After the Federal Reserve initiated quantitative tightening (QT) in late fall of 2017, I published “96-Month and Subprime Auto Loans – It is All Good Until…” in May of 2018. At that time, household debt was at an all-time high, the Fed was raising interest rates at .25% increments, it was reducing its $4.5 trillion balance sheet blowout from the Great Financial Crisis at a snail’s pace, and traditional auto loans were morphing into much longer payment terms. The issue with a long payment plan is that a vehicle depreciates faster than the value of its outstanding loan balance, creating an underwater loan-to-value ratio.
The stock markets were not happy about the Fed launching QT, and the stock indices started to roll over and chop sideways during the winter of 2018 until late fall 2019. In mid-summer of 2019, the Fed pulled a Taper Caper by announcing an earlier than expected end of QT and launched an unprecedented REPO program in Sep. of 2019 to address a growing liquidity crisis in international banking.
By late Dec. 2019, it was clear to anyone that followed international news and financial markets that a global pandemic was brewing in China. The U.S. fiscal and monetary policy response to the pandemic and subsequent additions to the CARES Act, delayed financial risks that were baked in the cake with astronomical household debt, concern over the national debt that has reached $30.5 trillion as of today, and then we have that auto loan bubble.
A lot has changed in the world over the last two years that’s too complex to dissect for the scope of this article, but it’s all partially responsible for the current technical recession and potential hard landing the U.S. is careening into. Since mid-June, data for 2Q22 surfaced across multiple media platforms about a deteriorating supply vs. demand situation in the auto industry, and warnings were given about indebted plebes with car loans that are slated for the delinquent parking lot. The repo man will be more than happy to oblige banks in repossessing an ocean of new and/or used cars in the pipeline. It’s not the line of work I’d want to be in, but somebody has to do it.
Since mid-2020, wholesale used car pricing skyrocketed, and retail demand remains high in 2022. Retail prices have dropped a little, but the average price is still at a record high of $28,365, up from $21,572 two years ago. New vehicle production is expected to be sluggish through the rest of 2022 and 2023 due to ongoing supply chain issues and a shortage in microchips. Therefore, used car buying will likely hold momentum, and dealers can keep inventory at a minimum to maximize profits. Note that interest rates are rising in a recession and will likely create some demand destruction in the purchase of new and used vehicles.
New vehicle inventory remains low in 2022 and is attributed to the ongoing microchip shortage, supply chain issues, and the Russia-Ukraine war. The conflict created new vehicle production disruptions because of airspace restrictions, surging metal prices, and a shortage of palladium and neon. Pre-pandemic supply levels of microchips and metals may arrive by 2024 or 2025, which would return balance to pricing for new and used cars.
The following three charts on new vehicle data are courtesy of Wolf Street:
New vehicle sales have plunged across the industry in 2Q22. The most recent data for June printed an average 25% crash in sales vs. June 2019. That’s like the 1970s, and we have inventory shortages on top of it. Under current conditions, consumers are waiting months for delivery when ordering a new vehicle and are paying record-high prices with few to no incentives offered by dealerships. The average price for new vehicles sold by dealers at retail hit a new record high of $45,844, up by 14.5% vs. June 2021.
Affordability no longer exists anywhere in vehicle sales and the average interest rate on new car loans spiked to over 5% last month. Despite high trade-in values for used vehicles that lower the amount to be financed, the average monthly payment still jumped nearly 13% YoY.
Car Sales Crash 20%+ | Average Payment Skyrockets to $700+ – YAA
Average car payment hits record $712/month as new, used car prices continue to climb… “The average car is getting less affordable for the average person, with typical monthly payments hitting all-time highs. According to a report by Cox Automotive and Moody’s Analytics, the affordability of new vehicles continued to climb in May for the fourth month in a row, with monthly car payments averaging $712 per month… Consumer Price Index data from May showed that over the previous 12 months, new car prices have gone up 12.6%, This and rising interest rates have made monthly payments higher than ever. Used cars have increased even more with an increase of 16.1%.” – Fox Business, Jul. 3
Barron’s chimed in this past week with an ominous report that car repos are exploding.
Car Repos Are Exploding. That’s a Bad Omen… “Lucky Lopez is a car dealer who has been in the business for about 20 years. In recent meetings with bankers, where he bids on repossessed vehicles before they go to auction, he has noticed some common characteristics of the defaulted loans. Most of the loans on recently repossessed cars originated during 2020 and 2021, whereas origination dates are normally scattered because people fall on hard times at different times; loan-to-value ratios, or the amount financed relative to the value of the vehicle, are around 140%, versus a more normal 80%; and many of the loans were extended to buyers who had temporary pops in income during the pandemic. Those monthly incomes fell—sometimes by half—as pandemic stimulus programs stopped, and now they look even worse on an inflation-adjusted basis and as the prices of basics in particular are climbing… Banks’ auto lending standards… went out the window, and lenders jumped on the bandwagon of overpaying for cars, Lopez says. ‘Everybody thought the free gravy train would never end.’ Now, he says he has never seen so many people making $2,500 a month owing $1,000 a month in car payments… Pamela Foohey, law professor at Cardozo School of Law at Yeshiva University, warned in 2021 of an auto-loan crisis. Barron’s checked in with Foohey this past week. “The bubble is beginning to show signs of bursting soon,” she says, pointing to the overall spike in car prices that has led to larger loans and to rising repossession rates.” – Barron’s, Jul. 8
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