Peak Debt Part 2: Auto & Student Loans
Series: Peak debt
A confluence of driving forces nudges the global monetary system toward a reset, with deflation leading the charge.
Part 1 of the peak debt outlines the logic for this phenomenon and examines one of the debt components – household debt starting with mortgage debt.
Part 2 of the peak debt series digs into the auto and student loans component of household debts.
Part 3 of the peak debt series examines the state of corporate debt, how it is used and where it is heading.
In our previous article on peak debt, we examined mortgage debt in the US, concluding that a variety of factors will make any solid growth in mortgage debt unlikely in at least the next decade.
In this article we shall examine non-mortgage debts, namely revolving credit (credit card debt) and non-revolving credit (mainly student and auto loans).
Doubling clicking on revolving (credit card) debt reveals the following picture.
Credit Card Debt
Credit card debt declined from its peak during the financial crisis (a good chunk written off through personal bankruptcies) and never meaningfully recovered. New credit card debt practically ground to a halt in late 2015. At a paltry $178 million of new loans in Oct 2015, it signaled a sharp slowdown in debt growth and a harbinger of a dismal Christmas shopping season which indeed turned out to be one of the worst in recent memories.
Consumers tapped out?
Next up, let’s look at auto loans.
From the depth of financial crisis, auto loans have rebounded with a vengeance and have exceeded 1 trillion as ofQ4 of 2015. Is that a result of an improving economy and rising income among the borrowers? The answer, unfortunately, is a resound no. Rather, it is a result of buyers taking on record debt, enticed by equally lunatic financing terms as the vertical ascend of outstanding auto loans since 2011 illustrates in the chart above.
Against the backdrop of stagnant wages and increasing auto sticker prices, the only way auto sales are going through the roof is by stretching out the loan terms to lower the monthly payments and digging deeper into the subprime trenches in terms of underwriting standards in order to qualify an increasing pool of unqualified buyers. The insanity is painfully obvious across a broad set of metrics, courtesy of ZeroHedge:
- Average loan term for new cars is now 67 months — a record.
- Average loan term for used cars is now 62 months — a record.
- Loans with terms from 74 to 84 months made up 30% of all new vehicle financing — a record.
- Loans with terms from 74 to 84 months made up 16% of all used vehicle financing — a record.
- The average amount financed for a new vehicle was $28,711 — a record.
- The average monthly payment for new vehicles was $488 — a record.
- The percentage of all new vehicles financed accounted for by leases was 31.46% — a record.
If this feels reminiscent of the subprime home mortgage fiasco less than 10 short years ago, that’s because it is similar. The similar dynamics are at play here: auto loan originators and investment banks are packaging these subprime and deep-subprime loans into asset backed securities (ABS), slice them up into tranches with varying levels of toxicity and offload them to bond funds designed for retail investors (i.e. you).
How long can this insanity go on? Indications are those subprime and deep-subprime loans – they are called such for a reason – are starting to implode. As this Wolf Street article indicates, with up to a quarter of all new auto loans last year going to subprime borrowers, ABS delinquencies have gone up more than double of what one would expect during normal times.
On a brighter note, the subprime auto loans are only in the neighborhood of $200 billion. When it blows up, it will definitely hurt but won’t topple the banks. The downside? Loan growth is unlikely to continue unabated now that the retailers are witnessing how quickly these loans are going sour.
Lastly we look at one of the remaining pillars supporting the credit growth.
In 2015, 99% of all new non-mortgage credit growth came from auto loans and student loans.
Both auto and student loans outstanding have now each surpassed 1 trillion.
How are these students loans performing and how sustainable is this growth, you might ask? The federal student loan bubble bears all the markings and trajectory of the subprime mortgage crisis, except that it is likely to be more severe. Check out these somber emerging stats (link) :
- At least $122 billion of federal student loans defaults as of 2012.
- For-profit schools have the highest default average default rates at 22.7 percent. For comparison, 1 in 5, or 20 percent of subprime mortgage ended up in default.
- Delinquency rate for students in repayment is 27.3% (link)
For as long as the loans are in the balance sheet of the government (i.e. taxpayers), this student loan bubble can conceivably continue to expand. However, the benefit of credit growth in student debt is unlikely to spill over to the rest of the economy beyond the for-profit school administrators. On the contrary, thanks to the non-dischargeable nature of student loans (cannot be discharged through personal bankruptcy) and barring a taxpayer funded bailout, the debt overhang on the shoulders of graduating millennials with diminishing employment prospects would virtually guarantee that this cohort will be a lot more cautious than their parents when it comes to taking on personal debts.
Once you have a comprehensive look at the various components of debt, namely mortgage, credit card, auto and student loans, it should be obvious to most rational thinking people that the ability to take on significantly more household debt is limited, absent any new economic drivers. If anything, the demographic headwinds of the baby-boomers heading into imminent retirement with woefully inadequate savings would practically pre-ordain that credit growth from this population segment will be tepid.
As for the millennials who are already saddled with heavy student loans and dim employment prospects and having lived through the traumatic experience of seeing their homes being foreclosed upon during the subprime crisis, it would be safe to assume that their generational attitude towards debt would be much more cautious than that of their parents, which, ironically, is a good thing.
All in all, the fact that this generation has reached peak household debt would be a pretty safe bet to place.
In Part 3 we will examine corporate and public debts.