Subprime Auto Loans: The Next Financial Crisis?

August 1st, 2014
in Op Ed, syndication

Written by , GEI Associate

An investigation by The New York Times has revealed that millions of Americans with shoddy credit are being handed auto loans from used-car dealers, who are ignoring or even fabricating their financial information including income and the ability to repay the loan. These subprime loans, whose borrowers have credit scores at or below 640, have very high risks of default and pose serious financial threats to the borrowers and the investors who are buying these loans as bundles. This is reminiscent of the doomed subprime mortgage loans that led to the financial crisis in 2008, although auto loans make up a smaller scale.

Follow up:

Once again, the lucrativeness of the loans are driving banks to ignore the aftermath of the shady trading - the meltdown of the financial system that we witnessed less than a decade ago.

The New York Times wrote:

"The New York Times examined more than 100 bankruptcy court cases, dozens of civil lawsuits against lenders and hundreds of loan documents and found that subprime auto loans can come with interest rates that can exceed 23 percent. The loans were typically at least twice the size of the value of the used cars purchased, including dozens of battered vehicles with mechanical defects hidden from borrowers. Such loans can thrust already vulnerable borrowers further into debt, even propelling some into bankruptcy, according to the court records, as well as interviews with borrowers and lawyers in 19 states."

A graph in the New York Times article shows that the auto loans market has well rebounded in volume since 2009 and unfortunately the portion of subprime loans with it:

So why is this risky subprime loan trading being left unchecked? That is because auto dealers are exempt from oversight by the Consumer Financial Protection Bureau (CFPB) thanks to an amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. The amendment backed by Rep. John Campbell, the U.S. Representative for California's 45th congressional district, was put in the bill with the argument that auto dealers are a part of Main Street, not Wall Street, and therefore should not be part of the new changes to financial oversight and regulation by the government proposed by the Dodd-Frank bill. Campbell was heavily involved with the auto industry prior to joining the Congress, most recently serving as Chairman and CEO of Saab of Orange Country in 1999.

With the volume of total subprime auto loans now at $145.6 billion, urgent actions need to be taken by the Federal Trade Commission, the government agency that has the power to shut down the irresponsible auto dealers. Auto loans might be smaller in total volume compared to mortgage loans but the negative impacts brought upon by the defaulting of the subprime loans will undoubtedly cause massive damages to the recovering banks, possibly a smaller scale blow-up along the lines of 2008.


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