The troubling trend in subprime auto loans

Over the weekend, Jessica Silver-Greenberg and Michael Corkery documented in The New York Times the sudden subprime bubble in used car loans. The article tells the story of several low-income Americans who received high-interest loans they couldn’t repay and saw their cars repossessed by banks. The article is a harrowing read not only for the individual human stories but also for the similarities between today’s subprime second-hand auto lending and the subprime mortgage bubble in the early to mid-2000s.

Policymakers have made some progress on reforming our financial system since the subprime home mortgage meltdown, but the used car loan bubble is a reminder that factors underlying the financial crisis still exist.

The causes of the financial crisis and the Great Recession of 2007-2009 are many and interconnected, but at the heart of the matter was the tendency of the financial system to channel debt to low-income households. The various sources of the savings that fueled this debt boom ranged from capital flowing out of emerging market economies to the savings of high-income Americans.

Economists Michael Kumof and Romain Ranciere of the International Monetary Fund developed an economic model that shows how the higher savings of the rich are transformed into lending to the poor by the financial system. And in their book House of Debt and in earlier research, economists Atif Mian of Princeton University and Amir Sufi from the University of Chicago detail how mortgage lending was targeted toward areas where earnings growth had stalled or even declined in the run up to the crisis.

Anecdotally, The New York Times story shows that the individuals receiving these new used auto loans are also struggling economically. In this regard, today’s new lending bubble is similar to the subprime mortgage bubble—except that when it pops it won’t be as economically destructive.

First, used cars aren’t as large a source of wealth as housing. A large decline in the value of cars wouldn’t cause a significant reduction in consumption. Second, there’s no evidence that securitized used car loans are a major part of the financial system today compared to mortgage-backed securities in the mid-2000s. So while there are very real costs to the individuals who are given loans they can’t handle, the risk to the broader economy doesn’t seem significant, at least right now.

The problem is that the U.S. financial system still has the facility to create debt bubbles that target low-income Americans, fueled in part by high and rising evels of income inequality. Our financial system is less fragile since the housing and financial crises, but clearly there’s room for improvement.

July 21, 2014

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