WEBVTT - Auto Lending Poses Next Great Subprime Crisis (Audio) 0:00:00.120 --> 0:00:04.359 Does this sound familiar? Hasty loans without verification of incomes 0:00:04.440 --> 0:00:08.399 or job histories, default rising on loans that buyers just 0:00:08.560 --> 0:00:12.879 can't repay outright fraud by salespeople. No, it's not the 0:00:12.960 --> 0:00:17.040 US housing market ten years ago. It's the auto industry today, 0:00:17.079 --> 0:00:20.759 where many car dealers are gaming the loan application process 0:00:21.000 --> 0:00:23.960 so low income borrowers can drive off in new cars 0:00:24.000 --> 0:00:27.280 they can't afford, and those auto loans are bundled into 0:00:27.280 --> 0:00:32.040 securities for investors. It's classic subprime. Less than a decade 0:00:32.040 --> 0:00:35.760 after the mortgage crisis caused the Great Recession, as explained 0:00:35.760 --> 0:00:40.879 in movies like The Big Short, so the banks started 0:00:40.880 --> 0:00:44.760 filling these bonds with risky and risky on mortgages Inky Baja. 0:00:45.640 --> 0:00:48.840 That way they can keep that profit machine channing right. 0:00:49.960 --> 0:00:55.160 By the way, these risky mortgages are called subprime. Our 0:00:55.240 --> 0:00:58.560 guests are Patricia McCoy, professor at Boston College Law School 0:00:58.600 --> 0:01:01.960 and author of the subpri i'm Virus, and Gary People's, 0:01:02.000 --> 0:01:06.760 professor at Syracuse University College of Law. Patricia, sub prime 0:01:06.880 --> 0:01:09.759 car loans have been around for a long time. Explain 0:01:09.880 --> 0:01:13.119 what's been happening in the last eight years or so. Well, 0:01:13.160 --> 0:01:16.240 they certainly have been around, and in the last last 0:01:16.280 --> 0:01:24.320 eight years, UH auto lending UM became the new growth 0:01:24.440 --> 0:01:29.280 area for subprime loans. UH mortgage lenders are basically not 0:01:29.360 --> 0:01:34.959 willing to make subprime loans anymore, but UM car dealers 0:01:35.000 --> 0:01:40.320 were very eager to expand their markets by selling cars 0:01:40.360 --> 0:01:45.920 to weaker and weaker borrowers and lenders stepped in willing 0:01:46.040 --> 0:01:50.440 to make loans to people who might have difficulty paying 0:01:50.480 --> 0:01:54.880 back the purchase price of the car. Gary, Are there 0:01:54.920 --> 0:02:00.160 any legal restrictions here in terms of who can get 0:02:00.240 --> 0:02:02.320 these kinds of loans when they buy a car? Or 0:02:02.400 --> 0:02:05.240 is it kind of a free for all? It's it's 0:02:05.240 --> 0:02:08.200 pretty much a free for all. One of the interesting 0:02:08.280 --> 0:02:12.680 things about god Frank is the one area that was 0:02:12.800 --> 0:02:16.239 left out of regulation were auto dealers. And auto dealers 0:02:16.720 --> 0:02:20.240 finance the vast majority of auto loans, and then of 0:02:20.280 --> 0:02:24.600 course seldom UH to to finance companies, and they are 0:02:25.040 --> 0:02:29.000 specifically excluded from regulation in your god Frank, So your 0:02:29.040 --> 0:02:31.360 regulation you would be looking at would then be up 0:02:31.400 --> 0:02:34.079 to the state. And I, you know, I practiced in 0:02:34.120 --> 0:02:37.840 New York and even though the general New York Usury 0:02:37.880 --> 0:02:42.520 Statute doesn't apply to most automans, Patricia, the name of 0:02:42.520 --> 0:02:46.600 your book is the subprime virus. So with the auto loans, 0:02:46.680 --> 0:02:49.520 where do we see the virus or the cracks in 0:02:49.560 --> 0:02:53.880 the system. What's really interesting is we're seeing a replay 0:02:54.200 --> 0:03:01.000 of the mortgage crisis in terms of the dealers don't 0:03:01.160 --> 0:03:06.560 check whether the borrowers can UH have the ability to repay. 