Cash for Clunkers Fail

With the Cash for Clunkers deal ending on Monday, it’s time to do some analysis on its usefulness.

Clunkers Positives

Let’s look at some positives to begin with.

• We are reducing the total supply of cars on the road, hence increasing the value of cars that car manufacturers can sell in the future
• Average gas mileage is improving nationwide. I read that the average improvement on the cars turned in from this program is somewhere between 5-7 miles per gallon. This will reduce these peoples annual gasoline costs and hence reduce our nations dependence on oil.

That’s about all I can come up with. I do not think the incremental benefit of driving in a nicer car (thus making you happier, more productive, etc.) is a benefit of this program. That is accounted for in the extra amount people are paying for their new car. These are also sales that will most likely already be happening within the next few months or year, anyway, so the only incremental edge from the program there is the extra few months buyers will get to enjoy the benefits of a newer car.

In the Red

Now, let’s look at the negatives of the program.

• Some people are actually turning in cars worth more than $3500 or $4500. Unfortunately, the deal does not give any rebate value to your old car, so clunkers redeemed worth more than $4500 are actually being redeemed at a loss.  It sounds ridiculous that this could happen, but I do not think this was very clear that there is no trade-in value given to your car, and thus it has happened.
• The government has been so slow paying the rebates to the dealerships (which front the rebates) that some of them are going out of business as their cash flow dwindles. Of the $1.9 billion in rebates that the dealers have given out, only 7%, or $145 billion, has been repaid by the government thus far. Auto producers are offering dealers bridge loans as they wait for the government bureaucracy to get the payments out faster.
• The program is merely borrowing sales from previous and future months. Apparently, car sales dropped dramatically for the two weeks prior to the program as people waited for the program to start. Likewise, anyone who was planning to this sort of purchase over the next 3-6 months surely sped up their plans and made the trade over the last few weeks. Thus, the sales over the next few months should drop even more than normal.
• The program is encouraging the buying of new cars to some people that should probably not be adding a car loan to their debt. The government is trying clean up a subprime mortgage crisis in one hand, while encouraging car loans for many people who, from the look of the car they were driving previously, should obviously not be owning a new car. Obviously, this is not true for everyone. Some people can afford a car payment and merely have driven that clunker too long. However, the program naturally targets the wrong demographic in my opinion. Poor form, I say. 
• Purchasing new cars means you are buying an asset where are you are 15% under water the moment you take it off the lot.  In other words, you go from owning an asset outright that you are probably through making payments on (perfect in a recession) and can sell for fair value if necessary, to monthly car payments for 115% the resale value of what you just purchased.  It’s like selling a house you own outright at the fair value price of $50,000 in order to buy a house worth $300,000, yet taking out a mortgage worth $345,000 for that house.

Clunker Conclusion

Yes, the positives are significant.  Reducing oil costs and emissions is helpful longer term for our environment.  However, is it helpful to our economy?  Are these positives really what we need right now?

Basic economics.  If demand stays the same, reducing supply increases the price of cars on the road.  We have seen this happen quickly as dealers stopped offering any other discounts or incentives during this period.

However, we temporarily increased demand, by borrowing from future demand.  So, demand will drop in the coming months and prices will come back off.

Where do we end up?  Back where we began.  The auto manufacturers (especially US manufacturers who have only 2 cars in the top 10) will not see an overall change in cars sold on the year.  However, the taxpayers are out an extra $3 billion.  This $3 billion has been effectively redistributed to a demographic which I believe does not need more debt via car loans.

I do believe the intentions of the program were good.  I did not criticize or hail it to begin with.  However, I think it was poorly planned and even more poorly executed (typical government program) and thus the program was a failure.  For the few people who upgraded correctly and can afford their new car, please thank your neighbor for the extra $4500 cash in your pockets.

*image source: showitortowit.com

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