion auto loan market isn’t nearly as big as the mortgage market during the last housing bubble. But it’s one of many bubbles that has created a dangerous investing environment.
• Easy money policies have led to reckless borrowing and spending...
During the past seven years of near-zero interest rates, Americans have borrowed trillions of dollars to buy cars, houses, commercial property, fine art, and just about everything else. Margin debt, which is money borrowed to buy stocks, hit an all-time record high earlier this year.
Overall household borrowing hit $12.1 trillion last quarter. That’s its highest level in five years, according to the Federal Reserve Bank of New York.
Even more concerning, debt levels have grown much faster than the overall economy. The Bank of International Settlements says U.S. household, corporate, and government debt jumped from 218% of gross domestic product in 2007 to 239% last year. Meanwhile, the real median U.S. household annual income has fallen from $57,795 in 2008 to $55,218 today...
The Fed has created an “Alice in Wonderland” economy where almost no one asks, “Does it make sense to borrow this much money?”
Instead they wonder, “How much can I get?”
• Seven years of zero percent rates have already warped the economy...
Yet, the Fed might launch an even more radical policy soon. Earlier this month, Fed chair Janet Yellen said negative interest rates are “on the table...if the economic outlook were to deteriorate in a significant way.” It would be the first time the Fed has ever used negative rates.
Negative interest rates don’t make sense to most people. There’s good reason for that. The whole point of lending money is to earn interest.
With negative rates, the lender pays the borrower. This means banks charge depositors for holding their money. This absurd arrangement is supposed to encourage borrowing and spending. Yellen has said the purpose of negative rates would be “to spur” lending.
• The mainstream media mostly brushed off Yellen’s comments...
However, negative rates in the U.S. are a real possibility. On November 21, John Williams, president of the Federal Reserve Bank of San Francisco, said the Fed should consider negative rates.
Williams is one of the most closely watched Fed officials. He said negative rates would give the Fed more flexibility during the next crisis.
We need to think more about whether going to negative interest rates gives us more room.
When the U.S. economy runs into trouble again – and it will – the Fed will respond with a flood of easy money...
With rates already near zero, there’s a good chance the Fed could drive its key rate below zero for the first time ever. This would punish savers, encourage more reckless borrowing and spending, and push the U.S. economy deeper into Wonderland.
Chart of the Day
A record number of people are borrowing to buy cars...
Today’s chart shows the percentage of car buyers who took out a loan to buy a new car. As you can see, the figure has steadily gone up since the financial crisis.
This year, 86% of new car buyers took out a loan. That’s up from 80% in 2010. It’s also an all-time high. Used car buyers are also borrowing like never before. About 56% of used car buyers have taken out loans this year, up from 47% five years ago.
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