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Autos Highly Pumped

If the car loan bubble bursts, what would happen to automakers and the economies of automaking states?

It’s been quite a ride for the automotive industry, but a years-long run of record production, sales and employment growth is about to gear down.

Why the slowdown? There simply are too many vehicles on the market, and used car prices are falling. That’s putting increased pressure on auto dealerships to move new cars, but they’re stuck with higher than normal inventories despite a continuing barrage of low-interest loan offerings.

The already huge glut of used vehicles will get bigger when a new wave of off-lease vehicles hits the market. Dealerships will have 14.5 million used vehicles on their lots in 2018, 22 percent more than in 2015, says J.D. Power and Associates. And dealers already have more than 4 million new vehicles to move.

A production slowdown is a matter of when, not if. Major forecasters say production will decrease as early as this year but no later than 2018.

“People in Alabama who are directly impacted by the auto industry should brace themselves for the likelihood of decreased production and employment,” says Mark Thornton, an economist and senior fellow at the Mises Institute, a libertarian nonprofit in Auburn.

Cutbacks could have a significant impact in Alabama, where retail auto sales are $12.6 billion and represent 19 percent of the state’s retail sales total. Alabama’s auto industry has an economic output of more than $6.2 billion and employs almost 39,000 people at auto, engine and motor parts suppliers.

How much a slowdown will impact Alabama and the rest of the nation is subject to speculation. So is the damage from a subprime auto loan bubble that Thornton and others say is part of the landscape.

The amount of auto loans, both owned and securitized, has soared to a record $1.1 trillion nationally, up from just under $700 billion in 2011, according to the Federal Reserve. Thornton and others say too many of those loans are subprime and risky. Earlier this year, for example, a Morgan Stanley researcher noted that 60-day-plus delinquencies and default rates are moving back to the great recession levels for prime and subprime auto securitization.

“There is a bubble in automobiles,” Thornton says. “I would be terribly surprised if there wasn’t. The Federal Reserve’s low interest-rate policy over the last many years has created this bubble.”

“Automakers and auto financiers have used this policy to expand the amount of loans, car sales and car leasing. Interest rates on normal automobile loans are at historic, all-time lows, and the amount of subprime automobile loans is also thought to be very high. Automobile loans can now be for as much as seven years. You can see this mania for yourself on television where auto makers are advertising their vehicles and the great deals that you can get on the vehicles and financing.”

Bernard Swiecki, senior automotive analyst at Michigan-based nonprofit Center for Automotive Research, says a slowdown is ahead but downplays the ramifications of a subprime auto loan bubble. He says that, as of late June, most subprime auto lenders are still making money off those loans.

Also, even if defaults increase, he says the impact would be somewhat muted because they are a small part of the automotive industry and the overall economy. Total vehicle loans outstanding, for example, are about a tenth of residential mortgage loans.

Swiecki is concerned, however, that easy car loan policies have been overused and might hurt the auto industry down the road.

“The automotive industry is selling the most expensive vehicles we ever have,” he says. “The average transaction value is more than $34,000 a unit, but wages have been slow to recover from the recession. Household earnings haven’t been rising as much as the price of cars, and that’s a concern because a car is one of the most expensive things a typical household buys, second to a house.

“The capability to pay for this now-more-expensive vehicle has to come from somewhere, so what we’ve been doing is just extending the loan duration. Now we have a situation where loans are longer than they’ve ever been and the loan amount, despite the longer lengths of loans, is higher than it’s ever been.

“The real concern is this: We’ve taken these steps of easy credit and longer loan duration and that makes it easier to put someone into a vehicle today. In the short term, that should drive sales and make more revenue for the entire industry.

“However, in the long-term, you have to think about what happens when the consumer wants to buy that next vehicle. You always want someone around for multiple product cycles and it’s what happens with that next vehicle purchase that has us concerned.

“At that point, because of a longer loan duration, that consumer is more likely to find themselves upside down on their loan. They may walk into a vehicle dealership expecting to trade in their vehicle and to get a bit of equity for the next one they buy, and they may be surprised to find they either have less equity than they expected or they actually have debt on that vehicle that they either have to cover out of pocket or roll into the price of their (new) vehicle.

“So, we’re concerned,” Swiecki says. “Enabling current vehicle purchases with the means we’re doing it possibly is hindering the next vehicle purchase three, four or five years down the road, depending on the customer’s situation.”

Despite bumps in the road ahead, Swiecki believes the auto industry could do much worse. CAR forecasts decreased — but not dramatically lower — new vehicle sales next year through 2020, with sales back to current levels in 2022.

“You have to keep in mind what the contraction looks like,” he says. “In 2009, it was a perilous cliff because not only did we have automotive problems like massive overcapacity among car companies and suppliers, but we had this epic, historic economic crisis.

“This time around, our forecast says that contraction will be a plateau — to be flat. Given that we’ve had two years of record sales in a row, 2015 and 2016, you could really do worse than hit record sales levels two years in a row, to hit record transaction values and then plateau out and sustain that. If that’s what your downturn looks like, you’re doing pretty darn well.

“For anyone who doesn’t believe that, look at where things were in 2009, and then you get an idea of what it could look when things really turn ugly. You have to keep in mind some perspective for some of these conversations.”

Charlie Ingram is a freelance contributor to Business Alabama. He is based in Birmingham.

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