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Years of reckless lending and borrowing are nearing another predictable end: surging defaults and losses. As Oaktree Capital Management’s co-chair and credit specialist, Howard Marks, has noted: “The worst loans are made at the best of times,” when credit and optimism are plentiful.

While risk-sellers continue to insist that households are in good financial shape (just as they did in 2007), credit card delinquencies (90+ days late on payments) have increased to a near-record 12%, second only to the 13.8% high in 2010.

Consumers tend to pay auto loans first over mortgages since vehicles are often essential for work. It’s ominous, then, that new auto loan delinquencies (90 days or more) in the second quarter matched the rise in 2020 and 2010 before that. The subprime auto-loan delinquency rate, considered a leading economic indicator, leapt 9.3% in August (ABA Banking Journal+1). See, Auto industry is Flashing a Warning Sign on the U.S. economy:

The auto industry is flashing warning lights on the state of the U.S. economy. Automakers’ profits are getting squeezed by tariffs. A subprime auto lender recently collapsed, and some car retailers are warning that consumers are pulling back.

CarMax , the biggest seller of used cars, said Thursday that its sales and profit plunged in the latest quarter. The company’s results, which sent its stock tumbling 20%, is the latest in a series of unsettling developments in an industry under strain from President Trump’s tariffs and carmakers’ recalibration of expensive electrification strategies.

“The consumer has been distressed for a little while. I think there’s some angst,” CarMax Chief Executive Bill Nash told analysts on a call Thursday. Consumers with better credit profiles “seem to be sitting on the sidelines,” Nash said.

Ford said this week it was offering lower interest rates to buyers with the weakest acceptable credit histories as it tries to unload unsold F-150 pickups, its bestselling model.

Profits at CarMax’s finance arm also declined, as the performance of loans originated in 2022 and 2023 deteriorated, and the company increased its provision for losses.

At the same time, Tricolor, a subprime auto lender and car dealer owner, abruptly filed for bankruptcy liquidation earlier this month amid government investigations and a bank partner’s allegations of fraud. The Dallas-based company offered auto financing to customers who lacked credit history or a Social Security number and operated 65 dealerships.

First Brands, a major auto-parts supplier behind products such as Fram oil filters and Anco windshield wipers, is preparing to file for bankruptcy protection, with more than $6 billion in outstanding debt.

In epic complacency, lenders and credit investors have been accepting record-low compensation for escalating capital risk. Investment-grade bonds are paying just 74 bps (the lowest since 1998, indicated by the gold line below) and high-yield investors just 275 bps over similar dated treasuries (the least since 2007, shown by the blue line below).

See, The Credit Market is Humming and that has Wall Street on Edge:

One concern is that lending to riskier borrowers has been growing for years, first through traditional bonds and loans, then in the form of private credit and the revival of complex asset-backed debt. The longer that credit boom lasts, the more likely it is that defaults will rise. Likewise, the higher the valuations of corporate bonds and loans, the more susceptible they become to selloffs.

The fate of the market could depend on the direction of the economy. Some investors note that the current benign environment could continue if inflation pressures ease and there is no further deterioration in the labor market, allowing the Federal Reserve to boost economic activity by cutting interest rates and relieving pressure on borrowers.

Credit is the foundation of the economy and financial markets. Leaping loan defaults, along with the lowest risk compensation for investors since past bubble peaks, is a foreboding combination for all risk assets.

High-yield analysts at Barclays compared the current situation—with valuations so high and signs of stress emerging—to being in a Star Wars garbage chute with Princess Leia and Han Solo and “the walls compressing on all sides.”

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