Deformations On The Dealer Lots: How The Fed’s ZIRP Is Fueling The Next Subprime Bust


On any given day, Janet Yellen is busy squinting at 19 essentially meaningless labor market graphs on her “dashboard” looking for evidence that ZIRP is working. Well, after 71 months of zero money market rates—-an unprecedented financial absurdity—-there are plenty of footprints dotting the financial landscape.

But they have nothing to do with sustainable jobs. Instead, ZIRP has fueled myriad financial bubbles and speculations owing to the desperate scramble for “yield” that it has elicited among traders and money managers. indeed, the financial system is literally booby-trapped with accidents waiting to happen owing to the vast mispricings and bloated valuations that have been generated by the Fed’s free money.

Nowhere is this more evident than in the subprime auto loan sector. That’s where Wall Street speculators have organized fly-by-night lenders who make predatory 20% interest rate loans at 115% of the vehicle’s value to consumers who are essentially one paycheck away from default.

This $120 billion subprime auto paper machine is now driving millions of transactions which are recorded as auto “sales”, but, in fact, are more in the nature of short-term “loaners” destined for the repo man. So here’s the thing: In an honest free market none of these born again pawnshops would even exist; nor would there be a market for paper backed by 115% LTV/75-month/20% rate loans to consumers who cannot afford them.

Indeed, instead of the BLS concocted “quit rate” and other such aggregated data noise about the nation’s massive, fragmented, dynamic and complicated complex of thousands of local and sectoral labor markets—- about which the Fed can and should do nothing—-Yellen might be gazing at the $1.6 billion in bids attracted earlier this year by Prestige Financial Services of Utah. That occurred in the junk bond market, which the Fed does heavily impact, and could not have possibly happened in the absence of ZIRP.

In a word, the $390 million offering was 4X oversubscribed–even though the bonds were  issued by a newly minted financial conduit that has no operating history; and its only assets are piles of 20% interest rate loans made to people who have been in bankruptcy:

“Investors, seeking a higher return when interest rates are low, recently flocked to buy a bond issue from Prestige Financial Services of Utah. Orders to invest in the $390 million debt deal were four times greater than the amount of available securities.

What is backing many of these securities? Auto loans made to people who have been in bankruptcy.

An affiliate of the Larry H. Miller Group of Companies, Prestige specializes in making the loans to people in bankruptcy, packaging them into securities and then selling them to investors.

“It’s been a hot space,” Richard L. Hyde, the firm’s chief operating officer, said during an interview in March. Investors are betting on risky borrowers. The average interest rate on loans bundled into Prestige’s latest offering, for example, is 18.6 percent, up slightly from a similar offering rolled out a year earlier…. To meet that rising demand, Wall Street snatches up more and more loans to package into the complex investments.” (NYT)

Now the purpose of the financial market meltdown in 2008 was to purge the market of exactly this kind of dodgy lending by predators like Prestige Financial Services. And initially that’s exactly what happened.

As shown below, the subprime market shrunk from more than $125 billion at the bubble peak in 2007 to only about $60 billion by 2009. Market discipline was finally being brought to bear in this dodgy corner of the junk credit market and sketchy loan books were being drastically liquidated. That in turn meant that the US auto market was being downsized to a more sustainable level of demand based on consumer incomes, not unrepayable debt.

But the cleansing action didn’t last long. The Fed’s lunatic ZIRP policy steadily forced more and more institutional bond managers, pension funds, insurance companies and retail mutual fund investors desperate for yield into junk ABS paper. So as shown below, the subprime auto market—something which would exist on the fringe of the financial markets, if at all—came roaring back. At the end of 2013 it had re-attained the bubble peaks of 2007, and by the end of this year will be at all-time highs.

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