0:03:06.760 --> 0:03:10.360 The lender makes the loan without checking it in most 0:03:10.400 --> 0:03:14.840 cases here Santan Dare and then the lender sells on 0:03:14.919 --> 0:03:21.320 the loans, packages them for sale to Wall Street. Investors 0:03:21.360 --> 0:03:26.200 are not checking UH and are buying this stuff regardless 0:03:26.280 --> 0:03:32.919 of the elevated default risk. Um. It's really back back 0:03:32.960 --> 0:03:37.920 to the future. Well, so Gary, so what so let's 0:03:38.080 --> 0:03:40.080 let's talk about the people taking out the loans. What 0:03:40.160 --> 0:03:44.400 happens to them as you know, they they're they're getting 0:03:44.440 --> 0:03:47.480 loans that they can't afford to pay, and it's they're 0:03:47.480 --> 0:03:50.040 getting those loans are getting bundled. But what's happening to 0:03:50.080 --> 0:03:55.560 the actual car purchasers here, Well, depending on how life 0:03:55.600 --> 0:04:00.080 that circumstances go, eventually something happens and they can at 0:04:00.120 --> 0:04:02.640 the payment that's sometimes a couple of months in and 0:04:02.760 --> 0:04:05.320 maybe that's a year end. You know, something happens with 0:04:05.360 --> 0:04:08.400 the car, something else happens in their life and they 0:04:08.640 --> 0:04:12.240 they they miss a payment and or they realize how 0:04:12.240 --> 0:04:14.640 bad off they are and then actively choose no longer 0:04:14.680 --> 0:04:17.520 to keep paying UM. But yeah, the people lose the 0:04:17.880 --> 0:04:22.080 car and then often get sued UM for the deficiency 0:04:22.120 --> 0:04:26.080 that's owed after the cars repossessed, because often these cars 0:04:26.080 --> 0:04:29.039 are sold at at huge markups with a bunch of 0:04:29.080 --> 0:04:32.520 garbage feeds and and other things in it like extended 0:04:32.600 --> 0:04:36.080 warranties and and other things that drive up the price 0:04:36.160 --> 0:04:39.080 even above what the car was even remotely worth. So 0:04:39.200 --> 0:04:42.240 these folds are well underwater. They end up losing the 0:04:42.279 --> 0:04:44.960 car and then getting sued and you know, either filing 0:04:45.000 --> 0:04:48.120 bankruptcy or having their wages garnished. But it's bad news 0:04:48.120 --> 0:04:53.040 for folks. Patricia explain the allure of the subprime auto 0:04:53.120 --> 0:05:00.440 bonds for investors and whether they're protected um from large losses. 0:05:01.560 --> 0:05:06.760 So the the topp alur is that the interest rate 0:05:06.800 --> 0:05:10.799 on these bonds is higher than the interest rate on 0:05:10.800 --> 0:05:16.080 on blue chip bonds and government bonds of uh, you know, 0:05:16.240 --> 0:05:22.280 of running around five UM, and so they're chasing yields. Uh. 0:05:22.520 --> 0:05:26.840 The reason I think that investors are not doing adequate 0:05:26.920 --> 0:05:32.359 due diligence is twofold. Um. They think that the higher 0:05:33.040 --> 0:05:37.640 interest rate will compensate them for the higher risk and 0:05:37.720 --> 0:05:39.960 at the end of the day, even if the default 0:05:40.040 --> 0:05:43.360 rate is high, they'll get a high enough rate of 0:05:43.440 --> 0:05:48.480 return to to make money. Uh. The other thing is 0:05:48.520 --> 0:05:54.440 they're they're betting on the fact that the securitization has 0:05:54.560 --> 0:05:59.760 been designed with a big safety cushion to absorb losses 0:05:59.800 --> 0:06:03.719 and to protect them from losses. Uh. Last time in 0:06:03.760 --> 0:06:06.200 two thousand and eight, it didn't quite turn out that way, 0:06:07.480 --> 0:06:10.440 just quickly in about thirty seconds, Gary, it will it 0:06:10.440 --> 0:06:13.599 be different