A decade after the collapse of the subprime home mortgage industry almost pushed the U.S. economy over a cliff, now subprime auto loans are at a tipping point, according to a recent Bloomberg report. And just like those bad home mortgages of 10 years ago, banks securitize these auto loans and sell the repackaged bonds to investors. While most analysts predict the outcome will be nothing close to the devastating global financial crises of 2008-2009, the rate of fraud and delinquencies resembles the mid-2000s bubble that ended up catapulting global markets into chaos.
Many of the world’s largest banks are involved with this surge in subprime auto loan underwriting. Bloomberg has estimated that Wells Fargo’s market share of securitized auto loans stands at 23.5 percent, even though the bank’s own analysts warned in March that investors should minimize exposure to these bonds. But with these securities boasting yields as high as 5 percent – often more than twice the rate of U.S. Treasuries, for example – investors are still snapping them up. The auto bonds market could soar in value as high as $26 billion this year, a 250 increase from 2009, when car manufacturers were suffering from the financial crises’ hangover.
But with some industry experts suggesting as much as $12 billion in bad auto loans may have to be written off this year, the relentless thirst on Wall Street for this type of debt could be unhappily quenched at any moment.
One of the big drivers behind what Bloomberg’s Gabrielle Coppola describes as a “race to the bottom” is the relationship between the Spanish banking giant Banco Santander and the automaker Chrysler. Since 2013, as Chrysler’s sales roared, the two companies launched a relationship that has evolved into one of the sector’s most prolific subprime lending machines. Easy auto financing was made available to consumers, who otherwise had no other options. Financing helped fuel car sales this decade.
But federal and state investigators have found that Santander has permitted dodgy lending practices by dealerships in as many as 30 states. For example, researchers have found that only up to 10 percent of borrowers had their incomes verified; many had low or even no credit scores. Meanwhile, terms for auto loans have stretched as long as 84 months (7 years), previously unheard of in an industry where the 60-month car loan has long been the norm. “It’s quite likely that the exuberant 2016 auto sales figures were inflated by easy-to-get subprime loans with low, long-term payments, enticing buyers to purchase more car than they could afford,” concluded Olivier Garret on Forbes.
Earlier this year, Santander reportedly paid almost $26 million to settle lawsuits launched by the attorneys general of Delaware and Massachusetts over the tactics it employed to finance and securitize subprime auto loans.
Other factors are also driving the subprime auto lending boom and its soon-to-be bust. With more citizens relying on ridesharing as their sole source of income, drivers for Uber and Lyft increasingly take on these loans in order to have a suitable vehicle to drive. Last year, Uber launched a financing program for its drivers who were unable to secure an auto loan through conventional means.
New York City epitomizes the struggles of Uber drivers who often find themselves stuck with cars underwritten with onerous loans or leases. When Uber arrived in New York earlier this decade, part of its pitch to drivers was to free them of the city’s medallion system, in which the owners of these taxi permits would rent them out at exorbitant rates to the largely immigrant workforce. But as Alison Griswold vividly described this new system on Quartz, the result has been a similar form of indentured servitude, only with different type of shackles. Medallion owners have been replaced by shifty auto lending companies, which have convinced drivers to sign contacts that are hard to differentiate from those that would be issued by loan sharks.
Many drivers find themselves burned by “deep subprime” loans and leases within a system rife with abuse across the Big Apple. “When Uber first came to New York it talked about freeing drivers from such practices,” wrote Grisworld. “Instead the company has pushed more drivers into burdensome leases and rentals, and lent legitimacy to the way these dealers do business.”
A collapse of the subprime auto loan industry would not only be a huge setback for banks, but also for many cities, which are increasingly cutting back on public transportation services as they surmise ridesharing can pick up the slack. The problem is, the likes of Uber and Lyft (which still are not profitable) have a hard time recruiting drivers, as many burn out when they realize they can’t just drive when they want and make easy money doing so. Easy access to auto loans is one such carrot, but the stick of debt, and the burden of falling behind on payments, often pushes drivers to give up on their ridesharing gigs. “Uber creates a debt-to-work pipeline,” wrote Mimi Kirk on the blog CityLab in her article on the pitfalls of being an Uber driver. “The drivers are taking on significant financial risks to get the chance to earn a wage.”
But that system is not working, so while the big banks may suffer a few nicks, transport systems could confront a big gash – and meanwhile, more consumers will find themselves in a financial death spiral.
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