Last year, Americans bought more new cars than ever before. Given that auto sales make up around a fifth of all retail spending, 2016’s banner year is being hailed as a sign of burgeoning consumer confidence across the country.
The US closed out 2016 with just shy of $1.2 trillion in outstanding auto loan debt, a rise of 9% from the previous year and 13% above the pre-crisis peak in 2005, in inflation-adjusted terms. The number of cars and trucks on the road, meanwhile, rose by only 1.5% last year, and 9% since 2005, according to US transportation department data. Total household debt levels are now a hair under their 2008 peak, with some of the fastest growth in recent years down to auto loans.
So What's driving the Car Buying BOOM?
Lenders are more comfortable with risk these days, as reflected by rising loan-to-value ratios and ever-longer loan terms. But those signs also suggest that lenders might be letting car buyers borrow more than they can afford. Mortgage regulations tightened after 2008 to prevent banks and other credit intermediaries from writing loans on the freewheeling terms that led to the subprime boom and bust. Auto lending attracts far less scrutiny—and therefore, offers more opportunity.
This is particularly true of subprime auto lending—that is, loans made to borrowers with spotty credit histories—which has surged along with the rest of the business. Nearly a quarter of outstanding auto loans are subprime; these account for around one-fifth of auto loan originations.
More than 6 million American consumers are at least 90 days late on their car loan repayments, according to the Federal Reserve Bank of New York. “The worsening in the delinquency rate of subprime auto loans is pronounced, with a notable increase during the past few years,” said the bank a few months ago.
So does that mean the “next subprime lending bubble could be about to burst,” as Salon recently put it?
Subprime auto loans don’t pose anywhere near the same risks to the financial system as subprime mortgages. For one thing, consider their value. When the US housing market started tanking in 2007, Americans had amassed just shy of $10 trillion in mortgages; around $7 trillion of that was securitized (chopped up and packaged into bonds to sell to investors).
Despite recent growth, US consumers have racked up a mere $1.2 trillion in auto loans, and “only” about $97 billion of that has been securitized, according to Fitch, a ratings agency. Even a chain reaction of auto-loan defaults isn’t big enough to blow up banks like the housing collapse did.
What’s more, cars aren’t the flippable investment commodities that houses were in the 2000s (and still are). The exotic dancers of Miami aren’t buying five Ford F-150s on credit, like in the famous scene in The Big Short. And however creepy repossession technology might be, it means derelict cars don’t drag down the value of nearby cars while lenders seize assets, the way foreclosed houses do to neighborhoods.
The second-order effect
Although auto loans themselves aren’t a big systemic risk, there is still plenty to worry about. The automotive industry is a key part of the US economy. Carmakers and auto parts suppliers account for more jobs than any other manufacturing sector, generating around 3% of GDP, according to the American Automotive Policy Council, a trade group. Directly and indirectly, the sector employs around a million people.
The Federal Reserve is now starting to raise interest rates, and since rates heavily influence car demand, that could curb car buyers’ enthusiasm, given how many consumers are loading up on debt to purchase new rides. As delinquencies rise, so does the risk that a glut of car repossessions will drag down the value of used cars—which, in turn, eats into new car demand.
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