Cars Aren’t Houses

General Motors Financial Co. disclosed in Securities and Exchange Commission filings early this month that it is in receipt of a subpoena from the U.S. Department of Justice. According to the filing, the company said the subpoena requests documents relating to its subprime originations and securitizations since 2007 as part of the DOJ’s investigation into whether the company violated the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, also known as FIRREA.

FIRREA is an interesting statute. It was enacted as a result of the savings and loan crisis of the 1980s and 1990s — when approximately one third of the S&Ls in the country failed, leaving depositors high and dry — and gave the DOJ a tool to go after the bad actors and behavior that caused the failures. If you read the statute, it appears to apply only to depository institutions, but the DOJ has used it to reach any activity that has an effect on a federally insured institution, and courts have tended to support a broad application of the law. So, for example, FIRREA could apply where federally insured banks that invested in GMF’s securitization pools were misled about their credit quality.

It is obvious that the DOJ thinks auto finance and mortgage finance work the same way and are subject to the same pitfalls. Recall that home values were skyrocketing before the financial crisis, and that many consumers were using their homes as ATMs, refinancing their mortgages and taking cash out (thus increasing their obligation) over and over again. There were also many documented instances of fraud, both by consumers and loan officers, which allowed consumers to get into mortgages they really couldn’t afford. When the bubble burst and the economy tanked, there were quite a few defaults in the mortgage securitization markets. However, the auto securitization markets continued to perform quite well.

Why is that? With the caveat that I’m just the lawyer and not the finance guy, here’s what I think.

First, cars aren’t houses. No one in their right mind purchases a vehicle expecting it to increase in value. Doesn’t everyone say a new car loses 20% of its value when you drive it off the lot? When the housing market crashed, everyone said that folks forgot that home values can rise and fall — they don’t always keep going up. In the auto world, you’re financing a depreciating asset. Everyone knows it’s a depreciating asset, and everyone’s underwriting standards take that into account. Ergo, auto ABS continued to perform when mortgage ABS had tanked.

Second, I suspect banks and finance companies have gotten very good at predicting who will default and when. Of course, there are always unexpected hazards, like a divorce, job loss, or medical catastrophe. But statistics being what they are, underwriting standards can take that into account, resulting in better performing assets.

The DOJ has had some real success prosecuting folks for the ills of the mortgage market. And probably, rightfully so in many cases. I’m sure the DOJ has seen reports of an increase in subprime originations, but I suspect many of those originations are folks who were prime credit before the financial crisis. They’re back on their feet and moving back up the credit spectrum — I’m not surprised that as the economy improves, more people are accessing credit.

The unfortunate part of all of this is that it’s going to cost GMF a pretty penny to explain the car market to the DOJ. I don’t know what the DOJ will come up with, but I expect it will find something to complain about (it’s better than conceding that there’s nothing there). Of course, the agency could also find something legitimately serious. I’d expect the former and be surprised about the latter, just based on how the auto ABS markets have performed in past years. I guess these investigations are now a cost of doing business. But, man, what a cost.

Michael Benoit is a partner in the Washington, D.C., office of Hudson Cook LLP. He is a frequent speaker and writer on a variety of consumer credit topics. Michael can be reached at 202-327-9705 or mbenoit@hudco.com. Nothing in this article is legal advice and should not be taken as such. Please address all legal questions to your counsel.