The United States of Debt

Subprime Loans Are Back

This time, they’re coming for our cars.

car dealership.
According to Experian Automotive, fewer than 15 percent of new cars sold in the last quarter of 2015 were paid for outright.


Remember the Great Recession, when we swore we would never again borrow money so we could buy things we couldn’t afford? “A consumer culture invites us to want more than we can ever have,” Nancy Gibbs wrote in Time in 2009, but America’s new “culture of thrift invites us to be grateful for whatever we can get.”

Take cars, for example. We were, the magazine predicted, going to eschew newer models for their mature—and less costly—counterparts. “The buyer at the used-car lot feels both frugal and green,” the magazine warbled. “That hatchback isn’t used, it’s ‘pre-owned.’ ”

Do I need to tell you what happened next?

Auto sales are on a tear. Last year, Americans purchased almost 17.5 million new cars, SUVs, minivans, and pickup trucks, the largest number since 2000, and an increase of about two-thirds from the depths of 2009. Leasing is up, too. There are a number of reasons we’re going back to the dealerships: The economy is improving, gas is getting cheaper, and it’s getting easier and easier to buy a car with borrowed money.

According to Experian Automotive, fewer than 15 percent of new cars sold in the last quarter of 2015 were paid for outright. A little more than half of used-car buyers, too, relied on credit. It’s not, in and of itself, a bad thing that most cars are not bought outright. The average car costs $33,000 new or $18,000 used. Few of us keep that sort of cash on hand, and even if we did, we’d likely be draining valuable savings to fund the purchase. If you have an emergency, after all, you can’t turn to your car. (Well, you can, through a disreputable financial instrument marketed to the desperate called a title loan—but you shouldn’t.)

What’s concerning is what’s happening with those cars purchased with subprime loans—you know, those instruments of mass financial destruction that contributed to the housing crash. In February, defaults on delinquent subprime auto loans topped 5 percent, according to Fitch Ratings. That’s worse than the number of similar defaults during the Great Recession. Heck, it’s worse than the number of defaults after the dot-com boom turned to a bust. It fell back to 4 percent in March, something the company attributed to the temporary boost many receive from their income tax refunds.

The subprime auto boom originates in the Federal Reserve’s response to the Great Recession. The Fed cut the benchmark interest rates on the short-term loans it makes to banks to close to zero, meaning that safe investments such as government bonds gave little in the way of return. Of course, many investors want to put their money in things that throw off income without putting all their eggs in the stock market basket. Subprime auto loans—which charge higher interest rates to consumers deemed high risk—seemed to offer a solution.

So what makes this subprime offering different from the one that set off the housing crash? Financial experts believe because our autos are such a lifeline to our financial lives, people will pay their monthly loan bills over almost any other bill. It’s not like Americans can do without access to wheels, since public transportation is less than robust, to put it kindly, in many areas of the country. People whose cars are repossessed can lose their jobs as a result.

Moreover, as Bloomberg View’s Barry Ritholtz pointed out last month, cars are easy for a financer to seize when a borrower can’t keep up. Whereas it can take years to dispossess a homeowner for nonpayment, something many homeowners no doubt realize, finance companies can often get their merchandise back with little effort. Prolonged court delays are rare. In many cases, the repo man is virtual—technology exists that can remotely render the car useless.

As a result, Wall Street was more than happy to meet the demand. So instead of combining bits and pieces of lousy mortgages and selling them off as new investments, they turned to lousy car loans.

There is something, however, auto loans of all sorts share with housing loans that should concern us: a history of discrimination. A 2014 report by the Center for Responsible Lending revealed that blacks and Latinos are more likely to get sold add-on products when purchasing a car—and dealers often told them if they didn’t agree to take on the extra frills, they wouldn’t get approved for the loans. And in many cases they paid more for financing than their white counterparts.

And how did that happen? The lender offering the financing sets the loan rate, but dealers can then add more interest as they see fit. Now a number of car financing companies are coming to settlements with the federal government, which claims the loan issuers should have known what was going on at dealerships and put a stop to it. In 2013, it was Ally Financial. This year? Toyota Motor Credit, which will refund more than $20 million to black and Asian consumers who signed on for one of their loans between 2011 and the day of the settlement.

Finally, it’s worth noting that too much auto debt—whether loaned or leased, subprime or prime, can cause people problems even if they don’t default. And that’s something that should also worry us. Take Yannerys Castillo, who we’ll meet in our Slate Academy series the United States of Debt. Castillo’s aging Chrysler needed expensive repairs. Doing without a car wasn’t an option. There was no way Castillo, then a 22-year-old single mother, could take public transportation between her job in Boston, her home in the nearby city of Lawrence, her college classes in New Hampshire, and her 5-year-old daughter’s day care.

So one day in the spring of 2012, Castillo went to the closest car dealership near her home. She walked out with a three-year lease on a Nissan Altima. “I test-drove a couple of cars, and I saw white one, and I said, ‘I want this one,’ ” she recalled. The lease payments would set her back by $350 a month, causing her not an insignificant amount of hardship. She would put groceries on her credit card because she needed her salary to make her monthly car payment. When I asked her if anyone at the dealership pointed out that amount could be a stretch on a $35,000 annual income, she laughed. “It’s all marketing, right? They’re going to want you to get the fancy car.”

The history of the automobile is entangled with debt. Not too many people could afford to buy a car for cash in the early part of the 20th century, any more than they can now. By 1919, General Motors established a subsidiary that would finance installment plans. A customer put down a deposit, drove the car home, and then made payments until he paid off the purchase in full.

Ford, founded by notorious hater of credit Henry Ford, attempted to resist and instead offered a savings plan for would-be customers called the Ford Weekly Purchase Plan, which worked similar to layaway plans. It flopped. “After people would get $50 or $75 they would want a vacation or something and they would withdraw it,” one dealer claimed. Ford finally began to offer loans to customers in the late 1920s.

All this history should point to a truth that should have been obvious in 2009: Predictions of newfound financial discipline were always more than a bit optimistic. For Americans, cars are often an expression of status and a necessity. In retrospect, it seems almost inevitable that once the initial shock of the downturn wore off, many of us would seek out a new set of wheels.