How to Give Thanks at “Peak Debt”

By David Stockman  |  November 25, 2019

A recent Wall Street Journal piece on the raging insanity in the auto loan market tells you why this going-on-126-months-old “recovery” is a ticking time-bomb, not a singular success that warrants the Federal Reserve doing “whatever it takes” to extend.

The focus is car loan terms and a record share of auto borrowers who had negative equity on the old loan when they bought a new ride and took out a double-down loan. An especially poignant anecdote leaves little to the imagination:

John Schricker took out a loan to buy a car in 2017. Then he took out another. And then another.

In two years, the 40-year-old electrician signed up for four auto loans, each time trading in the previous car and rolling the unpaid balance into the next loan. He recently bought a $27,000 Jeep Cherokee with a $45,000 loan from Ally Financial Inc.

Mr. Schricker, who lives in Bethel Park, Pa., said he didn’t intend to cycle through so many vehicles. He replaced one because it had 100,000 miles and another when he went through a divorce, and he changed cars again when his family was expanding.

Mr. Schricker would like to get a new car because the Jeep Cherokee started having mechanical problems this year. He recently discovered the vehicle was in an accident before he bought it, a fact he said the dealership didn’t disclose.

He estimates that even if he sold the vehicle, he would still owe Ally up to $18,000. Ally said it couldn’t comment.

If Mr. Schricker sold the “asset,” he’d end up with no car, no way to get to work, and no transportation for his family.

He would have an uncollectible $18,000 debt. And it’s only a matter of time before his clunker gives out or a recessionary downturn causes electricians’ work to shrink. These contingencies would lead to exactly that baleful outcome.

This is no aberration. Fully 33% of customers who traded in cars to buy a new one this year had negative equity. That’s up from 28% five years ago and 19% a decade ago. These underwater borrowers owed about $5,000 on average after they traded in their cars. That’s up from about $4,000 five years ago.

One reason for this negative treadmill is that car prices keep rising. So, $45,000 loans on rapidly depreciating mid-market cars have become a necessity to keep the wheels turning in much of Flyover America.

Rising car prices have exacerbated an affordability gap that’s increasingly getting filled with auto debt. Easy lending standards are perpetuating the cycle, with lenders routinely making car loans with low or no down payments that can last seven years or longer.

The irony here is hard to ignore.

The Fed claims to be driving interest rates toward zero (and below) due to low inflation and the risk of flagging growth. That’s even as Main Street households are being lured into staggering levels of debt to keep up with rising prices…

This sort of irony often ends in tragedy, and we have no reason to think this situation will end any different.

Since January 2007, median weekly earnings of wage-and-salary workers with a high school education are up 22%. But that doesn’t compare well to a 29% rise in average new vehicle transaction prices. And that gap doesn’t include carry-in debt from the last vehicle.

The “low-flation” brigade in the Eccles Building has no clue about what’s happening on Main Street.

Indeed, “hedonic adjustment” by the Bureau of Labor Statistics magically turn a 29% rise in dealer lot prices to just 5.9%. So, Mr. Schricker is undoubtedly relieved to know that the $45,000 loan hanging over his head comes with increased quality and functionality on his Jeep Cherokee, which apparently got banged up in a plain-old car crash.

The BLS’s crude indices can’t begin to capture the real-world complexity illustrated in the simple matter of new car prices. In this case, the Fed is actually getting the inflation it claims to desire – new car prices are up at a 2.14% annual rate since January 2007.

But, inside our monetary central planners’ puzzle palace, this is “low-flation” because the BLS’s new car price index is up by only 0.48% per year.

The Main Street economy is barely running in place, even as Fed policies cause it to churn deeper and deeper into unsustainable debt.

New auto sales peaked at 18.5 million units in the second quarter of 2005. Notwithstanding all o the Fed’s huffing, puffing, and egregious money-printing in the 14 years since, they posted at 17.7 million units in the second quarter of 2019. That’s 4.2% lower that they were nearly a decade and a half ago.

And, of course, there are now 14.3 million more households in America than there were in the second quarter of 2005. That’s 13% growth.

At the same time, auto debt is just plain up, from $800 million to $1.73 trillion. That’s 45% growth.

The Fedheads never mention these types of non-sustainable trends. Their easy money has added precious little to Main Street relative to their natural path of capitalist expansion.

In fact, the peak-to-peak growth rate of real gross value added by the nonfarm business sector has steadily diminished even as so-called monetary stimulus has sharply escalated.

The Fed’s balance sheet grew by 7% per year during the tech boom of the 1990s. It’s grown by 15% since the pre-crisis peak in 2007.

At the same time, the real growth rate of business value added fell by 50% and now stands far below the 4.1% growth rate that prevailed between 1953 and 1970:

  • 1953 to 1970… 4.1%
  • 1990 to 2000… 3.9%
  • 2000 to 2007… 2.8%
  • 2007 to 2018… 1.8%

What has grown smartly, of course, is the financial wealth of the top 1% and top 10%…

You’re Behind the Wheel…

This is the most politicized market in history. And the Tweeter-in-Chief is still in charge. So, the situation is changing almost by the minute.

It’s “Impeachment!” in Imperial Washington and all over the Mainstream Media. It’s “Easy Money!” on Wall Street and across Bubblevision.

And it seems as if the whole world has, indeed, gone mad.

Amid this chaos, prices will continue to rise and fall, trends will continue to develop and dissipate.

Well, The Stockman Letter is made for times like these. And we’ve updated our design to help us better navigate to not only the safest harbors but also the most promising opportunities.

The stakes are as high as they can be heading into 2020. Markets appear to be straining, catching up to an economy that’s been weak and getting weaker for years.

The Donald is tied up in the day-to-day movements of the major stock indexes like no president before him. The increasingly desperate incumbent will do anything he must to hold the White House.

It’s a major tipping point. And there’s no telling what the Donald’s great disruptions could do to your wealth.

You’ve got to be nimble to win in this market…

To common sense.

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR