Cash for Clunkers--A Penny Well Spent

Late last week, the Cash for Clunkers (Car Allowance Rebate System) was at risk of running out of money. So many people had used it, there were so many “pending deals”, and the website dealers use to request reimbursement is so cumbersome that there was a great concern that there would be more buyers wanting to take advantage of the program than there were funds available.

So, on Friday the House of Representatives quickly passed and sent on to the Senate a bill which would triple the Cash for Clunkers program from $1 to $3 billion (or from 250,000 vehicles to 750,000).

Some have questioned the program as throwing good money after bad and being another government bail-out boondoggle. I happen to think that it’s a pretty good thing.

Let’s try to put Cash for Clunkers in context: Take 3, $100 bills and put them on a table. Put a penny next to them.

The $300 represents the amount of money allocated by the government for the Troubled Asset Relief Program (if memory serves it was somewhere around $900 billion). The penny represents the $3 billion proposed for the Car Allowance Rebate System (Cash for Clunkers).

Over most of the last year we have had a succession of bad economic news. Trillions have been spent on bail-outs. All of this is money that Americans perceive as coming out of their pockets with little, if any, benefit.

Most people are like me. They see banks and other mega-financial firms being bailed-out to the tune of billions if not trillions of dollars with absolutely no benefit to individuals other than the fat-cat bankers who continue to get their million dollar bonuses. We see banks being rewarded for participating in the fraud that convinced many to take out mortgages that they shouldn’t have resulting in the “meltdown” which has had disastrous consequences.

And many see the bailouts of GM and Chrysler and think that they we get to pay for companies who through their own bad management went down the tubes and let the government bail them out.

So what are we getting for our “penny”? Trade in a gas guzzler and get up to $4500. Pretty simple. The dealer and the government will take care of the paperwork. Just as long as the vehicle being traded gets an EPA computed 18 miles per gallon or less in combined city/highway mileage and the new vehicle being purchased gets at least 4 mpg better than that. It’s a bit more complicated but that’s the gist of the program.

So, what are the benefits? Quite a few, actually.

A benefit for the “average” person. The person driving an older vehicle can get a government rebate which can be 2 or 3 or 4 times the trade value. It’s not a million dollar bonus like if you’re a fund manager at Bear Stearns but it’s not bad.

It gets less fuel efficient vehicles off the road. This is ostensibly what Pres. Obama proposed to do in the first place. Even the “minimum” fuel economy improvement (from 18 to 22 mpg) represents a bit over 20% improvement in fuel economy. So let’s assume you’re currently driving 300 miles per week (about average for most people), and you pay $2.70 per gallon. At 18 mpg, you’re spending nearly $45 and at 22 mpg you’re spending almost $37. The savings come out to $468 per year in fuel costs. And that’s just for a 4 mpg savings.

$4500 is a bunch of money! If your “clunker” is paid off, the $4500 you save can amount to nearly $100 per month in lower car payments depending on your credit (it might be less and it could even be more). But, let’s use $100—that would be someone with B- to C+ credit. Over the course of a 60 month loan, that’s $6000. That’s real money that hasn’t come out of the buyer’s pocket. That’s the insurance premium for many people. Or, for others, it’s a couple of week’s groceries per month. And it can get even better if the leverage from the $4500 makes the debt to equity equation more favorable to a buyer and results in a lower interest rate.

Dealers are benefiting! Reports coming out last week said that new car dealers were seeing the best traffic that they’ve experienced all year. That’s good news when industry estimates have been showing the projected volume of new cars to be about 10 million this year—down from about 14 million 2 or 3 years ago. Dealers are selling more of their new car inventory. That means that they’ll get out from under some of the interest payments they’ve been making on aged inventory (“floor-plan”—the cost of maintaining inventory). That means that sales people will be earning a bit more—and auto salespeople don’t make a whole lot of money to begin with. That means more potential business in the parts and service department. That means more people keep their jobs at auto dealerships.

Lenders are benefiting! Auto finance companies like Ford Motor Credit and GMAC will be doing more business. Credit Unions will be writing more loans.

Auto Salvage Companies will benefit. All those clunkers have to be destroyed (even vehicles that are in good enough shape to be resold). Their drive trains cannot be salvaged and must be rendered inoperable by the dealer. But salvage companies will generate income from the program.
A lot of those SUVs sold in the 90’s and the first 4 or 5 years of this decade will be coming off the road. Some to be replaced by “cross-overs”. Others by hybrids. Still others by sedans. That’s a good thing too. Hopefully people are getting it figured out that vehicles are not lifestyle or status statements. They’re a means of transportation.

Many of these vehicles will be paid for. Others won’t (such as those purchased used in the last 4 or 5 years). But the amount of the CARS rebate will mean that many of those owners of financed clunkers will be able to pay of the amount that they’re “upside down” (to use an industry term—another term for it is “buried”) and be able to successfully finance a new car.

Cash for Clunkers is just for new cars. There has been some speculation that it may also be extended to used vehicles but there has been no change on the website. There is a crucial difficulty with extending a program like this to used vehicles. That difficulty is the condition of the vehicle.

The condition of a new vehicle is known. It’s new. The condition (and the reconditioning) of a used vehicle is an unknown with one exception and that is manufacturer’s Certified Pre-Owned vehicles. Manufacturer’s programs only deal with their own brands and have rigorous standards which the vehicle must meet and which must be disclosed to the buyer—typically along with an enhanced warranty from the manufacturer. Perhaps this may happen in the future with the CPOV.

So, again as far as I’m concerned, this is a good program. It’s about time that with all the bail-outs that the average person has something which can directly benefit him or her. This program does that. Out of all the hundreds of billions that have been spent on toxic assets, etc. this “penny” is one which has the potential to generate a return and is a “penny” which is being well-spent. To the U.S. Senate: Approve the additional $2 billion!