Auto loans and the stability of U.S. consumption growth

One of the reasons so many economists and policymakers are concerned about the stagnant state of wage growth in the United States is its relationship to the growth of consumption and therefore overall U.S. economic growth. After all, about 70 percent of U.S. gross domestic product is personal consumption expenditures, an all-time high for the U.S. economy. Since the end of the Great Recession in mid-2009, consumption seems to be more strongly tied to earnings growth than in previous economic recoveries, the result being quite weak consumption growth.

Economists Atif Mian at Princeton University and Amir Sufi at the University of Chicago point out that the consumption of non-durable goods and services is sub-par compared to previous economic recoveries. But interestingly, the pace of the consumption of durable goods has been relatively strong by historical standards. What might explain the relative strength in demand for durable goods?

In a word: cars.

Automobile purchases as a share of retail sales increased quite a bit over the past six years, though still below pre-recession levels. The reason for this particularly strong increase in auto sales is the increase in debt financing for auto sales, particularly for low-credit borrowers. Put another way, the auto sales seem to be driven by subprime lending.

What’s troubling about this boom is that many of these subprime loans are originated by auto dealers. Auto dealers who originate these loans on their showroom floors are not regulated by the Consumer Financial Protection Bureau, the regulatory agency created in 2010 in the wake of the financial crisis. Elected officials in the U.S. Congress have pushed back on these supervisory efforts by the agency, even though the new bureau argues that it’s on sound regulatory ground in trying to regulate auto lenders who are not dealers and would seem to fall under their jurisdiction in the wake of discriminatory practices. At the same time, some auto lenders appear to be bowing out of the subprime auto lending business, prompted by declining profits on these kinds of loans. However, it’s not entirely clear this market will change or disappear on its own.

What’s the implications of these trends for the overall economy if the debt-fueled sale of automobiles is largely responsible for growing personal consumption despite weak wage growth? According to data from the Federal Reserve Bank of New York, auto-loan debt has increased substantially over the past three years or so and is now larger than credit card debt, which it was not prior to the Great Recession. Yet the situation isn’t nearly as perilous as the swift rise in home-mortgage debt, which sparked the twin housing and financial crises in 2007.

Many home purchasers prior to the Great Recession believed that housing prices would always go up, but cars are widely known to depreciate in value quickly. The result is that part of the U.S. financial system has pumping funds to low-income households to buy an asset that will not increase in value. This probably won’t result in systemic risk to the U.S. financial system, but for those car buyers with poor credit and falling-to-stagnant wages the future is unlikely to be bright for them or the local economies where they live.