We’ve been banging on about dangerous auto loans for years, but now there’s a new stat to add to the teetering tower of potentially economy-ruining loans: A fraud detection company used algorithms to spot fraud in car loans to the tune of $1 billion in just under a three year period.
Point Predictive uses machine learning artificial intelligence software fed billions of historic loans to teach it how to spot legit information on a loan application. It found that from February 2019 to December 2021, over 5,000 auto loans contained fake employers with false pay history for buyers. Point Predictive places the blame firmly on borrowers, saying in its press release:
Point Predictive found that in the cases of fake employer fraud, a borrower creates a fake employer to generate forged paystubs, falsified income and synthetic identities to car dealers and auto lenders during financing. The fake employers were identified by Point Predictive’s Fraud Analysts during investigations of loan applications flagged by Auto Fraud Manager – the companies consortium risk scoring solution used by auto lenders nationwide.
During the investigations, the identified fake employers were associated with fake websites, falsified incomes, high rates of confirmed synthetic identity, and high rates of defaulted loans.
“The rise in the use of fake employers on credit applications is astounding, and the $1 Billion dollar threshold only proves the growing threat of this problem”, said Justin Hochmuth, Senior Fraud Analyst at Point Predictive, “We’re uncovering about 100 new fake employers that are being created each week. The exceptional work done by our team and the power of Auto Fraud Manager prove that we are addressing this threat head-on and strengthening value to our partners as we work to significantly reduce fraud in multiple industries, from auto loans to mortgages and even personal loans and apartment rentals.”
Point Predictive says it saved dealers up to $21,000 on every fraudulent loan discovered, especially as loans containing fraud have a 40 to 100 percent rate of default. While such schemes might very well be only propagated by loan applicants, let’s not forget that, in the heady days before the 2008 collapse, home loan writers were very much active in pulling such schemes in order to get people into homes they couldn’t afford. From the New York Times:
In a study published last year, for example, researchers examined the 721,767 loans made by one unnamed bank between 2004 and 2008 and found widespread income falsification in its low-documentation loans, sometimes called liar loans by real estate agents.
More colorfully, the journalist Michael Hudson told the story of the “Art Department” at an Ameriquest branch in Los Angeles in “The Monster,” his 2010 book about the mortgage industry during the boom: “They used scissors, tape, Wite-Out and a photocopier to fabricate W-2s, the tax forms that indicate how much a wage earner makes each year. It was easy: Paste the name of a low-earning borrower onto a W-2 belonging to a higher-earning borrower and, like magic, a bad loan prospect suddenly looked much better. Workers in the branch equipped the office’s break room with all the tools they needed to manufacture and manipulate official documents. They dubbed it the ‘Art Department.’ ”
The prevalence of income overstatement is sometimes presented as evidence that borrowers cheated lenders. No doubt that happened in some cases. But it is not a likely explanation for the broad pattern. It is far-fetched to think that most borrowers would have known what lies to tell, or how, without inside help.
There are many parallels to be drawn between today’s wild west auto loans and the mortgage crisis of 2008. The auto lending business is a poorly regulated mess. Let’s just run down some of the issues Consumers Reports found last year:
- A credit score doesn’t necessarily dictate the terms of the loan offered. Borrowers in every credit score category—ranging from super-prime, with scores of 720 and above, to deep subprime, with scores below 580—were given loans with APRs that ranged from 0 percent to more than 25 percent.
- Some high credit scorers get high-priced loans. While, on average, borrowers with low credit scores are offered the worst terms, about 21,000 borrowers with prime and super-prime credit scores, about 3 percent of the total borrowers in that group, received loans with APRs of 10 percent or greater—more than double the average rate for high scorers in our data.
- Many borrowers are put into loans they might not be able to afford. Experts say that consumers should spend no more than 10 percent of their income on an auto loan. But almost 25 percent of the loans in the data CR reviewed exceeded that threshold. Among subprime borrowers, that number is almost 50 percent, about 2.5 times more than prime and super-prime borrowers.
- Underwriting standards are often lax. Lenders rarely verified income and employment of borrowers to confirm they had sufficient income to repay their loan. Of the loans CR looked at, these verifications happened just 4 percent of the time.
- Delinquencies are common. More than 5 percent of the loans in the data — 1 in 20, or about 43,000 overall — were reported to be in arrears. While delinquencies declined over the past year and a half, likely thanks to pandemic-related deferment programs, industry groups and regulators are bracing for a potentially sharp uptick in the coming months.
Not only is fraud rampant, but these loans are being used in asset-backed securities — a financial product made up of several loans packaged by a financial institution and sold to investors. Much like the mortgage-backed securities that caused the economy to topple back in 2008, these products bundle together risky loans and seemingly non-risky loans in order to ensure a steady profit for investors. From the Financial Times Tuesday morning:
Turning to another corner of the market, I asked Jenn Thomas of Loomis Sayles, who covers asset-backed securities, whether that market has felt any reverberations from the equity sell-off. ABS have not missed a beat, she said.
She describes the pricing of consumer ABS — backed by auto loans, credit card receivable, personal loans, and so on — as stable to the point of being range bound in recent weeks. Three new issues (in subprime auto, prime auto, and personal loans) priced yesterday, as the equity market was roller-coastering, and all were oversubscribed. The $40m triple B tranche of the consumer loan ABS, yielding 4.4 per cent, was oversubscribed by a factor of nearly five. “Demand is so heavy”, she said.
But as we’ve seen, all it takes is the strong breeze of a financial snafu to send asset-backed securities into a chain reaction that can bring down whole economies. At the end of the day, it is normal people who will suffer the consequences of this risky market place.
Auto debt grew to a staggering record high of $1.37 trillion last year, exploding by $80 billion just between 2019 and 2020, according to Experian. The credit rating agency also found the average payment on a new car reached $609 per month in the third quarter of 2021, up from $565 in 2020. Used car prices also skyrocketed to $25,909 — a 26 percent increase over just two years ago. Delinquencies on these loans remain fairly flat in the 4.5 percent range, despite the increased costs. Low delinquency means lenders have no reason to stop the flow of free money. Indeed, as CR reported over the weekend, lenders make money off of repossessions as well. The good times seem to be endless for car loan writers!