When the clock turned to 8PM this Monday, the most effective and possibly only directly stimulating program of the $787 Billion stimulus package came to an end. The wildly popular "Cash for Clunkers" program has been credited by the U.S. Department of Transportation for generating the sales of 625,000 new vehicles and injecting $2.58 Billion in capital directly into the auto sales market.
All of this sounds like a great idea doesn't it? Well let's not jump to conclusions without thinking this through first.
It sounded like a great idea in the early 2000's when the federal government increased the availability of home loans to increase home ownership, but such a foolhardy move nearly brought our economy to its knees.
I know what you're thinking: "we're talking about cars not homes and the government didn't artificially increase loan availability here;" well you're half right.
Cash for Clunkers didn't increase the availability of loans to consumers, however it did guarantee auto companies a cash injection of $3500-$4500 per vehicle they sold. From an auto companies' point of view they will be more likely to authorize a junk auto loan because it means money in their pocket now.
The counterargument of course is that most of the people who took advantage of Cash for Clunkers were already thinking about buying a car, unfortunately the reason they didn't buy before the Clunkers program is that they couldn't afford it or had serious concerns about their job security.
So let's take a look at the numbers, shall we? The top 10 models sold under the Cash for Clunkers program had an average MSRP of $19,770. The average 'Clunkers' rebate was $4128 leaving the average purchaser of a vehicle through this program on the hook for $15,642.
When you account for additional dealer incentives and down payments, this means that Cash for Clunkers generated roughly $8 Billion in auto loans. What happens to these auto loans? Well of course they get packaged in securities and sold as a pooled risk investment.
Does this sound familiar... it should.
According to an article today at autoloandaily.com 17% of buyers in the Cash for Clunkers program are experiencing buyer's remorse stemming from the nearly $300/month car payments that are now weighing down their family budget.
With the average rate of buyer's remorse between 6% and 8%, this represents a 2 to 3 times increase in at risk auto loans.
As unemployment continues rise and more and more 'Clunkers' participants lose their jobs that number is sure to go up before it comes down.
If and when these car buyers default on their loans, the cars will be repossessed and the securitized auto loans will lose their value precipitously. Gosh this sounds familiar, doesn't it?
If just 10% of 'Clunkers' buyers default on their loans, it will represent a 5% increase in automobile repossessions between 2008 and 2010.
Unfortunately, the trouble doesn't end there; all of the old used cars that were traded in must be destroyed as a provision of the program. While this may be environmentally responsible, it is not economically responsible. Many of these 'clunkers' would have wound up on a used car lot fetching around $2500 apiece.
This represents a loss of $1.56 Billion to the used car market, which must be made up through increasing the cost of the used cars already on the market. Additionally, the decreased supply will lead to another increase in the cost of used cars.
So now the worst part comes to fruition, all of these people who have traded in their old cars for shiny new ones who end up losing them because they can't make their payments will be equally unable to afford a used car at the new inflated price. This may leave thousands of out-of-work Americans without reliable transportation.
Meanwhile the defaulted auto loans will send a ripple through the stock market drawing on the balance sheets of banks, insurance companies, and investors who are foolish enough to dabble in these clunker securities.
Of course the magnitude will be far less than that of the housing crisis since we're dealing with much smaller volume and much smaller loans. Nonetheless the government may have set an economic time bomb with "Cash for Clunkers" that will send aftershocks of hardship through the country just as we begin to truly recover from the tsunami of economic troubles we face today.
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Interesting points, Jon. I think you're right that the success of Cash for Clunkers has been overblown, but for entirely the wrong reasons. I also must disagree with your assertion that it may have created an "economic time bomb."
ReplyDeleteI don't see the securitization of auto loans leading to anything negative. This is doubly true given that, by your numbers, there was just $8 billion in loans made (I will assume you're correct here; I think my point holds even if you are off by an order of magnitude).
Rather, Cash for Clunkers has likely only resulted in a temporary, unsustainable spike in auto sales, with equally temporary dips surrounding it. To put it more simply, those considering buying a car prior to the program put it off until it started, and those considering buying a car afterwards bought one earlier than they had otherwise planned. It is in much the same vein as the effect the one-time tax rebate checks had on GDP; it only led to headaches for economists who needed to take extra steps in smoothing their data.
However, if the purpose of Cash for Clunkers was not only to revive the auto industry, but to remove fuel-inefficient vehicles from the road in favor of those that are more economical, we may see some long-term effects in a number of areas, such as fuel usage (and by extension, lessening of demand-side pressure on gasoline's supply/demand curve) and the environment.
So while I wouldn't go so far as to say that Cash for Clunkers is a resounding success, I also can't imagine that it will be the final nail in the coffin of the (resurgent of late) economy.
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ReplyDeleteI'm not attempting to assert that it will be the final nail in the coffin, but it will be a speed bump on the road to recovery for the economy and it could have a devastating impact for certain individuals whose exposure to the program is a large portion of their personal balance sheet.
ReplyDeleteThis will be a manageable liability for insurance companies and the banks; it won't be a major problem for the auto industry, though there will be a drop off in sales; there will be major problems for individual families, those 17% or more who are finding that they can't afford their auto loans.
Those people who traded in their their old car and will lose their new one when they default on their loans will be left with no car and less money.
It may only be 100,000 people but in my book that's 100,000 people too many.
Also, if this does happen and the media picks up on it, as they undoubtedly would, the stock market would overreact and while the jitters would calm in a day or two, we've found that any significant fluctuation in market stability can cause weeks or months of diminished consumer confidence.
In terms of comparing this to securitizing housing loans, let's not get too crazy. In 2006, asset backed securities totaled about $10.7 trillion according to TheDeal.com. Several billion in car loans is a drop in the bucket. And, whether you believe it or not, lending is a lot tighter now than it was a year ago. I don't think too many people are looking to load up the books with crummy loans again.
ReplyDeleteAnd, I agree with DeFrances in terms of reducing oil dependence in the long run. If you put more fuel efficient cars on the road, it should help pull the oil demand curve to the left, no?
http://www.thedeal.com/newsweekly/features/chain-of-fools.php
I'm not saying that the magnitude of the effect will be comparable to securitized housing loans, but the mechanics of the situation will be identical if on a comparably microscopic level.
ReplyDeleteRecently another government program was announced that will spend $300 million on vouchers for energy efficient appliances, within two days Whirlpool's stock jumped 11%. Even if all of that $300 million went onto Whirlpool's balance sheet (an absurd assumption) it would only represent 3.5% of the company's annual earnings.
Its the overreaction of Wall Street that will be the problem, if people default on their loans and lose their new cars, the media will the story of how the government handouts are leading to people losing it all.
This will spread fear of government investment and lead the market on a downward trend for as long as the media continues to cover the story. At this point the 'stimulus' will be in full swing with government injecting capital all throughout the economy and newly wary investors will behave much more conservatively with government capitalized projects.
Its not going to give us another October 2008 or March 2009 drop off, but it will mitigate any positive impact that stimulus spending may have on the markets.
Also, I'd tend to disagree with the idea that companies aren't looking to load up on crummy auto loans. These companies are getting their $4500 automatically at the start, if the loans go bad and the cars get repossessed they can be resold as used for close to remaining balance on the loan. So the risk of a bad auto loan is outweighed by the immediate capital injection that comes from the sale.