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Home Publications Blogs Beat the Press Fraudulent Subprime Auto Loans: The Cost of Obama's Soft on Crime Policy

Fraudulent Subprime Auto Loans: The Cost of Obama's Soft on Crime Policy

Sunday, 20 July 2014 04:30

It is fraud when an issuer of a loan knowingly puts down false information in order for the loan to be approved. When a securitizer includes large numbers of these loans in securities, as Floyd Norris reports was the case with Citigroup during the housing bubble, this is fraud. 

The Obama administration decided not to pursue criminal cases against executives at the major banks who likely committed fraud on a large scale. As a result, most of these bank executives are almost certainly better off as a result of their decision to commit fraud, even though the fraud has been exposed, than if they had obeyed the law.

When crime goes unpunished it naturally leads to more crime. Hence the NYT reported today that subprime auto lenders are doing many of the same scams that subprime mortgage lenders did in the housing bubble days. They are issuing loans, often for more than the value of the car, based on phony income numbers that the lenders themselves wrote in. In a time of generally low interest rates, these loans can be attractive to investors and Wall Street banks are therefore anxious to purchase them and securitize them.

The scale of the subprime auto loan sector is an order of magnitude smaller than the subprime mortgage sector during the bubble days, so it does not pose the same risks to the financial system. (Also, there is not a risk of a downward spiral in car prices as was the case with house prices during the bubble.) However these loans can lead to enormous hardship for the people affected, causing many to be pursued by creditors for years or forced into bankruptcy.

Comments (6)Add Comment
You Too Can Be an Economic Predator: Turn on Your Fellow Americans and Escape Poverty
written by Last Mover, July 20, 2014 9:48
The loans were typically at least twice the size of the value of the used cars purchased, including dozens of battered vehicles with mechanical defects hidden from borrowers. ...

... The arithmetic is simple. The bigger size and rate of the loan, the bigger the dealers’ profit, or so-called markup — the difference between the rate charged by the lenders and the one ultimately offered to the borrowers. Under federal law, dealers do not have to disclose the size of the markup.

Thing is, the conservative right supports this in the name of individual freedom to reject the terms and conditions. No one is forced to buy these cars they will say. If they do, they pay a price for not educating themselves.

Never mind the asymmetry of information and George Akerlof's lemon car hit-and-run theory of ripoffs. Never mind the desperation of those living daily hand to mouth, for whom these deals actually do buy a few more weeks and months of breathing room like a payday loan does.

No matter how bad free markets may appear America they will say, they come nowhere near the destruction of the poor that government regulations bring.

Let the chips fall where they may. Let the economic predators work both ends of the lend-borrow chain to crush those on the bottom of the economic food chain into oblivion.

If fact it's actually healthy and economically productive to promote this kind of competition in the race to the bottom. Think of it this way. Those desperate borrowers are a mere step up away from becoming the very lenders who are doing them in.

That's why deep down they all support Obama don't they. He's their guy. As Dean Baker says, unpunished crime leads to more crime. That's why it must continue, to preserve that great American tradition of freedom to choose. Just say no to drugs America ... and broken overpriced cars paid for with your life as well.

You can do it. After all, since when did transportation become an essential economic good anyway?
Desperately Seeking Profit
written by PeonInChief, July 20, 2014 11:20
This shouldn't surprise anyone, since houses have now been wiped out as a profit center for investors. Most people need a car, so it's effectively a necessity. These loans are right up there with car title loans as a way to take what little we have left.
written by chmoore, July 20, 2014 12:56
It does make sense to focus on where the damage is done (for subprime auto loans - at the consumer level versus the financial system).

RE "When crime goes unpunished it naturally leads to more crime." Actually, more specifically, it's allowing crime to go un-prevented that leads to more crime.

Punishment by itself has a point of diminishing returns. Enforcement, arrest and conviction also matter, and punishment (and its cost, versus the gain from its success) only really needs to be severe enough for enforcement, arrest and conviction to be meaningful.

In the 'big government' argument versus the effective regulation argument, I tend to lean towards the effective regulation side, since 'big crime' is likely a bigger threat than 'big government'.

Beyond that, it might be useful to have better consumer oriented shopping tools - so we consumers have better knowledge of what we're getting into, and also better resources for consumer remedies. For example, if a car is going to be repossessed, it seems fair to have a 'safe harbor' condition where money paid is reimbursed if there's sufficient evidence that the conditions of the original sale were fraudulent.

Whether it's market speculators or car dealers & car loan issuers, the best overall prevention strategy against fraud is to make fraud cost more than it pays.
The Times really needs to show their work
written by EMichael, July 20, 2014 3:22
They say

"The New York Times examined more than 100 bankruptcy court cases, dozens of civil lawsuits against lenders and hundreds of loan documents and found that subprime auto loans can come with interest rates that can exceed 23 percent. The loans were typically at least twice the size of the value of the used cars purchased, including dozens of battered vehicles with mechanical defects hidden from borrowers."

I can guarantee you that there is no chance in the world, none, that Wells Fargo or any other reputable(sic) bank is lending twice the value of the the vehicle.

Not to say the story does not hold some truth, but that number and especially the description of the vehicles being sold point to buy here, pay here dealers, most of whom have their own lending department.

Lots of questions raised to someone who spent a couple of decades in sub prime auto lending.
written by dax, July 21, 2014 6:35
"Also, there is not a risk of a downward spiral in car prices as was the case with house prices during the bubble."

Dean is quite right that auto loans are a fraction of housing loans, but I think this assertion is a little too optimistic. As far as I can remember, used car values fell sharply during 2008-9 because many people were trying to unload them at the same time.
EMichael is wrong
written by David Cay Johnston , July 28, 2014 8:30
EMichael should read the chapter about this in my book The Fine Print. Having personally paid off or relative one of these outrageous loans I am sure that Floyd has his stuff right. Indeed thinking back over the 30 years I have been reading his work, and when I worked beside him, I can't think of any facts he had wrong.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.