For investors who see more risks building in auto securities, shorting the bonds is a tempting proposition. Outstanding auto loans grew by nearly 50 percent between 2010 and December 2015, the last period for which the data are available, and now stand at more than $1 trillion. Rapid growth can signal that lenders have not been paying enough attention to risks, as was the case during the housing boom last decade. There were about $170 billion of bonds backed by auto debt outstanding as of the end of last year, up more than 45 percent from 2010, but below pre-crisis highs.
New risks are also emerging that weren’t seen in the last lending cycle. Those include longer loan repayment terms, ballooning loan amounts and more willingness to finance used cars.
“The auto loan market is very similar to what we saw before,” she said, calling loan fraud one of her biggest concerns. “Borrowers aren’t well-documented, and in many cases they don’t even need credit scores,” she said. "It’s a real scandal this is happening.”
During and after the financial crisis, the Fed bought trillions of dollars in Treasuries and mortgage-backed securities. It didn't pay for them with wads of bills. Instead, it simply credited the sellers of the securities with bigger reserves at the Fed. So now banks have way more reserves than they could possibly use.
And that's a problem?
Yes, because the Fed can't conduct monetary policy the traditional way. In the past, if the Fed wanted to push up interest rates, it would sell a bunch of Treasuries. Banks would pay for the Treasuries by using money in their reserve accounts. That would leave them short on required reserves. To replenish their reserves they would borrow reserves from other banks at a well-known interest rate: the federal funds rate. That won't work any more because the banks have so much in excess reserves that any Treasury purchases they made wouldn't make a dent in the total.
So why exactly is the Fed paying interest on excess reserves?
As a way to raise short-term interest rates, to keep the economy from inflationary overheating.
Markets around the world are selling hard on Thursday, a day after U.S. stocks rose but faltered on the back of Congressional testimony from Federal Reserve Chairwoman Janet Yellen. Crude oil is down sharply, the yen is strengthening, gold has surged, and the yield on the U.S. 10-year Treasury note continue to slide. There is a scramble for safe-haven assets and a wholesale dumping of risk. Emerging markets, energy and banking stocks are under heavy pressure.
The slide toward global recession was sharply expressed this week in the descent of Japanese government bond yields into negative territory. In the US, the yield on 10-year Treasury bonds has plunged well below 2 percent, reflecting the same deflationary trends.
The proliferation of super-low and even negative interest rates is wreaking havoc on banks that remain burdened with bad loans and stand to incur more losses from energy-related assets that are souring due to the collapse of oil prices and its impact on energy revenues and profits.
Bank stocks in Europe are down an average of 27 percent so far this year, with Deutsche Bank, Germany’s biggest, suffering a loss of more than 40 percent. In the US, bank stocks are down 18 percent, with shares of Bank of America and Morgan Stanley having dropped 27 percent and 28 percent, respectively.
US stocks overall have fallen by more than 9 percent since the beginning of the year, and stocks in Europe have declined even more sharply. In the US, tens of thousands of job cuts have been announced in both the industrial and retail sectors. Among the major non-retail firms announcing layoffs are Johnson & Johnson, Norfolk Southern, US Steel, Yahoo and Altria. Energy and mining firms have laid off thousands more workers.
The worsening social crisis impacting broad sections of the US population is reflected in the wave of store closings and layoffs by major retail chains, including Wal-Mart (269 stores, 16,000 job cuts), Macy’s (40 stores, 4,500 layoffs) and Sears-Kmart (more than 50 stores, thousands of job cuts).
US economic growth is estimated by the government to have slowed to 0.7 percent in the final quarter of 2015, and data on manufacturing continues to show recessionary conditions.
US corporate profits are also down. Profits reported by firms in the S&P 500 index for the fourth quarter of 2015 are down 4.1 percent from a year earlier. Sales are down 3.5 percent. This means profits have declined, year-on-year, for two straight quarters, the first time that has occurred since 2009. Sales have fallen for four consecutive quarters.
The near panic in financial circles was summed up in a statement released last week by strategists at Citibank, which declared, “The world appears to be trapped in a circular reference death spiral.” Predicting that the world economy would grow by only 2.7 percent this year, far below the already depressed projections of the International Monetary Fund, Citibank warned of “a proper/full global recession and dangerous disorder across financial markets.” Its report concluded, “The stakes are high, perhaps higher than they have ever been in the post-World War II era.”