Subprime Meltdown Looms in Auto Loan Industry

By: Stephen A. Innamorato, III

It’s often said that insanity is repeating the same mistake and expecting a different outcome. Insanity has struck again, this time in the subprime auto loan industry.

Auto loans made to car buyers who have low credit scores are generally considered subprime. Obviously, these types of loans are very risky.

It was subprime mortgage loans to home buyers which ultimately caused the 2008 financial crisis on Wall Street. Regulations put in place by the Clinton administration during the 1990s under the Community Reinvestment Act forced mortgage lenders to make risky home loans to buyers. The lenders gave in and made the risky loans which were then securitized and sold to investors.

By the time the securitized home loans reached Wall Street, many of them were in default and the mortgages were worthless. The American taxpayer was ultimately forced to bail out the big Wall Street firms that purchased the worthless mortgages.

Recent reports show that the percentage of subprime auto loans has risen from 5.1% in 2010 to 32.5% in 2017. A high percentage of these loans were made to people with no credit score.

Lenders bundled these subprime auto loans into securities (i.e. securitized) and then sold them to investors on Wall Street. Defaults on these loans have reportedly reached their highest levels in 7 years.

Why were investors willing to buy these risky subprime auto loans? Didn’t they learn anything from the 2008 crisis? The only lesson they learned appears to be that when in financial distress, look to the American taxpayer for relief.

Here again, the blame rests mainly with the federal government. Federal laws and regulations put in place after the 2008 crisis have made it harder for banks to make a profit. Hence, big banks have been willing to underwrite subprime auto loans in order to make their financial portfolios look more attractive to investors.

Wall Street investors are now expressing an increased concern over the high rate of delinquency in the subprime auto loan market. Should the American taxpayer get stuck bailing out Wall Street again if that market goes belly-up? The answer is no!

President Donald Trump has promised to loosen many of the financial regulations which are strangling the banking industry. Those regulations were put in place by the Obama administration under the Dodd-Frank Act. That’s another Obama-era law which should be repealed. Unfortunately, Trump and Congress are not acting fast enough.

Wall Street shouldn’t get another government bailout because of risky investments. After the 2008 crisis, banks should’ve realized that making bad loans isn’t the answer to government’s overregulation of the lending industry. Instead, the banks should’ve lobbied heavily against Dodd-Frank. The banking industry is a big donor to establishment politicians in Washington, D.C. Less regulation of the industry should’ve been sought in return.

Government bailouts of any private industry are just another form of crony capitalism. Businesses saddled with debt they voluntarily assumed are free to restructure under the federal bankruptcy laws. Those laws are constitutional and should’ve been utilized by Wall Street during the 2008 crisis.

Consumers who take out risky auto loans also bear personal responsibility. People shouldn’t buy what they cannot afford. Didn’t consumers learn that after the 2008 crisis? The potential crisis looming in the subprime auto loan industry is just more insanity.