Return of the Subprime Loans!

They’re Back! Subprime Loans Are in Vogue Once Again

February 20, 2015—Maybe this time will be different.

The last time subprime loans dominated the credit market, we had a slight hiccup. OK, it was more than a slight mistake. The banking system collapsed and the greatest financial crisis in eighty years took place. As you might remember, it was pretty ugly.

Can you recall Cash for Clunkers, the $2 billion dollar give-away to jumpstart the auto industry? Well, there is a new wave of subprime car loans being reported. At least if this one blows up the worst that can happen is they repo your car instead of your house.

According to Equifax the credit reporting agency at least forty percent of the new car loans are going to customers with less than perfect credit. That subprime credit was given to about 50 million customers and they got almost $190 billion in cash.

You might think that the lending industry would have learned a lesson from the collapse in 2008, but it appears that they didn’t pickup much from that beating. Maybe they think if things go upside down again that the Treasury will bail them out.

Not all of the debt is going to finance cars. More than a quarter of the money is going into credit cards and personal loans. Those loans have no collateral except the promise to pay.

Why the change in policy from extremely tight credit to a new era of lending?

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There is a logical reason to tap into the market for subprime loans. For one thing a lot of borrowers that got burned on the housing collapse have had time to recover. They may have had good credit for many years and got caught when the market collapsed. That turned their credit into a nightmare. Some of that bad debt has matured and they are in a much better position to borrow.

Second lenders margins have been squeezed by the QE program and this type of lending will add some money to the balance sheet providing that they can collect the debt. Many of the new lenders are not banks; they are firms that are being created by hedge funds and private equity investment. These firms can take more risk than conventional banks and are anxious to lend in this environment.

So will this time be different?

History tells us that this time will probably not end differently. The lenders will race each other to get as much paper as they can, on the street at the highest yield. When they reach the last borrower that can qualify is when the problem will probably start. They will make “exceptions” to their own rules and we all know what happens when that wild card hits the table!

Do you think subprime loans will cause another bubble? Tell us in the comments.

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