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Tuesday, November 7, 2017

Cars are a long-term payment scheme

“The bottom line is that most people do not buy a home but rather commit to a long-term payment scheme.”

Izabella Kaminska, FTAlphaville, November 7, 2017

And the good phrasing doesn't stop there: her line refers to a Convexity Maven (Harley Bassman) note "House of Cards."

The above lede on the Financial Time's Alphaville blog caught my eye. It applies equally to the auto industry. Over 70% of new car purchasers use some sort of finance, and trade those wheels in before the loan matures for another financed "ride". At a 7.6% interest rate (the base rate from a major OEM's web site), and with a 7-year loan, a "purchaser" will still owe half the face value of the loan at the 4 year point. With 17% depreciation per year, their trade-in will just equal their loan value in the 52nd month.

Even I took out a loan – a 0.9% financing deal was too good to refuse. However, I didn't do a long loan, only 4 years, and I put 50% down so that I'd never be upside down. As it turns out, though, interest rates have stayed really low, and my short-term savings hasn't been earning at best 0.1%. So I might just as well have dipped into savings and paid cash for the whole thing. In any case, the four year consolation prize of being free of car payments will soon be here.

The point at which someone trapped in a long-term car payment scheme breaks even will vary with the depreciation rate, interest rate and length of the loan. Here are sample calculations. Note that a shorter-maturity loan pays down much more principle in the first year, and so purchasers aren't underwater for long. The cost, of course, is a higher monthly payment. Here I assume (unrealistically) that the loan is for 100% of the car value as reflected in the resale market – no extended service plan rolled in, no downpayment. The number of permutations with the latter is unwieldy. So if the car is valued at $60,000, then with a $10,000 downpayment (or tradein plus incentives), an 84-month, 7.6% loan remains rightside-up throughout but provides $5000 equity only in the first year, before that $60K has depreciated much, and then again from the 55th month.


Car payment calculations, $50,000 loan
Maturity
(months)
Interest
rate
Monthly
Payment
Depreciation
rate
Upside down
until:
847.6%$76917%52
846%$73017%50
843.9%$68117%46
847.6%$76916%48
846%$73016%45
843.9%$68116%40
727.6%$86717%33
723.9%$78017%26
607.6%$1,00417%12
603.9%$91917%4
600.9%$85217%1
480.9%$106117%0

Monday, October 30, 2017

Graph(s) of the Day: Govt Transfer Programs

Mike Smitka

Ten days since the last graph ... time to add another. Here are the largest transfer programs in the US as a "stacked graph." These include those not only of the Federal government but also much smaller state and local programs. I've not included private transfers. Those aren't large, or more precisely are no longer large, in an era when few companies provide employer-funded defined-benefit pensions.

First, you can see the magnitude of government transfer programs. In our $20 trillion economy, they come to $2,700 billion or about 14% of GDP. (Remember, transfers don't show up directly in GDP, they are personal income and enter the economy only when someone spends the money.) However, the graph is not particularly helpful, because this is nominal GDP, which reflects not just "real" growth but also inflation. To better convey the magnitude, you should divide each of these series by nominal GDP. Rather than ask you to do that – it is straightforward task in FRED – here's the graph for the total divided by nominal GDP. You can see that there was a big increase with the Great Recession, but that the amount is slowly decreasing. I expect that is muted because of the retirement of the Baby Boomers, and not just by the still partial recovery during which 2% of prime-aged workers have yet to re-enter the labor force. But admit that I have not dug in deeper.

We can also look at the composition. In the early 1950s there were few retirees as a share of the population, and many of those retired did not qualify for social security. That changed as more and more workers were "vested" in the program (which was enacted only in 1937). As a share unemployment was much higher, but that's as part of a very small total. The catch-all other category looms large as a share of transfers, but small as a share of GDP. Neither Medicare nor Medicaid existed until 1966. Today retirement programs predominate: social security and medicare together are $1.6 trillion. State-level healthcare programs (Medicare) adds another $560 billion. The remainder includes miscellaneous small items such as veteran's benefits ($90 billion), food stamps (or formally SNAP, at $65 billion), and tax rebates, such as the $7,500 that a well-heeled American gets back from the purchase of a Tesla Model S but also the much more substantial earned income credits that help a low-income individual offset various taxes. In other words, what we would commonly refer to as "welfare" is too small relative to our $20 trillion economy for FRED to break them out as separate line items. [For much, much more detail see Table 3.12 Government Social Benefits in the National Income and Product Accounts.]

