The Myth That This Time Is Different

11 | By Shah Gilani

Remember subprime?

It’s not that it’s back. It never left.

But this time is different.

Remember how low interest rates led investors into buying packaged, securitized boxes with black holes?

It’s not that that’s back. It never left.

But this time is different.

What’s different? Today I’ll tell you…

The Dice Are Different

The new subprime buildup isn’t about credit-damaged borrowers taking out mortgages. And new securitized boxes aren’t being filled with mortgages.

This time is different because credit-impaired borrowers are buying autos, borrowing on newly minted credit cards and taking out personal, mostly unsecured, loans. This time, institutional investors, mutual funds and retail investors are buying pieces of packaged leveraged loans.

This time is different because the dice are different.

What isn’t different is how the game ends. It’s still craps, and a lot of players will crap out.

According to a report released today – compiled by credit-reporting firm Equifax Inc. for The Wall Street Journal — in the first 11 months of 2014, four out of 10 auto loans, credit cards and personal loans went to subprime borrowers with credit scores of less than 640. That’s 50 million loans for $189 billion, in 11 months.

I’ve written about subprime auto loans here before. Subprime lending has helped boost auto sales 59% since 2009. That’s why we’re seeing record auto sales – lenders are throwing record amounts of money at borrowers, especially subprime borrowers.

Non-bank lenders, like private equity companies and hedge funds and venture capital firms, are able to borrow at next to nothing and put that money out to work in the “free market.” There they look to maximize the yield they get on the loans they make.

These non-bank lenders play in different sandboxes. Some throw money at auto dealers, both new- and used-car shops, so anybody who comes in the door can get a loan, as long as they’re willing to pay sky-high interest rates. Some back lending sites, like LendingTree or Elevate, which help themselves and their backers by lending money at high rates.

In 2014 LendingTree upped the loans it made to borrowers with FICO scores of 500 to 619 by 761% over 2013. None of the loans were mortgages.

Elevate, for its part, lends out at annual interest rates from 36% to a mere 365%.

Bound to Break

The New York Federal Reserve said last Tuesday that total household debt rose $306 billion in just the fourth quarter of 2014.

With so much of that debt being carried by subprime borrowers, something’s bound to break.

But not to worry.

Most of the debt that might turn rotten isn’t sitting on banks’ balance sheets. It’s in private hands. Or public hands, depending on which investors are backing private equity shops, hedge funds and VC firms – or, sometimes, as in a lot, the crap gets packaged and sold off to other yield-hungry “investors.”

Banks themselves are packaging some new, old stuff this time around.

They’re making “leveraged loans” to companies whose balance sheets are leveraged up with debt already. Borrowers apparently like the leverage to sometimes speculate on their own businesses, maybe buy each other out, maybe pay their controlling masters’ fees, maybe pay dividends, maybe buy back their overpriced shares, maybe just pay off old debt with new debt.

But not to worry.

Most of the debt that might turn rotten isn’t sitting on the banks’ balance sheets. No, they syndicate big loans among club banks who are in on the same game, package them up (you know how that works) and sometimes, for good measure, “structure” them into collateralized loan obligations with funky “tranches” and different credit quality profiles that pay different buyers different amounts with different associated risks.

But not to worry.

Institutional investors, pension plans and mutual funds are buying these bits and pieces, and they’re being put into exchange-traded funds (ETFs) so individual investors can grab that little extra yield they’re so desperate for.

In other words, don’t worry, this time risks are being spread around, not to just the same people as before, but to new investors who just know this time is different.

P.S. In case you don’t know how to play craps, I recommend the “don’t pass” line. That’s a bet against the dice.

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11 Responses to The Myth That This Time Is Different

  1. jerrycollie says:

    Thanks for the update, Shah.
    I know you said “not to worry”; but something tells me this is not going to end well. I’ve known people who took out loans with no intention of paying off the loan, even if they had the money.

  2. Glenn Melcher says:

    Sounds to me like the same players, the same game, the same outcome. Why is it that masters of the universe don’t understand limitations. Oh yes it’s because there are no significant consequences!

  3. Edouard D'Orange says:

    I agree that this newer sub-prime lending and re-packaging game is dangerous and poses risks to the financial system. And I know that you are saying that this is the same as the last crisis. But is it? The banks aren’t holding so much of these potential bad paper and sub-prime loans. And the amounts don’t nearly reach those of the mortgage market defaults. People aren’t going to lose houses. They are going to lose cars and other household products. And investors are going to lose money in ETFs and other investments. So is this going to be the huge problem that was the 2007-8 financial crisis?

  4. jerrycollie says:

    And I suppose with all this money going to subprime borrowers, prime borrowers probably can’t get a loan they need to finance their business or education. It all makes perfect socialist sense, if subprime borrower is a euphemism for a minority borrower.

  5. ASHLEY says:

    Why are we worried about small potatoes. There is either a 17 Trillion Dollar national debt or is it 200 Trillion? It is beyond payback. The country is broken financially. The Fed is bankrupt. They are lonely they want everyone in the same pond for group sex. . So they are making everyone complicit in their scheme then who is to complain. Listen, we have a more sinister problem facing us. Robots are replacing workers.

    Who will fund our social security, our work comp, or unemployment insurance, our medicare, our taxes, the Fed’s lien on our taxes. We are headed for the socialism of robots and if they get AI and fight our wars. Why do they need us? Both Hawking and Musk fear AI. Robots do not care about black holes or Telsas. So what is a little more debt to a doomed species?

  6. Glenn Melcher says:

    So last time it was not that the mortgages were the problem. It was the derivatives that were underlying that caused the panic. Nobody knew who owned what or how much! Same game same players same outcome.

  7. Sivaji says:

    Isn’t debt expansion has to reach the sub-prime borrowers to make money for the investors??, I am not sure how any investors would make money without lending to a risky borrower ???.

  8. Sivaji says:

    As long as the borrowing cost remain low, sub-prime loans should be fine, Hope fed wouldn’t raise rates and keep the borrowing frenzy continue for a while.Economy will be in more trouble if we don’t expand credit.economies will fail this time, because of quantity of credit is less,rather than the quality of credit is bad.

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