Supply-Demand Disconnect?

Guest Post by Eric Peters

The price paid for the average new car continues to climb – it’s about $34,000 now – but sales of new cars are declining. This seems cognitively dissonant.

Or at least, economically dissonant.

Shouldn’t prices fall when demand ebbs?

Yes, they should . . . in a free market, which is free to respond to market signals. But we don’t have a free market. We have a Borg-like hybrid creature, a mix of free market and corporatist-socialist elements.

Unlike 7 of 9, it is not pretty.

Artificial demand is created by government mandates and regulations for “features” such as ASS – automated start/stop, which has been added to almost every new car not because of market demand but because the government demands that new cars burn slightly less gas, however much cash that burns.

Since the government isn’t paying for the demand it creates, someone else has to.

This would be us – the people buying new cars with all the “features” the government demands. But most of us haven’t got unlimited means to pay for them.

And so we finance them.

Car debt – as measured by the length of the average new car loan – has roughly doubled over the past quarter century, from three-to-four years to six.

To be fair, it’s not all Uncle’s fault.

Probably two-thirds of all new cars come standard with an tablet-style touchscreen and features and amenities such as AC, power windows and locks, four wheel disc brakes and alloy wheels that were once optional in most cars.

When car loans were 3-4 years long, most people could not afford luxury features as described above and so did without them. This market pressure kept the prices of most cars – average cars – within the economic reach of most people. Cars such as Cadillacs and Mercedes-Benzes were around, but rare – and driven almost exclusively by affluent people who could afford them.

Then along came easy credit – and extended financing, which has made it possible for the government to increase “demand” without apparent cost – and for people to demand what they can’t afford.

The several-fold increase in leasing – or rather, renting – is another barometer worth considering.

Thirty years ago, leases accounted for about 5-8 percent of all new car transactions; today, they account for about 23 percent. Again, it’s a way around the high cost – and a way for people to drive more car than they can afford. The lease payments are lower than monthly payments on a new car loan because you are renting the car for a short period of time, usually just 2-3 years.

But there are built-in limits and we may be in sight of them.

Loans on cars can’t be pushed out much beyond the current 6-7 years because cars are appliances – like microwave ovens or toasters. They lose value from the moment you open the box – or drive off the lot.

They also wear out with use, which contributes to the loss of value.

There is a financial tipping point with cars – the point at which their market value is less than the outstanding principle of the loan. That tipping point can be pinpointed. It is reached at about 6-7 years from the day the car left the dealer’s lot. This is why loans are “hung up” at this particular point and haven’t been pushed out much farther.

Because they can’t be.

Bankers are people who are usually good at math.

But then people are, too – at a gut-check level, at least. When a person making payments on a car realizes, after four or five years of making payments, that he still owes the bank more than the car is now worth, there is a temptation to cut losses – and stop making payments.

Many do exactly that. Note the latest repossession/default data – it is upticking, especially among buyers under 35, who are statistically most likely to bite off more than they can chew.

The bank is then left holding the proverbial (and empty) bag.

What’s in the bag – the loss – is then written off, but it doesn’t disappear into thin air. The costs of that loss are transferred onto the back of someone else, perhaps in the form of loan-shark interest rates on the repossessed – and now much-depreciated – five or six-year-old used car dumped by its original owner.

Or, the losses are folded into the costs borne by others for home loans and so on. Bankers do not just absorb the losses and smile.

There are synergies at work which will accelerate a denouement the likes of which we’ve never seen; which no one has ever seen.

There have been ups and downs in the car business – like any other business. But we are approaching a unique nexus. Or perhaps critical mass is the better way to describe it.

Not only are government mandates imposing increasingly impossible costs, not only are more and more people chaining themselves to unprecedented debt to buy new cars, new cars are also becoming more and more disposable – due to the exponentially increasing mechanical and electronic complexity of their systems – which are being added for regulatory compliance reasons and because people want more and more features and amenities – which they can’t really afford but which they can get loans for.

These systems wax ever-more-expensive to fix – and the nature of complex systems is that they tend to require fixing (often, replacing) sooner rather than later.

A very good example of this being an electric car’s battery pack. These can cost many thousands of dollars to replace – and can be counted on to need replacing years before the car itself would otherwise need replacing. But the car’s value has depreciated to a point at which it no longer makes economic sense to replace the battery, because of the high cost of doing so vs. the low value of the car, which by this time is probably only a third what it was when new.

So the car gets thrown away sooner. At eight or nine years old rather than 12 or 15.

The owner jumps back on the debt carousel. He finds it more manageable to get a new loan for a new car than to come up with a large lump sum (several thousand dollars) to fix what he has.

He’s still paying, though – and he’s paying more. It’s just made to seem like less.

Meanwhile, our wallets grow thinner – faster.

A time is approaching when there will be nothing left in our wallets except dust and lottery ticket receipts.

And we won’t even have enjoyed an evening with Jeri Ryan for our trouble.

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