All of this provides an anchor to the economy: these flows continue even if we enter into a recession. That's important, because when someone loses a job, the impact spills over to local retailers and others, and leads to additional job losses, the "multiplier" of Economics 102. Now as you can see from the data, unemployment benefits are generally trivial, and they are also time-limited (24 weeks or roughly 6 months). But they increase sharply during a recession, and act as another component of our "automatic stabilizer," allowing people to cut consumption less and thereby partially offseting the spillover effects from the loss of a job. It's important not to overstate the cushion this provides, as it's hard to find a job during a recession. Benefits aren't very generous, either, averaging only about $300 per week – for many workers the replacement rate is only about 50%. Given the severity of the Great Recession, Congress did recognize the importance of even partially stemming the cascading effects of job losses; the ARRA temporarily increased the duration of unemployment insurance for up to 99 weeks. If you'd been earning $36,000 per year, however, and just barely making car and house payments, you couldn't make ends meet on $1,200 per month in unemployment checks. Goodbye house, but keep the car or you'd be unable to work even if a job became available.

Wednesday, October 25, 2017

Sticky Prices and Macroeconomics

Mike Smitka

We're now starting on AD/AS analysis in my intro macro class. It involves a lot of handwaving, given the simplifications imposed by using blackboard models – do we want our y-axis to be "the" price level or the rate of inflation π or (later in the term) the rate at which π is changing? At the same time the x-axis is a broad aggregate, (real) GDP, that we conceptualize as a physical aggregate. So why do they behave as supply and demand curves ought to, sloping up and down, respectively? One answer is that prices are sticky. If you want the argument, go to a textbook.

The more general issue is one that plagued the classical economists: if prices adjust freely, then why should there ever be unemployment, or other unsold goods? Why should productive capacity in an economy ever sit idle? Here the key is that prices are sticky. My wage, for example, is set but once a year, and that in accord with a salary pool based on expected tuition and other revenue sources, which likewise are updated only once a year. So if a shock hits the economy – prices rise unexpectedly (or inflation, the rate of price rises, rises unexpectedly) I will see my pay fall behind, and even if the university does set out to adjust things, it may take a couple years to get back in synch. Since labor accounts for a bit over half of all costs for producers of goods and services in the US, most attention focuses on that behavior.

Now I've never seen a breakdown of the frequency of wage changes across the economy, though I've never looked and I'm not a labor economist. But the Federal Reserve Bank of Atlanta Inflation Project does recompile the data that underly the Consumer Price Index into goods and services that are "sticky" and those that are "flexible". Over time they average out to be about the same, inflation truly is general, but in the time frame of a few years they can and often do move in opposite directions.

Their web site details which goods are sticky and which are flexible, with the weights each have in the CPI basket of goods and services. On the flexible end are things such as gasoline, electricity prices, food purchased in a supermarket, women's clothing and (yes!) new car prices – think of all those rebates and subvented [jargon for manufacturer-subidized] loans and leases that appear when sales are slow. On the sticky side are personal care services (how many years since my barber upped his price? – the sign's yellow!), fast food prices, school fees and beer prices.

For building a supply model we'd want to look at components of business costs besides labor, things like the billing rates for lawyers and accountants or xerox paper. No one to my knowledge has put together a comparable flexible/sticky producer price index. But for building theory, all we need to know is that in the real world prices are sticky.

Saturday, October 21, 2017

Dealer Musings (II): Ruggles on Gap Insurance

David Ruggles

Gap insurance is a by-product of the extension of car loans to longer maturities. Once only 3-4 years, loans now extend out to 7 years (and sometimes more). At current interest rates of 7.6% (quoted on a Chevy dealer website), at the end of 3 years the purchaser will have only paid $18,200 on a $50,000 loan. However, the resale value may only be $25,000 or 50%. So the purchaser will be “upside-down” on their loan by $7,000. Now there’s generally some sort of downpayment, but purchasers can add on extras that aren’t figured into the insurance value of the car but might be built into the loan. So if they total their car and are paid only the replacement cost (less deductible!), they’re in trouble. Or in this case, their truck in Texas was underwater, and their auto loan is, too.