with the auto loans than it was with 0:06:13.680 --> 0:06:16.480 the with the marriages. As far as protection shouldn't for 0:06:16.520 --> 0:06:21.560 the investors, I think, well, you know, I think people 0:06:21.600 --> 0:06:23.640 are going to lose money eventually like they did in 0:06:23.760 --> 0:06:27.360 the housing market. You can't. You can't loan people money 0:06:27.400 --> 0:06:30.520 that you know they can't pay back on an asset 0:06:30.560 --> 0:06:33.960 that's appreciating value would make money even when you're selling 0:06:34.000 --> 0:06:38.480 people cars at interest. You know, they said this ten 0:06:38.560 --> 0:06:40.719 years ago, and housing, Oh well we're protected. Well, of 0:06:40.760 --> 0:06:43.560 course they weren't. We've been discussing how less than a 0:06:43.640 --> 0:06:47.360 decade after the Great Depression, the financial industry has embraced 0:06:47.400 --> 0:06:51.120 another type of subprime debt, auto loans. Our guests of 0:06:51.160 --> 0:06:54.359 Patricia McCoy, professor at Boston College Law School and author 0:06:54.400 --> 0:06:57.840 of the sub Prime Virus, and Gary People's professor at 0:06:57.880 --> 0:07:03.320 Syracuse University College of Law. Gary, let's talk about the 0:07:03.480 --> 0:07:07.960 US auto loan sector. It's small compared to the eight 0:07:07.960 --> 0:07:11.200 point four trillion dollar mortgage market. It's about one point 0:07:11.240 --> 0:07:14.760 one trillion dollars in loans compared to the mortgage market. 0:07:15.160 --> 0:07:17.840 So no one is suggesting that this will cause the 0:07:17.880 --> 0:07:20.920 next crisis. But is there a trickle down effect or 0:07:20.920 --> 0:07:25.840 any lasting consequences for the industry. Well, it's hard to 0:07:25.840 --> 0:07:30.440 know for sure. But obviously, if you have potentially thousands 0:07:30.520 --> 0:07:34.720 of individuals who are losing their ability, uh to get 0:07:34.760 --> 0:07:38.640 themselves around work and otherwise, that's going to have effects. 0:07:38.680 --> 0:07:41.160 And then I think you're gonna have ripples from the 0:07:41.240 --> 0:07:44.600 number of defaults. I mean, the number of defaults are 0:07:44.640 --> 0:07:48.040 you know, significant, And I think that will will have 0:07:48.120 --> 0:07:53.200 some effects. Patricia, when when we talk, when we talk 0:07:53.280 --> 0:07:54.960 about the way that we think about the way that 0:07:55.000 --> 0:07:59.360 the dealers have dealt with this, how exactly are they 0:08:00.120 --> 0:08:03.520 encouraging this sort of these sort of loans. And how 0:08:03.600 --> 0:08:05.440 is it that the dealers are you know, what are 0:08:05.440 --> 0:08:10.280 they doing to be complicit in how these loans happen. Well, 0:08:10.440 --> 0:08:14.360 the dealers in many cases are actually the ones who 0:08:14.400 --> 0:08:19.320 are having the borrowers complete the loan applications. And the 0:08:19.480 --> 0:08:24.520 dealers don't make money unless they sell a car. And 0:08:24.640 --> 0:08:27.200 with these borrowers, they're not going to sell the car 0:08:27.800 --> 0:08:32.760 unless the borrower can get financing. That creates a really 0:08:32.800 --> 0:08:41.160 bad incentive for some unfortunately dishonest dealers to help the 0:08:41.240 --> 0:08:45.720 borrower fill out the loan application by inflating their income 0:08:47.040 --> 0:08:50.600 or saying that they work in a fancier job than 0:08:50.640 --> 0:08:55.200 they do. Um. And so we call these lawyers loans 0:08:55.400 --> 0:09:00.360 and and unfortunately with fantan Dare, a lot of funds 0:09:00.440 --> 0:09:03.679 turned out to pay liars Lunds and Gary. Let's talk 0:09:03.679 --> 0:09:06.920 about Santon Dair, which has agreed to