Subprime Lenders & Auto Market

SUBPRIME LENDERS &amp AUTO MARKET 1

Subprime Lenders &amp Auto Market

Subprime Lenders &amp Auto Market

The rising borrowing costs for the subprime lenders in the automarket push more firms to offer to loans to the less qualifiedborrowers leaving the economy and the financial system at risks. Carloans are attractive to potential buyers and businesses that offerthem are boosting their sales forcing other car dealers who did notprovide such loans before to apply the same scheme to rocket theirsales and high-profit margins as well. According to Lee, Tucker,Wang, and Pao (2014), during the past six months coming to September2014, over $110 billion auto loans originated to borrowers withcredit scores of less than 660. Worse of it all, 64% of the $110billion went to borrowers with credit scores of less than 620.

The initial lower financing costs lure new subprime lenders into theauto lending businesses. Some of the firms even hire new technologyand employees to facilitate the lending arena. New companies,therefore, lower their standards anticipating the same for theestablished lenders a situation that invites both players insignificant financial troubles down the line. This asset-backed bondmarket squeezes the profit margins resulting to firms creating moreuncertainties in a bid to maintain the markets. Private equity firmsback up the majority of the new players while the rest of theestablished firms experience difficulty in limiting the credit values(Lee et al., 2014). Giving out loans to borrowers with undeservingcredit scores eventually leaves these firms at high risks ofinability to recover the full value given the high likelihood ofdefaulting.

In summary, the rising borrowing costs for subprime lenders and automarket lure companies to offer more loans to borrowers with poorcredit while targeting the high-profit margins. These firms can eventake extra miles to employ new staff and technology to facilitate thelending. Unfortunately, the majority of the borrowers pose highprobabilities of defaulting. This situation forces the firms to findmeans of recovering the loan by either reselling the asset orincurring the sad losses thereby making it even a riskier loanbusiness.

References

Lee, Y., Tucker, A., Wang, D., &amp Pao, H.(2014). Global contagion of market sentiment during the US subprimecrisis. Global Finance Journal,25(1),17-26.doi. dx.doi.org/10.1016/j.gfj.2014.03.003