Used engines for clunkers still in stock…

September 3rd, 2009

The Cash for Clunkers program ended last week in a wave of controversy. Many are praising the program as a success, as dealers have sold more cars in the CARS month than they have the rest of the year. Indeed, getting $4500 for a car that’s barely worth $1000 is an enticing proposition.

It is still important to mention the increase in fuel economy that the new wave of cars in our driveways will achieve, is a step in the right direction of helping the environment and reducing our dependence on oil, foreign or otherwise.

Many, however, were vehemently opposed to the program, expressing disapproval of the use of nearly & 3 billion of taxpayer money to fund it. Also, thousands of dealers across the country are missing millions of dollars each as they hold on to clunkers they’ve yet to be reimbursed for, and the method of destroying the old vehicles is dangerous and rather environmentally unfriendly.

Unfortunately, those opposed to the program were right, but there are other downfalls to the CARS program that will only become evident in the future, and therefore have largely been neglected.

CARS has created an automotive bubble. Much like the housing bubble which recently popped, the automotive bubble created by this program is on a much smaller scale and won’t have as drastic an effect as the housing fiasco, but will quite easily negate any immediate benefits that car buyers believe they’re currently enjoying.

The clunkers traded in during CARS will be destroyed. The old used engines will be seized, and the chassis will be crushed or shredded. Almost 700,00 clunkers that would have either ended up on the used car market, or in a junkyard selling their used engines and other parts to keep other similar cars running are now scrap metal. These effects are already being felt right now as many used-car dealerships are reporting a shortage of used cars available for them to buy and resell, according to this clunker article.

It also creates a big hole for the folks wqho could not afford to buy a new car and may need a good used engine for the clunker they are still driving.

Here is the problem as I see it:

Let’s use the most commonly traded-in clunker ( as it should be!), the Ford Explorer, as an example. Now that a large number of Ford Explorers have been removed from the used car market, their resale value will now increase. We’ll also consider that Ford has suffered extensively due to the recession and has significantly cut production of slow-selling trucks like the Explorer, thus making new Explorers that will be on the used car market in a few years also harder to find and likely to increase in value.

Let’s also say a family is in the market for a used 2002 Ford Explorer. But instead of finding them for around $8000 as they’re currently valued, they’re finding them for $10,000 or more. Also, since there are far fewer Explorers to choose from, they have little negotiating power. The family is also going to finance this vehicle; although the recession should be causing banks to tighten their lending belts, FICO has dropped the minimum credit score necessary to finance a car as a direct result of the CARS program according to this article. So the family buys their used 2002 Explorer for $10,000.

Lets go into the future 3 years, and that 7-year-old Explorer will become a 10-year-old Explorer. The market will have forgotten about the immediate effects of CARS and will return to adjusting its own prices. When it does, that $2000 of extra value the vehicle had will eventually disappear… and the family will then be upside-down on it, owing more money than it’s worth. The scenario looks even bleaker if the family was only able to finance the vehicle because of the current easing of the FICO lending restrictions.

That family may very well default on that loan, and the CARS program – which artificially inflated the price of the car and also lured the banks into a potential subprime automotive loan – will be the culprit. If this happens hundreds of thousands of times, that will be more of the same mess we’ve been trying to clean up for almost two years.

But it doesn’t end there.

The CARS program has created a bunch of new car buyers who may not of been able to afford a new car without all the “help”, which has depleted automakers’ supplies of small and fuel-efficient cars. Now that automakers are ramping up production to replenish those supplies – just in time for the buying frenzy to end – there will be a surplus of those cars, and they will lose value. That in turn will make the small, fuel-efficient cars people bought to replace their clunkers lose their value as well.

The value of those vehicles will be in even more jeopardy if the big truck market ever rebounds… after all, people quickly forgot about the oil shortages of the 70s and began buying big trucks again in the 80s and 90s. By nature people forget, If big trucks once again become fashionable, that will not only make the condition worse as in the Explorer story (non-fiction) described earlier, then the small and fuel-efficient cars that people just bought to replace their clunkers will fall out of favor. And then the used-car market will be inundated with small and fuel-efficient cars, and their values will drop significantly.

Either way, the same upside-down scenario will exist: the too-good-to-be-true deals people got on their small cars during CARS will have lost its luster, and they will owe more on their small and fuel-efficient cars than they’re worth, and if they were barely able to qualify for the loan (perhaps only because of the CARS rebate), they could again default on those loans.

Sounds familiar doesn’t it. It seems like everyone except the people who should have known that the CARS program would ultimately be a problem, did not see it. The folks who could not or did not buy a new car on a knee jerk reaction knew it.
Thus, the short-term advantages of the CARS will be quickly nullified, and the automotive industry will continue on its tumultuous path of uncertainty.

Like the housing bubble, this mini-bubble created by CARS for the automotive industry is guaranteed to pop. When it does, it will further damage the already-ailing industry, and inevitably slow the process of economic recovery. Try to find a clunker engine in a year or two?