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The song remains the same, part 2

We all know in cities like Nashville and most of the U.S., a car is essential to anyone who needs to work. Lenders prey on this need, based on the premise that, "You can sleep in your car, but you can't drive your house to work."

And the exorbitant interest rates they can charge allow the securities created from all of these loans to provide a much better rate of return than lower risk securities. But if significant portions of these auto loan securities become distressed with high default rates, the losses could again threaten the stability of the global financial markets.

While one may believe "we have learned our lesson," that is unlikely. The reason is when too many people begin making too much money, the normal checks-and-balances that would cause entities to pull back and behave more cautiously, fail.

Car loans, which have had low default rates, because people are willing to make great financial sacrifices to keep their vehicles because they need transportation, remain dangerous because of deprecation.

When a loan is booked, the underlying value of the security, the car or truck, begins to deteriorate immediately. A $15,000 loan on a 5-year-old vehicle carries a high degree of risk because by year two of the loan, the vehicle may only net $2,000 to $3,000 at auction.

And as qualified borrowers are put in vehicles and loans, the market for more bundled securities may become inflated, as more investors look for greater paper profits. Which increases the risk that the cycle will be repeated with another financial crisis.

Oddly, you cannot trust someone offering you a loan to assess whether the loan is viable, because, as Sinclair Lewis said, "It is difficult to get a man to understand something, when his salary depends on his not understanding it."

The New York Times, "Investment Riches Built on Subprime Auto Loans to Poor," Michael Corkery and Jessica Silver-Greenberg, January 26, 2015

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Rothschild & Ausbrooks, PLLC
1222 16th Avenue South, Suite 12
Nashville, TN 37212

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