While low interest rates have fueled a boom in auto sales since the Great Recession, we are now staring down the barrel of the coming used car price crash. There are many factors contributing to the deflation of the auto-lending bubble beyond rising interest rates, and all of this loose lending is bound to end poorly for many companies that extended credit.
Many auto industry observers, present company included, have suspected that auto lending has been on an unsustainable path for quite a long time. Now, there are more voices in the world of finance documenting the obvious: used car prices must come down in the near future.
This week, Morgan Stanley’s auto team released a bombshell report that makes the most compelling case we have yet to see for a challenging used car market in the near future. Shockingly, their base guesstimation sees a 20 percent drop in used car prices, and their worst case scenario forecasts an unimaginable 50 percent drop in prices. According to their estimates, in their best case scenario, prices remain flat.
What’s going on?
Auto lending has run amok in many ways and is largely responsible for the possible coming debacle. Beyond the effect of rising interest rates, there are several layers to this perfect storm. Factors include a radical increase in off-lease supply (cars being returned), record subprime lending (high interest rate loans to not-so-creditworthy borrowers), falling new car prices, record car inventory, and new technological advances that are quickly making old cars obsolete.
OK, that was a lot of information
It’s actually very simple. There’s simply too much supply in every corner of the market, and credit is getting more expensive as interest rates rise.
Another nail in the coffin is the advent of advanced driver assistance systems that will revolutionize the market by 2020 and dramatically increase safety. These systems will make old cars much less safe than new cars. This will, of course, significantly affect the value of older models that lack the new, shiny safety features.
The wider implications
Car companies and auto dealers stand to lose a whole lot under the worst-case scenario. They’ve depended on the auto-loan bubble to boost sales, and if it ends, they’re going to hit a wall. Remember, it wasn’t very long ago when General Motors and Chrysler needed bailouts from the federal government just to stay alive.
If used prices crash really hard, the fallout could spread and cause a new snag in the financial system. If you remember the mortgage crisis that caused the Great Recession, this scenario is going to sound awfully similar. Much of this auto debt was securitized and sold off to investors, and if people start defaulting en masse, you’ll see a lot of damage to the financial system, and potentially to the wider economy.
We can sit here and talk all day about the reckless behavior that led to this rabbithole. Instead, let’s explore how this is going to affect you as a consumer.
How to navigate the new landscape
As prices start coming down, don’t expect to get a lot out of your trade-in when you go buy a new car. On the other hand, there will be cheaper cars to be had, used and new, for all consumers. That’s good news for millions of us who needs cars to get around.
If you find yourself in the market for a new car, consider leasing so that if we see a used-car price crash, it’s won’t be your problem. If you decide to buy a new car anyway, spend the extra cash on including an advanced driver assistance system on your new vehicle so that your car isn’t considered “unsafe” in coming years.
Protect yourself as a consumer and plan accordingly. If you really want to limit the damage to your personal wealth, don’t buy your own car unless absolutely necessary.
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