Now consumers can be quite naive about this risk. That's not true of banks. If the borrower defaults and the bank repossesses the car, they’ll be out the “gap” between the balance of their loan and the wholesale value of the car (plus the out-of-pocket costs of hiring a “repo” specialist, and cleaning up and transporting the vehicle to auction). Hence “gap” insurance. (Of course the same issue faces anyone involved in vehicle finance.)

...don’t be surprised if some GAP insurers become insolvent...

Friday, October 20, 2017

Friday class, Friday graph of the day: Trade

Mike Smitka

Krugman (co-author of Krugman & Wells, our Economics 102 textbook) won his Nobel Prize for work in international trade, but his "open economy" chapter remains at the end of the book. That textbook structure dates back to the first true "principles" text in 1947, written by Paul Samuelson (another Nobel laureate, and a co-founder with Heckscher and Ohlin of modern trade theory). Since then all successful new texts chose to market themselves as potential replacements, which is realistic only if they are close to what econ profs were already using. We do not see product differentiation! But that's a topic for Econ 243 (Economics of Strategy / Industrial Organization) and not Econ 102.

Thursday, October 19, 2017

Dealer Musings (I): Ruggles on Recalls

David Ruggles

I wish I had something pleasant to say about things affecting dealerships. I'll try to come up with something before the end of this series. But if a person long on the sales side of the industry can't think up an optimistic story, maybe there isn't one. After all, how many perennially downbeat sales people have you met?I start though with safety recalls, and follow with gap insurance and then the latest twist in branding that pits the Factory against dealers.

Wednesday, October 18, 2017

Graph of the Day: Wed 18 Oct

Mike Smitka

Today saw the latest release on residential construction. The default graph on FRED is the total number, of course with multiple series for new starts versus permits versus under construction, and by region. But between 1960 and today the US population rose 80%, from 180 million to an estimated 325 million. Everything else being equal – and it's not, we know that the baby boomers are retiring and downsizing – we would expect the desired amount of housing to reflect the size of our population. So my graph makes that adjustment, dividing by population. As you can see, the current level of housing under construction has doubled since its December 2012 trough, but remains significantly lower than at any time prior to the Great Recession.

Monday, October 16, 2017

Graph of the Day: Mon 16 Oct

October 11, 2017

Among the "headline" inflation numbers, experienced observers look not at the overall monthly, seasonally-adjusted CPI but at the CPI less food and energy. You all know what's happened to energy, but you also know that it's temporary, until the effects of Harvey wear off. Food has such effects when a droughts or floods will hit a major crop area one year but not the next. So look at the graphs – not a formal statistical test, but a start! – and look for co-movements of these three indices. Don't see any? Maybe that's why the focus is on "core" inflation!

...inflation remains below 2%...

Friday, October 13, 2017

Graph of the Day

Mike Smitka

This graph shows:

  1. the nominal interest rate, here on 3-month Treasury bills (which are short-maturity US government bonds and typically have the lowest interest rate among similar maturity instruments),
  2. the corresponding 3-month rate of inflation for the economy as a whole, in the form of the quarterly GDP implicit price deflator [which is thus much broader than the CPI measure of inflation, as befits an economy-wide interest rate, and which carries an odd name tied to the technical use that motivated developing the measure], and
  3. the difference of the two, the "real" interest rate.

Monday, October 2, 2017

The Price of Oil

Mike Smitka, Professor of Economics
Washington and Lee University in Lexington VA
from WashU in St. Louis MO, where I'm participating in a conference

Both governments and automotive companies are placing large bets on alternative vehicle drivetrains, above all electric vehicles. In this context Roberto F. Aguilera and Marian Radetzki's The Price of Oil, which Gavin Roberts reviews for Eh.net, appears to be a "must read." I have yet to look at it, and would certainly like to see whether more recent evidence backs up their core claims. Their bottom line is that both new technologies and new politics will keep the price of petroleum low for the next decade. In contrast, I believe both high technical and intractable political hurdles impede the commercialization of battery electric vehicles. Low oil prices amplify these challenges. Really cheap oil makes EVs unlikely to eliminate the gas engine by 2040.

...really cheap oil makes EVs unlikely to eliminate the gas engine...