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ECON What’s Behind the Subprime Consumer Loan Implosion?
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  1. #1
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    What’s Behind the Subprime Consumer Loan Implosion?

    https://wolfstreet.com/2019/11/28/wh...oan-implosion/

    What’s Behind the Subprime Consumer Loan Implosion?
    by Wolf Richter • Nov 28, 2019 • 109 Comments

    These are the good times, but why are subprime credit cards, auto loans, and short-term installment loans blowing out?
    This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:

    OK, we’ve got a situation in subprime consumer loans. The delinquency rate on credit-card loan balances at the nearly 5,000 smaller commercial banks in the United States – this means all banks except the largest 100 – is blowing out, according to Federal Reserve data. In the third quarter, the delinquency rate at these banks rose to 6.25%. That’s higher even than during the peak of the Financial Crisis.

    Back in 2016, the credit-card delinquency rate at these banks was in the 3% range. It has more than doubled in two years.
    Credit card balances are considered delinquent when they’re 30 days or more past due. This delinquency rate means that out of the banks total credit card balances, 6.25% are 30 days or more past due. This is a disturbingly large rate.

    But delinquencies are a flow. Balances are removed from the delinquency basket either when the customer cures the delinquency, such as catching up with past-due payments, or when the bank “charges off” the delinquent balance against its loan loss reserves. But as these delinquent balances were taken out of the delinquency basket, even more new delinquencies fell into the basket, and the delinquency rate rose.

    Subprime auto loans have also been blowing out. In the third quarter, the serious delinquency rate of the $1.3 trillion in auto loans has risen to 4.71%, the highest since the worst months of the Financial Crisis, when the auto industry collapsed, and when the US was facing the worst unemployment crisis since the Great Depression. In the third quarter, about 21% of all subprime auto loans were seriously delinquent – meaning 90 days past due.

    Then we got another glimpse of this upheaval in subprime with some of the specialized lenders that cater to them.

    For example, World Acceptance Corp., which does small short-term consumer installment loans, and some larger medium-term loans to people who need money desperately and have subprime credit ratings. Like most specialized subprime lenders, World Acceptance charges blistering interest rates, but then it also has large default rates.

    It reported disappointing results now two quarters in a row, and its shares have plunged 45% over the past four months. So what’s going on here?

    Back in 2009, people were defaulting on their auto loans and credit cards and their installment loans because over 10 million people had lost their jobs. This is not the case today. Back then, new unemployment claims – a sign of layoffs – spiked to astronomical levels. These days, they’ve been hovering near historic lows. So today, these people are working, and they’re falling behind on their debt service.

    Subprime doesn’t mean poor or uneducated. Subprime means having a credit score below 620.

    For example, a family of two working adults and two kids: The household income is $200,000. They bought a house and stretch to make the mortgage payments. They bought nice cars and have to make payments. Their kids cost all kinds of money, and it adds up, and they’re spending every dime they make. Then one of the earners gets seriously sick and can’t work for a few months, and the deductible on their health insurance is $4,500, and soon their six credit cards are maxed out.

    So they go through daily triage about what to pay: mortgage payments, auto loan payments, minimum payments on their maxed out credit cards, groceries, clothes for the kids, bills, gas, and so on. And they fall behind, and late fees are racking up, and their credit score drops below 620, and they’re subprime.

    They can still borrow, and they can still get more credit cards, but now under the terms of being subprime.

    So banks take risks on credit cards because credit cards are immensely profitable. Until they’re not. Credit cards – unlike auto loans or mortgages – are unsecured loans. And recovery when the loan goes sour is small. The bank may sell the delinquent credit-card account to a debt collector for cents on the dollar and that’s all it may get.

    The hope is that income from interest and fees from other subprime credit cards that are still current are making up for the credit losses. The whole thing is structured that way.

    So the banks take big credit-card risks for big profits. And when the losses pile up, at least at first, they’re just part of the cost of doing business. The calculus works out in good times, and snaps back in bad times.

