The auto bubble

The rise in Canadian consumer debt is mostly due to auto loans. Could we be on the road to another financial crisis?

Have you noticed that there are hardly any old jalopies on the roads? It seems like everyone is driving a new, or practically new, car. Indeed, the sight of a Mercedes or Porsche doesn’t impress anyone anymore.

I don’t like to generalize from anecdotes, but it hit me when I saw a pizza delivery guy park his 2016 Honda CRV in front of my neighbour’s house.

But this is nothing new. There are always people who choose to go deeper into debt — sometimes for as long as eight years — to buy the hottest, shiniest, newest SUV just to impress the neighbours. Meanwhile, the banks are enjoying the spoils of auto loans — the latest trend in subprime borrowing.

But upon further analysis, I discovered a reality that was far more alarming:

• from 2007 to 2015, the value of the Canadian automotive financing market almost doubled, totalling more than $120 billion today;

• in 2007, only 14% of loans had extended amortization periods. Today, 69% of auto loans in Canada are financed for 72 months or longer;

• it is estimated that 40% of auto loans are financed for 84 months or longer, with 96-month loans making up 14% of the market; and

• last year, 25% to 35% of Canada’s auto loans were subprime.

Let’s not forget boomers who, in search of freedom, finance a Harley over 12 years, a boat over 15 years, or a $200,000 RV over 20 years. And what about people with a poor credit record who are offered — and accept — loans with an interest rate of 25%? And what about the growing number of people who, even before paying off their existing car, go out and buy a new one, and end up with a balloon loan and owing more than what their car is worth?


Granted, car sales have boosted the Canadian economy in recent years. Banks, especially, are increasingly active in the auto loan market. Moody’s recently noted that auto lending by banks has grown annually by 20% since 2007. In fact, the rise in Canadian consumer debt is mostly due to auto loans.

But it doesn’t end there. Have you seen the film The Big Short? The movie details how, in the lead-up to the 2008 financial crisis, financial institutions repackaged subprime real estate loans into complex investment products (asset-backed securities, or ABS), which generated hefty profits for banks, while concealing the high risk inherent in these products. Canadian and US banks have been using this same strategy for several years now with auto loans.

Are we in a bad remake of 2008? An Automobile Consumer Coalition (a.k.a. Car Help Canada) report points out the following factors behind the proliferation of subprime loans: “the general push within the financial industry to increase the number of ABS loans and the continued decline of stringent lending standards required of consumers.”

The report goes on to say that “in their continued pursuit [of] greater profits, financiers are taking on ever greater risk, hoping that, in the short run, their investments will be paid off quite handsomely.”

Of course, auto financing plays a lesser role in the economy than the real estate market. So there is little chance it will be the catalyst for the next big crisis. But haven’t we already been down this road?