The Next Great Crash: Auto Loans?

From 2001 to 2007, the Federal Reserve undertook inflationary money policies explicitly designed to encourage a major boom in housing. Mortgage loans went through the roof. The major bust in housing is what precipitated the economic crisis of 2008.

Problem: Government bureaucrats, like those at the Federal Reserve, rarely learn their lessons. Similar policies pursued from 2001 to 2007 have encouraged a major boom in the auto market. Car loans are in the same position as mortgages were pre-2008.

For automobile sales, business is booming:

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Correspondingly, total auto loan debt in the USA has increased tremendously:

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This is a problem on two levels. First, increasing levels of debt are rarely a positive thing. Generally, greatly increasing levels of debt indicate a psychological malaise among consumers. They are mortgaging their futures for pleasures in the moment. This can have drastic consequences down the line, both on a personal and macroeconomic level.

That’s just one problem. The other problem, which housing did not face quite as much, is this: cars are depreciating assets. They lose value the second you drive them off the lot, and it only goes downhill from there. Whereas a mortgage on a house can pay itself off if you buy the right kind of home in the right location, a car will probably never do this unless it is carjacked by a celebrity at some point. Bottom line: going into debt for a depreciating asset is almost never a good idea. But this is what people are doing en masse across the USA.

This is dangerous to the economy. Auto loans are extremely leveraged and thrown out like candy. Most consumers taking out $15K+ loans on a new car could easily spend $8K or less in cash on a high-quality and reliable used vehicle. This, in my opinion, is the best way to buy a vehicle. But I recognize that most Americans do not have this kind of cash on hand. Median bank account balances across the USA are near $5K, which is horrendous. Even more horrendous: nearly 30% of American families report living paycheck to paycheck with no cash savings at all. But people want brand new cars. They want the status and luxury of a new car, which is indeed a luxury. So people with a mere $5K in the bank, or nothing at all, take out a $15K+ loan on a brand new depreciating asset that loses value the second it drives off the lot.

Perpetual debt is sickness in the minds of Americans. Pay off one debt, move on to the next. Or worse, simply stack them all on top of each other and juggle a car loan, student loans, and a mortgage all at once. Debt, debt, debt. Whoopee.

CAR MARKET BUST?

The car market is booming today. But there are worrying signs on the horizon:

Car sales have been booming. But there’s a worrying sign in the latest retail sales report that the industry might have to shift to a lower gear.

Total light vehicle sales in October were at a decade high, and have been above 18 million for two months running, according to figures from Autodata. There is never been a time where sales have been over 18 million for two straight months.

But the retail report released by the Commerce Department Friday showed a decline in spending at motor vehicle dealers. The 12-month rate of spending on vehicles didn’t match the admittedly superb rate of growth in unit sales for the second straight month.

That means promotional activity. Volkswagen not surprisingly, in October revved up incentives by 56% compared with the same month of 2014, to counter the effect of the revelations that it illegally put defeat devices onto its diesel line. But it wasn’t just VW. Industry wide, incentives rose by 14%, according to media reports citing Autodata figures.

There have been a number of factors behind the surge in vehicle sales — the improving jobs picture, tumbling gasoline prices, loose lending and the revival of the housing market (the latter is particularly a driver of pickup truck sales).

But the rise in incentives suggests that auto makers realize that banner times may soon end. It’s not to say that auto sales will turn negative, but the prospect of higher interest rates, of slowing employment gains and tighter lending all could help puncture the auto boom.

This is a problem:

Auto sales have been a prop for the economy. They’ve been boosted by imprudent lending, with the average auto loan rising to $27,000 when the median household income of only $53,000, for an astonishing 65-month maturity — with 19.3% of auto loans going to people with subprime credit ratings.

The monthly volatility of auto sales makes trend changes difficult to see; this should be high on your list of things to watch. The inevitable crash in auto sales will be ugly, dragging down the entire economy. Automobiles have a higher multiplier effect on the economy than most retail products due to their size and complexity — consuming large amounts of raw materials and labor, requiring people to transport, sell, and finance them.

When the next recession hits, many people with basically no cash savings and a huge car loan are going to get their vehicles repossessed. Dealers are going to suddenly have way more used cars on their hands then they know what to do with. They’re going to want to get rid of these. Enter supply and demand: there are going to be amazing deals on used cars, which will also lead to amazing deals on new cars. The flooding of the market with fairly new and high-quality repossessed cars is going to smash prices across the board. Bad for producers, bad for retailers, but great for consumers ready to make a deal.

The auto industry, people associated with the auto industry, and people associated with people associated with the auto industry, are going to suffer. In other words, there will be a negative economic ripple effect across the entire country.

Housing prices have also increased rapidly over the past 4 years. San Francisco is the worst example of this, being in a full-blown real estate mania. What will happen if the housing market busts at the same time as the auto market? There will be an utterly resounding recession. It will be worse than 2008.

But it’ll be different next time. The Federal Reserve cannot repeat the same tricks it used to paper over the last recession. They have already expanded the monetary base over 800% since 2008. Most of this has gone into the excess reserves of the major banks. They can raise fees on excess reserves to attempt forcing these banks into lending out excess reserves. But this will present the threat of mass inflation, maybe even worse. This want to avoid this. Everything they’ve done over the past four years was explicitly meant to avoid having to do this again. But if the recession is serious enough, the federal government will demand they pursue inflationary policy in order to fund the federal deficit.

This will exacerbate another problem: investors will pile into relatively secure long-term US Treasury bonds. Rates will be pathetically low, but the security will be worth it to investors. This deprives the private sector of vital funding for capital ventures. This will have severely negative long term impacts. A dollar invested in the private sector is a dollar put to productive use – if not immediately, then eventually. A dollar given to the federal government is a dollar ultimately wasted. Basically, investors will be shoveling money into the federal furnace to be wasted on welfare, boondoggles, and foreign wars, while the private sector will starve.

CONCLUSION

Personally, I think a recession within 2016 or 2017 is inevitable. Perhaps I’ll have to eat my words, but I don’t think so. At that time, I intend to have a large cash reserve. The deals to be had on repossessed cars and foreclosed homes will be phenomenal.

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