The Safety of the Business of Subprime Consumer Lending

[Forza]

The securities that consumers put up to get subprime loans, e.g. a car, a boat, an antique chair, mean most of these loans aren't safe. True or false?

 

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[MJ DeMarco]

I don't think asking for an absolute answer is really doing the question justice. As a business is it risky? Or as a loan? The key for success in the business is risk mitigation.

I know guys in the payday loan business who are making a killing. Those are subprime loans.

 

[MattThomas]

Its really difficult to say. And in many ways, I'd say this type of business will have severe profit and loss swings depending on the economic environment. So to that end, yes it is risky.

On the other hand, if you can find a good enough hedge to this kind of risk, this business can be safer.

There were a lot of abuses in the past that has made this kind of lending even more risky, but I feel there is certainly some element of risk even if the practices themselves are relatively honest.

 

[Forza]

I wonder what would happen if there is hyperinflation? When the prices of everything is going up so fast, do subprime lenders boost the interest rate even higher than the inflation?

 

[MattThomas]

They'd have to. Since the "Nominal" Interest rate would have to compensate for the rate of inflation (Nominal Interest Rate = Real Interest Rate + Inflation), the rate would have to go up.

 

[Forza]

This type of business could completely bomb in a steep recession couldn't it?

If there are a lot of loan defaults, would enough people buy the underlying assets at even 50% of their estimated value?

 

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