The Cash for Clunkers car wreck

Dan Mitchell picks out one thing of the infinitely long list of worst features of the Barack Obama (mis)adminstration:

Three economists (from MIT and Tex A&M) have crunched the numbers and discovered that Obama’s Cash-for-Clunkers scheme back in 2009 was a failure even by Keynesian standards.

The abstract of the study tells you everything you need to know.

The 2009 Cash for Clunkers program aimed to stimulate consumer spending in the new automobile industry, which was experiencing disproportionate reductions in demand and employment during the Great Recession. Exploiting program eligibility criteria in a regression discontinuity design, we show nearly 60 percent of the subsidies went to households who would have purchased during the two-month program anyway; the rest accelerated sales by no more than eight months. Moreover, the program’s fuel efficiency restrictions shifted purchases toward vehicles that cost on average $5,000 less. On net, Cash for Clunkers significantly reduced total new vehicle spending over the ten month period.

This is remarkable. At the time, the most obvious criticism of the scheme was that it would simply alter the timing of purchases.

And scholars the following year confirmed that the program didn’t have any long-run impact.

But now we find out that there was impact, but it was negative. Here’s the most relevant graph from the study.

It shows actual vehicle spending and estimated spending in the absence of the program.

For readers who like wonky details, here’s the explanatory text for Figure 7 from the study.

The effect of the program on cumulative new vehicle spending by CfC-eligible households is shown in Figure 7. The figure shows actual spending and estimates of counterfactual spending if there had been no CfC program. Cumulative spending under the CfC program was larger than counterfactual spending for the months immediately after the program. However, by February 1 the counterfactual expenditures becomes larger and by April has grown to be $4.0 billion more than actual expenditures under the program. It is difficult to make the case that the brief acceleration in spending justifies the loss of $4.0 billion in revenues to the auto industry, for two reasons. First, we calculate that in order to justify the estimated longer-term reduction in cumulative spending to boost spending for a few months, one would need a discount rate of 208 percent. Given the expected (and realized) duration of the recession, it seems difficult to argue in favor of such a discount rate. Second, we note that Cash for Clunkers seems especially unattractive compared to a counterfactual stimulus policy that left out the environmental component, which also would have accelerated purchases for some households without reducing longer-term spending.

By the way, the authors point out that Cash-for-Clunkers wasn’t even good environmental policy.

One could also argue that this decline in industry revenue over less than a year could be justified to the extent the program offered a cost-effective environmental benefit. Unfortunately, the existing evidence overwhelmingly indicates that this program was a costly way of reducing environmental damage. For example, Knittel [2009] estimates that the most optimistic implied cost of carbon reduced by the program is $237 per ton, while Li et al. [2013] estimate the cost per ton as between $92 and $288. These implied cost of carbon figures are much larger than the social costs of carbon of $33 per ton (in 2007 dollars) estimated by the IWG on the Social Cost of Carbon [Interagency Working Group, 2013].

So let’s see where we stand. The program was bad fiscal policy, bad economic policy, and bad environmental policy.

The trifecta of Obamanomics. No wonder the United States suffered the weakest recovery of the post-WWII era.

A comment adds:

You missed one more. It was also bad social policy. There are two more things about the program that bothered me deeply.
Firstly, the program removed from the buying public a source of decent used cars. All of those cars were the types of cars that the less-affluent of our society typically buy. Now they had a choice of either keeping a much older clunker going, or doing with out transportation. Because all of the vehicles within their price range of affordability had been removed from the road.
Secondly as a car collector, I hate what it has done to the used parts market. A whole generation of good used car parts was removed from the marketplace. It was a requirement that the engines on these vehicles be run until they seized, and then the rest of the car was mandated to the crusher. This part never made ANY sense to me.
So, this program made a dent in the normal operational fabric of society that will have implications in the decades to come as well.

One of the accusations of Cash for Clunkers was that it would prompt people to purchase cars they couldn’t afford and then would have repossessed, just like the subprime housing crisis that crashed the entire economy.

Well, a few years later, the National Motorists Association reports:

For the past couple of months, there have been rumblings that auto loans are indeed on the same downward spiral as home loans were in 2008.  Fitch recently announced that loans issued in 2015 may end up being the worst performing ever in the history of auto-loan securitizations. Fitch rates the loans as cumulative net losses projected to reach 15 percent, exceeding the peak loss during the 2008 financial crisis.

This is a slow-moving train wreck however because experts are unsure about loans issued in 2016. The auto loan instability has to do with the fact that institutional investors grabbed subprime auto loan securities because of higher yields (similar to the subprime house loan crisis of 2008). These subprime auto loans have been repackaged several times over and stamped with a high credit rating.

Negative equity has hit an all-time high. During the first three months of 2017, the average negative equity per traded vehicles reached $5,195 which is the highest ever according to Edmunds.  Also the highest ever—the 32.8 percent of trade-ins with negative equity.  When the negative equity is then rolled into the new loan for the new vehicle—the consumer starts in a steep hole. In the event of a loan default, net losses soar.

Why all this negative equity? Business Insider says there are three reasons:

1)    Even though vehicle prices have gone up, consumers buy more expensive models because interest rates are low and longer loan terms keep the payments at an affordable monthly cost.

2)    Loan terms are longer. In the first three months of 2017, loan terms reached a record 69 months. Terms between 73 and 84 months (seven years) accounted for 32.1 percent of all vehicle loans in the fourth quarter of 2016, up from 29 percent in 2015 during the same period. Used-vehicle loans accounted for 18 percent, a two-percent increase from 2015.

3)    Used vehicle values are falling. In May, the Used Vehicle Price Index by J.D. Power Valuation Services declined for the tenth month in a row.

Also, just like with the mortgage crisis, many consumers who are seeking funds to buy a car do not really have the credit rating or the money to buy a car but are lured in with less than stellar lending practices. This usually means much higher interest rates for people who are already on the edge financially.

How can all this affect a motorist?

The New York Times recently profiled a subprime auto loan borrower named Yvette Harris who is still paying off her 1997 Mitsubishi even after it was repossessed.  Her auto lender took her to court and garnished her wages in order to pay off the difference of the sale value of the car and the outstanding loan. This is now a common practice of subprime lenders. Unable to recover the balance of loans by repossessing and reselling the cars, some are aggressively suing borrowers to collect what remains.

Why not take the chance on a risky borrower?

If he or she defaults, subprime lenders can repossess the vehicle and persuade a judge in 46 states to garnish the borrower’s wages to cover the balance of the car loan.

The impending subprime auto loan crisis might indeed be worse than the recent subprime loan mortgage crises for individuals. With a mortgage, a homeowner could turn the keys in and walk away. Not so with auto loan debt. Repossession is just the beginning of the quagmire for many car owners caught in the subprime auto loan trap. New York Legal Assistance Group consumer lawyer Shanna Tallarico said, “Low-income earners are shackled to this debt.”

In February, a Bloomberg article stated “To be clear, this doesn’t point to an imminent, 2008-style meltdown. After all, the U.S. auto-loan market is about $1.1 trillion, which pales in comparison with the $8.9 trillion U.S. mortgage market and $8.6 trillion of dollar-denominated corporate credit. And only about one-quarter of the outstanding car loans have been extended to subprime borrowers, who are the ones having the problems.”

Yvette Harris, the single mother living in the Bronx, mentioned earlier says this has been a nightmare. Even after $4,133 of her wages were garnished and she paid an additional $2,743 on her own, the lender still sought an additional $6,500. All for a vehicle that probably has a blue-book value less than $2,000.

 

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