    We can use the nearly 5,000 smaller banks with their credit-card delinquency rate of 6.25% as a stand-in measure for subprime. Here is why:
    The largest 100 banks have a delinquency rate of just 2.56%, which remains low by historical standards, and is just a small fraction of the peak delinquency rate during the Financial Crisis. They can offer the most sophisticated incentives and marketing to attract the prime-rated customers. Overall, they have most of the customers and most of the credit card balances. And they get the lion’s share of prime customers. They also go after subprime. But since they have the lion’s share of prime customers, the portion of subprime customers don’t weigh heavily in the mix.

    But smaller banks can’t offer the same kinds of incentives and marketing and often miss out on prime customers. So proportionately, they end up taking more subprime customers, including those that were turned down by the largest banks. And in this way, they become a measure of subprime credit card delinquencies.

    But why are credit card loans and auto loans and other risky consumer loans now running into this kind of turmoil, when they hadn’t in 2016? There is no employment crisis. We haven’t seen millions of people getting laid off. But there is something else going on here.

    I can see two factors.

    One factor in the subprime turmoil is greed. People with a subprime credit score know their credit score. They know they’re having trouble borrowing. They’ve been turned down. They can’t buy a car and finance it at the ultralow interest rates they see in ads because they don’t qualify. Same with credit cards. They tried to get the 2% cash-back credit card with no annual fees and 7.9% APR and got turned down. They’re now conditioned to take whatever they can get.

    In other words, for the industry, they’ve become sitting ducks. Lenders offer them credit cards with the highest interest rates and the biggest fees. Auto dealers make big-fat profits off these folks. And specialized subprime lenders charge them dizzying interest rates to finance these cars.

    That’s all they can get. No one forces these people to take those loans and credit cards, but they’re trying to maintain their lifestyle, however basic it may already be, and they’re trying to feed their kids and drive them to school, and so they borrow at these high rates to make ends meet.

    But the high interest rates increase the probability of default because these people who are already strung out will have even greater trouble making the payments. That part is driven by the industry’s greed. Aggressive subprime lending went into overdrive starting in 2014, and private equity firms piled into it, and smaller banks went after it, and it’s now coming home to roost.

    The other factor in the subprime turmoil may well be something else, something that would impact people the most who are already strung out, people who have jobs but they’re living from paycheck to paycheck, and not necessarily because they’re splurging, but because, at their level of the economy, prices of goods and services they need have risen sharply and outpaced their incomes. And this can happen overnight.

    This includes healthcare costs, and it includes food costs, and apartment rentals, and cars have gotten a lot more expensive, and the like. But cars and apartments and cellphones have gotten a lot better too, and these quality improvements are added to the price. Think of the move over the years from a four-speed automatic transmission to an eight-speed automatic, or from two airbags to 10 airbags, or from a basic cellphone to a smartphone.

    But for figuring the inflation measure of the Consumer Price Index, the costs of these quality improvements are removed from the index. This is the principle of hedonic quality adjustments.

    Inflation measures the loss of purchasing power of the dollar: what the same thing costs over time. But when quality improves, such as in a car, it’s no longer the same thing, and the costs of those quality improvements are removed from the inflation index.

    So the CPI for new cars has been essentially flat since 1995, meaning no inflation for 20+ years, when in reality, the actual prices have jumped. For example, the price of a new Toyota Camry jumped by 25% between 1995 and 2019.

    With used cars, it’s even worse. The CPI for used cars has declined by 11% since 1995. But actual used car prices have soared since then.

    This goes for many other products and services across the spectrum. And then consumers, even when their income rises faster than inflation as measured by CPI, run into this problem where their income no longer suffices to buy these goods and services, including used cars and health care or housing, because actual prices of these goods and services have far outpaced both inflation as measured by CPI and wage increases.

