We can only hope that lessons were learned from the 2007 sub-prime mortgage crash which literally brought down the worldwide economy. Even today the impact is still there for everybody to see although there are concerns that history may be about repeat itself, not with the mortgage market but with the sub-prime auto loan industry. This is an industry which has increased in value from $2.5 billion in 2009 to a staggering $26 billion in 2016. So what is happening?
Growing concerns
There are a number of factors which have come into play to suggest that Wall Street’s insatiable appetite for high yielding bonds is back with a vengeance. Only recently we saw Santander and partner Chrysler repackage $1 billion worth of sub-prime auto loans which were then sold to investors with a 5% yield. Historically a 5% yield was neither he nor there but in this low interest/low inflation rate environment it is becoming more attractive to investors. Even though it is but a drop in the ocean for the $1.2 trillion auto financing sector, it could have a significant knock-on effect.
Concerns about vetting process
Concerns regarding the vetting process for sub-prime auto loans have reached crisis point across the US with at least two states looking to take legal action against individual lenders. Indeed there have been rumours that the recent Santander/Chrysler bond launch included assets where only one in 10 customers had been vetted to a high standard. These accusations have been denied by the parties involved but there does seem to be growing concern that Wall Street investors are turning a blind eye to the increased risks in order to bag an attractive yield.
Knock-on effect
Nobody would ever suggest that the sub-prime auto loan sector would have anywhere near the impact that the mortgage industry had when it collapsed, there could be a knock-on effect. If lending money to the money market was seen as a greater risk then investors would require a greater return which would push up financing costs for businesses and consumers in the US. This could lead to mortgage defaults in the property sector, problems with credit card debt and put household incomes under significant stress. This in turn would reduce economic activity leading to subdued economic growth and yet more pressure on the US federal budget (as if Donald Trump needs any more pressure!).
Risk/reward
Contagion is a major issue with money markets as we saw with the 2007 mortgage crisis, which saw regulators around the world fighting fires on a daily basis. There is already evidence to suggest that fraud could also be a potential issue going forward with some sub-prime auto loan applicants defaulting the day after signing their loan agreement. It will be interesting to see how the regulators react in the short to medium term because time is of the essence if this issue is to be addressed and put to bed.
This will be a stern test to see whether lessons were learned back in 2007 and we can only hope that history does not repeat itself in the sub-prime auto loan industry. The knock-on effect to the US economy could halt the ongoing, sometimes fragile, US economic recovery.