NEW YORK (TheStreet) -- The growing scandal over Volkswagen's (VLKAY) (VLKPY)  use of software in its diesel vehicles to mislead regulators is not a problem for only this German car manufacturer. It's a crisis for the entire auto industry, because if a large automaker like Volkswagen feels the need to cheat to survive, it highlights just how weak and fragile the entire industry is.

In fact, the news about Volkswagen in recent days could be a "Lehman Brothers" moment for carmakers. Just as the failure of that investment bank unleashed volatility in the stock market and made investors realize the scope of the housing collapse and the excessive risk that Wall Street banks had taken, Volkwagen's current woes could cause investors to realize what a mess the the auto industry is in.

The Ugly Truth About the Auto Industry

The car industry has been in trouble for years -- that's the plain truth. There are too many car manufacturers around, too many makes and too many models. And there is simply not enough demand. The chart below (extracted from data compiled by the Federal Reserve Bank of St. Louis) compares consumer prices over the past 10 years and new vehicle prices, both rebased to 2005. The picture becomes quite clear; prices for new cars have significantly lagged inflation. Simply put, the industry has lost its pricing power.

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Silicon Valley in the Rearview Mirror

Will Tesla (TSLA) - Get Tesla Inc Report dominate the future of the auto industry? Will Apple  (AAPL) - Get Apple Inc. (AAPL) Report develop this decade's version of the Model T, or will it be Google  (GOOGL) - Get Alphabet Inc. Class A Report and its self-driving cars? Who knows? But more and more, there are headlines about how Silicon Valley has fresh ideas for the auto industry. They have underscored that the traditional auto industry is primitive and its evolution has been marginal.

If Silicon Valley can do in years what the auto industry couldn't achieve in decades, you know that innovation is the problem. The auto industry continues to plod along in the slow lane and is wholly unsuited to today's fast-paced world where innovation is at the fore.

Car Company Stocks: What's Next?

The inevitable conclusion here is that the industry has to scale back significantly, just like the banking sector did in 2008-2009. General Motors' (GM) - Get General Motors Company (GM) Reportbankruptcy in 2009 was really just the preface. There is no room for big, sluggish auto manufacturers such as GM and Volkswagen, with their thin margins and massive scale. It's time for smaller, more focused players that have more emphasis on technology and innovation rather than capacity.

If you think that that makes an opportunity for purchasing shares of manufacturers like Tesla, however, you may be in for a surprise. Tesla is trading at a sky-high price-to-earnings ratio of more than 200, meaning there's no margin for error baked into the stock's price.

Although it may be tempting to buy the conventional manufacturers at their lows or Tesla at high levels, neither is a good idea. The automakers must consolidate aggressively first and stocks in the sector will feel a lot of pain before that process is complete.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.