Could car loans be the source of the next crash?

Auto industry insider fears auto loans could be a ticking time bomb like subprime mortgages in 2008-09

News analysis

During the COVID flash recession, annual vehicle sales bottomed out at 8.9 million in April 2020, only to rebound to 18.7 million in April 2021, the fastest annual change on record.

Prices have also risen, eating away at the average consumer’s discretionary income. By mid-October, “the median weeks of income needed to purchase the average new vehicle in September rose to 42.2 weeks,” a substantial increase from the pre-pandemic average of around 34 weeks.

Many car buyers have resorted to debt.

A survey by automotive analytics firm The Zebra found that 50% of Americans financed their last car with a loan. Total auto loans nearly doubled to nearly $80 billion in March 2021 from $40 billion at a 2020 low.

The size of the auto loan market is huge, with total debt outstanding in the United States of $1.5 trillion. That’s 9.1% of national household debt, according to the Federal Reserve Bank of New York.

Much of this debt is repackaged by banks and sold to investors seeking a return in today’s relatively low interest rate environment.

Lucky Lopez, a Las Vegas-based auto loan broker with more than 20 years of industry experience, describes the process in an interview with online investment research and financial media firm Hedgeye: “They [lending banks] hiring brokers like me to fetch their paper and sell it to other banks like Wells Fargo, Bank of America, individuals, hedge funds, stuff like that.

Heeding the call of yield-hungry lenders, post-pandemic borrowers have also been prompted to take on more debt. A study by the Center for Microeconomic Data found that loan forbearance programs artificially boost borrowers’ credit scores throughout 2021.

With investors desperate for yield and borrowers vying for approval, banks have gone on a lending binge in 2020 and 2021.

“They were just handing out money,” Lopez told The Epoch Times. “The big culprit was the banks that relaxed their LTV [loan-to-value].”

Used car prices have skyrocketed during the pandemic and car dealerships have been forced to overpay for their goods and, in turn, overcharged banks that provided car loans.

“The dealers started calling the banks, ‘Hey man, I gotta sell this for 150%, 160% of the LTV… Can you do that?’ and banks that traditionally didn’t, started doing it,” Lopez said, paraphrasing the industry dynamics he had witnessed.

For perspective, online loan broker LendingTree cites the average LTV ratio for a car loan in 2019 at 87%.

Increase in outstanding payments

Loans well above the market value of their collateral pose a serious risk to lenders, especially as a growing number of borrowers simply do not pay.

“We’re seeing delinquencies go up before the layoff cycle begins,” former Federal Reserve Bank of Dallas adviser Danielle DiMartino Booth said in an interview on the “Forward Guidance” podcast, implying that rising unemployment could accelerate delinquencies.

The Consumer Financial Protection Bureau also showed that loans issued in 2021 and 2022 are experiencing higher delinquency rates than previous years.

As Stansberry Research put it, “delinquencies lead to defaults, which lead to bankruptcies.”

Booth and Lopez both see a possibility of contagion, whereby subprime auto loan defaults will force massive liquidations as banks try to recoup their losses.

Normally, banks remedy non-payment by repossessing cars and auctioning them off. However, with many 2020 and 2021 loans issued at 150% LTV or more, banks are reluctant to engage in an auction, where it is difficult to get even 100% of the car’s value.

As a result, banks have largely refused sales and continue to delay the auction process, according to Lopez.

Lack of sales leads to a glut of supply.

“This massive excess inventory continues to grow every week because lenders don’t want to recognize the loss on loans,” Booth said.

She predicts regulators will step in at some point and wonder why lenders haven’t liquidated the cars they repossessed. Citing the 2008 housing crisis, she noted that’s “what regulators did in the housing crisis”.

“They’re going to have them clean these loans off their books, and then we’ll see used car prices drop,” Booth said.

Private fund managers have apparently also taken an interest in the auto loan market.

“Investors are shorting the auto industry,” Lopez said in reference to the numerous calls he receives from hedge funds and wealth management firms asking for insider details.

He believes that if there is a full-scale financial crisis following mass auto liquidations, it will occur in the first quarter of 2023.

Lopez worries about the government’s reaction.

“We’re probably looking at some kind of intervention where they’re going to start regulating the auto industry. … It’s going to totally crush the auto market,” he said.


Liam Cosgrove works as a freelance journalist covering business, markets and finance. He received his bachelor’s degree in mathematics from the University of California, Santa Barbara.