Subprime Lending Drives Spending

June 13, 2014

A concern that we highlighted in yesterday’s post is that the only way the U.S. economy can generate significant consumer spending is through aggressive lending to borrowers with low credit scores. Here is more evidence supporting that view.

In the chart below, we plot retail spending on appliances, furniture, and home improvement, or “home-related spending” (blue line) and spending on new autos (red line) from 1998 through 2014. We have highlighted the two major subprime lending booms we’ve seen in that period — the subprime mortgage lending boom from 2003 to 2006, and the subprime auto loan boom from 2010 to 2014. In order to be able to include 2014, we focus only on the first four months of each year.




When subprime mortgage lending was booming from 2003 to 2006, so were purchases of home-related goods. As soon as the subprime mortgage lending market crashed, so did home-related spending. In fact, in 2014, home-related spending is still below its 2006 level in nominal terms. It’s a pretty incredible boom and bust.

For auto spending, growth was positive prior to the Great Recession, but unspectacular. But as soon as subprime auto lending heated up in 2011 and afterward, so did purchases of new auto vehicles. The growth in new auto sales from 2011 to 2014 has been really impressive. So once again, spending in a particular market is strongest when subprime lending in that market is strongest.

It appears that the key to boosting spending in the U.S. economy is subprime lending. The financial system was lending against homes before the Great Recession, and now it has moved to lending against cars. But the basic message is the same.

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15 Responses to Subprime Lending Drives Spending

  1. david land on June 13, 2014 at 8:57 ami

    Enjoying the book and the website. I am assuming there isn’t a wealth effect associated with owning a car, so the subprime auto lending boom shouldn’t pose a large risk. I would appreciate your thoughts.

    • Gordon K on June 13, 2014 at 5:20 pmi

      Perhaps the “wealth effect” from owning a home is also an illusion. The risk as it applies to auto lending is related to those holding the loans. In this case securitization has likely spread that around. Loan yields for subprime paper are nothing like the 0.9% you see advertised – those advertised rates mostly get folks into the dealership. But when you combine subprime auto loans with student loan debt, it is a pretty big mess. Student loans have no underwriting standards (for the most part). Student loan proceeds can be used for living expenses.

  2. Simon on June 13, 2014 at 12:27 pmi

    Thanks, for the insights.

    However, i noticed yesterday, that car sales as a share of total spending is not back to pre-recession levels.

    Isn’t this condradicting your theory of a subprime car loan “bubble”?

  3. Al on June 13, 2014 at 5:47 pmi

    This data point is interesting, but it begs the questions of why subprime lenders lend and borrowers borrow. One dismaying aspect of Great Recession punditry is the tendency to pre-judge categories of activity prima facie, or by relying upon ex post data to characterize ex ante decisions. Subprime lending growth may be a proximate mover, but something happened to expectations to motivate such money transactions.

  4. C. Charlie on June 13, 2014 at 8:48 pmi

    Can you please show the subprime lending boom on charts as well? Thanks.

  5. Ralph Musgrave on June 14, 2014 at 1:15 ami

    Perhaps one day the dummies who rule Washington DC will realise that there is an alternative way to boost spending: simply create and spend more Fed created money into the economy (and/or cut taxes). That way, households wouldn’t need to borrow so much in order to spend (as pointed out by Keynes nearly a century ago, and as advocates of Modern Monetary Theory keep pointing out).

    But of course the criminals, I mean bankers who bribe, I mean fund politicians wouldn’t like that. So they’ll pay megabucks to politicians to ensure that households are permanently short of cash. That way, lending opportunities for the mafia, I mean bankers are expanded.

    • Kaleberg on June 14, 2014 at 11:05 pmi

      Subprime borrowers are rarely constrained by taxes. Odds are they get an earned income credit.

  6. Maximum Bob on June 14, 2014 at 7:51 ami

    Basically, the future is like a gold mine. Inexhaustibly, prosperity is borrowed from the future to be enjoyed in the here and now.

    • Ralph Musgrave on June 15, 2014 at 8:13 ami

      Borrowing from the future is a physical impossibility. How do I borrow steel, concrete, cars or any other commodity from people in 2025?

  7. Mr Mister on June 14, 2014 at 1:41 pmi

    I think another important feature related to auto loans is the fast increasing average length of car loans. I believe the average note right now has crossed the five year duration mark. This means that in a few years there will be a tidal wave of “upside-down” collateral out there, with much of it associated with borrowers who are not going to be able to make up the difference between the loan and vehicle value. Some of these borrowers even started their loan with more than 100% LTV to begin with. Moreover, with many loans having 70-80 months duration nowadays, this situation is going to force many to hang on to vehicles longer than they otherwise would, thus putting a drag on future new car sales. Anyhoo, I have a strong suspicion that all of this is not going to end well.

  8. rakesh on June 14, 2014 at 9:02 pmi

    Silly point. How can you borrow against a car?

    • Kaleberg on June 14, 2014 at 11:08 pmi

      You can’t borrow against a car, but someone is going to bundle all these subprime auto loans, slice and dice them, get them re-rated AAA+ and I don’t mean Automobile Association of America. Then, they’ll use them as collateral to leverage themselves into something big, collect tens of millions of dollars in bonuses, then someone will miss a car payment and we taxpayers and working stiffs will have to bail out the billionaires again. I’ll bet all the cars will get repossessed and junked lest someone who works for a living gets a piece of a break.

  9. Matt Talbot on June 15, 2014 at 10:59 ami

    This really is the predicament of the US economy.

    Growth financed by giving consumers more debt is not sustainable, because debts come due. Growth financed through rising wages is sustainable, because wages don’t need to be paid back.

    If we want sustainable economic growth, we need to make sure that median wage growth tracks increases in productivity.

  10. James G on June 18, 2014 at 1:53 ami

    Car loans are typically of a MUCH shorter duration than mortgages. There is also no incentive for banks (credit unions, etc.) to make no down payment home loans in order to side step regulations prohibiting direct investment in cars as there was with real estate. Finally, there is no Federal Auto Authority whose sole purpose is to provide financing for low income Americans to buy cars regardless of whether they can afford them.

    So, I don’t think it’s fair at all to make the analogy between an excess of loans in the housing market in 2007 and an excess of loans in the auto market now. Couldn’t this be a positive result of reduction in borrowing costs related to collateralization.