Have you heard about the student debt bubble? It is a serious potential threat, but it isn’t the scariest bubble in the country right now.
Auto sales have been booming over the past two years, and if that sounds like good news for the economy, it’s because you may not have been scrutinizing the loans enough. Many economists are debating whether or not there is an auto bubble and just how serious it might be.
As always, this closer inspection can show you the root of the problems to help you avoid potential trouble in your own finances.
Subprime Loans
If you paid attention to the mortgage bubble, then this phrase should strike a nerve. On the chance you aren’t familiar with the concept, here’s a quick recap. The housing bubble was essentially the result of deregulating loan restrictions for mortgages.
When the major banks noticed the new opportunity, they aggressively advertised and financed subprime loans (loans aimed at borrowers with bad credit scores) to cash in on the increased interest opportunities.
The results were huge increases in home sales that dramatically and artificially raised home value. Because so many of the loans were to people who couldn’t actually afford them, widespread foreclosure dried up the banks’ liquid assets and caused them to go under. The result was the Great Recession, the effects of which are still haunting the country today.
In the case of cars, deregulation has once again spurred lenders to increase their numbers of subprime loans. In fact, one in three current auto loans is now to a subprime borrower. The effects today are causing car buyers to suffer higher interest, longer terms on their loans and a massive increase in repossession. Of the subprime loans, another one in three are delinquent within seven months.
Repo
Since repossession is on the rise, dealers and lenders are facing their first obstacles. Repossessed cars are always worth less than what was originally purchased and driven off the lot. So, if someone defaults on a car loan too soon, the lenders are losing money on the venture. Even worse, repossession is not an exact science, and many vehicles that are in default disappear.
In response to this, subprime lenders are using new techniques to mitigate the risks. First, high-risk cars are equipped with GPS tracking devices to make sure they don’t disappear. Second, many lenders are installing technology that enables them to remotely disable a vehicle. Increasing repo conversions help lessen the potential of a bubble burst, but they don’t eliminate the economic downturn that is still looming.
Impact on Auto Industry
Even though the major banks are claiming that they have the capital to withstand widespread loan defaults, that doesn’t fully protect the economy. Even assuming that they can weather a complete collapse, the auto industry itself is in trouble, and the trouble stems directly from the increasingly popular loan techniques.
First, the subprime lending is inflating personal debt, specifically in a large car-buying demographic. This is pushing them to hold onto their cars for a much longer period of time, reducing new car sales in the process.
Secondly, repossessed cars sell much cheaper than new ones, and they are luring large numbers of buyers away, further crashing sales for the manufacturers. Regardless of how the rest of the economy handles the situation, auto manufacturers are heading towards a near inevitable slowdown that is likely to cost jobs alongside profits.
Tying in Other Issues
The last piece of the big picture is to apply the auto loan situation to the rest of the economy, and the results are not encouraging. Subprime lending is a way for almost every major industry to make short-term gains, and the bulk of the banking industry is in full support. Everything from personal debt to new computers is being financed with the same reckless abandon.
The real threat isn’t just an auto bubble, but a number of smaller bubbles expanding side by side and bursting too closely together. As scary as it sounds, none of the industries are out of control, yet.
Consumer awareness, education and potentially regulatory changes for subprime lending could all prevent any of the bubbles from deflating, but without sweeping change from somewhere, the current economic upswing is in long-term trouble.
Regards,
Ethan Warrick
Editor
Wealth Autority
