"Follow the money" is one of the oldest truisms. Sooner or later, if you want to know the truth about something, or someone, or some industry, find out where the money is going, watch how it's being raised, see how it's being spent . . . and draw your own conclusions.
We've already seen how the US auto industry (and Europe's, too, for that matter) is threatened by a tidal wave of vehicles coming off lease over the next few years, as well as technological obsolescence. Used car prices are predicted to drop by as much as 50% over the next few years, which will undoubtedly force new car prices to decrease as well - otherwise few will be willing to pay them, since the new-to-used differential will be so great.
There's another reason why vehicle prices are going to have to drop. It looks as if many of us are struggling to afford them at any cost. The Wall Street Journal recently reported:
The average price of a new car is now $31,000, up $3,000 in the past four years. But at the same time, the average monthly car payment edged down, to $460 from $465—the result of longer loan terms and lower interest rates.
In the final quarter of 2012, the average term of a new car note stretched out to 65 months, the longest ever, according to Experian Information Solutions Inc. Experian said that 17% of all new car loans in the past quarter were between 73 and 84 months and there were even a few as long as 97 months. Four years ago, only 11% of loans fell into this category.
Such long term loans can present consumers and lenders with heightened risk. With a six- or seven-year loan, it takes car-buyers longer to reach the point where they owe less on the car than it is worth. Having “negative equity” or being “upside down” in a car makes it harder to trade or sell the vehicle if the owner can’t make payments.
There's more at the link.
Jalopnik elaborates that there's a significant downside to longer-term loans.
These extra-long car loan terms seem good for new car buyers because they help keep the payments down, ideally under $500 a month. But as the story notes, it takes buyers much longer to reach the point where they owe less on the car than it is worth.
In the meantime, you're spending all that money each month for years at a time on a depreciating asset when it could be better spent on other things, like a mortgage or building up a savings account. You also may end up paying a ridiculous amount in interest over those years.
Again, more at the link.
Think about it.
- 73 months = 6 years, 1 month - 50% longer than most people spend in high school, or to earn a 4-year undergraduate degree.
- 84 months = 7 years - even worse.
- 97 months = 8 years, 1 month - twice as long as most people spend in high school, or take to earn a 4-year undergraduate degree.
That's an awful long time to burden oneself with an auto loan, on top of existing debt such as study loans, credit cards, lines of credit, etc. (to say nothing of a housing loan). What if you want to get married during the term of your auto loan? You now have to carry that expense into your new (and hopefully lifelong) relationship, burdening your partner with it, even though the vehicle you bought may not be suitable for a couple (particularly if they plan to have children). If you need a more suitable vehicle, as Jalopnik warns, you may be 'upside-down' on your loan (i.e. owe more than the vehicle is worth), and therefore have to take out an even larger loan to buy what you need.
There's another factor to consider. I've written on many occasions about the real rate of inflation, as compared to the 'official' rate (which is deliberately understated to a ridiculous extent, so as to hold down mandated-by-law increases in entitlement costs). The inflation-adjusted cost of a motor vehicle is claimed to be relatively constant over time. (Click the chart for a larger view.)
However, average US incomes have not kept pace with the real level of inflation over time. Even using the deliberately-skewed, politically-correct, understated 'official' inflation rate, the bottom three quintiles show a decline:
When one uses a more realistic measurement of inflation, as we discussed last year, the inflation rate - and the resultant decline in effective household income - is far greater. Put in its simplest terms, most US households currently have significantly less disposable income, in terms of the buying power of their money, than they had in previous decades. Therefore, while auto prices may have held reasonably steady in inflation-adjusted dollars, the incomes of those who buy them have not. They're now effectively much lower. (If you doubt this, do your own measurement. Compare the cost of typical groceries and supplies for your household in 1997, in 2007, and this year. I guarantee you, the cost difference will be much greater than can be accounted for by the official rate of inflation! My wife and I reckon our expenses for normal household groceries and supplies have more than doubled over the past ten years; yet our personal incomes have not grown to anything like the same extent. I'll be surprised if you haven't seen something similar.)
That's why the duration of auto loans has had to increase. People no longer have sufficient disposable income to afford both their normal living expenses, and the monthly payments on that auto loan over a more 'conventional' term. That's also why many US cars are now sold through short-term leases rather than auto loans - because loan payments are simply too high. To take a wider perspective, it's also why most housing mortgages have stretched from fifteen to thirty years, in most cases, and why most people can't afford to put down a deposit of more than one or two per cent on their homes - and therefore are very, very vulnerable to another housing downturn. (When Miss D. and I bought our house in Texas, a year and a half ago, I was told by the bank official handling our loan application that we were the first couple in six months to have taken out a 15-year loan, putting down a 20% deposit. This is, apparently, simply impossible for most couples today. That's a very scary thought!)
Putting all those factors together, I'd say the US auto industry is in very serious trouble indeed. Many of its customers simply can't afford its vehicles at their current price levels; and even those who can, often have to stretch out their auto loans to unconscionable lengths to reduce the monthly payment, thereby crippling themselves with additional interest charges (and affecting their ability to access other forms of credit, for the duration of the auto loan). In order to sell cars to those who can't afford even such extended payment terms, the industry has hamstrung itself by leasing millions of vehicles. As those short-term leases expire, they will vastly increase used-car inventories, making it impossible to both resell them all, and simultaneously sell more new cars, all at present, inflated prices. The industry has been hoist on its own petard.
Herbert Stein famously said that "If something cannot go on forever, it will stop." I rather suspect that's about to happen to the US auto industry in its present form. Unless it changes, it'll simply price itself out of its own market . . . and that'll leave it nowhere to go.