    This goes increment by increment. What might have worked last year, suddenly doesn’t work anymore this year. These consumers with jobs, that have been living from paycheck to paycheck, suddenly find themselves confronted with a 20% increase in health insurance premium or a 10% increase in rent, or both.

    And suddenly, their whole fragile equation doesn’t compute anymore, from one day to the next. And they fall behind. As more consumers are getting caught up in it, subprime starts to blow out, even in what are considered the good times because actual prices have outrun these people’s incomes, and they’re confronted with it, such as with rent or healthcare, from one day to the next.
    The wonder of our time isn’t how angry we are at politics and politicians; it’s how little we’ve done about it. - Fran Porretto
    -http://bastionofliberty.blogspot.com/2016/10/a-wholly-rational-hatred.html

  2. #2
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    UM, this is a no brainer, as my nephews and nieces tell me. IF you live paycheck to paycheck, are in staggering amounts of debt, and generate virtually no money to repay the interest, much less the principal on those loans, then you will indeed get a "crisis." Insert into washing machine, put in quarter, hit button, rinse, repeat, and then dry. Been there and done that, gang.
    Doomer Doug, a.k.a. Doug McIntosh now has a blog at www.doomerdoug.wordpress.com
    My end of the world e book "Day of the Dogs" is available for sale at the following url
    http://www.amazon.com/-/e/B007BRLFYU

  3. #3
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    For example, a family of two working adults and two kids: The household income is $200,000.

    Man...I can't even imagine having that kind of income every year. I'd love to try to make ends meet on that!
    What is the lake of fire? What is it's purpose? Is the lake of fire eternal hell? Is there any hope of escape for those cast into this lake?
    http://bible-truths.com/lake1.html

  4. #4
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    Quote Originally Posted by Doomer Doug View Post
    UM, this is a no brainer, as my nephews and nieces tell me. IF you live paycheck to paycheck, are in staggering amounts of debt, and generate virtually no money to repay the interest, much less the principal on those loans, then you will indeed get a "crisis." Insert into washing machine, put in quarter, hit button, rinse, repeat, and then dry. Been there and done that, gang.
    If most of US have not been there at sometime in our lives. You JUSt weren't trying enough.

    Had a friend that canceled his cable when the sawmill went down here. People at the desk told him in two years of delinquencies he was the first to cancel before he owed.

    Probably should add this though. Consumer debt as a whole is in decent shape.

    http://www.reuters.com/article/us-us...-idUSKBN1XN2OH

  5. #5
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    The problem is not usually income because in many cases we are dealing with people who are making a lot of money. It is on the spending side. If they stopped buying a $2 cup of coffee every day, that would free up nearly $700 a year, which would pay at least some of their utility or whatever bills. Nope, it is on the obsession to maintain lifestyle no matter if you can't pay for it. This is why the debt will never be repaid and the system will crash under the weight of it all.
    Doomer Doug, a.k.a. Doug McIntosh now has a blog at www.doomerdoug.wordpress.com
    My end of the world e book "Day of the Dogs" is available for sale at the following url
    http://www.amazon.com/-/e/B007BRLFYU

  6. #6
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    Nice find. Thank you.
    1. If you import the Third World, you become the Third World. It really is that simple.
    2. The greatest trick the devil ever pulled was to convince the world he didn't exist
    3. If you have not been to the range in a month, you are under performing.

  7. #7
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    Me too, HFC!

  8. #8
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    Low income income is a tricky thing, gang. The subprime Loans, are likely based on "income" that includes Food Stamps, free cell phones, free medical care and free premiums plus some form of Social Security type income.

    So, this allows them to have a much higher standard of living since they likely have more actual income that would be indicated on their loan sheets. Plus, they use this extra income to increase lifestyle.

