Put brakes on auto-lending bubble before it bursts
The U.S. auto market is booming, with new car sales on track to hit 16.5 million in 2014, the best year since 2006. On the whole, this is great for the economy, since more demand for cars means more jobs in automobile manufacturing, sales and service. It’s a plus for the environment, too, since the average fuel efficiency of new cars is rising. There’s just one catch, though, and it’s a pretty big one: The car boom might be a bubble.
Increasing evidence suggests that the Federal Reserve’s ultra-low interest rate policy is goosing car sales, both new and used, beyond the level that economic fundamentals can sustain. The signs include the proliferation of long-term, low-interest loans for borrowers with high credit scores and increased subprime lending for credit-challenged consumers. A new report by the nation’s commercial bank regulator, the Office of the Comptroller of the Currency, observes that “signs of risk in auto lending (are) beginning to emerge,” in the form of weakened underwriting standards and a “substantial” rise in lenders’ average loss per vehicle over the last two years. Yet investors, ravenous for higher returns in the era of zero interest rates, continue to snap up bonds backed by such loans.
It’s a dynamic reminiscent of the subprime mortgage bubble that helped cause the Great Recession — and, in that sense, precisely what Wall Street and Washington had promised to avoid in the future. But the analogy should not be overstated. The car-loan market is far smaller than the housing market, and the underlying assets — vehicles — are by nature more mobile and, hence, more marketable than houses. The risks to individual consumers and investors are significant, but the systemic risks to the U.S. economy from an overheated car-loan market are, accordingly, modest.
The OCC report strikes us as just the kind of regulatory vigilance the situation requires: In a market dominated by self-interested boosters, it’s a dose of objective information that, if heeded, could help ease the bubble before it gets out of hand. On a more aggressive note, the Justice Department has issued a subpoena to General Motors’ car-lending subsidiary, seeking documents on the company’s underwriting and securitization practices. According to GM, the department cited no specific potential violations; the company is cooperating and the inquiry seems to us more like a response to news reports about the overheated auto-loan market than the start of a substantial civil fraud investigation. So far, it seems that most of the froth in the car-loan market results from legal behavior, which represents the unintended but foreseeable consequence of Federal Reserve policies.
Still, the Justice Department’s gesture might be useful if it helps induce a more cautious atmosphere in the market, reminding investors and consumers alike to prepare for the inevitable Fed monetary tightening. No, a subprime auto-lending bubble probably can’t and won’t cripple the U.S. economy. But the longer it goes on, the more people will get hurt when it abruptly stops. It would be better for all concerned to tap the brakes now than to risk a crash later on.