Details in this article in the LA Times. To summarize, auto dealerships have created what is called a “buy here, pay here” model where under-qualified customers can take out high interest loans on aging, high-mileage vehicles that they sell. Those loans are then packaged, securitized, then sold to banks, hedge-funds, etc. Now, several private-equity firms are buying the lots outright to capitalize on the profits. There are a few parts of the article that really strike me as troublesome:
I am increasingly troubled by the how accustomed we’ve become to feeding the sheep to the wolves. We seem to want to increase the number of interactions between the weak and the poor, the sophisticated and the ignorant, without any regard to morality or the consequences. It’s one thing for the George Soroses of the world want to gamble on such risky propositions, but all of this garbage is increasingly bought by pensions and regular investors (indirectly). More problematic is that everyone expects to be bailed out when it all blows up.
That is just amazing considering we are currently living through the flaws in that logic. It’s just amazing to me that someone can make that argument in earnest.
Is this just the new normal? Give people enough rope to hang themselves, book the short-term profits, then move on to the next scheme. It’s sad that this is what our country has come to.
That said, there is one fundamental difference between a high-interest auto loan and a sub-prime home loan. That is, there is no belief on the part of either party that the asset will appreciate.
One key factor to the sub-prime fiasco was that purchasers thought that their homes would go up in value and they would be able to re-fi once the teaser rate expired. Mortgage brokers played up this possibility (in fact, basically guaranteed it). Once home prices stopped going up re-financing became impossible and the rates exploded.
The failure rate on home loans were correlated way beyond what the ratings agencies assumed. I’m not entirely sure that they are for auto loans - although one could certainly make the argument that broader economic trends (unemployment in particular) could cause a high number of these loans to all fail at once.
In the end, I’m with you - consumer-debt-backed investment instruments are a very bad idea, and inevitably lead to sellers pushing debt onto people that they normally wouldn’t simply because they can then pass the debt on to a third party.
Once again, people are not being held responsible for their own actions. These are adults, presumably, that choose to buy a car on these terms. No one is holding a gun to their heads. What is the problem here?
The investors who are buying the securities certainly know about the housing market implosion are are choosing to buy them anyway. So what’s the problem?
As long as there are no bailouts if this goes to hell, I really don’t see how anyone has a problem with this. What is your solution for people who need cars but can’t get a conventional loan? Walk? Taxpayer money to buy them a car? Let’s hear your solution.
The problem is that dealerships are taking an advantage of the market and need. They’ve found a way to get rid of old merchandise at inflated prices because their merchandise is more than just a commodity – it’s a need.
I’m horrified. This is 10x worse (ethically) than the mortgage fiasco.
Most of us are not okay with price-gouging for quality food. Rarely will a Doper say, “Well, you don’t HAVE to eat fresh food/organic/healthy/etc. You can just eat junk!”
I don’t see this as price gouging, though. You can walk into any of those buy-here pay-here places and buy a $2000 car for $2000 in cash. For the most part, the dealership would prefer it that way, because they get to make their $500 and put the transaction behind them.
If you don’t have 2 grand you can get a loan and pay 3 or 4 grand for the same car. If you have really awful credit, you can get an ultra-high-interest loan and pay 6 or 8 grand for the same car.
How much you pay has nothing to do with what kind of car it is or how much it’s worth, and everything to do with your own credit history. The alternative is to just simply get turned down for a loan, which would probably hurt some of these people even more.
This is also different from payday lenders in 2 major ways. One, the terms are much simpler (you pay x per week for y weeks, or else we take your car). Two, if your car gets repossessed you’re no worse off. You can’t get into a credit spiral doing this, unless you get a payday loan to cover your car payment.
You can be in my state, which allows deficiency judgments. A repo’d car is sold at auction, the price less costs of sale applied to the debt, and the borrower still owes the balance. Creditor can sue, obtain a judgment, and collect by garnishment or other legal means.
Although I find these sorts of predatory lending practices abhorrent, and do see some passing similarity to the housing bubble, there are some fundamental differences that make me think this is less likely to explode as spectacularly.
The subprime auto market is listed as 7 Billion which is small potatoes when compared to the to the trillions that were at risk in the Real estate collapse. If these loans crash and burn they won’t take the economy down with them so there is less likely to be a bail out.
Cars are much are easier to repossess and rsell so there is less danger of the bank being stuck with a repossessed car than with a repossessed house.
As suggested by JAS09 people don’t buy cars as an investment based on the assumption that they are going to resell them and turn a profit.
Related to 3, the housing market is more uniformly volatile than the car market. The problem with the housing bubble is that the loan bundlers assumed that that each loan would succeed or fail independently and so by putting bits of 1000 loans together they were diversified and so reduced the overall risk. The problem was that the failure rate of the mortgages depended on the market and so they tended to succeed and fail together. When they all failed at once, crash goes the economy. With cars I would think that there is less correlation with the success or failure of each loan being directed by the individual circumstance rather than by some over arching market force. Of course if the economy really goes south and they get mass defaults on car loans I’ll be wrong. But in that case investing anywhere is likely to be a bad idea.
The dealer is vastly overcharging for the car to start with, and then selling off the loan for cash. They’re making twice as much profit (per the quotes in the OP) by persuading people to take these loans. They DON’T prefer cash up front because they don’t make as much money.