    I am on Social Security, and when you add in the base SS, the Medicaid premiums paid the food stamps paid, and the various other federal bennies, if I chose to I could have a much higher lifestyle than if I was a good boy and paid all my bills off.
    Doomer Doug, a.k.a. Doug McIntosh now has a blog at www.doomerdoug.wordpress.com
    My end of the world e book "Day of the Dogs" is available for sale at the following url
    http://www.amazon.com/-/e/B007BRLFYU

  9. #9
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    If people with incomes of $200,000 a year are having problems making ends meet, it is absolutely a matter of wrong choices and attitudes. They need to listen to Dave Ramsey. My daughter and I are making ends meet on very little more than her SSI check at the moment (she gets about $775/month, if you aren't aware of what SSI looks like). I should start getting SS pretty soon, which will help. I suppose we are probably eligible for food stamps, but hadn't considered applying for them. If we can make ends meet on that -- staying out of debt, and keeping an emergency fund in the bank -- someone making $200,000/year can have no excuse.

    Kathleen
    Behold, these are the mere edges of His ways, and how small a whisper we hear of Him.
    Job 26:14

    wickr ID freeholder45

  10. #10
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    Kathleen, the income limit for food stamps is $1350 or less. The hard asset limit is $3500 each. $775 a month would likely get you $175 or so food stamps, and if you are over 65 it will be the cash program, which allows you to get cash when you use your food stamp card.

    I got no sympathy for somebody making $200,000 a year and saying they got "no money."
    Doomer Doug, a.k.a. Doug McIntosh now has a blog at www.doomerdoug.wordpress.com
    My end of the world e book "Day of the Dogs" is available for sale at the following url
    http://www.amazon.com/-/e/B007BRLFYU

  11. #11
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    Quote Originally Posted by Doomer Doug View Post
    Kathleen, the income limit for food stamps is $1350 or less. The hard asset limit is $3500 each. $775 a month would likely get you $175 or so food stamps, and if you are over 65 it will be the cash program, which allows you to get cash when you use your food stamp card.

    I got no sympathy for somebody making $200,000 a year and saying they got "no money."
    Thanks, Doug. I might apply for them later. Right now I'm still using up the money that came from the cash-out of the house I sold in Oregon (using it to repair this place). Once that's gone, I'm sure we'll be eligible.

    Kathleen
    Behold, these are the mere edges of His ways, and how small a whisper we hear of Him.
    Job 26:14

    wickr ID freeholder45

  12. #12
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    Yeah, my Dad died in June so I am looking at some hard assets pretty soon here. As long as you have an income over $1350 and hard assets over $3500, which would be money left from the sale of your Oregon House they won't lift a finger to help you. They call it bleed down and force you to use up all of your assets first, and then they will help you.
    Doomer Doug, a.k.a. Doug McIntosh now has a blog at www.doomerdoug.wordpress.com
    My end of the world e book "Day of the Dogs" is available for sale at the following url
    http://www.amazon.com/-/e/B007BRLFYU

  13. #13
    Liz Warren before she had a lobotomy called it the two income trap. People buy into neighborhoods because of they believe that the school district will give their kids a leg up. It doesn't always work that way. I have a sibling who did that in a neighborhood outside of NYC. The district was hit with a disparate impact lawsuit and lost. My niece went from a high school that was 75% white to 30% until she graduated. She was the last to enjoy being in any honors or AP program.

    Fortunately she went through college and after a few years is in professional career track. But it is often those with the most aspirational goals for their kids that pay a very high price.

  14. #14

    We have used debt

    Debt borrowing against the future to buy something now.

    Back in the bad old days you only borrowed to buy long term asset like house or 50 % of car.

    And you paid back the loan. People used to hold parties to celebrate burning the mortgage.

    Doesn’t matter what economic class you can always borrow to live above your means but at some point the music stops.

    Now it’s winding down. All that credit and there will be fewer jobs to support paying it back. Retail will be toast, finance will automate and consolidate, manufacturing will automate.

    All those 100k loans for lesbian dance and social justice warrior degree’s will be about as valuable as toilet paper. And we are supposed to feel sorry for these moron’s...

