Hello and welcome you are listening to Patrick Boyle on
Finance, a podcast exploring ideas from quantitative finance,
examining events occurring in markets right now and financial
history to see what lessons can be taken away, including
interviews with some of the most interesting people in the world
of finance. To learn more about the podcast
visit on finance.org. Over the last three years, we've
seen the biggest car price increases in history.
Last year, the average cost of a new car in the United States was
$47,000, and the average used car price today is just under
$30,000. Between January 2021 and January
2023, used car prices have gone up 52%, while new cars rose by
almost 28%. During that same period, the
median household income in the United States saw a 13%
increase, meaning that in the past couple of years used car
affordability went down by almost 40% and new cars became
15% less affordable. The price hikes can be traced
back to the pandemic, when manufacturers halted car
production due to a lack of demand during lockdown in 2020
when economies reopened. There were shortages of
important parts like semiconductors, and factories
were unable to scale up manufacturing quickly enough.
This meant that buyers who needed to buy a car over the
last few years were forced to pay at or above sticker prices
for new cars. Long waiting lists meant that
people who might have preferred to buy new cars were buying used
cars to get one quickly enough, and because hardly any cars had
been built in 2020. There was a shortage of 1 to 2
year old cars, so they found themselves buying older cars
than they might have wanted, and they had to pay through the nose
for them. Car buyers today aren't just
faced with higher car prices either.
Central Bank's efforts to curb inflation over the last year or
so have pushed the average interest rate on a new car or
truck loan to just under 9% in the second quarter of 2023.
Up from 5.7% a year ago. Lots of drivers, seeing these
high prices, decided to hold on to their cars a bit longer than
they might normally do, just wait till prices fall a bit
before buying. For this reason, people have
been keeping their old cars on the road a lot longer than they
historically have. These older cars that might
normally have been scrapped are being patched together and kept
running. All this extra repair work has
been great for mechanics, but it's meant that it has become
significantly more expensive to get your car fixed than it was
in the past. Mechanics get to charge a
premium when things are this busy, and car parts become more
expensive when demand is high. We're not done yet, though.
Auto insurers have found themselves losing money on
underwriting car insurance policies.
And so auto insurance policy prices have been rocketing, too.
Anyone who's needed to buy a car, either new or used,
recently has been faced with a perfect storm of price
increases, and there's been no easy way to avoid it.
So let's look at why this has been happening and how things
might work out going forward. So in 2021 and early 2022,
global shipping problems, a semiconductor shortage and
factory shutdowns collided with a rapid increase in consumer
demand for cars, pushing vehicle prices sharply higher.
It was initially believed that as auto manufacturers ramped up
production and higher interest rates kicked in, that things
would normalize. Instead, prices for new cars
continued to rise as automakers build fewer new cars and focused
on the most profitable luxury models rather than the budget
models where the shortage is now greatest.
A dip in used car prices in 2022 helps to lower overall inflation
that year, but used car prices began rising again this spring
as low supply encountered a new surge of demand.
The high new and used car prices turned out to be surprisingly
sticky. New cars in particular continued
to get more expensive in 2023 as manufacturers fought to maintain
the fatter margins they had enjoyed in 2021.
Pre Pandemic. The dynamic in the auto business
was that both pricing and profitability were under
constant pressure, driven by consumers shopping for discounts
online. Price comparison websites were
the car dealers nemesis. If you advertised the price that
was too high, buyers wouldn't turn up on the dealership lot.
At the same time, automakers were producing more cars than
there was demand for, and then they had to offer incentives to
clear inventory. Dealers made their profits on
volume and financing, often dealing with consumer complaints
for hidden charges like paperwork fees.
When customers came rushing back in 2021 to buy new cars,
semiconductors needed for building modern cars were still
hard to source. Manufacturers were also
struggling with sourcing parts from China that was still
enforcing lockdowns and Russia and Ukraine, where parts like
wiring looms are made. Auto manufacturers allocated the
scarce parts they could get to the highest priced, highest
margin models, trucks and SU V's.
They made-up for the lower sales volumes with higher profits on
each sale. So while new cars were now being
built, about 5,000,000 cars that normally would have been
produced never were. The car shortage really worked
for car dealers too. They could charge well above
list price, especially for the hottest new models as stimulus
programs rolled out and office workers were adjusting their
lifestyles now that they could work remotely.
There was more demand for new cars than supply, and car buyers
were willing to pay up to get the car that they wanted.
The Bureau of Labor Statistics in the United States published a
study recently that showed the dealer markups accounted for
between 35 and 62% of total new vehicle consumer inflation from
2019 to 2022. The markups were good for
dealers even if the lower sales volume was bad.
In aggregate, the last 2 1/2 years have been an extremely
profitable period for car dealers, the best time they've
had in quite a while. Tom Bark and the President of
the Federal Reserve Bank of Richmond recently told an
interviewer that during this two year period, auto dealers and
auto manufacturers discovered that a low volume, higher price
model was actually a very profitable model.
Consumer demand is still incredibly high.
And this is the case all around the world.
Britain's used car market just recorded its strongest spring in
three years, with 1.8 million cars sold between January and
March. This year.
There were a record 82.5 million visits to the Autotrader website
this March, 15% higher than a year earlier.
Automakers cut way back on building their cheaper models
and even low spec models if they're more expensive cars.
They rolled out electric vehicles in response to
government subsidies. But even with the subsidies,
these don't tend to be affordable to the average car
buyer. The lack of new affordable cars
being built meant that consumers on a budget could only find used
cars in their price range. And of the five million cars
that were never built, the shortfall I mentioned earlier,
most were affordable or entry level vehicles.
