SUBOPTIMAL

I mentioned today in Alloy’s Slack that I’d seen another alarmist headline about subprime auto loans. Subprime meaning loans with avariciously high interest rates issued to people with poor credit. It is exceedingly expensive to be poor.

Rory pointed out that he feels like he’s been reading that type of headline—about auto loan delinquencies rising, repossessions spiking—for years. We get habituated to alarms. This one has been sounding steadily, so are we right to ignore it?

I think it’s worth exploring, because I don’t know the answer offhand, and it’s likely you don’t, either. What we all do know is that there was an inescapable link between subprime housing loans and the Great Recession. Having lived through it, “subprime” isn’t a word I can read without significant alarm. I don’t understand the mind bending complexities of the financial instruments that banks and lenders used to repackage bundles of horrible mortgages, but I do know they flew the entire economy straight into the side of a mountain. 

The Great Predation

As of November, things seem bad. Fitch Ratings, one of the large credit ratings agencies (which is owned by Hearst, interestingly) recently released figures showing that of all the subprime borrowers out there, more than 6% are 60 days or more behind on their car payments. Reuters also noted that two subprime auto lenders, PrimaLend and Tricolor, both went bankrupt recently. Tricolor, allegedly, for scamming banks to secure financing. PrimaLend, which is still operating for now, because it hasn’t been paying its creditors for months, because the people it is lending to aren’t paying their auto loans.

Risky bets don’t always pay off, and these are companies whose entire business is issuing auto loans to those most likely to not be able to afford them. I’m not qualified to characterize the entire industry, but it doesn’t take very long to find lots of evidence of predatory lending practices. Or that the justice system doesn’t have a lot of resources to go after the predators, which emboldens them. So maybe the trouble is contained to this niche, in which consumers aren’t protected enough and risk is high.

The Risk Pool

So we have a vulnerable group of consumers, an underpoliced group of lenders, and a mess of delinquencies. The question is what the impact is–how the subprime auto loan sector affects the broader economy, or whether it is a symptom of some larger disease. In other words, are subprime borrowers a bellwether for where the rest of us are headed?

For some context. I turned to Matthew DeBord, who spent years at Business Insider covering this beat. The first question I asked him was, “are Rory and I crazy? Have we indeed been seeing these headlines for years?”

“It’s a recurrent panic kind of thing,” DeBord told me, explaining he’d been writing about this same exact type of concern for roughly 15 years. “It’s not that big of a deal.” Except for those falling behind in their payments, he noted.

“It’s not systemically important to the broader economy.”

That’s because subprime customers represent a small fraction of the overall auto market. This makes sense. These buyers have been getting squeezed out as prices increase while wages don’t. Wards puts subprime loans at just 15% of the new car market. Fewer loans are being written for these buyers, too.

And unlike a house, which is difficult to repossess, cars are easy. As DeBord told me, after repossession, there’s no difficulty in reselling the asset. 

A subprime auto loan crisis is not likely to tank the economy. 

The Portends 

That context is somewhat reassuring, but could pressure on subprime borrowers be correlated with, rather than the root cause of, some sort of broader financial crisis? 

DeBord doesn’t think so.

That doesn’t seem to be happening. To use the subprime housing market as an example, the crisis was precipitated by a crash in house prices. Those who had speculated against an increase in housing prices, including banks, were destroyed. By contrast, this sector isn’t highly leveraged, and auto values are steady, according to CNN’s Chris Isodore, writing on this very subject. 

Those that do invest in the financial products that come out of bundled subprime loans also know what they’re doing, DeBord noted. “Pros play in here,” he told me. They manage the risk for the relatively high returns.

If the uptick in delinquencies signifies anything, it’s the overall economic pressure consumers are experiencing. Inflation puts pressure on everything, and auto loan payments are just one of the many areas in which Americans are falling behind. 

None of this excuses practices within the subprime industry which are unsavory, but those practices don’t put a major sector of the economy at risk (as the subprime housing crisis did). This is reassuring unless you’re falling further and further behind. A series of thousands of micro-scale tragedies and hardships that signifies little for the broader structure of things.

And while this isn’t a warning sign about an economic upheaval, it also must be said that it seems unlikely relief will be coming for those who are struggling.