It’s difficult to teach any financial literacy class, especially at the high school level, without addressing the issue of subprime lending in the auto industry—when dealers obtain loans for people whose credit scores or income level would indicate a high probability that they’ll default on high-interest loans.
Dealers and lenders sometimes work together in predatory schemes to take advantage of poor or risky potential customers. A story in the New York Times found that some used-car loans carried interest rates that exceeded 23 percent, much higher than the single-digit interest paid by most people. Furthermore, the amount borrowed was typically at least twice the value of the car being purchased, meaning the borrower would be unable to sell the car to pay off the loan, leaving repossession and bankruptcy as the only option.
It has been good for the car salesmen, not the borrower and car owner. But it has also been good for the banks, which typically package up these subprime loans with others and sell them off as securities. Once they’re in the securities market, borrowers often find themselves with nobody to talk to who might be able to arrange a repayment plan when they face hardship.
But even if borrowers were able to contact someone, the Times found that dealers had often falsified records, misstating borrowers’ income and making it look as though they were better able to repay the loan than they actually are. Or, dealers just lied about the borrowers’ employment information. All of this is illegal, and everyone involved knows it’s illegal. The problem has been that no agency or even a group of people had been investigating this unscrupulous activity.
Until now. The US Consumer Financial Protection Bureau and the Federal Trade Commission have started looking into this practice. Let’s hope they move swiftly. This is the same type of banking practice that plagued the housing industry before the Recession began in 2008: probable defaults on loans, packaged as securities, that were underwritten for more money than the house was worth.