Cash for Clunkers is a bit of a Clunker

On one level “Cash for Clunkers” (CfC) is viewed as a big success. The first $1 billion was used up in a month and 245,000 new cars, 45% from the US car companies,  were purchased.  Congress looks like it is adding $2 billion more to the program, which the government now believes will be spent in another month.  This compares to its initial forecast that the first billion would not be spent fully until November, when the program was scheduled to end.  The seasonally adjusted annual rate (SAAR) of sales in July was 11.2 million. According to Reuters, 994,000 new cars and light trucks were actually sold in July, down 12.1% from a year ago, but up 30% from the previous month.

Without going into great detail, here is a shorthand review of the CfC program. If one trades in a car less than 25 years old that gets a rated 18 miles per gallon or less, one can get a reduction in the price of $3500 if the car purchased gets at least 22 miles per gallon and the pickup in mpg is 4 to 10 mpg. If it’s over 10 mpg the reduction is $4500. One can further negotiate with the dealer on the value of spare parts in the car.  The actual engine block and other critical parts of the car have to end up in the scrap heap. The dealer has to certify a number of elements of the transaction before receiving the rebate. The money is being diverted from a loan program related to green energy.

This seems like a pretty good deal for a new car buyer, particularly if he or she was preparing to trade in or sell a used car anyway. It’s an easy calculation to determine whether the CfC provides a better deal than a straight trade-in.  11.2 million SAAR of sales is about at the minimum replacement rate for scrappage one would expect from the existing fleet of about 240 million cars and light trucks. No doubt, this did accelerate some car sales, likely borrowing from the future but reducing inventories—some might say too much—, providing traffic and cash flow to the dealers, preserving some jobs and boosting the economic statistics. Combined with some other factors, such as better employment stats, maybe this provides a boost to consumer confidence, which is an important factor in getting the economy moving in the right direction. I’m just not sure that the numbers really add up. Let’s look at a few.

If you want to see a very good analysis of many of the metrics on this program you can read Matthew Wald’s piece in the August 8, New York Times, “Doing the ‘Clunker’ Analysis”: http://www.nytimes.com/2009/08/08/business/08clunker.html?scp=1&sq=doing%20the%20Clunker%20calculus&st

I will paraphrase some of what he says and add a bit to it.  It looks like the stats on the clunkers are that they averaged about 16 mpg while the new cars purchase averaged close to 26 mpg. If, on average, these cars were driven 12,000 miles per year there would be a savings of about 280 gallons of gasoline per car. That’s about 1.6 million barrels of gasoline a year for the 245,000 cars or maybe $202 million less spent on gasoline (at $3/gallon x 42 gallons/barrel). Since a gallon of gasoline emits about 20 pounds of CO2, the 67 million fewer gallons of gasoline consumed reduces CO2 emissions by 670,000 Tons per year. Over a 25 year life that would be 16.75 million Tons of CO2.  Without taking into account the cost of money over 25 years that still comes out to about $60/Ton of CO2 that was eliminated from the atmosphere. Is this the target price for cap and trade or a tax? Granted, as discussed above, this program is doing more than just reducing CO2.  But, ultimately, at the lowest cost possible, reducing CO2 emissions is what has to happen. We found that the program worked better than expected.  Why not raise the bar to a bigger spread between the clunker and a new purchase.  Every purchase done today will be producing emissions for close to 25 years.  What if the spread would have been 15 mpg rather than ten?  Of course, at that spread the US car companies would not have gotten 45%.

I did have an interesting e-mail dialogue with a terrific car dealer in Wisconsin, Frank Hallada, who has both GM and Ford dealerships.  His experience is anecdotal, but somewhat telling.  I will quote him direct:   

“The “Cash for Clunkers” has certainly spurred interest in the car business.  The incentive is to the consumer with the clunker….. We have been giving the customer credit for the monies, much like a rebate.  We have currently delivered 13 new vehicles and have yet to receive an approval status from the government.  The paper work is the responsibility of the dealer and the dealers are finding it to be a bit complicated.  We have been told that we would receive payment in 3-7 business days of an approved claim.  We have 7 claims that are a week old and are still in the under review status.  I spoke with 3 dealer friends on Saturday and none of them have received payments.  We will be required to trash the motor of the clunker 7 days after payment from the government.  We will then sell the vehicle to an authorized salvage yard for no more than $50. 

I believe the program could have been successful with a $2,500 rebate.  All but two of our clunkers have a value of $1000 or less.  The demand has slowed in the last few days.  I think the biggest problem with continued success,will be the availability of new vehicle inventory.  I have sold out of the most popular models at both the Ford and GM store.”

I am not sure that the program is really accomplishing what it was expected to. It has been a nice gift to those with clunkers, particularly if Frank’s experience is typical. But, it is truly replacement demand, not new demand.  And, it probably means that the buyers took on additional debt to buy the new car, or used a substantial amount of cash that might have been available for other uses. $60/Ton of CO2 reduction, at best, seems a high price to pay, particularly if the loan program, which was primarily for capital stock which results in real growth, is not replenished.  If the additional $2 Billion is used up in this quarter, it will make the quarter look quite good, but the fourth quarter will look less good.  Another example of unintended consequences. And, no real step forward in true carbon reduction.

This entry was posted in Automobile Industry, United States by Jack Rivkin. Bookmark the permalink.

About Jack Rivkin

Jack Rivkin retired in 2008 as EVP, CIO, Head of Private Asset Management of Neuberger Berman(NB) and from NB's Executive Management Committee. He was also on the Lehman(LB) Council on Climate Change(CC) and the NB CC Fund Advisory Board. He has been engaged with the United Nations and other entities on policy issues related to Private Capital and CC. He is an Associate Fellow of the Asia Society. He has continued on the NB Mutual Fund Board and with his CC responsibilities. He began his investment career in 68 as an analyst at Mitchell Hutchins(MH), and became Director of Research(DOR) there. After Paine Webber(PW) acquired MH, he served as DOR; CFO of PW; CEO of PWMH-the equity trading and investment arm of PW; Chmn of MH Asset Management and President of PW Capital. 87-92 he was DOR and, subsequently, Head of the Worldwide Equities Division of LB. 93-95, he served as a Vice Chairman and DOR at Smith Barney (now Citigroup). He was an EVP with Citigroup Investments 94-01, responsible for private equity investments. He was also an adjunct professor at Columbia University teaching a course in Security Analysis. He joined NB in 2002. He is the co-author of “Risk & Reward—Venture Capital and the Making of America’s Great Industries,” Random House, 1987. He is a regular guest on various media. He is the principal subject in a series of Harvard Business School cases describing his experience as DOR and Equity Head at LB. He has served as a director of a number of private companies and the NYSSA. He is currently a director of Idealab, Dale Carnegie, Operative, World Policy Institute and other private companies. He is a member of the Economic Club of NY, the Anglers Club, Theodore Gordon Fly Fishers, and a lifetime member of Trout Unlimited. He continues to be an active private equity investor when he isn’t fly fishing. Mr. Rivkin earned his Professional Engineering degree from the Colorado School of Mines and his MBA from the Harvard Business School

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