Speaker 1: Does this sound familiar? Hasty loans without verification of incomes
Speaker 1: or job histories, default rising on loans that buyers just
Speaker 1: can't repay outright fraud by salespeople. No, it's not the
Speaker 1: US housing market ten years ago. It's the auto industry today,
Speaker 1: where many car dealers are gaming the loan application process
Speaker 1: so low income borrowers can drive off in new cars
Speaker 1: they can't afford, and those auto loans are bundled into
Speaker 1: securities for investors. It's classic subprime. Less than a decade
Speaker 1: after the mortgage crisis caused the Great Recession, as explained
Speaker 1: in movies like The Big Short, so the banks started
Speaker 1: filling these bonds with risky and risky on mortgages Inky Baja.
Speaker 1: That way they can keep that profit machine channing right.
Speaker 1: By the way, these risky mortgages are called subprime. Our
Speaker 1: guests are Patricia McCoy, professor at Boston College Law School
Speaker 1: and author of the subpri i'm Virus, and Gary People's,
Speaker 1: professor at Syracuse University College of Law. Patricia, sub prime
Speaker 1: car loans have been around for a long time. Explain
Speaker 1: what's been happening in the last eight years or so. Well,
Speaker 1: they certainly have been around, and in the last last
Speaker 1: eight years, UH auto lending UM became the new growth
Speaker 1: area for subprime loans. UH mortgage lenders are basically not
Speaker 1: willing to make subprime loans anymore, but UM car dealers
Speaker 1: were very eager to expand their markets by selling cars
Speaker 1: to weaker and weaker borrowers and lenders stepped in willing
Speaker 1: to make loans to people who might have difficulty paying
Speaker 1: back the purchase price of the car. Gary, Are there
Speaker 1: any legal restrictions here in terms of who can get
Speaker 1: these kinds of loans when they buy a car? Or
Speaker 1: is it kind of a free for all? It's it's
Speaker 1: pretty much a free for all. One of the interesting
Speaker 1: things about god Frank is the one area that was
Speaker 1: left out of regulation were auto dealers. And auto dealers
Speaker 1: finance the vast majority of auto loans, and then of
Speaker 1: course seldom UH to to finance companies, and they are
Speaker 1: specifically excluded from regulation in your god Frank, So your
Speaker 1: regulation you would be looking at would then be up
Speaker 1: to the state. And I, you know, I practiced in
Speaker 1: New York and even though the general New York Usury
Speaker 1: Statute doesn't apply to most automans, Patricia, the name of
Speaker 1: your book is the subprime virus. So with the auto loans,
Speaker 1: where do we see the virus or the cracks in
Speaker 1: the system. What's really interesting is we're seeing a replay
Speaker 1: of the mortgage crisis in terms of the dealers don't
Speaker 1: check whether the borrowers can UH have the ability to repay.
Speaker 1: The lender makes the loan without checking it in most
Speaker 1: cases here Santan Dare and then the lender sells on
Speaker 1: the loans, packages them for sale to Wall Street. Investors
Speaker 1: are not checking UH and are buying this stuff regardless
Speaker 1: of the elevated default risk. Um. It's really back back
Speaker 1: to the future. Well, so Gary, so what so let's
Speaker 1: let's talk about the people taking out the loans. What
Speaker 1: happens to them as you know, they they're they're getting
Speaker 1: loans that they can't afford to pay, and it's they're
Speaker 1: getting those loans are getting bundled. But what's happening to
Speaker 1: the actual car purchasers here, Well, depending on how life
Speaker 1: that circumstances go, eventually something happens and they can at
Speaker 1: the payment that's sometimes a couple of months in and
Speaker 1: maybe that's a year end. You know, something happens with
Speaker 1: the car, something else happens in their life and they
Speaker 1: they they miss a payment and or they realize how
Speaker 1: bad off they are and then actively choose no longer
Speaker 1: to keep paying UM. But yeah, the people lose the
Speaker 1: car and then often get sued UM for the deficiency
Speaker 1: that's owed after the cars repossessed, because often these cars
Speaker 1: are sold at at huge markups with a bunch of
Speaker 1: garbage feeds and and other things in it like extended
Speaker 1: warranties and and other things that drive up the price
Speaker 1: even above what the car was even remotely worth. So
Speaker 1: these folds are well underwater. They end up losing the
Speaker 1: car and then getting sued and you know, either filing
Speaker 1: bankruptcy or having their wages garnished. But it's bad news
Speaker 1: for folks. Patricia explain the allure of the subprime auto
Speaker 1: bonds for investors and whether they're protected um from large losses.
Speaker 1: So the the topp alur is that the interest rate
Speaker 1: on these bonds is higher than the interest rate on
Speaker 1: on blue chip bonds and government bonds of uh, you know,
Speaker 1: of running around five UM, and so they're chasing yields. Uh.
