The Next Debt Bubble or The Last War?

Illustration by Mike Faille/National Post

I recall hearing from my mother once that my grandparents had been deeply scarred by the great depression. In a multitude of ways it had affected the financial decisions they made for years after it was all over. It would probably be fair to say that investors have been similarly scarred by the 2008 financial collapse, and that no matter how far into the past it recedes, for a generation there will likely always be a nagging doubt about investing as they recall the days when the very future of currencies, countries and their savings seemed in very real danger.

This guy right here would like to give you a car loan even if you can't afford one! Isn't that nice?  Don't read the fine print.
This guy right here would like to give you a car loan even if you can’t afford one! Isn’t that nice?
Don’t read the fine print.

That concern has made us all highly suspect of debt and the cavalier attitudes of Wall Street financiers who remain unfazed by the dramatic peril they engineered through the early 2000s. So it should not go unnoticed when sentences with the words “subprime”, “growth” and “asset backed loans” seem to be on the rise, and recently that has been exactly the case.

Back in the early summer of 2014, Yahoo Finance ran a story about the growth of subprime auto loans and high interest leveraged loans. The short story was that banks had begun to take on more risk to counteract the weak economy and lack of decent yielding products in the market (themselves a product of trying to stimulate the economy).

In September The Economist also published a story called “Bad Carma” detailing some frightening statistics about borrowing rates, riskier assets and ample credit, all dog whistle terms to any investor who took the time to read anything following 2008.

That was followed by a report from CNBC in October regarding concerns of a new subprime lending bubble on the backs of auto loans. Again citing the same looming threat of a growth in the loan market of riskier quality, primarily driven by the desire to boost short term profits.


Finally, in the beginning of this year we have begun to see some of the expected fallout of these subprime loans going bad. While default rates are still low, delinquency rates have started to creep up. Again, the culprits were car buyers with weak credit scores that had been offered subprime rates (like 22% or more) to buy cars. In fact according to the Wall Street Journal 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November.

It’s easy to be suckered into an early freak-out with these reports, but details matter and in this instance the details, while troubling, are not the cause for concern it would be easy to let ourselves get into. According to The Economist, while the blueprint may look similar to the lead up to 2008, the fundamentals don’t match. First the total car borrowing market is $905 billion, or less than a tenth of total mortgage debt. Secondly subprime lending in the auto sector is a more established practice and accounts for about 20% of auto loans since 2000. But most importantly no one is under an illusion about the value of a car after it is driven off the lot. In the housing crisis borrowers and lenders convinced themselves that they would never lose value on a home, but in the auto sector cars are always a depreciating asset.

So should we be worried? I believe this is more a case of fighting the last war. We are so hyper aware now of what created the last bubble that we are watching for it with super vigilance. That’s not to say there isn’t risk. Wells Fargo recently announced that they would be capping the total percentage of subprime auto loans they make, and in Canada subprime auto loans are part of our dangerous growth of consumer debt. So it pays to e vigilant, but imagine if we were equally wary of tulip bulb prices and technology stocks? Wouldn’t that be ridiculous? It is good to be wary of known dangers, but it’s what we don’t know, or worse, what we choose to ignore that invariably wounds us most deeply.

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