Does this sound familiar? Hasty loans without verification of incomes or job histories, default rising on loans that buyers just can't repay outright fraud by salespeople. No, it's not the US housing market ten years ago. It's the auto industry today, where many car dealers are gaming the loan application process so low income borrowers can drive off in new cars they can't afford, and those auto loans are bundled into
securities for investors. It's classic subprime. Less than a decade after the mortgage crisis caused the Great Recession, as explained in movies like The Big Short, so the banks started filling these bonds with risky and risky on mortgages Inky Baja. That way they can keep that profit machine channing right. By the way, these risky mortgages are called subprime. Our guests are Patricia McCoy, professor at Boston College Law School and author of the subpri i'm Virus, and Gary People's,
professor at Syracuse University College of Law. Patricia, sub prime car loans have been around for a long time. Explain what's been happening in the last eight years or so. Well, they certainly have been around, and in the last last eight years, UH auto lending UM became the new growth
area for subprime loans. UH mortgage lenders are basically not willing to make subprime loans anymore, but UM car dealers were very eager to expand their markets by selling cars to weaker and weaker borrowers and lenders stepped in willing to make loans to people who might have difficulty paying back the purchase price of the car. Gary, Are there any legal restrictions here in terms of who can get these kinds of loans when they buy a car? Or is it kind of a free for all? It's it's
pretty much a free for all. One of the interesting things about god Frank is the one area that was left out of regulation were auto dealers. And auto dealers finance the vast majority of auto loans, and then of course seldom UH to to finance companies, and they are specifically excluded from regulation in your god Frank, So your regulation you would be looking at would then be up
to the state. And I, you know, I practiced in New York and even though the general New York Usury Statute doesn't apply to most automans, Patricia, the name of your book is the subprime virus. So with the auto loans, where do we see the virus or the cracks in the system. What's really interesting is we're seeing a replay of the mortgage crisis in terms of the dealers don't check whether the borrowers can UH have the ability to repay.
The lender makes the loan without checking it in most cases here Santan Dare and then the lender sells on the loans, packages them for sale to Wall Street. Investors are not checking UH and are buying this stuff regardless of the elevated default risk. Um. It's really back back to the future. Well, so Gary, so what so let's let's talk about the people taking out the loans. What happens to them as you know, they they're they're getting loans that they can't afford to pay, and it's they're
getting those loans are getting bundled. But what's happening to the actual car purchasers here, Well, depending on how life that circumstances go, eventually something happens and they can at the payment that's sometimes a couple of months in and maybe that's a year end. You know, something happens with the car, something else happens in their life and they they they miss a payment and or they realize how bad off they are and then actively choose no longer
to keep paying UM. But yeah, the people lose the car and then often get sued UM for the deficiency that's owed after the cars repossessed, because often these cars are sold at at huge markups with a bunch of garbage feeds and and other things in it like extended warranties and and other things that drive up the price even above what the car was even remotely worth. So these folds are well underwater. They end up losing the car and then getting sued and you know, either filing
bankruptcy or having their wages garnished. But it's bad news for folks. Patricia explain the allure of the subprime auto bonds for investors and whether they're protected um from large losses. So the the topp alur is that the interest rate on these bonds is higher than the interest rate on on blue chip bonds and government bonds of uh, you know, of running around five UM, and so they're chasing yields. Uh. The reason I think that investors are not doing adequate
due diligence is twofold. Um. They think that the higher interest rate will compensate them for the higher risk and at the end of the day, even if the default rate is high, they'll get a high enough rate of return to to make money. Uh. The other thing is they're they're betting on the fact that the securitization has been designed with a big safety cushion to absorb losses
and to protect them from losses. Uh. Last time in two thousand and eight, it didn't quite turn out that way, just quickly in about thirty seconds, Gary, it will it be different with the auto loans than it was with the with the marriages. As far as protection shouldn't for the investors, I think, well, you know, I think people are going to lose money eventually like they did in
