La Burbuja de los Autos en USA

Negative Equity in Auto Loans and the Bust of the Auto Bubble
Nouriel Roubini | May 4, 2008

We have been worrying for a while about the collapse of home sales, the free fall in home prices, reckless lending practices that occurred in mortgages and now millions of households being “under water” or with negative equity on their mortgages.

But guess what? The same kind of credit mess did occur in auto sales and auto loans. The latest auto sales for April have been an unmitigated disaster. As Reuters put it:

“U.S. auto sales fell to their lowest annual rate in more than 15 years in April as weak consumer confidence and rising gas prices hit the industry's most profitable vehicles hardest.”

So auto sales are free falling and desperate car makers are cutting on prices and providing further price cuts via loose financing terms. But at the same time a time bomb of negative equity in auto loans is emerging. For the last few years auto loan lenders sharply loosened their lending standards, used aggressive, deceptive and predatory lending practices, allowed households to buy cars with little equity in them (as zero down-payment deals became the norm) and thus caused a bubble in car production and in car sales (individuals with cars too big and too many cars each) that was financed with a reckless lending bubble.

Sounds familiar? The car lending bubble was as reckless as the subprime and mortgage bubble. And now this credit bubble is going bust leading to rising default rates, significant negative equity in car loans (25% of all car loans are “under water”), massive losses to auto loan firms and a severe recession in the auto industry.

A brilliant piece on National Public Radio described this car loans disaster:

Drowning in Debt
Being 'Upside Down' and Other Car Loan Hazards

Morning Edition, May 1, 2008 · Americans who bought cars beyond their means are falling behind on their loans in record numbers.

Auto loan delinquency in the United States hit a 17-year high in the fourth quarter of 2007, according to the American Bankers Association. Some 3.13 percent of car loans were overdue 30 days or more.

"Most consumers are carrying much more debt for their car than ever before," says Philip Reed, a consumer adviser for Edmunds.com, an automotive information site.

Edmunds.com estimates that nearly a fourth of borrowers are "upside down" in their car loans, meaning the car is worth less than the loan balance.

"These people don't have much flexibility…. They can't even walk away from the loan," Reed tells Steve Inskeep. "They actually have to pay to get free from the debt that they have."

Putting Less Money Down

The rule of thumb used to call for putting down 20 percent of the car's purchase price.

But these days, Reed notes, many people are buying higher-end vehicles and they're buying cars when they're younger. "So as a result they're putting less down," he says. "They're keeping that money so that they can make car payments. There has been a trend to being more upside down than ever before."

The cost of a car has risen in relationship to most people's earning power.

Auto manufacturers' financing arms "have struggled to find ways to keep putting people in cars. So they've had to become more creative," Reed says. They've offered incentives, leases and longer-duration loans — averaging almost 64 months in 2007.

"We are ... encouraged to buy vehicles, to finance vehicles, to get more car than we need as kind of a patriotic move to keep the economy going," Reed says.

Beware the Finance Office

After settling on an initial price, car buyers end up in a dealer's finance and insurance office — and that's where the car's cost can go up.

"It's at this point that they begin to sell you extra products," Reed says. "They also begin to work on your loan. They may have a credit application all ready. But if you're not on your toes, they can actually inflate the interest rate at that point and you can end up paying quite a bit more than you should be paying."

People who get victimized "have some problems with their credit rating," Reed says. "So they go into the ... room and the finance officer says, 'You know, we both know you've had a few problems, but you're nice people so I'm going to take care of you.'"

Then the rate rises. Say you qualify for a loan with an interest rate of 6 percent, Reed says. Financial officers "may sell it to you at 8 or 9 percent. So they're making quite a bit of money on you over the term of the loan."

Troubled Borrowers In Denial

Borrowers behind on their loans tend to avoid dealing with the situation, Reed says. "They don't want to answer the phone, they don't want to open the mail, they don't want to confront the problem that's in front of them...."

But they have more options than they realize, such as selling an expensive vehicle and buying a more affordable one with more reasonable loan terms, he says.

"People need to be much more realistic about the vehicle that they buy and what they are willing to pay for it," Reed says. "It really begins ... with deciding what you're able to afford. People have been sold the American dream, which is a beautiful, sexy, hot car that's going to make everybody envy them. And now they're sort of paying the price for making a poor decision."