Economy

Auto Loan And Credit Card CDOs In Hiding

The press has focused on mortgage-based CDOs and the huge write-offs that investment banks and commercial lending companies have had to take because of the subprime market falling apart. Morgan Stanley (MS) said, when it announced its $10 billion write-off with last quarter’s earnings, that its exposure to mortgage instruments was now under $2 billion.

What the market has failed to acknowledge, at least so far, is that there are huge pools of CDOs based on auto loans and credit cards.

If the economy continues to get worse, credit car and car loan defaults are going to rise. As The Economist writes: “A consumer-credit slump, which looks increasingly likely, would clobber securities backed by credit-card and car loans, which are also pooled in CDOs.”

One of the problems with car loans and credit cards is that they are not backed by an asset as solid as a home. While home prices may be falling, they are still down only about 10% from their peak in most markets and 20% in some of the hardest hit.

The value of a car drops immediately, as it is “driven off the lot” as they say. Most cars lose over 50% of their value in the first two years. Used cars sales are being squeezed by incentives and discounts offered on new cars.

The credit card situation is worse. With most credit cards, there is no collateral. If the consumer defaults, the claw-back is likely to be zero.

Total US credit card debt is well over one trillion dollars, so, it is not a small problem.

As the mortgage mess demonstrates, CDOs carry so much leverage that the percent of mortgages that needed to default  to cause a problem was fairly small. Subprime defaults are still only about 1% of all loans in the category.

The auto and credit card CDO troubles are still out there, waiting from them to “show up” on some bank’s balance sheet.

Douglas A. McIntyre

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