the housing market. You can't. You can't loan people money that you know they can't pay back on an asset that's appreciating value would make money even when you're selling people cars at interest. You know, they said this ten years ago, and housing, Oh well we're protected. Well, of course they weren't. We've been discussing how less than a decade after the Great Depression, the financial industry has embraced
another type of subprime debt, auto loans. Our guests of Patricia McCoy, professor at Boston College Law School and author of the sub Prime Virus, and Gary People's professor at Syracuse University College of Law. Gary, let's talk about the US auto loan sector. It's small compared to the eight point four trillion dollar mortgage market. It's about one point one trillion dollars in loans compared to the mortgage market. So no one is suggesting that this will cause the
next crisis. But is there a trickle down effect or any lasting consequences for the industry. Well, it's hard to know for sure. But obviously, if you have potentially thousands of individuals who are losing their ability, uh to get themselves around work and otherwise, that's going to have effects. And then I think you're gonna have ripples from the number of defaults. I mean, the number of defaults are you know, significant, And I think that will will have
some effects. Patricia, when when we talk, when we talk about the way that we think about the way that the dealers have dealt with this, how exactly are they encouraging this sort of these sort of loans. And how is it that the dealers are you know, what are they doing to be complicit in how these loans happen. Well, the dealers in many cases are actually the ones who are having the borrowers complete the loan applications. And the
dealers don't make money unless they sell a car. And with these borrowers, they're not going to sell the car unless the borrower can get financing. That creates a really bad incentive for some unfortunately dishonest dealers to help the borrower fill out the loan application by inflating their income or saying that they work in a fancier job than they do. Um. And so we call these lawyers loans and and unfortunately with fantan Dare, a lot of funds
turned out to pay liars Lunds and Gary. Let's talk about Santon Dair, which has agreed to pay twenty six million dollars to settle an investigation into predatory subprime auto loans by Massachusetts and Delaware. Taught about the partnership between Fiat Chrysler and Banco Santander. Well, it's probably a little to outside of my area of expertise. UM. I'm mostly on the uh, the consumer end, and what I see is that, you know, these dealers are kind of inco
hoots with with the finance companies. They know that. I think these finance companies know what these dealers are doing, pushing these loans with nobody that people can't afford UM, and you know they these lives are being pulled by the dealership UM, and the the finance companies are are complicit in that they know what's happening. They're not bothering to to to check to make sure the dealership UM is doing what uh, you know, confirming that these incomes
are even remotely close to what they're uh. I mean, this is happening on a regular basis where these folks are being steered into loans where that the documentation is clearly a complete sabrogation. Can you talk a little bit about Saint and Dair and Chrysler. Well, Chrysler is up the big three US auto dealers, the smallest one and UH and the weakest in terms of the demand for its cars, and so it was quite eager to extend its customer base down the credit spectrum to weaker UM consumers.
But to do that it needed a financing arm, and Santon Dair was conveniently very eager itself to expand into auto financing and particularly subprime. One of the reasons that Santon Dair was attractive was that it had a computerized algorithm for analyzing the credit worthiness of sub time borrowers, and supposedly it was foolproof. Well, uh, didn't turn out that way. Well, Gary, so what what do you have these legal actions taken against Santon Dair? What what did
the attorney's general find here? Gary? About thirty seconds, I'm probably not the best prepared to answer that question if it's not an entity that I've been involved with. So I don't know the answer to that one. All right. Um, we do know that Santander agreed to pay twenty six million dollars to settle an investigation by Massachusetts and Delaware, and it's been subpoenut or question by a group of about thirty states regarding its auto loane underwriting and secure
deization activities. Thank you both for being on Bloomberg Law. It's been a very interesting. Patricia McCoy, professor at Boston College Law School and author of the Subprime virus and Gary People's professor at Syracuse University College of Law. Thank you both.