pay twenty six 0:09:06.960 --> 0:09:10.880 million dollars to settle an investigation into predatory subprime auto 0:09:10.920 --> 0:09:14.760 loans by Massachusetts and Delaware. Taught about the partnership between 0:09:14.880 --> 0:09:20.600 Fiat Chrysler and Banco Santander. Well, it's probably a little 0:09:20.640 --> 0:09:24.240 to outside of my area of expertise. UM. I'm mostly 0:09:24.280 --> 0:09:28.920 on the uh, the consumer end, and what I see 0:09:29.160 --> 0:09:32.679 is that, you know, these dealers are kind of inco 0:09:32.760 --> 0:09:38.160 hoots with with the finance companies. They know that. I 0:09:38.160 --> 0:09:40.760 think these finance companies know what these dealers are doing, 0:09:41.120 --> 0:09:44.760 pushing these loans with nobody that people can't afford UM, 0:09:44.840 --> 0:09:48.360 and you know they these lives are being pulled by 0:09:48.400 --> 0:09:52.920 the dealership UM, and the the finance companies are are 0:09:52.960 --> 0:09:55.720 complicit in that they know what's happening. They're not bothering 0:09:55.760 --> 0:09:59.400 to to to check to make sure the dealership UM 0:09:59.600 --> 0:10:03.120 is doing what uh, you know, confirming that these incomes 0:10:03.120 --> 0:10:05.800 are even remotely close to what they're uh. I mean, 0:10:05.800 --> 0:10:08.880 this is happening on a regular basis where these folks 0:10:08.880 --> 0:10:12.000 are being steered into loans where that the documentation is 0:10:12.040 --> 0:10:15.640 clearly a complete sabrogation. Can you talk a little bit 0:10:15.640 --> 0:10:22.280 about Saint and Dair and Chrysler. Well, Chrysler is up 0:10:22.320 --> 0:10:26.559 the big three US auto dealers, the smallest one and 0:10:26.960 --> 0:10:29.520 UH and the weakest in terms of the demand for 0:10:29.559 --> 0:10:33.800 its cars, and so it was quite eager to extend 0:10:34.040 --> 0:10:41.240 its customer base down the credit spectrum to weaker UM consumers. 0:10:41.280 --> 0:10:45.440 But to do that it needed a financing arm, and 0:10:45.640 --> 0:10:52.360 Santon Dair was conveniently very eager itself to expand into 0:10:52.400 --> 0:10:57.760 auto financing and particularly subprime. One of the reasons that 0:10:57.840 --> 0:11:02.880 Santon Dair was attractive was that it had a computerized 0:11:03.800 --> 0:11:09.400 algorithm for analyzing the credit worthiness of sub time borrowers, 0:11:10.280 --> 0:11:15.559 and supposedly it was foolproof. Well, uh, didn't turn out 0:11:15.600 --> 0:11:20.920 that way. Well, Gary, so what what do you have 0:11:21.040 --> 0:11:24.200 these legal actions taken against Santon Dair? What what did 0:11:24.920 --> 0:11:34.880 the attorney's general find here? Gary? About thirty seconds, I'm 0:11:34.920 --> 0:11:38.880 probably not the best prepared to answer that question if 0:11:39.559 --> 0:11:42.880 it's not an entity that I've been involved with. So 0:11:43.040 --> 0:11:45.520 I don't know the answer to that one. All right. Um, 0:11:45.640 --> 0:11:48.920 we do know that Santander agreed to pay twenty six 0:11:49.000 --> 0:11:53.480 million dollars to settle an investigation by Massachusetts and Delaware, 0:11:53.480 --> 0:11:55.800 and it's been subpoenut or question by a group of 0:11:55.840 --> 0:11:59.880 about thirty states regarding its auto loane underwriting and secure 0:12:00.000 --> 0:12:03.640 deization activities. Thank you both for being on Bloomberg Law. 0:12:03.679 --> 0:12:07.920 It's been a very interesting. Patricia McCoy, professor at Boston 0:12:08.000 --> 0:12:11.440 College Law School and author of the Subprime virus and 0:12:11.480 --> 0:12:15.439 Gary People's professor at Syracuse University College of Law. Thank 0:12:15.480 --> 0:12:15.840 you both.