Cash for Clunkers Driving Up Prices

posted at 7:55 am on August 10, 2009 by Legal Insurrection

The much ballyhooed Cash for Clunkers program has had the unintended consequences of driving up the cost of new and used vehicles and used auto parts, according to independent studies of the auto markets. The Cash for Clunkers program demonstrates the danger of government trying to micro-manage supply and demand, and is a warning as to the dangers of Democratic plans for health care restructuring and a cap-and-trade system.

In a press release issued on Friday, August 7, 2009, Edmunds.com released the data on the effect of the program on new car prices. Edmunds found that the government-funded incentives had caused car dealers to reduce the discounts off manufacturers suggested retail:

“Since the program launched, we’ve seen that shoppers are getting less of a discount off sticker price for new cars,” notes Senior Analyst Michelle Krebs in her report on Edmunds’ AutoObserver.com. “In some cases, they are choosing less expensive trim levels and option packages than had been typical in recent months, but paying more for them.”

Edmunds also found that the incentive program came at the worst possible time:

“In truth, this program launched at the worst possible time of the year,” opined Edmunds.com CEO Jeremy Anwyl. “The annual summer sell-down typically creates a rush of activity for the industry, and this year that rush came right after automakers cut production in response to the floundering economy. It’s a simple case of supply and demand, bolstered by a reduced level of negotiation on the part of excited clunker traders. Add to this the automakers’ unseasonable reduction in incentives and the message is clear: if you buy a car this summer, you should expect to pay higher prices.”

As if price increases for new cars were not bad enough, the Cash for Clunkers program also appears to be driving up prices on used cars, creating a bubble in prices and the danger of a collapse in car demand. According to the Kelley Blue Book August Report:

With a total of 750,000 vehicles being removed from the marketplace, dealers are stocking up on used inventory in anticipation of low supply and high demand. This scenario is driving used-car prices up significantly in the short term, causing a bubble in values that will seriously impact used-vehicle values when the Cash for Clunkers program ends.

“Dealerships have reported increased foot traffic, creating a false sense of automotive market recovery,” said Alec Gutierrez, senior analyst of vehicle valuation for Kelley Blue Book. “As a result, dealers are going to auction to restock inventory, driving up used-car values. However, the effect of a supply reduction of this magnitude could have an immense impact on these values in the short-term, exacerbating the already-limited supply at auction. If this bubble comes to pass, dealerships will end up with excess inventory of both new and used vehicles and be forced to offer deep discounts to remove surplus inventory, driving values down. Ultimately, there will be the possibility of a severe contraction in auto sales as soon as the Cash for Clunkers program runs out of funding.”

But there’s more. The Cash for Clunkers programs is likely to drive up used car parts prices according to dealers who were interviewed for a Dayton Daily News article. While I haven’t seen any independent evaluation similar to the new and used car reports linked above, it makes sense that destroying working used cars would take the parts from those cars off the market, thereby decreasing the supply of used parts.

While Cash for Clunkers is being portrayed as a success, in reality it is driving up prices for consumers of all vehicles and used parts, but hits used car buyers and those who cannot afford a new car the hardest because the government rebates only apply to new vehicles. More important, this government program is likely to create a substantial distortion of market forces and a collapse of demand once the program ends.

Only in Washington could a program which uses borrowed money to drive up consumer prices, including a bubble in used car prices, be considered a success. I can’t wait for health care restructuring and cap-and-trade.

Cross-posted with updates at Legal Insurrection Blog

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