Are Auto Loans the Next Big Bubble?

Things spiral out of control very quickly in a financial bubble.

The 2008 recession was caused by speculation in the subprime mortgage market, inflating a bubble in the housing market that eventually lead to its collapse along with the global economy.

It’s 2017 now and the bull market is on record as the second-longest in history. This relentless upward march has made investors nervous, prompting the question: where is the next bubble going to come from and when will it pop?

Wait, what is a bubble?

The term “financial bubble” comes into play anytime a mania surrounds a particular asset, leading to massive price speculation and an eventual crash.

Famous instances of financial bubbles include the Japanese real estate bubble of the late 80s and the Dot-Com Bubble, when the NASDAQ increased 10-fold over a decade, before dropping 80% over two years. During the initial bursting of the Dot-Com Bubble in March 2000, companies were losing between $10 and $30 million a quarter.

Are Auto Loans a bubble?

There is talk of a bubble inflating in the auto loan market.

The overall debt market saw a deleveraging process occur after the recession in 2008. From a peak of about $12.67 trillion, total debt decreased by $2 trillion dollars. As of Q2 2017, total US consumer debt stands at $12.73 trillion.

Put another way, Americans hold $50 billion more debt today than they did before the onset of the 2008 recession that crippled the global economy.

autobubble1

Source: New York Fed

Of the $12.7 trillion in debt held by US households, two-thirds is in the form of housing debt (mortgages). The next largest piece of the pie is in student loans and auto loans (in green) are third, weighing in at $1.13 trillion as of Q1 2017.

What people don’t realize is that car loans are a sizeable piece of household debt but are dwarfed by mortgage loans.

However, there is cause for concern.

Auto sales are on an upward trend since 2008, reaching a high of nearly 18 million vehicles sold in March 2017. At the height of the financial crisis auto sales languished below 10 million. Since the crisis, mortgage loans have leveled off but auto loans have exploded. US consumers are buying cars with a fervor not seen since the early 90’s.

autobubble2

Source: The Atlas

The trouble is: they are increasingly unable to keep up with their car payments. Between 2010 and 2016 car loan delinquencies have more than tripled (0.5% to 2%). Meanwhile the average amount that car owners are financing has increased as well – rising more than 27% since June 2008 to nearly $30,000 as of December 2016.

Worryingly, subprime auto loans have increased as well and make up more than 20% of all auto loans. That means there is $300 billion in loans going to borrowers considered high-risk.

When you add it all up, the evidence does not bode well.But while the automobile debt market may be stretched, it’s not going to cause a financial crisis. The size of the total auto loan market is nowhere near the amount at stake during the housing crisis, and the subprime portion of that market is only about $300 billion.

It would be hard for a collapse in the auto market would not bring down the whole economy – especially when we are not seeing the amount of speculation in securitized debt as we did prior to the financial crisis in 2008. We’re also seeing a down-tick in auto sales as of April and May of 2017, suggesting that US consumers are pulling back a little.

The auto loan market is overheating and worth keeping an eye on, but we are not in bubble territory – yet.

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