Subprime Loans Are Back In a Very Bad Way
Recently, the Treasury Department announced that it was completing another round of stock sales, selling off more shares of GM as the federal government eases out of the auto market. The stocks were purchased as part of the administration's response to the financial meltdown of 2008, and the Obama administration has hailed the investment as a success that saved the U.S. auto industry and created 340,000 new jobs.
Yet the success of the program is equivocal at best. In addition to costing taxpayers billions, the auto bailout may be sowing the seeds of the next bubble, as an industry artificially propped up by the federal government is threatened by a mounting portfolio of subprime loans, compliments of the Federal Reserve.
As credit markets seized and consumer confidence tumbled in the mounting 2008 financial crisis, the auto industry was on the brink of collapse, with sales falling by 40 percent. The Treasury created the Automotive Industry Financing Program as part of the TARP bailout, to shore up the failing industry with taxpayer dollars. The Treasury provided financial assistance and purchased significant shares in both Chrysler and GM, as well as their financial affiliates, GMAC (now Ally Financial) and Chrysler Financial Services. All told, the Treasury poured more than $81 billion into these automakers.
Now, with the crisis abated and the economy continuing to stabilize, Treasury has been selling off its shares in both Chrysler and GM. By 2011 Treasury had divested its ownership in Chrysler, at a $1.3 billion cost to taxpayers. In December 2012, Treasury announced it would sell off the taxpayers' stake in GM within the next 12 to 15 months, and GM subsequently purchased 200 million shares from Treasury. After three rounds of sales, Treasury currently holds 101 million shares, or about 7.3 percent of the company. With stock prices currently at $34.16, it is unlikely that Treasury will recoup the taxpayer investment in the company, which would require a sale price of more than $50 per share. All told, many analysts suggest the GM bailout will cost taxpayers $10 billion to $12 billion.
While the administration claims to have saved the industry and more than a million jobs, the long-run benefits of these cash infusions remain questionable. As with every economic downturn, policymakers feel impelled to do something. The initial instinct is to prop up failing markets through easy money and more federal funds. Yet these efforts distort market prices and confuse investors. At a time when federal stimulus programs may be appropriate for reducing investments in certain sectors of the economy, these programs redirect resources back into questionable investment.
The automotive sector already faced challenging market conditions; plagued by regulation, not to mention labor and pension issues. The injection of federal spending and easy money does little to alter these fundamentals, which have a significant impact on long-run economic growth. Attempting to restore an industry to economic boom levels can only lead to additional problems down the road.
In fact, there are indications that the U.S. automotive industry is heading for another bubble. Ben Bernanke's quantitative easing has kept interest rates at historically low prices, and in the automotive world, the easy money is showing up in a surge of subprime loans. There were more than 6 million subprime borrowers in 2012-18 percent more than in the previous year. It seems as if the lessons of 2008 have been forgotten, or were never learned. In the $105.8 billion market for asset-backed securities, subprime auto loans account for more than $12 billion. In the first quarter of 2012, 93 percent of GM Financial's loans were subprime. In the auto loan market, there is even a new category known as "deep subprime."
Auto loans do not carry the same risk as housing loans, but there are some disconcerting parallels. The federal government props up an industry that now plays heavily in the subprime market. Meanwhile, the Fed continues its purchases of asset-backed securities to the tune of $40 billion a month. What could go wrong?