Oil Triggers New Subprime Crisis

The U.S. economy is huge, vast and interconnected in ways that are often hard to predict. That quality alone makes interventionism a risky undertaking. Sure, sometimes bad things will happen if the Fed doesn’t intervene to try and stabilize the economy but, on the other side of the scale, what are the unintended consequences when it does intervene? What we’re discovering today is that, when the Fed offers nearly free money to big banks, they’ll find ways to lend it out to people who don’t necessarily qualify for the credit.

Most of us remember that’s exactly how we got in so much trouble in the days before the Great Recession in 2008. The government gave big banks money to lend out for mortgages and then insured those loans against loss. What a deal! So, banks started lending out that money to pretty much anyone who claimed to have the income to support it, whether that claim had any merit or not. Making loans to people with sketchy credit is called “subprime” lending, and loading up on such loans, to people who couldn’t afford to pay them back, is how we found ourselves in a recession that wiped out billions. Interestingly, we got into that position because we forgot about another subprime lending crisis that happened in the late 1980s and early 1990s when Savings and Loan institutions were lending money to corporations with sketchy credit to build apartment buildings no one really needed. That was called the S&L Crisis, and it happened when the government gave out cheap money to lenders, then decided the raise interest rates. Does that sound at all familiar? If it doesn’t, you haven’t been keeping up on the news.

Here We Go Again

Those who don’t remember history are doomed to repeat it and here we are again. Once again the government is shoveling money to big banks and those banks are finding ways to lend it out to people who have less than sterling credit. This time it’s auto loans and a combination of low oil prices and a hike in interest rates is once again combining to raise loan defaults.

People with subprime auto loans are falling behind at a pace we haven’t seen for twenty years. The delinquency rate on car loans soared above five percent in February, alarming economists. It’s not surprising that the rise in auto loan defaults is occurring in states where the oil industry is collapsing, with the biggest numbers in North Dakota, followed by Oklahoma, Texas and Louisiana.

Bad Bond Funds

In the Great Recession of 2008 it wasn’t the collapse of the housing market that did all the economic damage; it was the collapse of the credit markets. Banks took all those crazy loans and bundled them into securities that they sold to other banks and financial institutions. When all those securities went bad financial institutions had to stop lending money so they could cover those bad debts. No person, no company could get a loan, no matter how good their credit. The credit markets froze and companies that suddenly could not borrow money to pay their employees announced layoffs by the thousands.

Now guess what’s happening to all those auto loans? If you guessed that they’re being bundled into securities and sold on the bond market, give yourself a gold star. The cycle keeps repeating because big banks give your Congressperson and Senators a lot of money to go easy on enforcement of securities regulations. Banks make a lot of money off subprime lending and, when it all goes bad, they know the taxpayers will be left footing the bill. Why would big banks stop when they’re getting a great deal like that?

The Game Is Rigged

Smart investors will realize the economy game is rigged and adjust their investment mix accordingly. Speculating in high interest bond funds is probably a bad idea because at least a few of those are tied to some type of subprime lending. Those of you nearing retirement will want to carefully monitor the percent of wealth you keep in stocks and consider shifting to liquid hard assets to preserve wealth. There’s no such thing as subprime gold.

It’s obvious big banks haven’t learned their lesson and, with the kind of money they can throw around, and the fact that they never have to pay for their misconduct, it’s unlikely they’ll ever change. The smartest thing you can do is protect yourself from the coming storm.