The great American financial crisis: Season II
Having flown in to London’s Luton Airport late one Friday evening, I took a direct train to St. Pancras International, before heading into the City to my lodging for the weekend. I sat down next to a young Brit who appeared roughly my age. While I had a pair of baggy track-pants on, he looked dapper in his suit and I discerned he was an upstart in the financial industry. Darting down towards St. Pancras, I reached out for the book I was reading at the time and placed it on my lap, cover-side up. Nothing works quite as well when you’re looking to break the ice with a stranger.
The Big Short: Inside the Doomsday Machine.Letting you in on a little secret here — this particular work by Michael Lewis is a gem when it comes to conversation starters. It hadn’t been five seconds before my companion remarked, “Ah, I love that book! Read it nine times already.” Bam. Not long after, we were diving into the contents of Lewis’ account and the portrayal of characters in the eponymous hit movie. My neighbor, somewhat rhapsodic on this subject, told me that a whole new subprime crisis had emerged in America lately — that of subprime auto loans — and an imminent disaster was looming. I was taken aback. How could such a catastrophe have befallen us so soon after the 2008 financial crisis.
Weeks later, I visited the States myself, spending a month in California. Over a decade had passed since my previous visit, so fresh opinion and judgement were a given. Frankly, it thrilled me to observe and absorb the ‘Zenith of Capitalism’. Americans love their cars. And not the sweet little hatchbacks we have in Europe. Big brawny, gas-guzzling vans and trucks from proud manufacturers like Chevrolet, Ford and GMC. Their beloved horses have been reincarnated as automobiles. While the appeal for electric vehicles is on the rise today, it contracts and expands with the price of oil, and sunk to a low when the price halved in 2014.
As many as 86% of the American workforce gets to their workplace by car. Public transportation, you ask? Consider it non-existent. In years gone by, Los Angeles boasted having the second best public transportation in the country. That is, until lobbying efforts from the rubber and tire manufacturers killed it, championing the sales of a larger number of cars. This parochial outlook portends that anyone living in Los Angeles today spends one-third of their waking hours stuck behind the wheel on a freeway. Fallacious campaigns have pressed for political action that hasn’t been in the best interest of the denizens.
Automobiles are expensive. The average price of a car in the United States today is $37,000, and people typically draw loans to pay for them. Banks have had to wise up since the 2008 financial crisis, and today, individuals with low FICO scores aren’t offered loans anymore. Instead, used-car dealerships are acting as financiers and doling out subprime auto loans all the time. Regardless of whether your home has been foreclosed, your previous car repossessed, or you’ve even declared bankruptcy, these schemes will still sell you a car. Such quagmire is a reality for subprime borrowers — any tardiness can jeopardize their job and there are no other means to purchase their mode of transport.
The crowded playing field in the subprime lending market today makes matters more precarious. Large organizations like GM Financial and Santander have expanded their subprime lending divisions and others have followed suit. A quarter of all car loans given out in the United States are already of the high risk variety. In order to compete with the bigger players, the smaller schemes have had to issue longer term loans, with less money put down, and at higher costs. The economics of money tells us that when you’re poor, everything will be more expensive, and this theory holds true once again. The astounding price of money for these loans is an average 19 percent. Unsurprisingly, the average default rate on the same loans is hovering around 30 percent.
Remember the mortgage crisis, where they bundled all the high interest loans together and sold them on Wall Street? That is precisely what is happening here as well. The similarities are stark between the housing crisis and the present situation with used car loans. While Wall Street insists they’ve learned their lesson, signs aren’t looking good, and the bubble looks set to burst. The evidence is there for all to see — when default rates are shooting up at such a staggering pace, levels of delinquency are at an all-time high and most investors won’t be protected for such a position. The situation could exacerbate if high delinquency rates push the prices of automobiles down so far that it becomes difficult for lenders to sell repossessed vehicles in order to retrieve their losses.
While the share of auto loans in the American economy isn’t as large as that of the home loans, a struggle to pay back car loans indicates a tussle with paying back mortgages, education loans and credit cards too. Similar to a decade ago, corporations are so flush with money that they’re seeking out higher returns that could be had from charging higher interest rates to subprime borrowers. The long term resolution is a genuine improvement in the financial positions of individuals through higher wages. It’s imperative that we don’t encourage another debt bubble simply because it gives illusory economic growth. Meanwhile, someone somewhere will be licking their fingers, having already shorted this market.
