Toyota and the Repo Man – Where We Are

Toyota and the Repo Man – Where We Are
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The newspaper didn’t put the two articles side-by-side, but they should have. The messages, after all, are unmistakable.

Car companies are in trouble, and not just the ones that are on the list of usual suspects, such as General Motors.

Add Toyota to the list.

According to USA Today, it was revealed by Toyota last week that since this past August the company has been extending SEVEN YEAR loans on new cars, all in order to keep sales up by cutting monthly payments to customers.

No more than any other auto company can Toyota keep this up.

Another USA Today article addressed the consequences:

The headline was “Repo Lots Overflow with Reclaimed Cars.”

(more after the jump)

The rate of auto repossession – referred to now as “collateral acquisition and remarketing” - is up 10% in the last year and up over 30% in the past ten years. The recent increase in repossessions is concentrated in more upscale vehicles, particularly pick-up trucks. But the core cause of the increase in repossessions is – can you say you’re surprised – overly “generous” auto loans, according to the chief economist for Manheim, an auto wholesaler. The chief executive at a large an auto auction company agrees, saying that his lots currently are “overflowing” with repossessed vehicles. The head of a Florida repossession company says his business “has skyrocketed.”

Yet, into the teeth of this storm, Toyota is pushing seven year car loans to keep sales up.

Just to be fair to Toyota, it’s undoubtedly not the only car company doing this, or something close to it. It’s been an industry pattern for decades.

But, it is creating an unsustainable level of consumer auto debt, and that has enormous and long-term implications for the overall economy.

In effect, car sales have become an automotive version of a classic pyramid scheme, in which an investor is promised – and receives – an unusually high rate of return. This, of course, encourages him to invest more and encourages others to invest. The only problem is that the return isn’t being paid from profits, but rather from the ever-growing flow of new investment money coming in from new investors.

Of course, the concept is doomed from the start. Eventually, there just aren’t enough people left to grown the scheme further, the flow of new money becomes inadequate, and the scheme collapses.

Carmakers are in the exact same position today as the famous proprietors of the pyramid scheme, such as Charles Ponzi, whose version was sufficiently, albeit temporarily, successful that his name has ever since been attached to the “Ponzi scheme.”

A seven year car loan is based on one unstated premise, which is shared by the lender and the borrower:

That it will be paid back by the borrowing of more money.

There is a reason why car loans have grown so long, and it’s not the price of the car.

Adjusted for inflation, for equipment which is standard now but was optional or unavailable then, the price of the average new car in the United States has not risen in fifty years. But, the length of the average new car loan has grown astronomically.

The reason?

The short answer is that buyers have been rolling over unpaid debt from previous car loans into loans for new cars, and doing it over and over. According to one study recently cited in the Los Angeles Times, the average new car loan term now exceeds five years and, even worse, the borrower is “upside down” on the loan the instant the papers are signed. In other words, even before the car leaves the showroom – at its actual purchase price – it’s worth less than the loan balance.

One website commenting on buyers signing seven year car loans headlined the story: “Stretching Out a (sic) Automobile Loan Over Seven Years? Are You Stupid?”

The article suggested that buyers who made that deal were, indeed, stupid.

But, why shouldn’t you accept a free – or partly free – car?

In reality, viewed from the perspective of an economist, it is the lender who is taking the risk in making extended term car loans.

It is the lenders who are knowingly making loans to a borrower who has no incentive ever to repay the entire loan according to the terms of the loan contract. It is the lenders who are knowingly making loans on cars that are not worth the amount of the loan. It is the lenders who are expecting the loan ultimately to be repaid from another loan, not the pocket of the borrower.

But, that’s only the short answer. It does not explain how this happened, which is the real answer.

The real answer’s in Part Two.

Ralph Kalal
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  (6021) posted on 02.20.2008

I am only halfway through the article, but can you say crash? Not really, but it reminds me vaguely of the financial events that led to the market crash in the early part of the last century.

Car Finder: