ChrisGraley (31.57)

Why cash for clunkers will have a very negative effect on the auto industry very soon!

October 04, 2009 – Comments (7)

I actually thought that "cash for clunkers" was a very good idea when I first heard about the plan. I originally only heard that it was a plan to give the consumer $4500 for buying a car with better gas mileage.

That wore off rather quickly when I found out that it wasn't on top off the trade in value for the car and you had to buy a new car to participate.

So effectively what we did is to target the guy that had a car with very little value. I have no problem with that part, as that guy needs more help than anybody! If we continued to focus on helping the little guy with things like getting him a dependable car so he doesn't lose his job, I'm all for it! But instead of helping the little guy, we actually hurt him. We forced him to go out and buy a new car! So now we have a guy that has even more debt than he had before.

In a lot of these cases, this may be the guy's first new car, so he goes to the car dealership and faces a salesman that knows that he pretty much already has a deal because 3rd party financing will most likely approve a deal with a down payment that is 25% to 35% of the cars value. The salesman's only job is to focus on trying to sell him the most expensive car that he qualifies for, so he gets a better commission This guy is now getting told that yes he can buy a nice car when before he was turned down for the the cheapest new car on the lot. Hopefully the little guy focuses on keeping that payment as low as possible, because with 3rd party financing he is paying credit card type interest. So they have a deal and the only thing stopping the little guy is that he needs to get the car fully insured so he can drive it off the lot. So the little guy calls his insurance company. About 99% of insurance companies use credit as a big rating factor. The little guy was already paying more for his insurance than people with good credit, but he didn't notice it as much because he just had liability and only enough to be legal with the state. His insurance payment will at least double and maybe triple, even if he has a good driving record. In the best case scenario, he is probably looking at at least $500 more a month in payments for his car and insurance.

OK, so it seems like the dealer made out like a bandit in this deal, but not so fast! The dealer shot himself in the foot and doesn't realize it yet. Remember when gas was $4.00 a gallon? Well in response to that dealerships were requesting more fuel efficient vehicles from the auto makers. The auto companies did respond, but it took a while. It's very hard for the auto industry to ramp up and slow down production of any particular model. It involves major machinery changes and a retraining of labor. By the time that the industry put more efficient vehicles on the market, the price of gas fell. The dealers were flooded with efficient models and low on less efficeint models. The auto makers were already re-tooling to produce the less efficient models again. Then the "cash for clunkers" hits. Dealerships sold a lot of cars and now need a more balanced inventory from the auto makers, but more than anything, they need cars to sell! The industry has to respond by trying to ramp up fuel efficient car production, but leaving the production of other models at the same high levels. They have to get cars on the lots or they will lose sales to lots that have better choices. The important thing here is that most of these cars being produced will not sell and I'll explain more in the next paragraph.

It's the economy stupid! People without jobs will not buy cars and the jobless rate continues to rise. A lot of the clunker buyers are going to default on their loans and those 3rd party lenders will be selling a lot of low mileage used cars to compete with the new cars from the auto industry at a time that the industry is ramping u production to replenish stock. If we have a spike in oil, it will only get worse, because the clunkers cars were at least more efficient than average and they will compete against a balanced offering from the industry in the long term, and a less efficient offering in the short term.

If you are thinking of buying any US auto maker, I would suggest a "wait and see" approach.