The New “Big Short” — This Is THE Crisis of 2017

Subprime auto loans are the new “Big Short.”

Of course you remember the first “Big Short” — subprime housing loans. Michael Lewis wrote a book about it.

In the wake of the subprime housing crisis, millions of Americans lost their homes and jobs. The global financial system nearly collapsed.

Thankfully, in the years that followed, the banks found religion. Lenders found their morals.

Consumers found responsibility. And Congress beefed up industry oversight.

OK, back to reality!

Years of ultralow interest rates led to “free money” deals where anyone who could fog a mirror could get a car.

Even “better,” if those buyers couldn’t pay their car off in the standard 48 months, they could extend their loan terms to 72 or even 84 months.

Well, those chickens are coming home to roost.

From The Wall Street Journal in September this year: “The share of subprime auto loans backing bonds that were at least 60 days behind on payments climbed to 4.86% in August, up from 3.98% a year earlier, according to Fitch Ratings. Annualized net losses reached 8.89%, up from 7.02% a year prior.”

That’s the first layer of bad news. It gets worse.

Here’s AFP on Nov. 30: “Especially worrisome is the rise in auto loans to borrowers with low credit score, and the accompanying signs of distress among that segment, New York Fed researchers said. Subprime auto loans now account for 33% of total loan balances outstanding…”

There are more bad auto loans than ever. And more of them are starting to fail.

But according to Experian Automotive’s Q3 report, it’s even uglier than that.


Experian’s risk tracking for the third quarter says 4.28% of all open auto loan balances are “deep subprime.” That means FICO scores that are off-the-map low.

Thus, 18.45% of all balances are “subprime,” or 550 FICO territory. And 21.48% are “nonprime.”

First, let’s agree “nonprime” means exactly that. It’s a loan that is not prime and could have an elevated level of default risk.

By Experian’s own reporting, this means 44.21% of all open auto loan balances in America right now are at least at risk of distress, if not eventual default.

That’s the really bad news. It’s possible 44 cents on every dollar of auto debt is at risk of distress.

This risk increases as interest rates continue to rise. And repossessions increase, more leases end and used car prices continue to fall due to inventory gluts. This is all happening right now.

Consider that at peak insanity in 2006, there were about $650 billion of subprime mortgages written in the U.S. There’s about $1 trillion in total auto debt in America right now.

The match to this powder key starts with buy-here-pay-here auto dealers. It spreads to finance companies, including divisions of some major automakers. And it, of course, includes some of the same Wall Street names you remember from the housing crisis.

It’s true subprime auto is not a subprime housing-sized problem.

It is, however, a looming disaster that could cut Detroit’s “recovery” off at the knees. It could stop the Trump market rally in its tracks. It could ignite a swift and steep market correction. It could be the opening kickoff of a recession.

Here’s your takeaway — they did it again. The banks, the unscrupulous lenders, the rating agencies… they used all the same tricks from the mid-2000s and securitized bad debt all over again.

And if you own mutual funds, chances are good you’re holding part of the bag right now, too.

Happy Holidays.


Amanda Stiltner
for The Daily Reckoning

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