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How the Fed Caused the Surge in Subprime Auto Loans

Jeffrey Nelson used a shotgun to make the down payment on a car loan.

Jeffrey and his wife, as reported by Reuters, bought a 2007 Suzuki Grand Vitara from a local dealership which easily arranged for them a $10,294 auto loan from subprime lender Exeter Financial Corp.

Last year was not a good year for Jeffrey, 44, who is a school-bus driver and local constable in Jasper, Alabama. He had experienced vehicle repossession and has heap of medical bills to pay up.

Jeffrey had to hand his shotgun, which was worth $700, over to the dealership for the $1,000 down payment.

Months after the purchase, the Nelsons divorced. Jeffrey moved into a mobile home, according to Reuters, and was incapable of paying off his debts. He had to file for bankruptcy. His wife, who is responsible for the $324 monthly payment, is also likely to file for bankruptcy.

At first, Jeffrey was happy a lender gave them second chance. But he now realizes that it is only exacerbating his financial dilemma.

According to credit reporting agency Equifax, subprime auto loans in the U.S., like the one received by the Nelsons, increased substantially by 18 percent in 2012. And a lot of subprime auto lenders are appearing in bankruptcy filings, Reuters court records review shows.

It’s The Fed’s Project
The Fed did two important things to help revive the U.S. economy: It purchased bonds, most of which are Treasury and mortgage securities, more than a couple of times. This infused a lot of money into the economy. It also reduced the interest rates in short-term loans to zero.

The Fed’s program has allowed billions of dollars to stream toward riskier and more speculative corners of the economy, Reuters said.

With low-yielding low interest rates, institutional investors crave for securities with substantial yields, such as bonds backed by subprime auto loans, regardless of bigger risk involved.

Lenders, like Wall-Street-backed Exeter, are aggressive to meet such demand, selling larger amounts of securitized subprime auto loans to fund—no other than—subprime lending.

According to credit ratings company Standard & Poor’s (S&P), lenders sold this year a total of $18.5 billion of bonds underpinned by subprime auto loans, up by more than $6 billion from the previous year.

In this period alone, there has already been $5.7 billion in securities sold which is $1.3 billion more than what was sold in the same period last year, Deutsche Bank said. Just a few days ago, Wall Street banks announced the sale of a total of $1.6 billion of subprime auto bonds in three separate deals.

The Fruit of the Efforts
Despite the Fed’s critics saying that the subprime auto lending growth is showing signs of the previous housing market bubble, the Fed’s efforts proved to have effectively bolstered the U.S. economy, pulling it out of the recession and boosting the stock market.

Fed Chairman Ben Bernanke has said that low interest rates have helped in the recovery of the housing market and caused increased sales and production of automobiles.

Auto sales are now near pre-recession levels. Automotive market analyst Polk predicted vehicle registrations to rise by more than 6 percent to 15.3 million this year and exceed 16 million in two years. This figure was last seen in 2007.

According to S&P, Santander Consumer USA Inc. is one of the biggest sellers of subprime auto securities. Capital One Financial Corp., General Motors Co. and Ally Financial Inc. are some of the lenders that are steadily lending to subprime borrowers.

But how do the Fed’s efforts look like in the borrowers’ case?

‘Begging for More Money’
Wayne Loveless, a cook at a local restaurant in Tennessee, had a hard time paying $329 every month for his 2006 Buick Rendezvous. He and his wife took out an Exeter auto loan to purchase the vehicle from a local dealership.

The Lovelesses secured a title loan a month after that with a 2001 Ford van as collateral. Reuters reported that the family also took out several payday loans amounting to $5,500.

Wayne used the borrowed monies for the car-loan payments and care for his wife’s handicapped brother. He told Reuters that the situation is stressful because they always have to beg for more money.

After five months, the Lovelesses filed for Chapter 7 bankruptcy with $9,900 (excluding the vehicle’s value) remaining balance with Exeter.

Wayne lost his job as a cook, Reuters reported, and is now working at a different company. He and his wife managed to keep the Buick.

Meanwhile, another subprime borrower, Charles Thomas, filed for Chapter 7 bankruptcy a few months before he secured auto loans with Exeter and Santander.

Thomas, who is working as an electrician in Illinois, had been rejected by six dealers already. However, a local dealership took a chance on him and preapproved his car-loan application.

Thomas told Reuters that he was presented two financing deals at the same time by Exeter. He purchased a 2012 Hyundai Sonata while his wife settled for the 2008 model.

Thomas’s wife lost her job which made the $900 monthly payment impossible to make. Thomas filed for Chapter 13 bankruptcy. His court filing shows that he owes Exeter $22,060 and Santander $11,538, Reuters found.

More Willing to Risk
Investors putting more money toward securities backed by subprime auto loans and the resulting growth in subprime lending make some market watchers worried. They said that the environment encourages lenders to compete by lowering credit standards.

The stories of Nelson, Loveless and Thomas are just a few examples of risk involved in subprime borrowing.

Subprime lenders charge annual rates of as high as 20 percent to cover the risk of lending to borrowers with questionable credit and ability to pay.

The Exeter loan the Nelsons received had an APR of nearly 22 percent according to Reuters.

Today, Jeffrey is still a school-bus driver and a local constable in Alabama, experiencing series of financial dilemmas. His ex-wife has the Suzuki.

He is earning $1,592 and spending $1,563 monthly. With $29 remaining in his pocket every month, he said he has to pull some money together to buy a siren and mount blue lights on his 1996 Dodge Ram pickup truck with which he drives around as a constable.

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