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Are Cars About to Crash?

New car sales have been one of the bright spots of the US recovery. And they’re still at it:

September U.S. auto sales to rise 10 percent: JD Power, LMC

(Reuters) – Strong demand drove U.S. new car and truck sales 10 percent higher in September, adding momentum to the industry’s best August in more than a decade, consultants LMC Automotive and J.D. Power said on Thursday.

Sales rose to 1.248 million new vehicles, or a seasonally adjusted annualized rate of 16.5 million vehicles. This follows a 17.5 million annualized rate in August.

“The strength in automotive sales is undeniable, as August sales performance was well above expectations and there is no evidence of a payback in September, suggesting that the auto recovery still has some legs,” LMC forecaster Jeff Schuster said.

LMC raised its full-year forecast for 2014 to 16.4 million vehicles from 16.3 million vehicles

Why have cars been so strong when housing in particular and consumer spending in general have been relatively limp? Two reasons. First, subprime lending has found a home in this market:

In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates

(New York Times) – Rodney Durham stopped working in 1991, declared bankruptcy and lives on Social Security. Nonetheless, Wells Fargo lent him $15,197 to buy a used Mitsubishi sedan.

“I am not sure how I got the loan,” Mr. Durham, age 60, said.

Mr. Durham’s application said that he made $35,000 as a technician at Lourdes Hospital in Binghamton, N.Y., according to a copy of the loan document. But he says he told the dealer he hadn’t worked at the hospital for more than three decades. Now, after months of Wells Fargo pressing him over missed payments, the bank has repossessed his car.

This is the face of the new subprime boom. Mr. Durham is one of millions of Americans with shoddy credit who are easily obtaining auto loans from used-car dealers, including some who fabricate or ignore borrowers’ abilities to repay. The loans often come with terms that take advantage of the most desperate, least financially sophisticated customers. The surge in lending and the lack of caution resemble the frenzied subprime mortgage market before its implosion set off the 2008 financial crisis.

Auto loans to people with tarnished credit have risen more than 130 percent in the five years since the immediate aftermath of the financial crisis, with roughly one in four new auto loans last year going to borrowers considered subprime — people with credit scores at or below 640.

The explosive growth is being driven by some of the same dynamics that were at work in subprime mortgages. A wave of money is pouring into subprime autos, as the high rates and steady profits of the loans attract investors. Just as Wall Street stoked the boom in mortgages, some of the nation’s biggest banks and private equity firms are feeding the growth in subprime auto loans by investing in lenders and making money available for loans.

The extra demand generated by allowing (apparently) anyone with a heartbeat to buy has supported the price of used cars, making new cars more attractive by comparison. Which in turn makes leasing seem like a good deal for all concerned:

The Mystery Behind Strong Auto “Sales”: Soaring Car Leases

(Zero Hedge) – When it comes to signs of a US “recovery” nothing has been hyped up more than US auto companies reporting improving, in fact soaring, monthly car sales. On the surface this would be great news: with an aging car fleet, US consumers are surely eager to get in the latest and greatest product offering by your favorite bailed out car maker (at least until the recall comes). The only missing link has been consumer disposable income. So with car sales through the roof, the US consumer must be alive and well, right? Wrong, because there is one problem: it is car “sales” not sales. As the chart below from Bank of America proves, virtually all the growth in the US automotive sector in recent years has been the result of a near record surge in car leasing (where as we know subprime rules, so one’s credit rating is no longer an issue) not outright buying.

From BofA:

“Leasing soars: Household outlays on leasing are booming at a 20% yoy pace – a clear sign that demand for vehicles is alive and kicking. With average lease payments lower than typical monthly ownership costs and with a down-payment not typically required to enter into a lease, the surge in vehicle leasing is likely a sign that financial restraints are still holding back some would-be buyers. Thus, as the economy improves, bottled-up household demand for vehicles could translate to higher sales.”

Chart 1: Households go for the low capital option: leasing soars
(yoy growth rate, inflation-adjusted)

Car leasing
It could also translate into even higher leases, which in turn bottlenecks real, actual sales.

Of course, the problem is that leasing isn’t buying at all. It is renting, usually for a period of about 3 years. Which means that at the end of said period, an avalanche of cars is returned to the dealer and thus carmaker, who then has to dump it in the market at liquidation prices, which in turn skews the ROA calculation massively. However, what it does do is give the impression that there is a surge in activity here and now… all the expense of massive inventory writedowns three years from now.

Which is precisely what will happen to all the carmakers as the leased cars come home to roost. But what CEOs know and investors prefer to forget, is that by then it will be some other management team’s problem. In the meantime, enjoy the ZIRP buying, pardon leasing, frenzy.

The above prediction is already coming true:

Falling used-car prices roil the auto market

(USA Today) – Used-car prices are sliding, a boon to penny-pinchers, but troubling for new-car sales.

The auto industry sales recovery in recent years means millions of used cars, many coming off lease, are starting to flood the market. The result is a decline in used-car prices that zoomed sky-high after the recession. And the decline is leading to talk that new-car auto sales growth may be peaking.

“We’re going to see a tremendous increase in used-car supply over the next couple of years,” says Larry Dominique, an executive vice president of auto-pricing site TrueCar.

That used-car cascade could dampen new-car sales in three ways:

•Less valuable trade-ins. Car shoppers may find their trade-ins are worth less than they expected when they go to buy new vehicles. That means they’ll have to shoulder larger new-car loans or forgo the purchases.

