There are some eerie similarities between the housing bubble that popped in the mid-2000s and the current state of the used car market. In both instances, we have peculiar circumstances that contributed to the relentless and unsustainable rise in prices. The ending is destined to be similar, although there will certainly be less collateral damage when it comes to the used car market due to its smaller size.
To recap, the housing market had been in a quiet, bull market ever since the early 90s following the savings & loan bubble, rising in a consistent and low-volatility manner along with the broader economy. However, the housing market took off in the aftermath of the dot-com bubble, when public interest and speculative interest in the stock market dwindled and the Federal Reserve was offering low rates. In concert with this, there was financial innovation through collateralized mortgages which pushed borrowing costs lower, increased capital flows to the sector, and contributed to the bull market.
Of course, this stage of the bull market's ascent was not fueled by fundamentals but rather FOMO and greed. And, the financial innovations exacerbated the issue through leverage and an assortment of exotic offerings like NINJA loans which meant unqualified borrowers were able to purchase homes with little capital.
Now if we shift to the used car market, we can see the similarities and also note some key differences. The pandemic increased the demand for cars due to people receiving stimulus payments. At the same time, the pandemic reduced the supply of cars due to supply chain issues. This caused prices to spike, but consumers didn't really feel it due to low financing costs.
Now, the value of these cars is normalizing, and many people are finding themselves underwater by a significant amount. And, this is coming about as financing costs have soared which is impacting demand, contributing to lower prices. Additionally, normalized supply chains mean that production is at full capacity with automakers eager to recoup lost profits.
The net effect is that we could see a wave of defaults as underwater borrowers are unable to make payments. Lenders can take repossession of the car, but they will also incur a loss if the car's value drops as it will.
The similarities are clear, but the major difference is that the auto loan market is much smaller than the mortgage market and is not systemically risky. Yet, it will cause a serious dent to businesses in the auto lending space but could be a boon to consumers who have been patiently waiting to buy a used car.