VIDEO: Storm Clouds Ahead for US Auto Industry

Longer loan terms, better quality has serious implications for auto demand.

Ever wonder how, with economic growth stalled and the Western World staggering at zero economic growth, everyone seems to be driving a new car?

An interesting analysis by former Reagan administration budget chief David Stockman, on his site www.contracorner.com, tells an interesting tale of how the industry has racked up record years, but might be facing a downturn shortly. 

Take a look at this chart:

From 2010 to the present, annual vehicle sales have risen from USD$740 billion to $1.1 trillion, if the trend holds throughout 2016.

This is possible not because the unemployment problem has been licked, but because of the financing. The combination of ultra low interest rates and creative, often subprime lending has allowed almost anyone with almost any form of income in America to buy or lease a new car.

To put financially strapped Americans into new wheels, American lenders are issuing riskier loans and over longer terms.

Look at this chart:

With typical loan terms now out to six years or longer, there’s a twofold challenge: The first is to the industry to make the vehicles durable enough to justify financing over 70 or more months, and the second is to the dealer network and that one’s tougher.

Today, about a third of vehicle trade-ins are “upside down”, meaning they’re worth less than the outstanding balance on the original loan. To refinance this debt and move the new product, some dealers are financing up to 120 percent of the value of the new car purchase, meaning owners are piling old debt onto new. 

According to Stockman, the amount of subprime auto loan debt is three times higher than on the eve of the 2008 crash.

Of course the flip side of a new car sales and leasing boom is all about the trade-ins. In a bubble like this, it doesn’t take much of an increase in used car and off lease vehicle supply to crash wholesale used car values, which in turns kills trade in value and drives the debt to equity ratio of new car owners even more upside down.

In the 2009 crash, sales dropped 20 percent and new vehicle sales imploded, falling to a little over 10 million from a peak of 18 million units.

According to Stockman, the amount of subprime auto loan debt is three times higher than on the eve of the 2008 crash and the number of used units on the market is increasing.

Take a look at this graph from Manheim Consulting compiled by The Wall Street Journal:

Now, the auto industry has always been cyclical. But this time it’s different.

The current boom is fuelled by super low interest rates and historically loose lending practices, combined with the one factor the financial community never seems to factor in: the build quality of current vehicles.

While trade-in value is determined by market forces, the longevity of modern cars and trucks isn’t. They last longer than ever before, reducing the absolute need to buy in an economic downturn.

In the past, 100,000 miles was an approximate limit. At that point, expensive components broke and like it or not, you were in the market for a new car. Not so today. There are at least three cars I know of in the ENGINEERING.com parking lot that are over 200,000 and I expect both my Infiniti G35 and my F-150 to hit that milestone.

The industry builds ‘em better than ever, so there will have to be another compelling reason to buy in the next downturn, other than necessity. Maybe self-driving cars?

Written by

James Anderton

Jim Anderton is the Director of Content for ENGINEERING.com. Mr. Anderton was formerly editor of Canadian Metalworking Magazine and has contributed to a wide range of print and on-line publications, including Design Engineering, Canadian Plastics, Service Station and Garage Management, Autovision, and the National Post. He also brings prior industry experience in quality and part design for a Tier One automotive supplier.