"Cash for Clunkers" - What's the real effect?

Thursday, August 06, 2009

Since Congress has now approved the extension of the “C.A.R.S.” program (known as “cash for clunkers”) and it will most assuredly be signed into law by the President I thought we should reflect on some of the potential impact of this program on the country and specifically the automobile business.

Let me first say that this is MY OPINION – while I believe it is an informed opinion, you will have to determine whether you agree with the assumptions. The facts will be unarguable, but the conclusions are open to debate.

The program was originally ONE BILLION DOLLARS and was to stimulate the removal of vehicles that are low fuel economy vehicles for vehicles that have higher fuel economy. The extension of the program will add TWO BILLION additional DOLLARS to this program. The intent is that if a large number of fuel consuming vehicles can be removed it will reduce the National fuel consumption, reduce pressure on fuel consumption, on fuel supplies and hopefully, eventually fuel prices. The additional benefit that is now being sought by the US Government is the stimulation of the Automobile Industry. This is designed to reduce Dealer and Manufacturer vehicle inventory, restart the need for Automobile Plant production, and bring back laid off workers in the Auto plants and Auto Parts suppliers.

This part appears to have worked. All of the manufacturers are experiencing historically low “days supply” of vehicles in Dealer inventory. Manufacturers are starting to produce vehicles to replace supplies of vehicles being sold down in Dealer inventory.

What are some of the effects? Who does it affect?

What can Dealers do?

The effects are many. Incentives to Customers under “CARS” is either $3,500 or $4,500. The average is approximately $4,200 per vehicle. This means that for the first Billion $$ about 170,000 “clunkers” will be removed from EXISTENCE. So far, one of the leading vehicles traded in under this program has been the Ford Explorer. This means that unlike previous New Car incentives that bring lots of buyers and lots of trades, for the first time the trades will NOT be sold back into the market IF they are taken under this program. With the expansion of the additional TWO Billion in funding there could be over 500,000 vehicles removed from existence. Dealers taking vehicles in under this program must pour a compound into the engine killing the engine and then within about 7 days have the vehicle delivered to and receipted by a salvage yard to crush the vehicle.

Who does this help? It helps new car Dealers. It helps manufacturers. It helps people with old cars that are not worth much $$ that can now get them traded for lots more than they are worth.

Who does it potentially hurt? This is a long list. IT starts with the Used Car Market. As previously stated, under previous incentives, big increases in new car sales would lead to an increase in trade in vehicles being inventoried by New Car Dealers. Many would be held and sold by those Dealers. Many would be sold to Wholesalers, Used Car Dealers or to Auctions to sell to other Dealers. Without these vehicles being in the “channel” all of these people will be hurt. Additionally, lower income, less credit worthy customers that are not qualified to purchase New Cars and who typically seek transportation from Independents, may not find vehicles to purchase. Those vehicles that are available will certainly cost more. IF a customer has a lower value vehicle, perhaps a $3,000 car, the customer is going to require the Dealer to give them either $3,500 or $4,500 in trade value to take it in on trade OR put it in the clunkers program and CRUSH it taking it out of circulation. This is going to lead to an inflated value of used cars.
However, this may help some of the existing sub-prime finance companies. The lower end repos may be the ONLY cheap cars at the auction because many of the vehicles similar to those repossessed will be crushed. Vehicles from finance company repossession inventory may likely be some of the few at the auction for Independent Dealers to purchase. It is likely that the lenders will see a much better return on the valuation of repossessions sold at the auctions. In addition they may see more competitive auction costs and pricing to lure these vehicles into auctions who are going to see less inventory and pressure to find vehicles for their sales.

Buy Here Pay Here Dealers that LIVE on the $2-3,000 car could be in big trouble. They are not going to be able to find as many of these as they previously did. They typically mark up the $2-3K car 3-4x selling the cars for $8-10K. IF these Dealers can only to acquire $5-6,000 cars they won’t be able to BHPH these vehicles as profitably and keep the payments inline still making a profit. Therefore these Dealers may have to look toward outside lenders. IF a customer would previously have been a contract held by a BHPH Dealer but has to buy a more expensive vehicle these Dealers may need to look toward finance companies to finance these customers instead of holding them in their BHPH portfolios, experiencing less profitability from their BHPH models. . Also, the restrictions in the Capital markets may make it tougher for a BHPH Dealer to sell bulk paper. With higher $$ vehicles their returns may be much lower. Therefore these Dealers may need to look outside more often to other lenders. They are going to need to secure the necessary sources to finance these vehicles for their traditional BHPH customers.