    At some point stupidity should be painful.

  15. #15
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    Quote Originally Posted by Hfcomms View Post
    For example, a family of two working adults and two kids: The household income is $200,000.

    Man...I can't even imagine having that kind of income every year. I'd love to try to make ends meet on that!
    No kidding !!!

    One of my most notable “preps” is to have conditioned my family to live on $150-200/monthly.....going on 25 years, now.

    And that only so we can continue to “function” by some loose sense of acceptable modern economic standards.

    Living off the land in the modern day is an adventure I’d be hard pressed to trade......
    “I would remind you that extremism in the defense of liberty is no vice! And let me remind you also that moderation in the pursuit of justice is no virtue.” Barry Goldwater.

  16. #16
    Sub prime loans are a huge business. Saw a mattress store with a sign offering financing on a new mattress up to 4 years. First off, if it takes you 4 years to pay off a mattress you can't afford a mattress. Sleep on the floor or a cheap air mattress. Second, such loans are at very high interest because those lenders know a percentage of those borrowers will default because they are irresponsible to begin with and a repossessed mattress isn't worth squat. The interest rates are high enough to absorb the defaults and still make a nice profit. I worked with a guy for years who invested in one of those lenders and he said his return on the investment was 3 times what he could get at a bank.

  17. #17
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    I sure don't feel sorry for the banks that have to do the write-offs. Why do they call it 'subprime consumer loans' when the real name is high risk loans. The banks and stores know the risks.
    We have never even dreamed of having a yearly income of $200,000. Yet our new house is paid for and we have money in the bank. Live within your means and you will have no problems.
    If you are reckless with your money then it makes little difference if you earn 20 thousand per year or 2 million per year. Anyone can easily spend more than they make.
    In so many ways, many, many people are just plain stupid.

  18. #18
    Quote Originally Posted by hiwall View Post
    I sure don't feel sorry for the banks that have to do the write-offs. Why do they call it 'subprime consumer loans' when the real name is high risk loans. The banks and stores know the risks.
    We have never even dreamed of having a yearly income of $200,000. Yet our new house is paid for and we have money in the bank. Live within your means and you will have no problems.
    If you are reckless with your money then it makes little difference if you earn 20 thousand per year or 2 million per year. Anyone can easily spend more than they make.
    In so many ways, many, many people are just plain stupid.
    Lenders who make those loans know the numbers and what percentage of them will go bad at some point. That's how they determine where to set interest rates and still come out ahead. No need to feel sorry for them. They are still making lots of money.

  19. #19
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    $200,000 a year, supporting a family? You make it, you spend it. It's the American way.

  20. #20
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    Banks committing suicide again with subprime loans....

    There is no money to bail out these suicidal banks....

    Look for buys in autos coming soon....

    Texican....

  21. #21
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    Remember most sub-prime loans made by auto dealers or even the mattress store are bundled together and sold on the financial markets. Thus those loans are owned by the pension funds, mutual funds and even the banks. Look at the Fidelity Capital & Income Fund, the Vanguard High Yield Corporate Fund Investor Shares or the SPDR Barclays Capital High Yield Bond and see what is in their holdings. This is a big business

    Those funds usually have a portion of their holdings in fixed assets. And since the government has manipulated interest rates down lower then normal anyone looking for a decent interest rate has to go out farther on the risk curve. Thus there is a huge market for what used to be called junk bonds but are now called sub-prime

    Look at the holdings for SPDR Bloomberg Barclays High Yield Bond ETF (JNK) below. Look at all the BB and below rated stuff. BB means ratings below investment grade. This is where the mattress companies loans end up. Same with all of those used car dealers

    This is a big business

    tbd

    Bond Ratings JNK
    US Government 0.00%
    AAA 0.00%
    AA 0.00%
    A 0.00%
    BBB 0.08%
    BB 49.41%
    B 37.84%
    Below B 12.64%
    Others 0.03%

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