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The Other Subprime Loans

Jul 31, 2020131.9K Shares1.9M Views
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Wall Street has suffered two sharp downturns in the first two trading days of June. It’s a disappointment after all the cheering for the market’s positive performance in May.
Monday’s worries were mostly about the financials, especially the struggles at Lehman Bros.and Wachovia. The shocker on Tuesday was General Motors’announcement that double-digit declines in the SUV/light truck categories would lead to big production cutbacks and shutdowns of four factories.
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Illustration by: Matt Mahurin
GM’s problems had been foreshadowed a few weeks ago when Ford’s CEO, Alan Mulally, rescinded his promises of near-term profitability because of a steep May dive in sales of SUVs and pick-up trucks. The bigger vehicles are the U.S. companies’ profitability sweet spot, so the market’s collapse is tantamount to financial disaster. Even the Japanese companies like Toyota and Nissan that have made big commitments to the high-margin big-car category will take serious profitability hits.
Why is this a surprise? The Ford Expedition, for example, is a four-ton behemoth that, with a full plate of options, rings up a sales sticker not much below the median yearly incomes of American households. With $4 pump prices, the Expedition drinks a buck’s worth of gas every 3.5 miles. The real question is why they’ve been best-sellers for so long.
The truth — usually missed in the fog of faux-analysis — is that these are not normal times. Fundamental changes are afoot. But no one knows how long they will take, or what might come out on the other side.
The SUV and the suburban McMansion are the linked symbols of American consumerism. And it turns out that the same folks who cooked up a housing boom out of subprime and “Alt-A” mortgages, also invented a subprime auto loan industry. People swamped with mortgage debt could still pile on loans to equip their four-bedroom/game-room split-levels with the right kind of wagon or two.
Readers can figure out the rest of the story. Subprime auto lending, much like subprime home lending, was another unintended consequence of the gusher of money the U.S. Federal Reserve Bank opened up after the recession of 2001-2002. As banks and auto finance companies ran out of good borrowers, they reduced credit standards and eased payment terms to suck more and more borrowers into the net. Just as in home mortgages, the riskiest loans were packaged into blue-ribbon-rated securities and sold off to investors too greedy or stupid or inexperienced to notice.
Now delinquencies are rising sharply, subprime auto loan investors are in full flight, and a quarter of car owners are “underwater” – they owe more in car loans than their cars’ resale value. The mothballed SUV factories are just another monument to the credit crunch, like the rows of empty condoson Miami Beach.
The solid growth of the 1990s was investment-driven, as corporate America integrated a host of startling new technologies into their everyday business processes. But it was also a decade of unusually favorable American karma. The baby-boomers were in their high-productivity, high-saving 40s and 50s. Forty years of government-led investment in Internet and related technologies were finally bearing fruit. Almost the entire world was happily on a dollar standard. The real costs of economic inputs, like energy, were mostly falling.
Investment-led growth tipped into a tech bubble when even experienced investors turned giddy in the late-90s tech boom. In recent American history, it is an unusual episode of an investment-led bust.
As business licked its wounds, the Fed was happy to let consumers take over. Consumer debt grew strongly during the 1990s, by about 6 percent a year in current (pre-inflation) dollars. Household debt rose from about 85 percent of disposable personal incomes in 1990 to approximate equality by 2000. But in the 2000s, the debt engines went into overdrive. The annual rate of household debt growth jumped to almost 12 percent by 2003, and has averaged more than 10 percent since the start of decade.
By the end of last year, household debt had ballooned to 136 percent of disposable incomes. From 2003 through 2005, net home equity borrowing not reinvested in housing accounted for more than 7 percent of disposable personal income.
Now the whole consumer-driven, debt-fueled sprint for growth has smashed into a brick wall, leaving a mountainous tangle of bad loans and big trade deficits.
A lot else is going wrong at the same time. The baby-boomers are turning into senior citizens; the dollar is in collapse; critical input costs, like energy, are rising sharply, and military spending has jumped to new levels, even as U.S. forces are under severe strain. If there is such a thing as an American karma, it has taken a decidedly wrong turn.
It is understandable that officials like Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson are almost solely focused on avoiding an even bigger crash. Wall Street and the investment community, after all, will be swallowing at least $1 trillion in losses and writedowns within a concentrated period of time.
What’s missing is any sense of what should come next. All the rescue efforts are aimed at helping the American public carry on borrowing and spending, keeping the consumer boom alive, gliding by the crisis as if nothing has changed. That is not a strategy. It is grasping at life buoys, or, in Metternich’s phrase, “propping up a corpse,” for want of any better ideas.
There are big questions ahead. The textbooks say that when a country is saving too little and spending too much, you raise interest rates. But can we do that without destroying our hopelessly overleveraged banks? Each year Washington borrows $700-800 billion abroad to finance its overspending. The collapse of the dollar suggests that those days are coming to an end. How do we wean the country away from its consumption binge? What we will do with all those store clerks and mortgage brokers?
We are clinging to the sides of a deep, dark, hole. The Fed and the rest of officialdom are turning somersaults to help us hang on. But at some point, we have to start building ladders to get out.
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Charles R. Morris, a lawyer and former banker, is the author of “The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash.” His other books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy” and “Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”
Rhyley Carney

Rhyley Carney

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