Re-visiting the Car

While I dream about owning a Nissan GTR that I saw at the Chicago auto show, in reality I drive an old Nissan Altima about 10 years old. That damn car will run forever since I take decent care of it and my frugal nature won’t let me replace it without a valid reason.

As I drive around in my older car, however, I can’t help noticing all of the expensive cars out on the street. Right now it is Saturday night here in Chicago in River North, and lots of people are “cruising” up and down the major streets, seeing and being seen, in their tricked out cars.

The situation is the same even when I visit a poorer neighborhood. A relative of mine moved to Beverly, in the south side of the city, and no matter how you drive to get there, you need to go through some pretty rough neighborhoods. New and expensive cars are ubiquitous, even there.

Let’s think a bit about car economics. If you use $25,000 / loan at 48 months as a starting price point, and the average rate of 6.5%, you are paying about $600 / month.

However, that “minimum payment” model has gone belly up. Here’s why.

Car manufacturers have gotten out of the 1) car loan business 2) car leasing business. In order for them to finance the loan, they need to guess what the resale value of the car will be at the end of the lease, as well as the likelihood of the owner defaulting (they can repossess the car but this is an added expense and it comes with the risk of the car being trashed along the way). They also need to have the cash available to make the loan, and pay interest on this entire amount of the cash, until it is paid back. The asset backed securitization model that let them push the risk onto outside investors has essentially seized up in the credit crunch, so they can’t unload these items off their balance sheet.

The car dealers and their financing arm look like lousy credit risks, so it is getting difficult for them to raise money, that they would in turn use to loan out to customers. Chrysler stopped leasing cars in August 2008. GM (through their financing arm GMAC) stopped financing (for sale or lease) customers with a credit score below 700. This article also mentions the fact that Ford is getting out of truck leases, and has an example of someone who leased a 2006 car costing $35,000 for under $200 / month (see how BUYING a $25,000 car costs $600 / month up above).

When it comes down to it, over 50% of Americans have a negative net worth, meaning that loaning them any money for anything is likely to be a losing proposition long term. The car companies have to put a lot of money into a $25,000 car and then they turn that into a string of payments to someone who doesn’t have much equity in their home or savings and they are pretty much just betting that person will continue to make payments AND that the car’s resale value won’t fall off a cliff.

What would you say if someone who had little in the way of savings and tangible assets, and who was burdened with heavy home debts, asked you for thousands of dollars to finance a car loan? You need to raise that money, and pay interest on the money, as well as take the risk on the car repossession and resale values years out, to someone who can’t even come up with much of a minimum payment.

The model is dead. Leasing is gone, and car loans to dodgy buyers are going the way of the dodo.

If you want a car, and you don’t have a lot of money, then you will need to put a big down payment of your own money on a used car more in line with your financial limits – which means a $2000 – $5000 car. When you go into those neighborhoods, or even nicer suburban neighborhoods, you will see many less shiny new cars out and about, because people can’t come up with the sales price and financing is fading away.

Even Mercedes and BMW will eventually feel it… while there are a lot of wealthy people, if they actually have to come up with the cash to purchase those $50,000 / or more cars, sales will plummet. With leasing deals limited, the customer will need to pony up a lot of cash to drive one of those cars off the lot.

I looked at the Chicago Tribune ads this weekend:
– GM, Chrysler and Ford all talked about the “total” car price, less incentives
– Toyota and Nissan still talked in terms of monthly payments, along with Audi and BMW

Part of the reason that Toyota, Honda & Nissan can still discuss monthly payments is the fact that their cars depreciate much slower than the US models. For instance, a Caddy will lose about 50% of its value in just 2-3 years, while the equivalent decline in value for a Honda, for example, will be far less.

With the easy financing gone, let’s all just re-evaluate our love affair with new and flashy cars. Beyond basic transportation and safety features, cars are viewed as a sign of economic virility or personal expression. But we can’t afford this anymore, and there is no one to finance this type of turnover (buying / leasing a new car every few years).

Paying interest on something that is rapidly depreciating is madness; in homes we are seeing a giant version of the same sucking sound (paying interest on an asset declining in value) with a corresponding wrenching impact on the economy; but the same thing happens each time you drive a car off the lot, especially when it is full of features beyond the basics.

In a way, we are back to square zero. Growing up, my family always bought used cars, as did most everyone I knew. Only a few of our wealthier acquaintances would buy new cars, and even fewer would do so every few years. Leasing, low interest rates and asset securitization allowed many Americans the (foolish) option of buying new cars, but now this option is receding into the distance.

This month the major US automakers posted huge declines against prior year sales, up to 40%. This shock was partially due to the fact that the economy went off a cliff, but another major element was the absence of low cost financing. Among all the other problems for car makers, add this to the list, and it is likely to be the bullet that finally takes them down, unless they are substantially rescued by the US government.

Cross posted at LITGM

8 thoughts on “Re-visiting the Car”

  1. I work in the Loop and take the train from Oak Park. I don’t own a car. My wife has a minivan to drive the kids around. It’s a very solid Toyota. Not a prestige vehicle, but it works. And it’s paid for. My Dad had a 1966 Oldsmobile that he finally got rid of in 1983. I have never understood the business of cars as personal expression.

