Is the used car market another financial bubble ripe for a painful pinprick?
Financial analysts have worried about subprime-quality auto loans building up to another disastrous bubble since at least 2013. Consumers with less than ideal credit histories have been able to buy used vehicles with limited credit checks or none at all. The resulting loans often carry inflated interest rates, but the buyer often gets to drive away in a dealer-certified used car that would have seemed unaffordable in recent years.
Is this a real bubble, or are economists and consumers too worried about subprime loans, which became a four-letter word after the 2008 subprime mortgage meltdown?
Credit bureaus seem eager to reduce the subprime auto loans tension. Moody's (NYSE:MCO) recently noted that banks have been "conservative" in their auto loan lending practices, doling out only 10% of their car loans to subprime consumers. These loan volumes aimed at credit ratings below 620 have not triggered an avalanche of defaults and delinquent payments, and the strong trends in new car loans mostly rest in high-quality borrowers.
"Consumers owe less now than they did during the recession so they can afford to take on more debt," the Moody's report stated.
Fellow credit ratings agency Equifax (NYSE:EFX) followed suit with its own reassuring notes on the auto loan market. "Our position is simply that there's an easy tendency to decry subprime in general because of what happened in the past, and it's not fair to do that," Equifax said in a research note titled "Not Yesterday's Subprime Auto Loan."
Can the credit rating gurus walk the talk?
So far, so inspiring. The experts say that the auto loan bubble is a mirage, and that the car loan market is healthy as a horse.
But that's not good enough. What does the actual evidence say?
Equifax offers this chart as evidence of a healthy subprime market:
The firm notes that subprime loans currently represent a lower portion of total car loans than they did at the peak of the 2008 crisis.
However, the overall loan volume is higher today. Doing the math, you'll find that the number of subprime auto loans in the first half of 2014 adds up to 2.6 million borrowers -- about equal to the 2.6 million subprime auto loans for the same period in 2007.
Equifax calls this a "stable" environment. The numbers don't always agree.
Keep in mind that the credit rating experts' stocks plummeted in the 2008 crash, along with a serious hit to their credibility. You didn't see Moody's or Equifax posting dire mortgage warnings in 2006 or 2007, even though default rates spiked in a flurry of unsustainable lending practices.
I'm not here to say that the subprime bubble in auto loans is about to pop and bring us back to the dark ages of another recession. Equifax and Moody's did bring some dry ammo to shoot down this potential bubble panic.
For one thing, auto loans generally come with longer-term commitments these days, which reduces the month-by-month repayment pressure on borrowers and lowers the total risk. Indeed, total write-offs are headed for the lowest full-year total since 2005 if year-to-date trends hold up for another four months.
For another, a popped bubble in used car loans wouldn't come close to the damage caused by 2008's mortgage crisis.
Used car sales added up to $228 billion last year, or 31% of total dealership revenues. The total balance of subprime auto loans stands at $46 billion right now.
It sounds bad, but it's actually just a drop in the economy's enormous bucket. American mortgage loans currently add up to $14.3 trillion. In other words, bad car loans come with far less economy-moving risk than the gigantic mortgage market.
What's the verdict?
Long story short, we may in fact be headed for the popping of a subprime auto loan bubble right now, despite the protestations of Equifax and Moody's. But if it happens, this disaster won't bring the economy to its knees again. It's a much smaller bubble than the 2008 subprime mortgage collapse, and it'll hurt a lot less.