Right now, the number of cars that would typically be
available second hand after coming off 3 year leases is
significantly lower than normal. The people who leased cars right
before the lockdowns are mostly buying out those leased vehicles
at the prices that were said in the lease agreement before car
price inflation kicked in. They'd be foolish to do anything
else. All of this means that the
competition for the most affordable vehicles is the most
intense. People who live paycheck to
paycheck, whose jobs require them to turn up to work in
person, just can't get by without transportation.
The job market has been quite strong for this group, who often
work in industries like hospitality and healthcare, so
they've been paying up for used cars as they simply have no
other choice. Because there's so much demand
for affordable transportation, there are a lot of cars on the
roads today that historically would have been scrapped by now.
Cars that you couldn't have given away for free a few years
ago are now a valuable commodity.
The average age of a car on American roads is now 13 1/2
years old, which compares to 9 1/2 years old a decade ago.
There are a lot of junkers available second hand and a lot
of high end, high spec cars available.
New but not many average cars available for middle class
people. So people are spending more and
more on cars. According to TransUnion, a
credit reporting agency, the average monthly payment for a
new car has risen by over $150.00 per month to 736 dollars
in the first quarter of 2023. Used car monthly loan payments
have gone up by an average of $110.00 to $523 over the same
period. In an economic slowdown, many
people could struggle to make these payments.
As interest rates have gone up, lenders have started backing
away from the auto loan market. This is partially driven by the
regional banking crisis that we saw earlier this year.
The falling availability of credit has been documented by
the Twitter account Car Dealership Guy.
Lenders are today worrying that car prices might collapse such
that loan sizes become greater than the value of the cars
securing the loans and they don't want to make any new
loans. This is particularly the case
for subprime auto loans where buyers are paying high prices
for low quality cars. If these cars break down, the
buyers may be unable to afford to fix them and just stop making
car payments. High interest rates combined
with only expensive vehicles being available makes for a
difficult car market, especially as consumers are starting to
feel squeezed. As of last month, there were
over 140,000 half ton trucks. By the top 4 truck makers, Ford,
Chevy Ram and GMC sitting on dealer lots unsold in the United
States. Many of these trucks are high
spec versions in the 60 to $80,000 range and they've been
sitting on dealers lots for over six months.
Dealers typically finance their inventory with what are known as
floor plan loans. These loans which a year ago
would have been quite cheap. Now of interest rates as high as
12%, and many lenders are trying to exit that business.
Increased pressure on disposable income has been putting the
consumer in a tight spot. Disposable incomes rose in 2020
and 2021 as the pandemic led to debt forebear and stimulus
checks and better unemployment benefits.
Today, as these programs are disappearing in the rear view
mirror, a lot of buyers are beginning to default on auto
loans. According to a recent Barons
article, the United States has been experiencing a surge in
vehicle repossessions. Auto dealers are reporting
repossessed vehicles going to auction where the buyers loan to
value. Our LTV ratio is over 130%.
According to the Barons article, subprime repos have nearly
doubled since 2020, to around 11 percent on average.
And they say that the bigger red flag is in primary possessions,
where borrowers have higher credit scores.
Apparently, prime auto loans typically have a default rate of
around 2%, and today that rate is sitting at 4%.
So what about auto insurance? Why has it gone up so much in
recent years? Auto insurance costs 20% more
today than it did in December 2021, and 70% more than it cost
a decade ago. This is not Greedflation, a term
that people use for businesses stuffing through price
increases. Using inflation as an excuse,
auto insurance companies are less profitable than they have
been in the past. There are not more traffic
accidents either. There are actually fewer
accidents, but the average payouts are much higher per
accident. Part of this is that the cars
being crashed are all more expensive to replace than in the
past. Part of it is that repairs and
replacement parts have become expensive too.
More cars are being totaled in wrecks simply because with some
new cars, replacement parts are unavailable.
And if you can't get the part, you can't fix the car.
Some Ev's and hybrids can be written off if their battery
gets damaged in an accident, as it makes up a significant
percentage of the value of the car.
Finally, there's been an increase in insurance claims
with attorney representation, meaning that litigation costs
have gone up for insurance companies.
So how might this work itself out?
Well, the situation may start to resolve itself soon.
Wholesale car prices have started to fall, and carmakers
are beginning to offer more incentives to buyers.
Kelley Blue Book data shows that average dealership prices in the
United States have fallen below list, which signals that demand
is easing. Prices have come down in recent
months for electric cars too. The fastest growing segment of
new car sales, though a small portion of the overall car
market. EV inventories have been growing
too, with most EV manufacturers building more cars than they've
been able to sell. With high interest rates, you
might see dealerships discounting some of the
expensive cars and trucks that have been sitting on their lots
unsold for months. It's increasingly expensive for
dealerships to finance unsold inventory.
Looking at stock prices, you can see new car dealership stock
prices are still at all time highs.
One reason for this is that even if consumers are struggling to
afford new cars, there's still pent up demand for new cars as
people still need to drive to get around.
And less cars were built in recent years than are typically
built once the excess inventory of high end cars is moved.
Maybe manufacturers will start churning out the affordable cars
that there's the most demand for.
Right now, it doesn't seem likely that cars can maintain
their high prices when buyers can't afford the loan payments
or the insurance costs that they're facing today.
Central banks have been raising interest rates sharply all
around the world to slow demand and cool price increases,
including for cars. Right now, that's making it very
tough for consumers to afford a vehicle they might need either
new or used. Thanks for tuning into this
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