Throughout my life, I have always been and remain something of a business news junkie. I follow markets, marketing trends, the media (natch) and consumer behavior quite closely.
A few days ago, I the following headline: “Subprime Car Loan Defaults Hit An All Time High in February.” I thought it might be an exaggeration, so I read it and then searched elsewhere. A second source put it as the highest level since 2007. A half hour later, I found a CNBC interview replayed on You Tube that confirmed the 2007 date.
Okay, why does this strike me as a big deal? Let us back just a bit. For much of my adult life, many mainstream economists would say that the economy was essentially stable. One outlier whom I loved to read was Hyman Minsky who argued forcefully that the economy was inherently unstable. He was suspicious of expanding credit too widely. Prior to his death in 1996, he developed his Financial Instability Hypothesis. To Minsky, there were, in broad strokes, three types of borrowers:
1) Hedge—These people have no problem making payments of both interest and principal (99% of the readers of this blog, I would presume). They dutifully pay off their mortgages or car loans and credit card balances and sometimes add a bit of principal to a payment to save interest expenses.
2) Speculative—these folks are stretched and can only handle the interest payments. I met more than a few in 2006-2008 who had interest-only mortgages.
3) Ponzi—name in honor of 1920’s Boston area conman Charles Ponzi, these dreamers are betting on rapid increase in asset value to bail them out. If you think they are imaginary, remember the sub-prime mortgage holders in 2007-2008, many of whom did not even have jobs or income but bought homes based on hope. Perhaps more amazingly, institutions gave them loans in a frothy real estate market.
Okay. So now we have the current issue of sub-prime car loans. They have always been part of the auto sales mix but it appears with the relief checks sent out during the early part of the Covid crisis plus the tax breaks for parents with young children, a number of rather poor credit risks were more flush than they had ever been. To their credit, many paid down their credit card balances and also saved part of the windfall.
Others, however, were able to buy new cars in 2021 and many were purchasing vehicles far more expensive than they have ever owned before. Now, these sub-prime borrowers are getting whipsawed by sharp increases in gasoline costs and rising food prices. So, some are behind on their car loans. The latest data say that 8.8% of sub-prime car loans are more than 60 days behind. If you have a long commute to work, you are really stuck—you need a vehicle and gasoline costs are soaring.
More ominous is that many had not paid off their existing car loan when they traded up last year and took out 84-month loans (seven years!) on their new vehicles plus what they owed on their existing car.
Most media headlines talk about low unemployment and how flush consumers are. There is no question people who were struggling prior to the pandemic got some real breathing room with the stimulus payments plus the tax credits. Now, with inflation hitting fuel and food, the sub-prime borrowers are in trouble again.
Whenever the next recession hits (2023 perhaps), more people are likely to slip out of the middle class than we have seen in some time. Dig beneath the headlines, I say. Things may not be so rosy as they appear.
If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a comment on the blog.
