IANA Rating Agency, but it I had to guess, the individual loans in the package is not what makes the whole package rated AAA, but the predictability of repayment.
To use very crude numbers, if I invest in car loans that are at 100% interest knowing that 45% of them will default in the year, then that’s a good investment. Never mind that the underlying investments are garbage products bought by terrible credit risks and defaulted on at alarming rates. What is AAA is the model of the overall profitability of the system. The minority of people who actually pay the atrocious terms make the system as a whole a good investment risk.
Yes, they got it wrong with houses because the assumption was that they would never decrease in value. As others have said this assumption is not built in to this system.
As I understand it there were really two assumptions with mortgage-backed securities:
Housing prices will continue to rise, or at least not go down. This clearly doesn’t apply to auto loans, and one would assume that those creating and rating these products know this.
Individual home mortgages in the pool did not have high correlation between their default rates. I’m not necessarily convinced that this mistake isn’t being made again wrt to car loans (in fact, the OP’s cite seems to indicate it is). So then the question becomes - are car loan defaults highly correlated the way sub-prime mortgage defaults were?
One of the causes of correlation with mortgages were ARMs with 2-year locks at super-low rates. Once the 2005 batch hit their first rate adjustment in 2007, the default rates went through the roof all at once. Do we know if there are any adjustable rate shenanigans going on here?
In simplified terms, you cut the pool into two pieces (say). One piece (the “equity” piece) is the first to take any defaults, but receives an enormous interest rate in exchange for being incredibly risky. Then only after all of the equity piece has been lost to default is the AAA piece at risk, but the AAA piece receives a low interest rate in exchange for being less risky.
Oh, sure, I understand the basic outline and structure of a mezzanine MBS and all that (not that I ever wanted to - thanks Wall Street!).
But, at least for the MBS market (and their resultant CDOs) the pricing and ratings assumed that the underlying bonds (and, thus, mortgages) were only slightly correlated. This proved to be wildly inaccurate.
And, of course, they did this stacking multiple times (taking a bunch of B-grade tranches from MBS’s and stacking them into a new CDO so that 80% was magically AAA again)… it was a brilliant plan while it lasted.
To give an idea of the relative scales, the article mentions $15 billion in car-loan securities over two years. From 2003-2007 $1.6 TRILLION worth of CDOs backed by mortgage-backed securities were created.
Well, that explains the two or three commercials I’ve been seeing every hour for a used car dealership that’s pretty obviously marketing itself to people who have trouble getting financing.
I disagree. At some point, I think compassion has to come into play. I appreciate that risk should be rewarded, but that doesn’t mean one should always take maximum advantage of someone else’s ignorance or misfortune. I think some of these guys basically operate like drug dealers, selling easy (expensive) credit rather than illicit drugs. The larger issue that troubles me is that everyone else seems to be okay with that. We seem to have become so enamored with easy money that we don’t even think about the collective responsibility we have towards one another to be decent people. Worse yet, our system often increases the number of interactions between people who want to take advantage with those who are more easily manipulated.
The problem is that compassion will come at the cost of losing your money and creating more expensive interest rates for everyone else.
Hell, some of my friends are like this. They are good people, but for whatever reason, they can’t take a piece of paper, or a computer program, and balance their income and expenses each month. Or if they can, they can’t ignore that sale at the mall and just have to have that latest and greatest thing.
Consequently when the bills come due, they don’t/can’t pay. They are my friends and I won’t loan them a cent because I KNOW I won’t get paid back. If they were complete strangers, the only way I would think about loaning them money is if I could charge an outrageous interest rate to make up for the fact that a hell of a lot of people like them are going to stiff me.
I feel bad for people who have to pay 21% on a car loan, but they are paying that because they have a history of not paying their bills on time. If you make me be “ethical” and loan money at 4%, I won’t do it because I will lose my shirt.
I’m not sure what solution you are proposing except to protect people from their own bad mistakes.
I think his solution is yours. Either loan at a non-debt peonage rate, or don’t loan. If the loan is so risky that you’d have to charge 25% interest, then to me that looks like a loan that shouldn’t be made at all.
Of course, the upside of legal payday loans and suchlike is that they cut out the loansharks. A legal payday loan isn’t going to break your kneecap when you can’t pay.
But at some point can’t we decide that only an idiot would agree to certain deals, and therefore if you agree to those deals you are proven to be such an idiot that you shouldn’t be allowed to agree to that deal?
OK, Lemur866, now explain to Ms. Acevedo why she has to go without the car she needs to get to work (because nobody is lending to her if they can’t do it at high interest rates) in order to satisfy your tender sentiments about eliminating “debt peonage.”
A high interest rate doesn’t necessarily mean that there’s predatory lending or anything unethical going on; every bank and lender probably has some computer system that calculates the APR for every loan based on their database of the performance of historical loans and historical loan holders, along with some parameters for risk-tolerance that are specific to their company.
In other words, if you’re a single mom working for minimum wage with a credit score of 450, they’re going to assign you a drastically higher APR on that car loan than they’d assign a woman attorney who’s a homeowner, makes $100k per year, and has a credit score of 695, all else being equal. And that’s assuming that anyone would be willing to loan to the single mom.
There’s nothing predatory or unethical going on there; the higher interest rate is the way that the lender attempts to compensate for the risk posed by the single mom.
What would be predatory would be the implication that the high interest rates are normal or even good, when in fact they’re terrible, or attempts to sell people cars they can’t afford with the intention of giving them a high-interest loan.
To answer the question, you buy AAA ratings… at least, that’s how it worked pre-2008.
Also, securitization of auto loans has been going on for over a decade now - I’m not too sure if this is anything new, or if it’s just a “slow news day” story. Even the article says as much:
Meaning that in the recent past, this (subprime auto-loan securitization) was a bigger market.
Yeah, but the problem is there’s no LIMIT and no REGULATION on how much CDOs can multiply. The original value of the auto loans mean nothing because all CDOs are is casino gambling. I can’t believe people are openly defending a return to the casino so soon after going bust. Freaking addicts! Or more likely, wannabe scammers looking to turn over a quick personal profit before everything goes to shit again.
And this is exactly what it looks like they’re doing with these loans. IMO, of course.
There have always been the high-rate loans available from dealers for people with bad credit, for at least as long as I can remember anyway. If someone is desperate enough and has screwed things up enough to need that sort of deal, it’s always been available. While IME those dealers are generally double-dealing scum, I wouldn’t ban them.
And I’m sure those businesses always do well in a bad economy, so it’s not surprising to see more of them at the moment.
But this seems to be a case of ‘more money to loan than you know what to do with so go find someone, anyone, and convince them to take some’.
Do you guys defending this practice really expect me to believe that these used car dealers are being truthful and honest and upfront with customers about the condition of their cars and the terms of their loans. Really? REALLY??
What practice are you asking about - the practice of securitization or the practice of selling used cars?
If the first, I don’t see why it matters to the buyer where the money comes from for him to purchase that '96 Ford Taurus (I don’t think it ever mattered to the buyer), if it’s the second, I don’t ever think that any adult expected car dealers (new or used) to have been “truthful and upfront” since about, oh, 1907.
According to nearly everyone in this thread, said people can’t afford the car, so they can’t get one. They must live within their means. And if they want people to do that, then they also don’t want anyone creating a market for this.
And this is what CP objects to. She states that, since a car is a need, they can charge 10x more than they need to earn a profit. She doesn’t have an ethical problem with providing these people a means of buying a car, just with charging so much for it.
Now whether they are actually charging more than they need, I have no idea. But it is unfair characterizing her position as being against the sales at all.