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Subprime Auto Loans Look an Awful Lot Like Bubble-Era Subprime Mortgages

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Does this sound familiar?
Loans on decade-old clunkers are being bundled into securities, just as subprime mortgages were a few years ago. In the last two years, investors have bought more than $15 billion in subprime auto securities.

Although they're backed mainly by installment contracts signed by people who can't even qualify for a credit card, most of these bonds have been rated investment grade. Many have received the highest rating: AAA.

How about this this?
Some analysts worry that the rush to securitization could lead to careless lending by dealers eager to sell more loans.

Except for a couple words in the first paragraph, the above could pretty easily be talking about the subprime mortgage crisis (you know, the one that helped nearly destroy the US economy and spawned a protest movement that recently closed the nation’s fifth largest port and wrecked a Whole Foods).

But it’s not. Both passages are from a series on "Buy Here, Pay Here car dealerships" that ran in The Los Angeles Times last week. The dealerships sell used cars to people with bad credit and no options. A typical deal described by the Times has a customer paying at least double the Kelley Blue Book price for a car on an installment plan, with interest peaking at over 30%. One in four of these borrowers will default.

Not that this has scared off investors. Subprime auto security sales jumped from $3 billion last year to $7 billion this year. Again, this growth came in an industry that is so sure that customers will default that many dealers install GPS trackers and ignition blockers in their cars.

A few numbers from March 2007 shed interesting light on this data. From Bloomberg: “About 10 percent of subprime loans were more than 60 days delinquent or in foreclosure as of Dec. 31 (2006), up from 5.4 percent in May 2005.” Also: “In 2001, subprime accounted for 5.4 percent of the total market to 2006's figure of 20.1 percent.”

We’ve seen something a lot like this before. And not that long ago. Except in this case, the default rate is actually a lot higher than on subprime mortgages, even in the middle of the crisis.

Of course, many people think we won’t see a repeat of the mortgage crisis. The Times quotes Kenneth Morrison, head of the asset finance and securitization practice at law firm Kirkland & Ellis: “I don’t think a blowup would happen because investors are very attuned to that risk now.”

Uh huh. We haven’t learned anything.
POSITION:  No positions in stocks mentioned.