Subprime Auto Loans are Imploding

Key Concepts

• Subprime borrowers
• Auto loans
• Delinquency rates
• Securitization (Asset-Backed Securities - ABS)
• Tranches
• Risk premiums
• Quality adjustment (CPI)
• Federal Reserve balance sheet
• Quantitative Easing (QE)
• Contagion risk

The Debt Problem and Auto Loan Delinquencies

The video begins by drawing a parallel between the 2008 subprime mortgage crisis and the current situation with auto loans. It highlights that US households hold over $18 trillion in debt, with non-housing debt reaching $5 trillion as of Q3 2025. Auto loans constitute a significant portion of this non-housing debt, totaling $1.66 trillion.

While overall auto loan delinquency rates (90+ days past due) are at 5%, which is not historically unprecedented, the true concern lies with subprime borrowers. The delinquency rate for subprime auto loans has surpassed 6.5%, reaching its highest point since 1994. This is exacerbated by the fact that the subprime borrower category itself is growing, accounting for 14.4% of consumers in Q3 2025, up from 13.9% the previous year.

Factors Contributing to Rising Auto Loan Issues

Several economic factors are contributing to this trend:

• Inflation and Rising Prices: The transcript argues that persistent deficits and money printing lead to rising prices, making it harder for households to afford expenses, including car payments.
• Vehicle Affordability: Despite CPI data showing flatlining new vehicle prices and slight declines in used vehicle prices (adjusted for quality), the speaker contends that actual sticker prices are higher than in previous years. The Bureau of Labor Statistics (BLS) uses quality adjustments in the CPI, which can lower reported costs by accounting for new features (e.g., stronger bumpers, navigation systems). However, the speaker emphasizes that consumers cannot opt out of these features, and the overall cost of vehicles has increased, making them less affordable.
• Extended Loan Terms: To cope with rising vehicle costs, borrowers are increasingly opting for longer loan terms, with 12-year (144-month) auto loans becoming more common. This practice is described as dangerous, as vehicles depreciate significantly, increasing the likelihood of borrowers being "underwater" on their loans (owing more than the car is worth). This is particularly problematic for subprime borrowers who may be taking out these long loans out of necessity.

Subprime Auto Lenders and Market Concerns

The situation is not merely a theoretical concern for the future; subprime auto lenders are already experiencing distress.

• Lender Collapses: Color Holdings and Primolend Capital Partners are cited as examples of subprime lenders that have recently collapsed.
• Increased Risk Premiums: Investors are demanding approximately a 0.5% higher yield on the lowest tranches of subprime auto loans compared to just two months prior, indicating growing investor concern about potential defaults.
• Lending Pauses: Automotive Credit Corp has indefinitely paused new lending.
• Echoes of the Past: JP Morgan analysts have noted that while subprime auto ABS tranches are designed to withstand stress, their structure is not unbreakable. This sentiment is compared to Ben Bernanke's 2007 statement about subprime mortgage markets being "contained."
• Fraud Allegations: Carvana is accused of fraud related to auto loans and subprime auto loans. Insiders have reportedly sold billions of dollars in shares, allegedly to fund separate companies that buy bad loans from Carvana's books. This was detailed in a Hindenburg Research report.

Scope of Risk and Potential Impact on Banks

A key question addressed is whether auto loan-backed securities (ABS) pose a systemic risk similar to mortgage-backed securities (MBS) during the 2008 crisis. The speaker's assessment is:

• Banks Unlikely to Collapse: It is deemed "almost certainly no" that banks will collapse due to auto loan ABS defaults.
• Company-Specific Risk: Companies like Carvana, CarMax, and other auto loan-focused businesses are at risk of collapse, as evidenced by the failures of subprime lenders.
• Limited Bank Exposure: Major financial institutions like JP Morgan, Wells Fargo, and Bank of America are unlikely to have the same level of exposure to auto loan ABS as they did to MBS.
• Data Comparison:
  • At its peak, US residential housing debt was $9.9 trillion, compared to the current $1.66 trillion in total auto loans.
  • Nearly 30% of all originated mortgages were subprime before the financial crisis, a higher percentage than the current subprime auto loan exposure.

Federal Reserve Intervention and Potential Outcomes

The transcript discusses the Federal Reserve's role in potential financial crises:

• Historical Precedent: The Federal Reserve has a history of intervening to bail out the banking system by purchasing distressed assets, as seen after the 2008 financial crisis (buying MBS) and in 2023 (buying Treasuries when they were underwater).
• Current Fed Actions: The Fed is currently winding down its balance sheet and selling MBS to purchase Treasury bills.
• Contagion Scenario: If contagion were to spread and large financial institutions were at risk, the speaker believes the Federal Reserve would likely begin purchasing auto loan ABS, similar to its past actions with MBS. This would effectively be another round of Quantitative Easing (QE).
• Desired Outcome: The speaker expresses a hope for a free-market resolution where lenders of bad loans fail, borrowers lose their cars, and these vehicles become available at better prices for responsible buyers.
• Unfavorable Outcome: The speaker fears a scenario where the problem becomes large enough to warrant Fed intervention, leading to more money printing, subsidizing failure, and ultimately making cars unaffordable for future generations, mirroring the current housing situation.

Opportunities and Conclusion

The video suggests potential opportunities:

• Profiting from Downside: There may be opportunities to profit from the decline of companies overexposed to bad loans.
• QE Scenario: If a bailout occurs via Fed purchases of auto loan ABS, it would represent further QE, with predictable market implications.

The speaker concludes by reiterating the potential for profit in certain market areas and encourages viewers to sign up for a "Traders Wanted" event to learn about strategies for profiting in commodities.