Speaker 1: The reason I think that investors are not doing adequate
Speaker 1: due diligence is twofold. Um. They think that the higher
Speaker 1: interest rate will compensate them for the higher risk and
Speaker 1: at the end of the day, even if the default
Speaker 1: rate is high, they'll get a high enough rate of
Speaker 1: return to to make money. Uh. The other thing is
Speaker 1: they're they're betting on the fact that the securitization has
Speaker 1: been designed with a big safety cushion to absorb losses
Speaker 1: and to protect them from losses. Uh. Last time in
Speaker 1: two thousand and eight, it didn't quite turn out that way,
Speaker 1: just quickly in about thirty seconds, Gary, it will it
Speaker 1: be different with the auto loans than it was with
Speaker 1: the with the marriages. As far as protection shouldn't for
Speaker 1: the investors, I think, well, you know, I think people
Speaker 1: are going to lose money eventually like they did in
Speaker 1: the housing market. You can't. You can't loan people money
Speaker 1: that you know they can't pay back on an asset
Speaker 1: that's appreciating value would make money even when you're selling
Speaker 1: people cars at interest. You know, they said this ten
Speaker 1: years ago, and housing, Oh well we're protected. Well, of
Speaker 1: course they weren't. We've been discussing how less than a
Speaker 1: decade after the Great Depression, the financial industry has embraced
Speaker 1: another type of subprime debt, auto loans. Our guests of
Speaker 1: Patricia McCoy, professor at Boston College Law School and author
Speaker 1: of the sub Prime Virus, and Gary People's professor at
Speaker 1: Syracuse University College of Law. Gary, let's talk about the
Speaker 1: US auto loan sector. It's small compared to the eight
Speaker 1: point four trillion dollar mortgage market. It's about one point
Speaker 1: one trillion dollars in loans compared to the mortgage market.
Speaker 1: So no one is suggesting that this will cause the
Speaker 1: next crisis. But is there a trickle down effect or
Speaker 1: any lasting consequences for the industry. Well, it's hard to
Speaker 1: know for sure. But obviously, if you have potentially thousands
Speaker 1: of individuals who are losing their ability, uh to get
Speaker 1: themselves around work and otherwise, that's going to have effects.
Speaker 1: And then I think you're gonna have ripples from the
Speaker 1: number of defaults. I mean, the number of defaults are
Speaker 1: you know, significant, And I think that will will have
Speaker 1: some effects. Patricia, when when we talk, when we talk
Speaker 1: about the way that we think about the way that
Speaker 1: the dealers have dealt with this, how exactly are they
Speaker 1: encouraging this sort of these sort of loans. And how
Speaker 1: is it that the dealers are you know, what are
Speaker 1: they doing to be complicit in how these loans happen. Well,
Speaker 1: the dealers in many cases are actually the ones who
Speaker 1: are having the borrowers complete the loan applications. And the
Speaker 1: dealers don't make money unless they sell a car. And
Speaker 1: with these borrowers, they're not going to sell the car
Speaker 1: unless the borrower can get financing. That creates a really
Speaker 1: bad incentive for some unfortunately dishonest dealers to help the
Speaker 1: borrower fill out the loan application by inflating their income
Speaker 1: or saying that they work in a fancier job than
Speaker 1: they do. Um. And so we call these lawyers loans
Speaker 1: and and unfortunately with fantan Dare, a lot of funds
Speaker 1: turned out to pay liars Lunds and Gary. Let's talk
Speaker 1: about Santon Dair, which has agreed to pay twenty six
Speaker 1: million dollars to settle an investigation into predatory subprime auto
Speaker 1: loans by Massachusetts and Delaware. Taught about the partnership between
Speaker 1: Fiat Chrysler and Banco Santander. Well, it's probably a little
Speaker 1: to outside of my area of expertise. UM. I'm mostly
Speaker 1: on the uh, the consumer end, and what I see
Speaker 1: is that, you know, these dealers are kind of inco
Speaker 1: hoots with with the finance companies. They know that. I
Speaker 1: think these finance companies know what these dealers are doing,
Speaker 1: pushing these loans with nobody that people can't afford UM,
Speaker 1: and you know they these lives are being pulled by
Speaker 1: the dealership UM, and the the finance companies are are
Speaker 1: complicit in that they know what's happening. They're not bothering
Speaker 1: to to to check to make sure the dealership UM
Speaker 1: is doing what uh, you know, confirming that these incomes
Speaker 1: are even remotely close to what they're uh. I mean,
Speaker 1: this is happening on a regular basis where these folks
Speaker 1: are being steered into loans where that the documentation is
Speaker 1: clearly a complete sabrogation. Can you talk a little bit
Speaker 1: about Saint and Dair and Chrysler. Well, Chrysler is up
Speaker 1: the big three US auto dealers, the smallest one and
Speaker 1: UH and the weakest in terms of the demand for
Speaker 1: its cars, and so it was quite eager to extend
Speaker 1: its customer base down the credit spectrum to weaker UM consumers.
Speaker 1: But to do that it needed a financing arm, and
Speaker 1: Santon Dair was conveniently very eager itself to expand into
Speaker 1: auto financing and particularly subprime. One of the reasons that
Speaker 1: Santon Dair was attractive was that it had a computerized
Speaker 1: algorithm for analyzing the credit worthiness of sub time borrowers,
Speaker 1: and supposedly it was foolproof. Well, uh, didn't turn out
Speaker 1: that way. Well, Gary, so what what do you have
Speaker 1: these legal actions taken against Santon Dair? What what did
Speaker 1: the attorney's general find here? Gary? About thirty seconds, I'm
Speaker 1: probably not the best prepared to answer that question if
Speaker 1: it's not an entity that I've been involved with. So
Speaker 1: I don't know the answer to that one. All right. Um,
Speaker 1: we do know that Santander agreed to pay twenty six
Speaker 1: million dollars to settle an investigation by Massachusetts and Delaware,
Speaker 1: and it's been subpoenut or question by a group of
Speaker 1: about thirty states regarding its auto loane underwriting and secure
Speaker 1: deization activities. Thank you both for being on Bloomberg Law.
Speaker 1: It's been a very interesting. Patricia McCoy, professor at Boston
Speaker 1: College Law School and author of the Subprime virus and
Speaker 1: Gary People's professor at Syracuse University College of Law. Thank
Speaker 1: you both.