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Is the Next Big Sub-Prime Crisis Coming?

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The importance of preparation for any financial market

Rich dad said, “Bull markets seem to go on forever, which causes people to become sloppy, foolish, and complacent.”

It’s no secret that the stock market is on a record rise…and that many professional stock traders are terrified. When markets rise like meteors, people get stupid. It happened in 2007, and according to a report from Zero Hedge, it looks like it may very well be happening again.

Writing about what they call SubPrime 2.0, Phoenix Capital Research cites a Bloomberg article:

Santander Consumer USA Holdings Inc., one of the biggest subprime auto finance companies, verified income on just 8 percent of borrowers whose loans it recently bundled into $1 billion of bonds, according to Moody’s Investors Service.

The low level of due diligence on applicants compares with 64 percent for loans in a recent securitization sold by General Motors Financial Co.’s AmeriCredit unit. The lack of checks may be one factor in explaining higher loan losses experienced by Santander Consumer in bond deals that it has sold in recent years…

As they point out, this means that auto loans are a $1 trillion debt market, and lenders are severely negligent in checking the income of those who purchase cars. While Santander only checked 8% of applicant’s incomes, AmeriCredit—a much more respected lender—only checked 64%.

As Phoenix Capital Research writes, “So… two of the largest autoloan lenders basically were signing off on loans without proving the person even had a JOB either roughly half the time or roughly ALL the time.”

Why is this a problem?

You may be thinking that this might not be as big a problem as the housing subprime crisis from 2007-2009. After all, aren’t auto loans much smaller in amount that housing loans? Yes, but the problem is not the individual loan amounts. Rather it is the bundling of these loans into debt investment vehicles that large institutional investors put things like pension funds into.

Those loans that Santander only checked 8% of income on, did you catch that they were bundled into $1 billion of bonds?

We may very well be in the state where we transition from market euphoria to financial distress. This is earily familiar to the housing crash, when large institutional investors lost billions upon billions of dollars on supposedly safe bond investments…all because of the laziness—and euphoria—of loan processors who were more concerned with closing a loan than making the right loan.

In 2007, it was houses. Today, it’s cars. The results could be the same.

Feast or famine?

Perhaps as you’re reading this, your heart just skipped a beat. For some of you it will be in fear. For others it will be with excitement.

Rich dad also said, “It is not possible to predict the markets, but it is important that we be prepared for whichever direction it decides to go.”

During the last subprime crisis, many people panicked. Some folks, tragically, ended their lives because their financial loses were so heavy. The result of this panic was that capital was withdrawn from the markets, and prices on cash-flowing assets tumbled.

Most people simple weren’t ready for such a steep dive in the financial markets. Rather than take what they perceived to be too big of a risk to invest, they rather held onto their money—the equivalent of putting it under a mattress and riding out the financial storm.

At the same time, Rich Dad Advisor Ken McElroy and I were excited. We partnered together to invest in multi-family housing, a.k.a., apartments, and the buying was good. In anticipation of a downturn, Ken and his partners had recently refinanced many of their previous projects, pulling out the equity tax-free while still having the operational income to cover their operational expenses and debt service.

As the market began to crash, the prices on multi-family housing began to drop as well. Prime assets that were not a good value just a year earlier were now looking like bargain bin specials. Ken and his team moved into action, searching and finding the best deals.

Ironically, many investors were not willing to give capital to the investments Ken and his team found. But there were a small number who saw the opportunity in front of them and decided to invest.

Today, all those investors are much richer…and those that skipped those investment opportunities are very regretful.

Back to basics

Ken and his team put into practice the adage, “Buy low and sell high.” Many of Ken’s investors have their money back, still have ownership in the properties and collect money each quarter—now an infinite return.

How did Ken and team pull this off? Like my rich dad encouraged many years ago, they were ready for whatever direction the market went.

This brings to mind a financial principle that sounds simple but takes a lifetime to master: You can make money in both up and down markets. In fact, just a couple years ago, I shared with you a five-point plan to make money in any market. It might be worth revisiting that post, but in short you must:

  1. Know your position
  2. Know how you’ll perform
  3. Get educated
  4. Slowly pare back your risk
  5. Buy in pars

If you’re one of those reading this with a heart-beat-skip of excitement, you know this is your time. If you’re feeling more panicky, it’s time to change your mindset. This is a time of opportunity. You just have to be prepared.

SubPrime 2.0 isn’t here yet. Maybe it will never be here…or maybe it will come like a thief in the night and catch many investors off-guard.

Regardless, now is the time to begin increasing your financial intelligence so that you can be prepared for whatever direction the markets take. It will be the difference between thriving and just surviving.

Original publish date: May 30, 2017

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