By Shaun Bradley*
After nearly a decade of being able to borrow money for next to nothing, interest rates are finally beginning to creep higher. Even the relatively small increases seen so far have caused problems in the previously booming automobile industry. The size of the auto loan market has ballooned to a historic $1.1 trillion, and subprime lending has once again become the norm. Teaser offers that allow people to get cars with zero money down and 84-month financing have fueled a wave of irresponsible spending. Americans’ tendency to associate success with having nice things has driven many people who can’t afford to buy a house to get the next best thing — a brand new car.
The data released so far in 2017, however, has started to raise questions about how much longer these spending habits can last. There has been a significant drop in new car sales and a sharp increase in the delinquency rates of subprime borrowers. Inventories across the country have started to build up, and if things don’t turn around soon, the excess cars sitting on lots will eventually force prices lower. According to analysts at Morgan Stanley, price declines will also impact the used car market, and some predictions are calling for up to a 50% decline by 2021.
Millions of borrowers who bought cars on credit could see the value of their vehicles plummet yet still have to pay off their full loan amount. It’s similar to 2008 when the mortgage market collapsed and plunged home prices across the country dramatically lower. Property values fell so much that people suddenly owed more on their homes than they were worth. Those homeowners then had to make the decision of whether to wait it out and keep paying their inflated mortgage rates or cut their losses and sell. Cars, on the other hand, have never been an investment, and this kind of situation in the auto industry would likely trigger an avalanche of private sales as people try to get out from under their debts.
Fitch Ratings Inc. talked about these recent developments in their latest report:
Fitch expects that deteriorating credit performance will be more acute in the subprime segment, driven to some extent by the expansion of less-tenured independent auto finance companies that have demonstrated higher-risk appetites and less underwriting discipline. … NADA’s Used Vehicle Price Index, which measures wholesale prices of used vehicles up to eight years old, declined over 6% in 2016 and was down 8% year over year through February 2017, marking the eighth consecutive monthly decline. Used vehicle prices were down 1.6% sequentially in February, reflecting the sharpest monthly decline for the index since November 2008 and a seasonal anomaly for February.
Wells Fargo is one of the largest holders of subprime auto debt and recently took steps to limit their exposure when investors started to recognize the possible downside. It has even been reported that many of these loans were given out to buyers who had no credit score at all.
The risks aren’t limited to just lenders and borrowers but also extend to institutional investors. Thousands of these high-risk car loans have been bundled together into products similar to the mortgage-backed securities that undermined financial stability in 2008. Investment fund managers have bought billions of dollars worth of this securitized debt while trying to maximize returns in this low-interest rate environment. Even though this bubble, on its own, isn’t enough to destabilize the economy, the additional problems with student loans and record high rental costs have had a devastating impact on the net worth of most working Americans.
The real reason these loose lending standards have reemerged in the auto sector is to prop up the system through consumerism. The trade-off has been a lack of any substantial savings by the average person. Instead of planning for their futures, people have financed overpriced cars for six or seven years while still having to make monthly payments on a student loan. This next generation isn’t going to have the extra money needed to afford a home, build an investment portfolio, or start a business. Instead, they’re setting themselves up to work for years trying to get out from under the stress that comes from accepting debt enslavement.
As time goes on, more and more weaknesses in the economy will reveal themselves. Whether it’s the collapse of the retail market, uncertainty in the Eurozone, or the automation of low-skilled workers, something will eventually cause public confidence to break. The auto loan market is a microcosm of the systemic imbalances that have become normal since the Federal Reserve and US government bailed out the system in 2008. Despite this clear manipulation, individuals who accumulated massive debts are still responsible for their actions, but the rampant lack of economic knowledge has led millions of people into a life in quicksand.
This article appeared at the MISES Institute.