  2. The Nissan Pathfinder was at 271,000 2 months ago when a pair of mechanics, consulted independently, announced there was a replacement transmission in its immediate future. I went down to GMC for a diesel pickup. They offered 5.25%. I financed myself at 0%. I think the resale on these is pretty good. Doesn’t matter if it is or isn’t, really; I should get 500,000 miles from this truck.

    There’s much to choose from but perhaps the Marxist insight that quantity changes quality is his most misleading and dangerous. We constantly see attempts to explore this, from the personal to the global. It fails immediately on the personal level, requires a few years to a decade to bring down cities and states, and 1 – 2 decades to bring down countries. So with the financing of shiny new gewgaws for individuals and social programs for societies. It’s death, but death a little delayed. Each level up the line states that it is exempt from the consequences visible in the level below. Yes, that behavior may have bankrupted individuals. (Financing new cars is the most common trigger of bankruptcy in the mid-20s set.) But it certainly won’t bankrupt our city’s pension system. Our state’s. Our country’s. It’s sheer quanity exempts the large system, which is qualitatively different from the small.

  3. “… cars are viewed as a sign of economic virility or personal expression.”

    I’d like to think that that is changing and that a flashy new car is now seen as a pile of unsecured debt on four wheels, and a new SUV as a $100 weekly gas payment. Sadly, I look around and don’t notice much waning in the “too much car” trend despite the overabundance of warning signs against such behavior. Blogging Stocks reported this morning that during this short break from high gas prices Americans have already started to drive more and resumed purchasing fuel-inefficient vehicles.

  4. Leasing was always a bad deal if you are the kind of person who prefers to minimize life-cycle costs by keeping cars for as long as they are reliable. At best a lease is like a two- or three-year trade-in cycle where you are always eating max depreciation. It may make sense if you can expense the lease or if you have a business need to drive a late-model car.

  5. “… cars are viewed as a sign of economic virility or personal expression.”

    By whom? The drivers or prospective passengers?

    A lot of otherwise inexplicable economic behavior makes sense in terms of status signaling. I believe Harry Hutton wrote the definite paper on this. If Eugene Fama doesn’t get the next economics Nobel, Hutton probably will.

  6. A study came out this year that said people with poorer peers spent a larger percentage on flash than people with that same income who had same earning peers. Intuitive but they made it sound more interesting than that.

    As for the rest: never under estimate culture and how fickle it is. When I lived in Australia in 1990 people pointed out with pride that Americans kept cars for an average of 4 years but Australians kept them for 8. The price differential didn’t explain the gap.

  7. When I first went to college, I bought a used (14-year-old) Ford Taurus wagon from my uncle for cheap. Since my uncle was a mechanic, and I visited him weekly, I was pretty sure the car was in good enough shape for my purposes.

    When I reached a stage in life where that car was no longer trustworthy (planning a 5000 mile road trip with some key dates along the way, including a party in Chicago and a training session in Seattle 2 days apart) I went with a brand-new, bottom-of-the-line 2004 Chevy Aveo. Paid it off in about a year. A couple years later my wife and I ended up working in different areas, so we bought a second (this time slightly used) Chevy Aveo, and paid it off in 6 months.

    I know the resale value on these cars is nothing near what we paid for them. I didn’t buy them to resell them, though, I bought them to get me from point A to point B reliably and comfortably. That’s really the key — if you buy a vehicle you can afford in order to get to point A to point B, and the reliability/features are worth the difference in price from a used car, then you’re doing good. If you buy a new car with extra bling in order to show off to your friends, and you need creative financing to do it, then you’re SOL now that the credit market has returned to sanity.

    Note I didn’t say the credit market “collapsed”, I said it “returned to sanity”. If you’re a good credit risk, you have your choice of loans — because banks need people like you on their balance sheets to cancel out the bad risks they already took! People who never should’ve got loans in the first place now can’t get loans… and people who can afford them can still get them.

  8. Two points:

    1: Hear hear for the durable Nissan, and for keeping well-running but old vehicles! I drive a ’93 4×4 pickup that I bought for 14k back in ’96, and have put 150k miles on it. It is long since paid for, runs like a champ, and since it has its share of dents, scratches and faded paint, I don’t care if it gets dinged in the parking lot by a door or shopping cart. Heck, I haven’t even washed it in two years. Because of a good driving record and the fact I only carry the minimum required insurance, it costs almost nothing to own. Plus nobody will bother to break in or steal it when it’s the crappiest ride in the lot.

    2: I was working down in west Texas a few years ago. Wondered why I was seeing clean, well-maintained and customized $50,000 trucks and SUV’s parked in front of houses most people would just as soon burn down than live in. I mean crap-shacks and shanties. My answer: illegal aliens from south of the border working in El Norte put their money into the one thing they might be bring with them or pass to friends and family should they get deported. It’s mobile equity.

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