The unstable subprime loans that cratered the housing market are making a comeback in the U.S. auto market.
Much of recent growth in domestic consumer goods is driven by cheap credit, according to Quartz. Those loans are now being peddled to Wall Street banks eager to cash in on auto sales.
Asset-backed securities (ABS) were a key source of instability during the financial crisis. In recent years, one of the fastest-growing sectors of the ABS market has been the market for subprime auto loans.
"Subprime auto ABS was one of the few auto sectors to have grown in 2013, and issuance continues to be strong thus far in 2014," a Barclays analysis said, adding that ABS comprised of packages of subprime loans are now at historic highs as a percentage of the US auto ABS market.
The auto market has been one of the few bright spots in a weak American economy, which puts the politicians in charge of regulation in a tough spot. Accordingly, lenders might start to tamp down the extension of subprime loans, dampening auto sales and affecting the economy.
U.S. consumer incomes are growing too slowly to supply the growth that the consumption-driven economy requires. The political solution has been to open the lending floodgates and send consumers on a debt binge. The fate of the auto market should provide an instructive example about whether policy makers are willing to go down that road again.
The banks may enjoy short-sighted profits as more cars leave the lots, but the system could come crashing down if borrowers begin to default. The trend of risky lending practices began with bailed-out GM, as the Washington Free Beacon reported in February 2013.
The increase in securitization has coincided with GM’s acquisition of AmeriCredit, one of the nation’s largest subprime auto lenders, which it renamed GM Financial (GMF).
"It’s becoming Fannie Motors," said Competitive Enterprise Institute finance scholar John Berlau. "They’re still using our tax dollars to break into exotic and money-losing propositions from Chevy Volts to subprime loans, both of which could literally and figuratively blow up in their faces."
Of GMF loans, 85 percent are subprime.
GM issued nearly $60 billion in ABS between 1994 and 2010. The bailed out automaker issued $5.6 billion in securities in 2012, a 50 percent jump from the average ABS issuance between 1994 and 2010 and $1 billion more than 2011, according to GM Financial spokeswoman Chrissy Heinke.
GMF has the riskiest lending portfolio of any major car company: 96 percent of its customers have credit scores below 660. GM’s lending habits parallel those in the housing market leading up to the 2008 crash, [Auto expert Ed] Niedermeyer said.
"There’s no doubt that all the makings of the bubble are here; risk is up subprime is up and this bubble has to exist for GM to look like a viable car company," he said.
GM executives are well aware of their role in creating an auto bubble that could eventually backfire.
General Motors of Canada President Kevin Williams is warning that subprime loans could doom the auto industry just as it did the housing industry in 2007.
Williams told the editorial board of Canada’s Globe and Mail newspaper on Monday that record Canadian auto sales could be attributed to cheap credit loans.
"The real question is, are you going to run the business the way you ran it in the past in order to drive market share exclusively? The answer is that’s not our intent because it [led to] a failed company," Williams said.