Commodity Trade Mantra

A Major Cause of the Financial Crisis is Coming Back

A Major Cause of the Financial Crisis is Coming Back

A Major Cause of the Financial Crisis is Coming Back

One of the biggest causes of the financial crisis is back.

Subprime lending is surging.

Subprime loans are made to people with bad credit. They’re riskier than traditional loans. Lenders charge higher interest rates on subprime loans to compensate for the higher risk.

Subprime lending exploded in the early-to-mid-2000s and fueled the housing bubble. When people couldn’t pay back these expensive loans, the housing market crashed.

It sparked the biggest financial crisis since the Great Depression…and almost took down the whole US financial system.

•  The subprime mortgage market is almost dead…

Subprime loans account for just 0.25% of the mortgage market today…down from 26% in 2006.

Banks have mostly gotten out of the subprime mortgage businesses. New regulations make it difficult for banks to make subprime loans.

•  …But subprime lending is making a comeback.

Lenders aren’t giving people subprime loans to buy houses much anymore. Instead, they’re giving subprime loans to people to buy cars… and to buy stuff on their credit cards.

The Wall Street Journal reports that subprime auto and credit card lending has surged to its highest level since before the financial crisis.

…[M]ore than one-third of all auto, credit card and personal loans from the start of January to the end of April went to subprime borrowers, according to the latest available data from credit-reporting firm Equifax Inc. That is the highest percentage since 2007.

Lenders made 53.7 million auto, credit card and personal loans in the first four months of 2015, up 46% from 2010.

Subprime auto loans are growing fastest, according to The New York Times:

Over all, auto loans to subprime borrowers — typically people with credit scores at or below 640 — have more than doubled since the financial crisis, with one in four new auto loans going to subprime borrowers. In the second quarter of 2014, for example, total auto loan originations hovered at the highest level since before the financial crisis…

Lenders made about $189 billion in new subprime consumer loans during the first eleven months of 2014. To put that into context, the subprime mortgage market was about $1.3 trillion before the financial crisis.

Subprime auto and credit card loans aren’t huge yet…but they’re not tiny either. And as we’ve explained, they are growing fast. It’s another disaster in the making.

•  Springleaf Holdings (LEAF) is one of the biggest players in subprime lending…

And its business is booming.

Springleaf has a $6.7 billion portfolio of mostly subprime loans. It charges subprime borrowers an incredible 27% interest rate, on average.

Springleaf’s earnings rose 14% during the second quarter. And its stock price is up 40% in the last year.

Fortress Investment Group (FIG), one of the largest hedge and private equity firms in the world, owns a majority stake in Springleaf.

Strict regulations have mostly stopped banks from making subprime loans. But those rules don’t apply to hedge funds. The Wall Street Journal explains how hedge funds are getting into the subprime business.

Tighter regulations have pushed many banks out of subprime mortgages and sharply limited their interest in other types of subprime loans…

The retreat has opened the door to non-banks like Fortress, which are flush with cash to invest and say they have learned the lessons of the financial crisis.

We’re skeptical… and we wouldn’t be surprised to see a Springleaf blowup come to a market near you soon.

•  If you trust that big financial institutions really have learned their lesson…

Then you don’t need to do anything.

And if you believe lending hundreds of billions of dollars to unqualified borrowers won’t cause another financial crisis…

You don’t need to worry that your stocks and bonds will lose value.

•  But… you might know your history. And it says not to trust big financial institutions…

In 2008, we learned that the financial system is rigged to reward financial institutions for taking crazy risks.

If a big financial institution takes a big risk and it pays off, it keeps the profit. If it takes a big risk and blows up the financial system, the government will bail it out…like it did in 2008.

Big financial institutions have zero interest in keeping our financial system safe and stable. Their incentives are to take big risks.

At some point, big risks like the growing number of subprime auto and credit card loans will cause another major financial crisis.

Chart of the Day

We mentioned earlier that Springleaf Holdings is one of the largest subprime lenders in America.

It charges customers an average interest rate of nearly 27%.

Today’s chart compares that rate with other common interest rates.

As you can see, Springleaf’s average rate is more than six times higher than the average mortgage rate.

And it’s nearly double the average interest rate on a credit card.

These super-high rate loans are extremely expensive for the borrower…making them hard to pay back.

Someone who borrows $1,500 at Springleaf’s 27% average rate for four years would end up paying $1,000 in interest.

 

 

Courtesy: Justin Spittler

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The views and opinions expressed herein are the author’s own, and do not necessarily reflect those of Commoditytrademantra.com or Moneyline.co.in.

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