The Disciplined Investor: Untold Auto Industry Woes

Quadrillions of pixels are being lit up discussing the problem of "underwater" home equity, yet little is being said about the same phenomenon in the auto industry. As I've gone about my daily life talking to people, naturally the economy comes up in discussions, and I make it a point to ask about their cars and if they have any interest in buying a new one. Many people are quite aware of (and voluntarily offer) the fact that they owe more than their car is worth and the dealer won't take their trade-in.

When it costs you thousands out of pocket to buy a new car, you don't. I checked my own situation: It would cost me $6,000 to sell my car (a Toyota Highlander Hybrid) today. Fortunately, I like the car. It runs great, and I am not in the market for a new one. So, similar to millions of other potential American car buyers, I am just saying no.

Where we are today is a function of the auto industry's short-sightedness in trying to drive sales earlier in the decade. In order to increase ASPs by getting people into cars they couldn't really afford, they extended loan durations in order to bring down the monthly payment into the "affordable" range, typically considered to be 8% of income. Federal Reserve data show that, for most of this decade, the average duration of new car loans was over five years.

Fed Auto Loan Data Federal Reserve Bank G-19 Statistical Release

This is not your father's Oldsmobile financing program. Remember the good, old days, when you'd have a down payment and a three-year loan? Cars depreciate really quickly, but a three-year loan amortized the debt even more quickly. Five-year loans are almost guaranteed to go underwater early on and will leave far less residual value when amortization is complete. All those cars pushed out the door over the past few years are now attached to many underwater loans and are being driven by people with big credit card balances and high mortgage payments on underwater homes. Any car sold within the last three years is simply not a candidate for a trade-in, and obviously, older cars provide very limited value as "down payment" on the new car. (These points all apply to leases as well; they are just loans in a different form.)

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At the time of publication, Dvorchakhad no positions in the stocks mentioned, although positions can change at any time.

Gary Dvorchak is a managing partner of Aviance Capital Management, a Sarasota, Fla.-based institutional asset manager that manages $200 million in growth and value equities and fixed income. Dvorchak holds a master's degree in business administration from Northwestern University and a bachelor's degree in computer science from the University of Iowa.