Obama Cheers The Auto Industry Over A Cliff

Obama Cheers The Auto Industry Over A Cliff

Even as the president celebrates a U.S. auto sales record, there are signs that the car bubble his policies helped inflate is already beginning to burst.
Edward Niedermeyer
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In his final State of the Union address, President Obama bolstered his economic credentials with what appears to be an uncontroversial fact: “Our auto industry just had its best year ever.” Sure enough, with just under 17.5 million vehicles sold, 2015 was indeed the highest annual sales volume ever recorded.

But not everyone in the industry shares the president’s triumphal perspective on the auto sector. In fact, just hours before the State of the Union began, the CEO of one of the country’s largest car dealership chains warned the industry that old, bad habits threaten to undo one of the president’s most cherished economic accomplishments.

Only days later, a lawsuit against Fiat-Chrysler alleges the automaker faked some of those record sales. Even as the president celebrates a U.S. auto sales record, there are signs that the car bubble his policies helped inflate is already beginning to burst.

No Buyers? Make More Vehicles

Speaking at the Automotive News World Congress adjoining the Detroit Auto Show, AutoNation CEO Mike Jackson warned that new car sales are unlikely to climb much past 2015’s record-setting number, an unusual argument for a car dealer to champion. The very optimism that seems so innate in car dealers and manufacturers alike, he argued, could turn a mere slowdown into another disaster.

‘Don’t be in denial. We’ve failed this test every time.’

Calling the entire industry “clueless” about managing slowdowns, he said, “We’ve never done it. Don’t be in denial. We’ve failed this test every time.”

Jackson said every auto manufacturer he had met with at the Detroit show had planned on growing sales in 2016, which he called a “recipe for disaster” in light of slowing demand. Pointing to the growth of “stair-step” incentives, where automakers provide bonuses to dealers who meet volume goals, he predicted rising inventories and shrinking margins unless the industry demonstrates unprecedented discipline.

“If everybody is ambitious in their plans and then produces to support that plan and inventory explodes and we have to push back, then you’ve lost control,” he warned.

Easy Money Fuels Bad Habits

The bad habits Jackson describes have crept back into the business over the course of the recovery, thanks to a rising tide of cheap auto credit fueled by low Federal Reserve interest rates. The low-rate environment has lowered the costs for lenders and boosted institutional demand for auto loan-backed securities, which not only brought more buyers into the market through subprime expansion but also helped them buy more expensive trucks and SUVs with extended loan terms.

Since car buyers are more indebted and face longer pay-off periods than ever, rising rates are likely to knock them out of the market for longer.

The average term for new car loans has climbed above 65 months, the average amount financed is breaking records as it approaches $28,000 per sale, and subprime loans make up 22 percent of the market, up from 17 percent in 2009. At General Motors, automotive revenue was actually down during the first three quarters of last year’s record-breaking sales, with finance revenue providing much of the growth.

With automakers and car buyers equally addicted to cheap credit, the Federal Reserve’s move to raise interest rates heralds an end to the party. The New York Fed has warned that each 100 basis-point increase in interest rates could cause a 12 percent decrease in auto production, and Fitch has pointed out the potential knock-on effects on auto loan-backed securities.

Since car buyers are more indebted and face longer pay-off periods than ever, rising rates are likely to knock them out of the market for longer regardless of how much automakers slash prices and profits. Ford got a small taste of this scenario late last year, when its “Friends and Neighbors” incentive program—which offered discounts of up to $10,000 on some models—failed to drive sales because it lacked a 0 percent credit offer.

Potential for Unbought Cars Glutting Car Lots

If the Federal Reserve continues to raise interest rates over the next four years, automakers will have to cut into their finance profits to subsidize the loans deals needed to keep the market at its high-paced rate. With automakers telling dealers like Jackson that they plan on continuing to grow sales, it won’t take long for this competitive pressure to turn the entire business into a profitless nightmare.

It won’t take long for this competitive pressure to turn the entire business into a profitless nightmare.

Dealers who have been suckered into giant inventories with stair-step incentives will be left holding the bag. Factories and suppliers that ramped up capacity during the credit-fueled boom will cut production and jobs as the auto bubble unravels and reverts to the wider economy’s disappointing mean.

This scenario is not inevitable, but unless the industry heeds the warnings from Jackson and others it could become more likely than anyone wants to believe. Already there are signs that the Obama auto bubble is unraveling: in addition to allegations that Fiat Chrysler falsified sales to hit volume targets, Deutsche Bank is investigating whether its employees exaggerated demand for auto loan-backed securities.

Unfortunately, the president’s sense of ownership of the auto sector’s apparent success has him cheering on big sales numbers instead of adding his voice to the calls for caution. Apparently even he fails to understand that a major component of his legacy—not to mention the U.S. economy—could be at stake if he continues to cheer the auto industry over a cliff.

Edward Niedermeyer, an auto-industry consultant, is the co-founder of Daily Kanban and the former editor of the blog The Truth About Cars. Follow him on Twitter.

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