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Cash for Clunkers

September 23rd, 2009 Leave a comment Go to comments

By now the Cash for Clunkers program is well behind us. Before the chaos of this financial crisis, I had never thought that the government would introduce such a program, and I’m not sure I’ll ever see another one like it in my remaining years. Given that, I’m glad that we (specifically, my parents) were able to take advantage of the program. Based on my experience, a few thoughts:

The government’s objective was the lift vehicle sales; there’s no doubt that they were successful. About 700,000 vehicles were sold under the program, resulting in a total of $2.87 billion paid out by the government. In addition to this, we should add the cost of processing the applications and any additional infrastructure needed to execute the program. The cost still comes in under the $3 billion the government had budgeted. This was a great thing for car dealers, for people who were able to take advantage of the program, and for the auto industry in general (production was ramped up and thousands of people were put back to work). However, my concern is about the short-lived nature of the program. I’m afraid that in the books of history, this will be but a blip. Now that the program is finished, we still have extremely high unemployment, we still have lack of desire for American cars, and we still have no evidence of improved American cars (in terms of quality and reliability). So, what will happen to the auto industry and all the workers who were put back to work over the next six months? I hate to say it, but it isn’t looking pretty – auto sales are down again, and I feel like it’s only a matter of time before production stops again. We need a more permanent solution to this problem…

Buying a car through the Cash for Clunkers program was quite an experience. Firstly, finding a car was an issue. Many dealer lots were empty and inventory was scarce. Dealers couldn’t really get cars from other dealers since the problem was systematic. We pulled the trigger pretty quickly – I spent a couple of days reviewing candidate cars, did my usual email blitz, and then ended up deciding where to go. We bought on the Saturday of the final weekend (the program was to end on Monday and Illinois law requires dealers to be closed on Sunday, so we effectively bought on the last day of the program). We visited two dealerships and I’d never seen dealerships so busy. Both dealerships were swarming with people – in the showrooms, on the lots, and in the tiny cubes doing paperwork. Sales people were juggling 4-5 deals at a time. Normally a sales person is asking what they can help you with within minutes of your entering a car dealership. Now you could be looking at a car or trying to get someone’s attention for over a half an hour before you finally got to talk to someone. It was taking about 5 hours to get a customer from agreeing on a price to out the door with a detailed and inspected vehicle (when normally it shouldn’t take much more than an hour or two). I asked the sales guy at the dealership what time they close and how their day yesterday went. He told me that the were supposed to close at 9pm the previous day (a Friday), but couldn’t. They had new customers walking in at 8:55, and ended up staying at the dealership until 1am. They returned to work at 5pm the following day. There was an immense buzz and excitement in the dealerships – something I’d never seen before, and unfortunately am not likely to see in the near future.

The Cash for Clunkers program created interesting distortions in the auto industry. Prior to the program dealers would do anything to get a car off the lot. In addition to rebates, the dealers were willing to pass along any marketing incentives they were given by the manufacturer, as well as part of any volume discounts they got. Basically, if they could make a couple of hundred dollars on a deal (or less!), they’d sell you the car. Heck, it was difficult to understand the quotes you’d get for a car – they’d be below the invoice less all available discounts – a price that just made no sense! As far as choice goes – you could get almost any color with any options – there was so much inventory either on the lot or with nearby dealers that you got whatever you wanted. After the program, things couldn’t be any more different. Cars were scarce – the only color available at all the Chicagoland Honda dealerships we spoke to but one was black. You’d be lucky if you could get pricing any lower than $50 below MSRP or so (I even received a couple of quotes OVER MSRP!). From an economics point of view the government incentive created a surplus for the consumer. However, much of that surplus was consumed by the dealers. As incentives disappeared and demand went up, prices went up by thousands. Of the $3,500 or $4,500 the government gave you, it wasn’t unusual for the dealership to take more than half (as a result of the higher prices). At the end of the day, this gives a double bonus to the dealers, and only a slight incentive to consumers. Dealers win because they reduce inventory and get MSRP for the vehicles sold. Consumers are told they’re getting $3,500 or $4,500, but in reality are getting much less since they paid much more for the vehicle than they would have paid before or after the program.

Another interesting dimension of the program is that the government didn’t put any restrictions on re-selling vehicles bought under Cash for Clunkers. What prevents someone from buying a new car at a steep discount and then turning around and selling it? Granted that after factoring in taxes and the dealerships’ higher prices this idea isn’t too lucrative, but depending on the situation (getting the full $4,500 and buying one of the less popular vehicles), one could make $1,000 or more doing this. Not preventing this from happening results in car prices (both new and used) falling (since there would be several new clunkers cars hitting the used market with less than 1,000 miles). Practically this may not be doable for most people since they’d lose the use of the vehicle (i.e. if I used my clunker to get to work everyday and then traded it for a new car, I can’t exactly sell my new car since I will no longer be able to get to work!), but I do find it interesting that the government didn’t limit this behavior.

Finally, one unfortunate side effect of this program is the cost to people who were in the market to buy a vehicle but don’t have a clunker to trade in. Because of the spike in demand, car prices shot up. If you had a clunker to trade, that was fine since the government rebate more than accounted for the increase in prices. However, if you didn’t, that $13,000 car you were looking at just jumped to $16,000 with no recourse for you. If you can delay your purchase until the program is over, inventory is sufficiently replenished, and demand has slowed again, you may be able to buy that car for $13,000 again. However, hopefully manufacturers learn from their mistakes and don’t create so much supply this time, keeping prices high. Even if prices to fall to the pre-clunkers level, the annoyance and inconvenience of not being able to buy for months is still significant.

I’m glad that I was able to be involved in a Cash for Clunkers transaction – it was great to see a buzz in dealerships that I’d never seen before. Getting $4,500 for our old van (which was probably worth no more than $500) didn’t hurt either. However, I’m not sure that in the long term the program will be as effective as the administration had hoped…

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