Dealers may have to turn to more traditional methods of acquiring vehicles. Searching through newspapers, online, E-bay etc for private party sales to find vehicles to sell to their customers. They may need to purchase more vehicles from private parties as auction consignments dwindle and trades at New Car Dealers decline. Maybe advertising “TURN YOUR CLUNKER IN HERE” or “WE’LL BUY YOUR CLUNKER” will generate some floor traffic, give them an opportunity to talk to potential customers or vehicle sellers about purchasing their vehicle outright BEFORE it hits the Clunker program. While they may have to pay a bit more for a good car, they get it on their lot. They avoid the auction system, culling through used car lots bidding for vehicles and maybe not finding the vehicles they want, where this will potentially cause people to have people bring vehicles to them. Some may even buy a car from them because they won’t qualify at a new car store. THEY MIGHT EVEN ADVERTISE, “IF YOU DON”T QUALIFY for CLUNKER”S PROGRAM, WE WILL BUY YOUR CLUNKER AND GET YOU FINANCED”. IT’s a spin on the “everyone qualifies” advertising.

Another area where there will be unintended damage to the market is the secondary parts market. The vehicles being scrapped will have very limited value in the secondary parts market. The engines will be unusable, leaving limited parts of the vehicle to be harvested before crushing the vehicle. There will be vehicles left in the market that need engine and transmission replacements to continue operating. The problem will be that Engine or Transmission remanufacturers rely on the existence of “cores” to remanufacture and sell as replacements are required. Without the vehicles being crushed to supply the engines and transmissions as “cores” there could be another shortage of available remanufactured engines and transmissions, driving up these costs and impacting on the owner of an older used vehicle that needs these replacement parts and can’t afford or qualify for a new vehicle.

Dealers need to evaluate their inventory, and those primarily focused on BHPH and may need to rethink their business model in these times. It is likely that the PURE REMOVAL OF over a half million used cars is going to have a long lasting effect on the market.

You may say wow, is the Government this stupid. Maybe!!!! Time will tell. The other potential argument is they are really smart. Remember the U.S. Taxpayer owns 60% of GM and a BIG share of Chrysler. IF they are successful in reigniting these two companies, get them profitable and spin off the shares back into the market, they will be able to SELL the stock held by the US Government and return BOTH companies to being private companies. This should be all of our hope. Hopefully they have the prescience to think this out far enough ahead. IF so, they will return the companies to private industry and get out of the car business. In my opinion, the faster the better. IF that is the plan, then I would have to say the whole idea is brilliant. It remains hopeful thinking whether or not the Government will do this and get out of the industry quickly [enough].

There may be less OLD used cars. Dealers need to become more educated about lender repossession auctions and the type of vehicles being sold and WHERE AND WHEN they are being sold. This will help them find vehicles to sell at a profit. The days of going to the New Car Store-Used car “bullpen” may dry up for awhile.

Even after this program is over, sales may likely drop because like any other incentive it pulls business ahead. Different than previous incentives which pull business ahead, the “residue” of used cars being in inventory that have to be sold down will not be there. New car Dealers will sell down their inventories and NOT be left with the old used cars they previously wholesaled to the BHPH Dealer.

{Personal opinion} Ok so here’s the editorial – While I am generally interested in how this works out, I believe it’s a bad idea. While it may stimulate auto sales so would a tax credit to all buyers. So would a credit for finance interest on auto purchases, new or used. So would being able to deduct Sales Tax on vehicle purchases. These would be “pure” incentives available to all which would help New and Used car Dealers alike. Now we are subsidizing our neighbors trading in their 10 year old Explorer that they chose to drive until the wheels fell off and now we are helping them with a $4,500 incentive. They will be well off enough to get financed and BUY a NEW CAR. Many lower income people will pay more money for used cars due to the shortage and the much lower end customer may not find a BHPH car at all. This is clearly an interference with the MAGIC of the SUPPLY AND DEMAND System. Anytime you put your “foot on the scale” and overweight the supply or demand side you create an unnatural reaction on the other side. This program is going to STIMULATE DEMAND, dry up supply and create a USED CAR PRICING BUBBLE due to the potential shortage of used cars.

WELL, enough editorial.. If the car companies heal, people go back to work and the Government sells their ownership quickly in GM and Chrysler, it may all be worth it.

IN the meantime, WE should experience stronger demand for reposssessions, which will be good news to lenders. Lenders will need to reevaluate the LTV’s and pricing of their programs to respond to the Dealer’s need to pay more for the vehicle.

Dealers in the used car business could suffer through some tough and confusing times. Hopefull this perspective is of value and will help.

Thanks for reading this. I hope it will be of some help in your perspective as you go through your respective days.

Bruce E. Newmark