What's Really Holding Back the Auto Recovery?By Karl Brauer August 25, 2010
Three years after the recession that started in December, 2007, and according to various economic indicators, one year into an economic rebound that began around July of last year, the strength of the recovery remains open to debate.
But using these dates as a baseline and comparing current auto sales numbers to recession/recovery patterns of the past confirms what many already know: this time it's different.
To now, there's been a consistent and now-predictable pattern in auto sales demonstrated in the past recession/recovery cycles. As one might expect, during a recession car sales decline, during a recovery they grow. But what might not be as obvious are the historically consistent proportions of this decline/growth pattern over the course of the previous five recessions, dating back to 1970.
Edmunds.com analyzed these recession/recovery sales trends and confirmed a direct correlation between the level of decline and the subsequent level of growth. Put simply, the greater the drop-off in auto sales during a recession, the stronger the rebound in sales during the first 12 months of recovery.
But not this time.
In the most recent recession, auto sales dropped 39 percent from their pre-recession rate of 16 million units in late 2007 to 9.7 million units during the depth of the recession (June, 2009). Based on the pattern of previous recessions, car sales should have recovered 71 percent from 2009's low point, delivering a Seasonally Adjusted Annual Rate (SAAR) of 16.6 million units by this June.
Instead, the industry enjoyed a meager 14 percent recovery in sales, to a SAAR of 11.1 million units.
What Up With That?
Why is this recovery different? What's keeping auto sales from rebounding like they have following past recessions? There are multiple causes, though high unemployment, high consumer debt and a substantial drop in home and stock values are the most prevalent.
These factors are curtailing consumer confidence and reducing willingness to commit to long-term financial obligations such as a new-vehicle purchase.
Here's why this auto-sales recovery has been a bust compared with prior rebounds:
Rates can't go lower than low: The government's ability to stimulate new-vehicle sales has been limited compared to previous recessions. Financing rates currently are at historic lows and have been for nearly a decade. In 1982, the interest rate on a new-car loan was 18 percent; in May of this year, the average new-vehicle finance rate was 4 percent.
Rock-bottom rates theoretically would encourage sales, but the near-perpetual availability of low-cost loans means buyers don't find cheap financing much of an inducement anymore, particularly if there are other pressures on household finances.
And despite such consistent lows, the rates aren't obtainable by everyone as they were a few years ago. It's no coincidence that easy credit and SAAR levels above 15 million units both vanished in 2008.
The new austerity and "substitution:" There's been a shift in consumer buying behavior; the recession has produced would-be new-car buyers who now are giving greater consideration to used cars when it comes time to replace a vehicle.
Normally, there's pent-up demand when consumers stop buying new cars that is balanced by an eventual spike in new-car sales. But today's vehicle owners are hanging on to their vehicles longer, and when they do finally decide it's time for a replacement, many are shopping lower-priced used cars instead of new.
A recent ballooning in used-car pricing seems to confirm the trend: Edmunds.com data indicate the average price paid for a 3-year-old used vehicle in July was up 10.3 percent compared with last year. And for many individual models, used prices have spiked well into double digits.
Historically high household debt: In the first quarter of 2008, households had amassed debt amounting to 131 percent of disposable income (1951: less than 40 percent). Households have reduced the figure to 122 percent over the last two years, but a deleveraging cycle to bring households back to more sustainable levels of debt is projected to take ten years.
What's the most important factor in reducing household debt? Increasing income - and household incomes aren't going to appreciably improve, of course, until unemployment rates ease.
The effect of government stimulus is fading: Last year, many buyers of new vehicles were able to take income-tax deductions for sales tax paid on new-vehicle purchases. And at this time last year, the Cash-for-Clunkers program gave attractive payouts to encourage new-vehicle purchases.
Neither incentive is available this year, and many still argue the current slow sales pace can be partly attributed to the thousands of "pull-ahead" sales the Cash-for-Clunkers bonanza stole from subsequent months.
Meanwhile, the effect of government stimulus in other sectors of the economy also is wearing off, meaning the private sector increasingly is shouldering the burden of sustaining a recovery. But the recovery languishes behind legitimate worries about deflation as households and businesses, racked by the recession, now are being much more discretionary about spending.
No Relief In Sight
What does this mean for the future of new-vehicle sales? The same factors depressing the recovery in auto sales over the past year are likely to continue for the foreseeable future, keeping sales in the low 12-million range even through next year, Edmunds.com predicts.
Although pent-up demand for new cars exists - and is growing - it will take time for buyers to reduce their debt loads, particularly if unemployment stays higher than 9 percent and home values languish.
New-vehicle buyers clearly have hunkered into a "needs-based" mindset. All indications suggest getting them back into "wants-based" mode won't happen anytime soon.