The growth of student loan debt has received no shortage of attention from politicians and the media in recent years, making it one of the top economic anxieties in post-mortgage-meltdown America. Behind the front-page investigations and populist political platforms, the numbers are indisputably chilling: student loan balances have surged from less than $18,000 per person to $25,000 per person in the ten years since 2005. But another class of debt is also growing at troubling rates without attracting anywhere near the same level of attention: car loans.
While American consumers have reduced their overall debt in the years since the Great Recession, car loans have grown at roughly the same rate as student loans, according to The St. Louis Federal Reserve. Together, loans for cars and education contributed 90 percent of the growth in consumer debt since the end of 2012. Outstanding auto loans have hit more than a trillion dollars, with an average balance of $12,000 per person (or nearly 8 percent of disposable income), while the dreaded student loans “epidemic” is not far ahead at $1.3 trillion outstanding.
When the media does obliquely cover the rise of auto loans, it’s usually under the rubric of praising “booming new car sales” in the wake of the auto bailout. This fits nicely with the narrative that the auto industry rescue drove a strong recovery in new car demand, which in turn has lifted the broader economic recovery. This ignores that new car loans, not the cars themselves, have become the new hot product and that Wall Street, not car-loving Americans, is the real market.
Juicing Subprime Auto Loans
Auto Asset Backed Securities (ABS), securitized bundles of car loans not unlike the mortgage-backed securities at the heart of the 2008 credit crisis, are the hidden driver of the auto debt boom. In the first two months of 2016 lenders issued $17.69 billion in new auto ABS compared with just $1 billion in credit card debt-backed ABS and $600 million in student loan-backed ABS. With subprime auto loans growing faster than the regular market, the return on these investments are improving even as the risk grows.
After all, relatively strong returns are what has stoked demand for auto ABS since the recession. With the Federal Reserve maintaining low interest rates and other central banks moving into negative rates, financial institutions have been seeking returns wherever they can be found, and bundles of car loans have filled that need nicely. But, like the MBS that brought down the market before them, those returns are juiced by a growing percentage of subprime loans mixed in with the safer but less lucrative prime loans.
In 2015 some 23.5 percent of all new car loans were subprime, a significant proportion but still not enough to trigger a broad economic meltdown. Still, there’s enough risk there to hurt auto lenders and trigger tighter auto lending that could halt the credit-fueled boom in new car sales. Delinquencies have been rising on auto loan ABS, reaching 4.7 percent in January, a new record for the post-2008 market, and 3.4 percent of auto loans are now 90 days delinquent or more.
Innovative Repo Techniques Aren’t Going to Help
Although rising delinquencies and defaults are finally opening the media’s eyes to the risk of an auto credit bubble collapse, many observers point to innovative new repossession techniques as evidence that a widespread collapse is unlikely. Bloomberg View’s Barry Ritholtz lays out the new techniques that he heralds as a firewall against an auto credit crunch:
Subprime loan underwriters often require borrowers to have their cars equipped with a device that allows the lender to remotely disable the ignition. GPS technology in the devices also lets a lender track a cars’ location and movements. Knowing where the vehicle is, and being able to remotely disable it, makes repossession a snap.
Photographs are taken of ‘millions of plates a day, with scanners mounted on tow trucks and even on purpose-built camera cars whose sole mission is to drive around and collect plate scans. Each scan is GPS-tagged and stamped with the date and time, feeding a massive data trove to any law-enforcement agency—or government-approved private industry—willing to pay for it’ according to Car & Driver magazine. The license-plate acquisition system called Vigilant, adds 100 million photos a month.
License-plate-readers, or LPRs as they are known, are now commonly found at mall entrances, mounted on utility poles, parking lots, toll plazas, and at major highway entrances. …Some repo companies are using drones to track vehicles and repossess cars; they also can track drivers via their own mobile phones.
These new innovations allow lenders to keep tabs on car loan borrowers, track their vehicles, and even shut them off if people don’t pay off loans as they promised. This protects against a 2008-type scenario, in which irresponsible loans default en masse, bringing credit markets to their knees.
But because auto loans aren’t as large of an asset class as mortgages, that risk was never as great anyway. The nightmare that these novel techniques do introduce is entirely non-financial: the rise of ubiquitous surveillance. In return for our ability to inflate auto sales through massive credit expansion, we need only to submit to more of the surveillance that already permeates society.
People Are Keeping Cars Longer
Meanwhile, the real systemic risk behind the auto credit bubble is not a scenario in which huge numbers of risky loans go bad, but a slower saturation of automotive demand. Cheap credit deals on new cars may not all go bad, but they keep people in cars for longer, making them less likely to return to the market.
To make credit deals seem even more attractive, lenders are lengthening loan terms: 29.5 percent of new car loans are longer than 73 months, while the average loan term is 67 months. These longer loans either keep people out of the market for longer between purchases (and despite booming sales, the average age of the American car continues to stay at record highs of around 11 years) or push them underwater. Nearly one in three vehicles traded in on a new purchase now has negative equity.
The new car business is an infamously cyclical enterprise, and most auto analysts now foresee an end to the stunning growth in car sales within the next year or two. The question is whether sales will merely “plateau” at their current strong levels, or if they will begin to fall dramatically due to high debt levels, long loan terms, and overheated sales.
An Economic Recession Waiting to Happen
The answer to that question depends on whether automakers continue to pump the market up by continuing to reduce lending standards, lengthen loan terms, and juice demand with leases and fleet sales. If automakers believe the redlined market is at sustainable levels, they will continue to overproduce vehicles, stack up inventories, and eventually face extreme price pressure.
The collapse of the auto credit bubble is far more likely to take the form of falling vehicle values than defaulting loans. When that happens, car plants in the United States will likely be idled or shuttered in favor of cheaper Mexican production, and the contagion will begin to spread throughout the American economy.
This is obviously a complex scenario, so it’s hard to blame the media for failing to see it coming. In comparison, the plight of student loan-saddled young people who face a lifelong burden with no chance of leaving their debt behind in a bankruptcy makes for far punchier copy. But the risks created by our overheated auto debt bubble are nonetheless real, and introducing new profoundly creepy forms of surveillance while increasing the chances of an economic downturn.
Rather than cheering at higher auto sales every month, it’s time to recognize that expanding auto credit is not a substitute for the missing piece of the puzzle: rising wages. Until American consumers start seeing a genuine improvement in their financial position, it’s critical that we not encourage yet another debt bubble simply because it provides the appearance of economic growth.