Sub-prime auto lending: The next bubble to burst?

Sub-prime auto lending: The next bubble to burst?

To anyone who lived through the 2008 financial crisis, the words “sub-prime lending” may cause flashbacks. For the unaware, the 2008 crisis and ensuing recession was caused, largely, by overvaluing sub-prime mortgages. Sub-prime refers to loans made to people with less-than-stellar credit.

Banks overestimated the ability of people with a low credit score to pay back mortgages, so they made a lot of reckless loans. These reckless loans were then bundled with other, more credit-worthy loans and resold. Since most of the loans were very high interest, they looked, on paper, like very lucrative investments. It wasn’t until a critical mass of people were unable to repay those loans that the market around them crumbled, leading to a banking crisis.

Many experts are now looking to the car lending industry and seeing similar signs. The number of people who can’t repay their car loans has been increasingly steadily over the past 8 months. The delinquency rate is now up to 2%, the highest it’s been since 2008.

At the same time, the number of loans being made is increasing at a rapid pace. The current outstanding auto loan balance in America is $249.5 billion dollars, also the highest mark since 2008. A high delinquency rate and an expanding loan market mean trouble, right?

Maybe not. There are a lot of reasons why a crisis in auto loans wouldn’t have anything like the impact that the mortgage crisis did. For one, the mortgage market was $8.4 trillion dollars in 2008, while the auto loan market just topped $1 trillion this year.

For another, the stakes are different. It’s much easier to repossess a car than to foreclose on a house, which makes it easier for lenders to recover their principle in the case of delinquency. The shortfall in the event of a bursting bubble will be much smaller. There’s also no impact on the value of cars from a series of repossessions. As comedian John Oliver has pointed out, there’s quite a lucrative market in reselling repossessed cars.

It’s also worth noting that houses are cars are different kinds of properties. Buying a house is partly a financial decision. One expects the price of the house to roughly keep pace with inflation, and that the equity in the house will be there when it comes time to sell. No one buys a car as a shield against inflation, and most people assume a car will have zero or near zero value when it comes time to sell it. That puts an upper limit on how hot the car loan market can get.

There are excellent reasons to be concerned about potentially predatory practices in the auto loan industry, but the health of the larger economy isn’t one of them. Humans aren’t always the best at learning from the past, but we do it occasionally. Repeating the mistakes of just a few years ago would be surprising, even for the worst history students.


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