- Wealth PMS
The next US subprime problem, apparently, is in auto loans:
Ms. Payne went with her daughter to a dealership that arranges loans for Santander and other auto lenders to buy the car. She said an employee at the dealership in Great Neck, N.Y., assured her that, even though she was on food stamps, she could afford the loan. At the time, Ms. Payne said she thought she was co-signing the loan with her daughter.
“I looked him in the eye and said, ‘I don’t have any income,’ ” said Ms. Payne.
The problem isn’t the origination. It’s the fact that these loans are getting packaged into Asset Backed Securities and sold off to other investors. In a chilling reminder of the original sub-prime problem (housing) we find that the lowest yield tranches of such ABS are also being rated AAA.
How does this work? If you package 1000 loans into an ABS package and sell securities off it, you can say:
Using a bad calculation procedure someone could estimate that look, such loans are very very unlikely to see a 50% loss. At best it’s a 30% loss. So we’ll rate the senior tranche AAA.
But you can’t package a pile of crap and say that the crap at the bottom is protected by all the crap at the top, so it’s better crap. It’s much more likely than statistics will tell us, that even the senior tranche fails. So, either everything fails, or nothing fails, and those are bad bets to take in size.
What’s happening now is that the party is on. Banks are getting fees to originate and package into loans (so much that it covers the “equity tranche” which they generally keep for themselves.) The buyers should be doing their own diligence but they are depending on a rating instead. The hunt for yield – caused by low interest rates – makes investors find products that look good today – without bothering that the underlying system is so weak it’ll all collapse.
The rating agencies have a spreadsheet “model” to justify their lack of understanding of human behaviour. There’s only $20 billion riding this right now – so it’s not as big as subprime (which had 100s of billions) but even $20 billion is enough to ruffle feathers. This is not going to end well.
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