Hello and welcome you are listening to Patrick Boyle on Finance, a podcast exploring ideas from quantitative finance, examining events occurring in markets right now and financial history to see what lessons can be taken away, including interviews with some of the most interesting people in the world of finance. To learn more about the podcast visit on finance.org. Over the last three years, we've seen the biggest car price increases in history.
Last year, the average cost of a new car in the United States was $47,000, and the average used car price today is just under $30,000. Between January 2021 and January 2023, used car prices have gone up 52%, while new cars rose by almost 28%. During that same period, the median household income in the United States saw a 13% increase, meaning that in the past couple of years used car affordability went down by almost 40% and new cars became
15% less affordable. The price hikes can be traced back to the pandemic, when manufacturers halted car production due to a lack of demand during lockdown in 2020 when economies reopened. There were shortages of important parts like semiconductors, and factories were unable to scale up manufacturing quickly enough. This meant that buyers who needed to buy a car over the last few years were forced to pay at or above sticker prices
for new cars. Long waiting lists meant that people who might have preferred to buy new cars were buying used cars to get one quickly enough, and because hardly any cars had been built in 2020. There was a shortage of 1 to 2 year old cars, so they found themselves buying older cars than they might have wanted, and they had to pay through the nose for them. Car buyers today aren't just faced with higher car prices either.
Central Bank's efforts to curb inflation over the last year or so have pushed the average interest rate on a new car or truck loan to just under 9% in the second quarter of 2023. Up from 5.7% a year ago. Lots of drivers, seeing these high prices, decided to hold on to their cars a bit longer than they might normally do, just wait till prices fall a bit before buying. For this reason, people have been keeping their old cars on the road a lot longer than they
historically have. These older cars that might normally have been scrapped are being patched together and kept running. All this extra repair work has been great for mechanics, but it's meant that it has become significantly more expensive to get your car fixed than it was in the past. Mechanics get to charge a premium when things are this busy, and car parts become more expensive when demand is high. We're not done yet, though.
Auto insurers have found themselves losing money on underwriting car insurance policies. And so auto insurance policy prices have been rocketing, too. Anyone who's needed to buy a car, either new or used, recently has been faced with a perfect storm of price increases, and there's been no easy way to avoid it. So let's look at why this has been happening and how things
might work out going forward. So in 2021 and early 2022, global shipping problems, a semiconductor shortage and factory shutdowns collided with a rapid increase in consumer demand for cars, pushing vehicle prices sharply higher. It was initially believed that as auto manufacturers ramped up production and higher interest rates kicked in, that things
would normalize. Instead, prices for new cars continued to rise as automakers build fewer new cars and focused on the most profitable luxury models rather than the budget models where the shortage is now greatest. A dip in used car prices in 2022 helps to lower overall inflation that year, but used car prices began rising again this spring as low supply encountered a new surge of demand. The high new and used car prices turned out to be surprisingly
sticky. New cars in particular continued to get more expensive in 2023 as manufacturers fought to maintain the fatter margins they had enjoyed in 2021. Pre Pandemic. The dynamic in the auto business was that both pricing and profitability were under constant pressure, driven by consumers shopping for discounts online. Price comparison websites were the car dealers nemesis. If you advertised the price that was too high, buyers wouldn't turn up on the dealership lot.
At the same time, automakers were producing more cars than there was demand for, and then they had to offer incentives to clear inventory. Dealers made their profits on volume and financing, often dealing with consumer complaints for hidden charges like paperwork fees. When customers came rushing back in 2021 to buy new cars, semiconductors needed for building modern cars were still
hard to source. Manufacturers were also struggling with sourcing parts from China that was still enforcing lockdowns and Russia and Ukraine, where parts like wiring looms are made. Auto manufacturers allocated the scarce parts they could get to the highest priced, highest margin models, trucks and SU V's. They made-up for the lower sales volumes with higher profits on each sale. So while new cars were now being built, about 5,000,000 cars that normally would have been
produced never were. The car shortage really worked for car dealers too. They could charge well above list price, especially for the hottest new models as stimulus programs rolled out and office workers were adjusting their lifestyles now that they could work remotely. There was more demand for new cars than supply, and car buyers were willing to pay up to get the car that they wanted.
The Bureau of Labor Statistics in the United States published a study recently that showed the dealer markups accounted for between 35 and 62% of total new vehicle consumer inflation from 2019 to 2022. The markups were good for dealers even if the lower sales volume was bad. In aggregate, the last 2 1/2 years have been an extremely profitable period for car dealers, the best time they've
had in quite a while. Tom Bark and the President of the Federal Reserve Bank of Richmond recently told an interviewer that during this two year period, auto dealers and auto manufacturers discovered that a low volume, higher price model was actually a very profitable model. Consumer demand is still incredibly high. And this is the case all around the world.
