The next financial sector bubble
Many people will borrow to purchase vehicles from car dealers. Leases are arranged with affordable monthly payments which cover a hefty rate of interest over a period of time.
As lenders compete, they offer loans to people who are less and less likely to afford them if they became slightly more expensive.
The risk to the buyer is that the longer the loan takes to pay, the more the value of car is likely to fall. So by the time the car is “bought”, it has no resale value. It is a bubble waiting to burst.
Some lenders manage this by re-selling whole loan books to the financial markets (asset backed securities). The market for asset backed securities only functions if people have confidence in the value of the assets. Asset backed securities were used by every major bank in the 2007 financial crisis.
Compounding the matter are the lenders piling in
The problem is that it is not just regulated banks lending to customers. It is also car manufacturers themselves who can earn more profits from each loan than they do from making the car.
The car isn’t the product, you are. Those purchasing repackaged loans rely on you to keep making payments for their own income. Some carmakers are selling nearly half their cars to customers they are lending money to.
The sensible ones do it through a regulated lender but it means that lender can’t diversify the risk.Its how IT loans used to work in the 80s.
The moment that demand for cars collapses makes shareholders of carmakers nervous. They are nervous because they know those who lent to the carmakers are nervous. If those who lend to the lenders are nervous, it’ll be a crash waiting to happen.
One Treasury Select Committee member called it “terrifying”.
Earlier this year, the Bank of England *tried* to warn politicians and policymakers that the level of consumer borrowing which fuelled UK growth was at levels not seen since 2008. The more household finances are under pressure, the more likely arrears will rack up.
Most of the £32bn of loans were taken out when interest rates were low. so if the Bank of England has to raise interest rates, it leaves borrowers exposed to higher interest rates on monthly payments.
If they default on the loan, the car is the collateral but its value to the lender is pretty much a write-down or another loss. The credit cycle works where as losses mount up, the cost of credit becomes more expensive. People have to subsidise the losses through higher interest payments anyway.
Is it really just the Financial Conduct Authority’s problem?
All the financial conduct authority can do is really tighten credit so lending is affordable. Slowing down growth in the market doesn’t make it manageable. It just gets rid of lenders with sharp practises.
One respected advice service for people in debt was concerned that lenders are not checking affordability rigorously before a sale. “It’s easy for someone when offered a higher spec new car than they were dreaming of to decide “it’s worth” the extra £100 a month. But it’s not so easy 6 months later when they are having to make the payments”
Most MP’s don’t care. At worst, they blame Brexit for rising borrowing costs. The last financial crisis also happened when major policymakers were distracted. The moment the financial markets lose confidence in this sector is the moment it will correct through contraction.
How big the bust may be will ultimately be an issue for the economy. Are the borrowers that pay for cars also borrowing to purchase homes or boats? Are families able to set enough aside to absorb the cost of worsening credit ratings? Is the economy resilient to a consumer slowdown when a correction happens?