•More expensive leases. Lease rates for new vehicles are based on predicted resale value. As resale prices fall, automakers adjust predicted depreciation schedules and have to raise lease prices.

Wholesale prices were down 0.4% in August vs. a year ago, down 1.6% from July and “prices should continue to trend down as supply outpaces demand,” writes Tom Kontos of Adesa Analytical Services, which tracks wholesale prices for used cars, in a note to the industry.

At retail, the average used car sold at a franchised auto dealership went for $10,883 last month, down 1.6% from a year ago and 2.4% from July, says CNW Research.

So falling used car prices will lead to massive write-downs by the auto companies now being forced to take back all those leased vehicles. Which means the currently rosy earnings projections for GM, Ford and the other automakers playing these games are wildly overoptimistic and will have to be scaled back in an, um, unruly fashion during the next couple of years.

This sudden unpleasant surprise will come just as the Fed has ended its last round of debt monetization and is hoping that the economy will be able to grow without help. But housing, the main linchpin of the consumer economy, is already flat-lining in much of the country (see Why Isn’t Housing a Bubble?). Add the auto industry to the negative column and there won’t be many bright spots by the end of 2015. And the Fed, no matter what it says today, will have no choice but to open the spigot once more.

14 thoughts on "Are Cars About to Crash?"

  1. If the text is running off the edge it’s probably your setup, try this:

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  2. We have found car-buying so unpleasant with traditional dealerships that we now buy only used cars from CarMax. Their loans are simple interest so it’s possible to prepay without penalty. Their service warranty is excellent, especially if you’re getting an expensive car with potentially-high replacement costs (we have a Volvo). Their vehicle prices are likely above-market but they stand by their cars and that’s very important to us.

  3. It’s a safe bet the percentage of subprime borrowers of school loans is greater than that of auto loans. And I don’t mean credit scores; just one’s realistic prospects of being able to pay back these loans. I buy used vehicles. I own both my vehicles and will soon be purchasing a loaded and rehabbed 2002 Acura Legend Type-S for less than $5k. I work with young ladies who make less than 20% of what I make but insist on borrowing money to buy a new or almost new car. They can make fun of the green Chevy Astro I drive to work. I just shake my head, wondering how they’ll ever repay the debt.

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  5. I spent a lot of time looking for a used car in West Palm Beach Florida.
    I finally found the car I wanted,a 2013 Chrysler 300.
    In my travels I saw a lot of border line swindles on the part of the car dealers,they are bandits without pistols.Here are some points to consider If you want to leave the dealership with your shirt still on your back & wearing shoes as you exit!
    1)The best buy is a late model used car,You still have miles & time left on the manufacturers warranty.You also can get a report on the car from Carfax which generally is reliable,any major problem with the car will most likely show up in their report.
    2)Many of the cars hitting the market are upper end leased luxury cars which are in good shape a) the people who lease these cars are usually not the type to abuse the vehicle;besides they leave a security deposit which they want to get back,they lose this deposit if they damage the vehicle.Also they have mileage limitations on the car,if they go over the limit they pay extra fees.
    As far as car adds in classified sections go,the info is often misrepresented,comeon’s to get you into their showrooms,often the car they are advertising doesn’t even exist.These dealers get away with larceny because they don’t need the more sophisticated shoppers,they can give anyone credit.They can give anyone credit because they can repo a car if need be and resell it.They can resell a car at a profit because used cars have a fixed book value.most of these sub prime customers would never get credit for merchandise that has no fixed book value,if the goods had to be seized the merchant would have a hard time profitably reselling them as used.
    3) these crooked dealers slip in dealer charges after the sale.They use various names but are generally called “document fees”,they can go as high as $500/$800 just to write up the paperwork after the sale is complete.
    The basic reason they sell so many cars is that they can extend credit to ignorant people who don’t rate a credit line & if defaulted the vehicle can be seized & resold at a profit! This makes everyone a potential customer!
    This will come to an end when the market becomes flooded with returned lease vehicles,generally 24 or 36 months & backlog of cars for sale go through the ceiling!

  6. Not to mention the currency war unleashed by the EU will most likely dampen exports forcing the US to devalue the dollar through more printing as we race to the bottom. Looks like a death spiral.

  7. And it helps to look for a used car in a large metropolitan area where the economy is not that strong such as Cleveland, Ohio. But go to http://www.carguru.com to see what the average selling price is for any model because you can overpay, relatively speaking, in these depressed areas also. Will be looking for a used pick-up truck in about 3 years, so timing should be perfect for all of these leased vehicles today flooding the marketplace. Gross overcapacity in the global vehicle manufacturing scheme today, so he or she who waits will be rewarded. If you have a personal property tax on vehicles as we do here in Virginia, always pays to keep current vehicle until the doors fall off. Based on something like 55% of Blue Book times 4.7%. Very expensive to own a vehicle in such a state that also just raised the sales tax on vehicles. Go West young man, go West.

    1. Good words David, but the west isn’t much better. Here in WA state, licensing on a new vehicles was almost 3% of purchase price (every year). The voters here voted for $30 per year licensing for all vehicles (in the year 2000), the legislature raised them after that citing ‘weight’, the voters then again voted for $30 and then the politicians raised them again and implemented a rule that vehicle owners had to buy new plates every two years. and it still goes on, a game of cat and mouse. The arrogance of politicians is mostly seen in the economy and why I read this site every day. Politicians and economists and bankers are not magicians, there are economic laws (like the law of gravity) that will rule all at the appointed time.


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