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Could the U.S. be headed for a second sub-prime crash?

MahurinRedlining_Thumb_566.jpg
MahurinRedlining_Thumb_566.jpg

The most succinct and uncontroversial explanation as to just how the recession began is that a massive surge in foreign capital in the early 2000s sent banks scrambling for investment opportunities and they found them by offering more loans to more people. This meant opening loans to consumers with a higher risk of not being able to pay them back — those being the sub-prime mortgages, which became a very familiar term in the early days of the recession. We’re still living through what happened next. And yet amazingly, data indicate that as corporations begin to recover, lenders in some markets are starting to return to the very pre-recession practices that created the crash in the first place.

Approvals for sub-prime car loans have risen steadily since 2009 and are now at their highest rate since the recession hit, when lenders instantly became warier about approving loans for people with less than ideal credit scores. New data from automotive market research firm CNW show that sub-prime approvals in March are up more than 28 percent over where they stood in March of last year. The average credit score of consumers approved for auto loans has been shrinking accordingly every month since the first quarter of 2010.

Of course, sub-prime loans are not an inherently bad thing. Many consumers, from college students with limited credit histories to people who fell behind on bills during the recession after losing their jobs, may have low credit scores without actually posing a risk of defaulting on loans. Indeed, sub-prime financing is the only path to car or home ownership for many people. The problem comes when banks are too loose about whom they offer credit to and consumers are too confident about their ability to repay loans. If the auto loan trend continues unabated, the country may just be headed for more economic fallout.

Looking back at the recession years offers the best view of the problems easy credit can create. At first glance, auto loan delinquency rates (PDF) of the last five years seem to point to better times ahead. The number of people past due on auto loans has dropped significantly since an all-time high at the end of 2009. But this doesn’t necessarily mean a healthier consumer.

Those delinquency rates — at an all-time high in 2009, followed by a sharp drop — are just a part of the auto financing picture, which is further explained by more of CNW’s research on sub-prime auto loans. Using CNW data, the New York Times reported last month on sub-prime loans dating back to before the recession. As with mortgages, sub-prime financing for cars reached historical peaks in 2006 and 2007. Then the American economy started to tumble, and by the end of 2008, not only had car sales overall taken a huge hit, but sub-prime financing was being extended to virtually no one.

Meanwhile, a Ford Motor Company credit bureau report (PDF) states that repossessions on outstanding loans reached an all-time high of 2.12 percent in 2009 — an increase of more than 60 percent from the 2006 rate.

What to make of all this? Transunion Credit Bureau’s loan delinquency rates follow CNW’s sub-prime rates, on about a two-year delay. Sub-prime credit saw a massive increase leading up to 2006, then a huge cutback between mid-2007 and late 2008, before slowly crawling back up. Loan delinquencies saw a steady increase leading up to 2008 before tumbling in 2009. By the second half of 2010, they were on the rise again. And then there are the repossessions. After reaching their all-time high in 2009, they’ve started to drop down.

It seems, then, that there’s a correlation between sub-prime credit and, a year or two later, people falling behind on their loans. When they fall behind enough, they default and their cars get repossessed — an echo of the sub-prime mortgage bubble burst. Restrictions on sub-prime credit and terminations of outstanding loans may simply mean that the people who still have loans to pay are already financially more stable consumers — and that making credit easier to obtain will just start the cycle all over again.

While lenders and consumers alike have hailed the loosening of credit restrictions as a “return to normal,” only time will tell if “normal” is just a prologue to another sub-prime crash.

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