In this market, the companies handing out loans make money whether you pay them back or not. Agents trick hard-luck, often ill-educated customers into predatory loan terms that are much worse than they agreed to with sky-high interest rates. One quarter of the loans default and lenders seize the property, which is worth far less than the purchase price. Wall Street money sees high profit margins and pours in money. Billions of dollars of oans are bundled together, securitized, rated triple-A by ratings firms, and sold off to hedge fund investors scrambling for yield. That finances more predatory loans and helps keeps the cycle going.
High subprime-housing bubble circa 2006.
But also the subprime car market in 2011, as the Los Angeles Times‘s Ken Bensinger is showing in a sweet three-part series on Buy Here Pay Here car lots.
Sunday’s story showed how the BHPH business model incentivizes predatory lending and default:
About 1 in 4 buyers default. In the real estate and credit card industries, that would be bad news. In the world of Buy Here Pay Here, it’s just another avenue for profit: The car can be repossessed and put back on the lot for sale in short order. A new buyer makes a down payment, takes on a high-interest loan and the cycle starts anew.
Provided they don’t get wrecked, these recycled vehicles just keep paying dividends. At some dealerships, cars have been sold and resold over and over — three, four, even eight times apiece, motor vehicle records show.
Default and repossession are so central to the business that many dealers plan on both. They equip cars with hidden GPS devices and remote-control ignition blockers to make the repo man’s work easier.
Many pursue their customers for years after they’ve seized and resold the vehicles. Some keep lawyers on staff, filing dozens of lawsuits each month to recoup unpaid balances and garnish debtors’ wages.
Good times in late capitalism. The finance industry pushed companies to send jobs overseas and gobbled up an increasing share of the national income, hollowing out the middle class and broadening the market for corporatized loan sharking. People don’t have jobs to buy new cars or even regular old used cars, so they can mark up the price on a clunker by half, charge a hefty down payment and usurious interest rates, repo the car, and repeat the cycle up to eight times with the same vehicle. And you have to have a vehicle, don’t you? Poor people are being pushed out to the suburbs by urban gentrification, but to get a job in the suburbs, you have to have a car since public transportation is iffy or nonexistent.
When you go to a Buy Here Pay Here lot, forget about little things like price tags. You know things are bad when a used-car dealer helps people sign up for welfare so he can lend against it:
Rarely are prices displayed on car windshields. Instead, negotiations focus on how much the customer can put down upfront and then pay each month.
Many dealers don’t worry about buyers’ credit scores — knowing they can’t be good — but they almost always insist on long lists of references so they can pressure friends and family when a payment is missed.
They also frequently help customers apply for the earned income tax credit for low-income workers — and then offer a loan against the anticipated refund to use as a down payment. Dealers report a surge in sales in the three months leading up to tax day.
That far-reaching customer service must be a big reason why Bay Area private-equity funds like Altamont Capital Partners and Alpine Investors are pouring money into the sector, by buying companies whole or buying their shares. Also: Poverty Inc. has fat profit margins: 38 percent on average. There’s even a $1.7 billion publicly traded finance company called Credit Acceptance Corporation that does nothing but buy securitized auto loans made elsewhere and lend money to make the loans.
The LAT reports in today’s piece that the subprime auto-loan securities market is running at a $14 billion annual clip in the first half, more than double last year’s pace and that it’s similar to how subprime mortgage loans were securitized, down to turning garbage into AAA gold:
Buy Here Pay Here is also being boosted by one of the sophisticated financial strategies that drove the nation’s recent housing boom and bust: securitization. Loans on decade-old clunkers are being bundled into securities, just as subprime mortgages were a few years ago. In the last two years, investors have bought more than $15 billion in subprime auto securities.
Although they’re backed mainly by installment contracts signed by people who can’t even qualify for a credit card, most of these bonds have been rated investment grade. Many have received the highest rating: AAA.
That’s because rating firms believe that with tens of thousands of loans lumped together, the securities are safe even if some of the loans prove worthless.
Some analysts worry that the rush to securitization could lead to careless lending by dealers eager to sell more loans, as happened with many mortgage-backed bonds.
Surely, Mr. Market is too smart now to let such a thing happen, right?
Nice work by Bensinger and the LA Times of digging into this business and showing us how it’s financed by big money.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.