Spending Some Time with Sub-Prime

Jamie Lincoln Kitman

Jamie Lincoln Kitman | Sep 02, 2016

From the two times Henry Ford went bankrupt trying to build cars, to the epic rises and falls of General Motors founder William Crapo Durant, and on to the great 21st century bankruptcies of GM and Chrysler, the automobile industry has always been a boom or bust kind of place.

Demand ebbs and flows, economies rise and fall. So it's hard to predict what the future holds. But one thing stands fast: the markets' rigid insistence that every fiscal quarter be an improvement upon the one before it. Add the practice of contractually tying top executives' compensation to stock performance and suddenly you see a big part of why the ambient mood of the modern auto executive is stressed out. And why so many shortsighted, foolish and outlandish schemes to boost sales and increase revenue appear and re-appear.

A case in point would be sub-prime credit, the growing practice of lending money to people with weak and blemished credit histories to buy cars. One applauds in theory the fact that there is any vehicle for helping disadvantaged Americans gain access to the highway, given that in many places car ownership is often a necessity for holding a job, proper childcare and all the exigencies of life. On the other hand, as John Oliver and his Last Week team ably demonstrate here…

… the sub-prime car market as it exists is the cruelest way to help the poor, penalizing them, like so many things, for the very fact of their poverty – higher transaction prices, higher interest rates, and rapid repossessions. It is one of the many human shortcomings of a transportation system that relies so heavily on private automobiles.

Like how-do-they-sleep-at-night pay-check lenders, a whole sub-species of usurious, low-rent buy-here, pay-here used car dealers prosper today, their horrifying m.o. outlined in this inspirational passage from Ken Shilson, the President of the National Alliance of Buy-Here, Pay-Here Dealers, delivered in an address secretly videotaped at a group conference in Las Vegas.

These people have negative equity all the way through and they’re not going to be able to hold their life together for the next seven years. You know the customer.  You know how to collect. You got the legal expertise. What’s holding you back?

Er, right. They charge too much, then repossess the car, over and over again. That's some business model. And, scarier still, as Oliver observes, is a new market in bundling automobile loans, sub-prime and otherwise, for sale to investors. He finds it strangely reminiscent of the market for bundling housing mortgages which market collapse knocked the world on its ass in 2008, though I suspect that, while gross, the sub-prime car loan instruments' potential for economy-ruining injury won't be as great.

"When sales decline, industry resorts to tricks to keep the party going."

Now it's only fair to point out that the sort of lending Oliver calls out is not tied to the new carmakers. But they've increasingly engaged in their own, less predatory but still highly profitable, sub-prime lending, charging such customers fatter interest rates as befits their theoretically higher risk of default. More profitable, but higher risk. And, like some other current practices, it's a risk not to be understated. For as noted when we came in, when sales decline, industry resorts to tricks to keep the party going.

We are seeing this in 2016, as car sales appear to have peaked once again. Hence an industry-wide trend to high cash incentives to purchase new cars, the highest ever percentage of all cars being leased (for low, low monthly payments), and the growth of factory-underwritten subprime loans. Each bears its own risk to the company, each presumably calculated down to the penny and yet each of which is capable of blowing up in their face. Which is why they said the last time they'd never go down these roads again. But keeping the numbers high, that's the only thing they know. So here they go again.

"Let's make a deal!"

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