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A new debt bubble has formed in the U.S. economy concerning auto loans. As this frightening balloon takes in more air, President Donald Trump may soon find himself in a financial crisis the likes of which his democratic predecessor confronted when he took office in 2009. This news is a bit more than worrisome.
Auto loans are poised to grind down the U.S. economy in the next couple of years similar to the housing bubble of 2008. Here’s why: Analysts are beginning to allude to the various warning signs: total auto loan debt has reached a staggering $1.1 trillion and delinquency rates are going up and subprime lending is a dominant theme.
For close to ten years, consumers have had the ability to borrow money at historically low interest rates. Thanks to seven-year auto loan promotions and motorists purchasing vehicles without any money down, reckless spending has been rampant – there was a $96 billion increase recorded in auto loan debt in 2016.
As the Federal Reserve begins to gradually raise interest rates, borrowers may find themselves under water.
Despite the greater chance of defaulting, subprime auto loans have played an important part in automobile lending. Subprime auto loans account for close to $200 billion of the entire market. Those with poor credit scores are also nabbing auto loans: consumers with credit scores under six-hundred have seen their acceptance rates grow by more than 23% from 2015 to 2016.
Subprime auto loans serve as a reminder of the housing crisis in that borrowers have difficulty maintaining the repayment schedule. The Federal Reserve Bank of New York reported in February that the delinquency rate for subprime auto loans has hit an eight-year high:
The worsening in the delinquency rate of subprime auto loans is pronounced, with a notable increase during the past few years.
The data suggest some notable deterioration in the performance of subprime auto loans. This translates into a large number of households, with roughly six million individuals at least ninety days late on their auto loan payments.
The subprime auto loan market is soaring and with it the subprime delinquency as well. This is a trend that is impacting bonds backed by auto loans, which appear to be toxic, reports Bloomberg.
The auto-loan backed securitization market has seen its demanding yields slashed in half and will be deeply impacted when a recession occurs. Although the risks are mounting, demand for these loans continues to be vigorous. As well, underwriting standards have not stiffened. A majority of the new entrants in this market are supported by private equity, a worry for car dealers.
Some of the biggest financial institutions are beginning to take notice. Wells Fargo – the largest holder of subprime auto debt – has started to limit its exposure because investors are observing developing risks and downsides. One of the main stories was the fact that many borrowers had no credit score at all.
Like the housing market a decade ago, it isn’t just subprime that is causing immense concern. It is the entire auto loan market.
Last month, Reuters reported on a Moody’s Investors Service report that took a look at a growing trend: the trade-in treadmill. This is when car trade-ins had outstanding loans that were worth more than the vehicles themselves. In 2016, this represented one-third of all U.S. auto trade-ins, and it is posing a tremendous risk to lenders.
Jason Grohotolski, a senior credit officer at Moody’s and one of the report’s authors, warned:
The combination of plateauing auto sales, growing negative equity from consumers and lenders’ willingness to offer flexible loan terms is a significant credit risk for lenders.
Analysts are also pointing to obvious weaknesses: a drop in new car sales, price declines in used cars, inventory build-up and overextended borrowers – many motorists will have an eighty-four-month plan, maxed out credit cards and a $30,000 student loan at the same time. And that, liberty readers, is a whole lot of debt.
It’s entirely possible that we could be staring at a 2008 financial crisis all over again – same problem different substance. When the mortgage market cratered, home values plummeted. Out of nowhere, occupants owed more to the bank than their homes were worth. These homes then flooded the market and no one had the money to buy these houses.
Today, it is the automobile. Millions will witness their vehicle’s value collapse but still have thousands of dollars left to pay off. To limit the damage, there will be a massive wave of private sales, but it will be a futile endeavor because many will not want to purchase a car.
Perhaps the auto loan market won’t create a nationwide financial crisis. That being said, when you start to factor in other developments – record student loan debt, soaring credit card debt and climbing inflation – a recession under President Trump certainly isn’t out of the realm of possibilities.