Subprime auto loans are not the second coming of the U.S. mortgage crisis

This past week on his show Last Week Tonight, the comedian John Oliver highlighted the rise of subprime automobile lending in the United States over the past couple of years. The lending practices that Oliver’s segment highlights—many of them deceptive—are clearly something policymakers should investigate. This subprime lending trend has been going on for several years now, with implications for how we think about the U.S. financial system. Oliver, though, carried his observations to an unfortunately familiar place—the subprime mortgage boom of 2002-2006—an analogy that’s seems telling at first glance but which is not really apt given the smaller effects of subprime auto lending on the overall economy.

First, the sheer size of home mortgages compared to auto loans should give us pause. According to data from the Federal Reserve Bank of New York, there were $1.1 trillion worth of auto loans in the second quarter of 2016, an almost 50 percent increase since the end of the Great Recession in the second quarter of 2009. The amount of mortgage debt is much larger ($8.84 trillion in the second quarter of 2016), and its growth during the housing bubble was much faster (almost doubling from 2001 to 2007).  Oliver recognizes this size discrepancy in his segment but not the speed discrepancy.

Oliver’s analogy has other problems as well. The reason why the collapse of the housing bubble was so vicious was because the inflation of the bubble increased consumer spending quite a bit. Many households used appreciating homes as a way to finance more consumption. But it’s well known that cars are a depreciating asset. They lose value over time. It’s highly unlikely that anyone is using their car as an ATM to finance spending. More households with auto debt will reduce consumption as money is funneled to service the debt on their cars.

The role of auto loans in the financial sector is also quite different than mortgages. Oliver notes that subprime auto loans are being securitized and sold to institutional investors just as subprime mortgages were before the housing crash and the onset of the Great Recession. Yet mortgage-backed securities weren’t just incredibly popular securities bought and sold by banks. They also became an integral part of the financial system, with banks using triple-A rated securities as risk-free collateral in inter-bank lending. These bonds were, in effect, privately created money used in the shadow banking system. There is no evidence that the securities based on auto loans are serving such a function right now.

But let’s not miss the broader point. The subprime auto-loan practices highlighted by Oliver seem to be very predatory. What’s more, loans made by auto dealers, known as dealer-originated loans, are not under the jurisdiction of the U.S. Consumer Financial Protection Bureau, the federal agency that would naturally look into these issues. Policymakers concerned by these trends may want to look into this exemption. More broadly, the continuing ability of some actors in the U.S. financial system to target low-income and low-credit workers with financial products is something policymakers need to keep in mind as they consider the role of the financial sector in creating strong and sustained economic growth.

August 18, 2016


Nick Bunker


Credit & Debt

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