Britain's used car market just recorded its strongest spring in three years, with 1.8 million cars sold between January and March. This year. There were a record 82.5 million visits to the Autotrader website this March, 15% higher than a year earlier. Automakers cut way back on building their cheaper models and even low spec models if they're more expensive cars. They rolled out electric vehicles in response to
government subsidies. But even with the subsidies, these don't tend to be affordable to the average car buyer. The lack of new affordable cars being built meant that consumers on a budget could only find used cars in their price range. And of the five million cars that were never built, the shortfall I mentioned earlier, most were affordable or entry level vehicles. Right now, the number of cars that would typically be available second hand after coming off 3 year leases is
significantly lower than normal. The people who leased cars right before the lockdowns are mostly buying out those leased vehicles at the prices that were said in the lease agreement before car price inflation kicked in. They'd be foolish to do anything else. All of this means that the competition for the most affordable vehicles is the most intense. People who live paycheck to paycheck, whose jobs require them to turn up to work in person, just can't get by without transportation.
The job market has been quite strong for this group, who often work in industries like hospitality and healthcare, so they've been paying up for used cars as they simply have no other choice. Because there's so much demand for affordable transportation, there are a lot of cars on the roads today that historically would have been scrapped by now. Cars that you couldn't have given away for free a few years ago are now a valuable commodity.
The average age of a car on American roads is now 13 1/2 years old, which compares to 9 1/2 years old a decade ago. There are a lot of junkers available second hand and a lot of high end, high spec cars available. New but not many average cars available for middle class people. So people are spending more and
more on cars. According to TransUnion, a credit reporting agency, the average monthly payment for a new car has risen by over $150.00 per month to 736 dollars in the first quarter of 2023. Used car monthly loan payments have gone up by an average of $110.00 to $523 over the same period. In an economic slowdown, many people could struggle to make these payments. As interest rates have gone up, lenders have started backing
away from the auto loan market. This is partially driven by the regional banking crisis that we saw earlier this year. The falling availability of credit has been documented by the Twitter account Car Dealership Guy. Lenders are today worrying that car prices might collapse such that loan sizes become greater than the value of the cars securing the loans and they don't want to make any new loans. This is particularly the case for subprime auto loans where buyers are paying high prices
for low quality cars. If these cars break down, the buyers may be unable to afford to fix them and just stop making car payments. High interest rates combined with only expensive vehicles being available makes for a difficult car market, especially as consumers are starting to feel squeezed. As of last month, there were
over 140,000 half ton trucks. By the top 4 truck makers, Ford, Chevy Ram and GMC sitting on dealer lots unsold in the United States. Many of these trucks are high spec versions in the 60 to $80,000 range and they've been sitting on dealers lots for over six months. Dealers typically finance their inventory with what are known as floor plan loans. These loans which a year ago
would have been quite cheap. Now of interest rates as high as 12%, and many lenders are trying to exit that business. Increased pressure on disposable income has been putting the consumer in a tight spot. Disposable incomes rose in 2020 and 2021 as the pandemic led to debt forebear and stimulus checks and better unemployment benefits. Today, as these programs are disappearing in the rear view mirror, a lot of buyers are beginning to default on auto
loans. According to a recent Barons article, the United States has been experiencing a surge in vehicle repossessions. Auto dealers are reporting repossessed vehicles going to auction where the buyers loan to value. Our LTV ratio is over 130%. According to the Barons article, subprime repos have nearly doubled since 2020, to around 11 percent on average. And they say that the bigger red flag is in primary possessions, where borrowers have higher credit scores.
Apparently, prime auto loans typically have a default rate of around 2%, and today that rate is sitting at 4%. So what about auto insurance? Why has it gone up so much in recent years? Auto insurance costs 20% more today than it did in December 2021, and 70% more than it cost a decade ago. This is not Greedflation, a term that people use for businesses stuffing through price increases. Using inflation as an excuse, auto insurance companies are less profitable than they have
been in the past. There are not more traffic accidents either. There are actually fewer accidents, but the average payouts are much higher per accident. Part of this is that the cars being crashed are all more expensive to replace than in the past. Part of it is that repairs and replacement parts have become expensive too. More cars are being totaled in wrecks simply because with some new cars, replacement parts are unavailable. And if you can't get the part, you can't fix the car.
Some Ev's and hybrids can be written off if their battery gets damaged in an accident, as it makes up a significant percentage of the value of the car. Finally, there's been an increase in insurance claims with attorney representation, meaning that litigation costs have gone up for insurance companies. So how might this work itself out? Well, the situation may start to resolve itself soon.
Wholesale car prices have started to fall, and carmakers are beginning to offer more incentives to buyers. Kelley Blue Book data shows that average dealership prices in the United States have fallen below list, which signals that demand is easing. Prices have come down in recent months for electric cars too. The fastest growing segment of new car sales, though a small portion of the overall car
market. EV inventories have been growing too, with most EV manufacturers building more cars than they've been able to sell. With high interest rates, you might see dealerships discounting some of the expensive cars and trucks that have been sitting on their lots unsold for months. It's increasingly expensive for dealerships to finance unsold inventory. Looking at stock prices, you can see new car dealership stock prices are still at all time highs.
One reason for this is that even if consumers are struggling to afford new cars, there's still pent up demand for new cars as people still need to drive to get around. And less cars were built in recent years than are typically built once the excess inventory of high end cars is moved. Maybe manufacturers will start churning out the affordable cars that there's the most demand for.
Right now, it doesn't seem likely that cars can maintain their high prices when buyers can't afford the loan payments or the insurance costs that they're facing today. Central banks have been raising interest rates sharply all around the world to slow demand and cool price increases, including for cars. Right now, that's making it very tough for consumers to afford a vehicle they might need either new or used. Thanks for tuning into this
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