While the subprime market for automobiles is nowhere near the size of that for mortgages, which eventually brought down the US economy in 2008, it is a sizeable market. There are growing concerns that an increase in auto defaults amongst subprime lenders could stunt economic growth in the short to medium term. While not necessarily a market which will bring down the US economy, subprime auto defaults are now at their highest since 2007.
What does this mean?
A recent report by the New York Federal Reserve suggested that there are 6 million Americans who are at least one payment behind with their car instalments. There are serious concerns that this figure will only rise in the short to medium term. When you also bear in mind that used-car prices, according to the National Automobile Dealers Association, have fallen by 8% year-on-year, this is a situation which does need monitoring.
One of the major concerns is that while the traditional banking community has been pulling away from more risky subprime auto lending, more specialist auto credit companies have been taking up the slack. Many of the criteria for these auto credit company loans are not as tight as they should be hence the reason why we have seen an increase in defaults.
When you bear in mind that auto loans totalled $179 billion out of a total subprime market of $1.2 trillion it will not exactly bring the financial sector down but it could cause damage to sentiment at the very least.
Wage inflation
As with many countries around the world at the moment, wage inflation is greater for those middle and higher income earners. The fact that the vast majority of subprime auto loan customers are in the low income bracket means that they will be feeling the pinch as the cost of living continues to rise. When you also bear in mind interest rates, although they have risen recently, are still historically low, how worse could the problem get when interest rates eventually return to more traditional levels?
There is no doubt that the gap between those at the lower end of the income spectrum and those at the higher end has increased during these difficult economic times. In many ways it is the middle to high income earners taking out auto loans which is keeping the momentum going at least on the surface. At some point the issue of growing defaults will need to be addressed although it is difficult to see a simple solution.
Subprime debt
Many around the world were unaware of subprime debt arrangements prior to the US collapse in 2008 which led to a worldwide economic downturn. Subprime mortgage companies were vying for business with customers who they knew had no chance of paying back their mortgages in full. While business numbers continued to rise, defaults followed suit and eventually the whole pack of cards came crashing down.
We should be grateful that the subprime auto loan market is but a fraction of the overall subprime market. The fact that many banks have stepped away from the more risky side of the industry is also positive. However, over the next couple of years we could see some of the specialist automobile subprime loan companies struggling to meet their liabilities and struggling to survive. At this moment in time investors are not taking much notice of this growing problem but at some point it will be staring them in the face.