And they are taking no risk, because they’re bundling and selling the loans, so defaults are no longer their problem. So they have absolutely every reason to persuade people to take out loans that there’s no way they’ll be able to afford.
This may not be as big a problem as the housing bust, but it’s the exact same thing.
Pawn your risk off on innocent investors via index funds, etc., and rake in the cash. When the thing goes bust, hey, you’ve got yours, screw everyone else.
The article states that the default rate is 25%. That is very high but it means that 3 out of 4 people who buy those cars pay them off. If the people who buy these cars had better alternatives then I bet they would take the alternative. Buying a car from these people with a high interest rate seems to be in their own best interests.
I rate my own intelligence very highly but I do not feel remotely qualified to tell strangers whether or not they should buy a car or how much they should pay in interest. If the profits are really so high, maybe some of the do-gooders can get into the business and provide cars for poor people cheaply. One of the reasons used cars are so expensive right now is that someone thought it would be a good idea to pay people for used cars and destroy those cars in the hopes that people would be forced to buy new cars made by the UAW. If the poor people who cannot afford cars want to have their interests factored in to political decisions they need to buy a political party like the labor unions did.
You have a problem with a business finding a need and marketing to it? Again I ask, what is your solution for people who need a car and can’t get a conventional loan? Asking the car fairy?
Persuading. Not forcing. Who are you to say what business arrangement that two consenting, competent adults can make? No one can answer my simple question, “If not this, then what?” How are people who have no other means to buy a car supposed to get one? Just because it’s not a deal you would make does not mean that no one else should be able to.
I think you are missing the target of the complaint.
High interest car loans for bad-credit buyers have existed for a very long time. They would still exist even without asset-backed securitization. Nobody is criticizing loan-sharking car dealers (at least I’m not) no matter how shitty they are.
The concern is that by allowing this type of derivative, and having a system that encourages the ratings agencies to slap a AAA rating on what is essentially a pile of loans of which 25% will fail even if things go well, we artificially incentivize large-scale loan creation. Rather than merely providing high-interest loans to people that need a car, and adjusting the rate to match the risk, originators now just want to push paper with little-to-no regard for whether the buyer has any chance of paying at all. The paper is sold immediately, and the risk is hidden in a mezzanine security. If the assumptions are wrong (as they were in the housing deriviatives market) then these assets are just a time-bomb waiting to go off.
The big concern will be if large institutions leverage themselves multiple times over to build up huge portfolios of these loans and associated derivatives (CDS and CDO). Since I haven’t seen any sign of that happening yet (although how could I?) I’m not overly concerned that the taxpayer will be asked to once again bail out institutions while their idiot managers keep their 10s of millions.
The secondary concern is that by providing a means for loan originators to guarantee profits with no risk to themselves you encourage them to provide loans to car buyers they never would in the past. These buyers are then stuck with payments that they cannot meet, and eventually will lose the car and potentially more. In a functioning market they would be limited to a cheaper car (just like in a functioning housing market you wouldn’t have no-doc loans for million-dollar homes… but that really did happen when the incentives got messed up).
You think that is bad? If they can’t collect the difference between the loan and the auction price, the lender can write it off as a bad debt and file a 1099 with the IRS, which makes the uncollected amount income to the borrower, and the IRS will come after them for the taxes on it.
How are rating agencies being encouraged to slap AAA ratings on these. The reasons the ratings agencies were giving AAA ratings was that the customers demanded them and the models were all based on historical data which meant that large price declines were never included in the models because they had never happened before. Financial institutions have gotten much more conservative about buying loans and no one is assuming that used cars will appreciate.
The cars in this care are what’s called a price-insensitive good, much like medicine to the sick, or water to the dehydrated, etc… People will pay for it more or less independent of any rise in price.
Assuming the point is to maximize your profits, you want to charge what the market will bear, which means that you jack that price up as high as you can go.
Giving someone a car loan on unfavorable terms because of bad credit isn’t really an ethical issue. Whether or not they need it to work isn’t the point; the point is that the unfavorable terms are compensation for the risk that the lender is taking on.
Look at it this way… if you planned on loaning out $20k for a car, would you loan it out at the same rate to the restaurant manager with bad credit who can’t afford a phone, vs the single guy making 100k a year? Of course you’d jack the rate up on the restaurant manager; she’s more likely to miss payments, default, etc… than the guy who’s pretty much flush with cash, so you try and make your money while you can.
If everyone paid off their loans on time, never missed payments and never defaulted, then the interest rates would be the same for everyone. That’s not the case, so that’s why there are credit ratings and different rates for different people.
It’s not an ethical issue- if they wanted to get cheaper rates, they shouldn’t have had “bad debts on old loans”; such are the wages of dumb-assery.
I really have no idea how car-loan-backed securities could get a AAA if the quoted default rate is anything like what was stated up-thread. The mortgage-backed ones were rated to fail if something like 2% of the underlying loans failed.
As to why they would pump up the ratings, bad models was certainly one of the problems. Another is that the instruments were sufficiently complicated, and the ratings agencies sufficiently lazy and/or incompetent, that they just rated them how the investment banks wanted (this is all for mortgage-backed securities). Since they got paid per security rated, they didn’t really care if they were wrong as long as the business kept coming. I don’t know if this is the paradigm used for these car-loan-backed securities. And I hope that your claim re: financial conservatism is true. But I know enough about the repeated failures in the industry to be skeptical that the powers-that-be have learned any lessons.