Liquidity Constraints and Imperfect Information in Subprime Lending

Access to credit markets is generally considered a hallmark of developed economies. In the United States, most households appear to have substantial ability to borrow; indeed, households in the United States have an average of over $23,000 in nonmortgage debt alone. Nevertheless, economists often point to limited borrowing opportunities for lower-income households to explain anomalous findings about consumption behavior, labor supply, and the demand for credit. Despite a sizeable theoretical literature that explains why some borrowers might have trouble obtaining credit even in competitive markets (e.g., Dwight M. Jaffee and Joseph E. Stiglitz 1990), there has been relatively little work relating the consumer behavior indicative of liquidity constraints to the actual functioning of the credit market. In this paper, we use unique data from a large auto sales company to study credit market conditions for precisely the population that is most likely to have a difficult time obtaining credit, those with low incomes and poor credit histories. These consumers, who typically cannot qualify for regular bank loans, comprise the so-called subprime market. Because the company we study originates subprime loans, its loan applications and transaction records provide an unusual window into the consumption and borrowing behavior of households that are rationed in primary credit markets. Moreover, we track loan repayments, allowing us to analyze the difficulties in lending to the subprime population. We begin by documenting the importance of short-term liquidity constraints for individuals in our sample. We present two pieces of evidence. Both are based on purchasing behavior and indicate a high sensitivity to cash-on-hand. First, we document a dramatic degree of demand seasonality associated with tax rebates. Overall demand is almost 50 percent higher during tax rebate season than during other parts of the year. This seasonal effect varies with household Liquidity Constraints and Imperfect Information in Subprime Lending