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Wonderland or wasteland? Detroit could thrive on U.S. drivers replacing their aging cars—but they'll need to hurry up
By Ed Wallace Businessweek

"When do you think the economy is really going to recover?" The question that one of the local weekend news anchors in Dallas-Fort Worth had asked me was simple. But I couldn't answer the question, because the answer is actually in his hands.

Instead I asked whether he, like millions of Americans, had locked up his discretionary spending when the world's financial meltdown became impossible to ignore last September. He had, he conceded. And when I asked how his colleagues saw this economic downturn, each from his or her own personal perspective, he agreed that it appeared that they had also pulled back on their personal spending.

"So," I summed up, "you don't believe the happy economic stories you're reporting either."

Thrice Burned…
This past February I reported in a BusinessWeek column that the biggest threat to the recovery of our economy was going to be the baby boomers' severely reduced spending habits. The boomers obviously had slashed their spending to the bone in response to the past few years' repeated disasters on (and by) Wall Street. Even now, though some stabilization is in sight (and I suspect that retail is slowing improving), hard data from the real world suggests that our consumer economy might be months from bottoming out.

Demand for high-ticket consumer services, hard goods, and imports are still all but moribund. Recently American Airlines (AMR) and Delta (DAL) both confirmed they will cut their capacity still further, while Southwest (LUV) reported that its flight bookings for June were even lower than May's. U.S. Airways claims that its revenue streams today are lower than in the period after 9/11. And British Airways (BAY.L) has asked 40,000 employees to work for one month without pay in order to lighten its financial statements' red ink.

Add to the mix the fact that U.S. rail loadings for both April and May were down nearly 25%, 16,000 more trucking jobs went away in April, and container dockings at Long Beach and the Port of Los Angeles have been down over 20%. All this seems to suggest that things are not quite as hopeful as they're being characterized. At best, the promise of pent-up retail demand improving in the near term—which is what it will take for long-term economic growth to start up again—is no easier to see.

Instead of asking any economist where the economy is going, it might be wiser to ask the 16,000 newly unemployed truck drivers.

That Payroll Problem
What may be the most insidious part of this current downturn is that many organizations are not just downsizing their workforces, they're cutting wages for those individuals lucky enough to be kept on. Many such firms were purchased in leveraged buyouts over the past decade, and they owe so much that they can't both service their loans and keep paying the same wages. Therefore, the current unemployment figures don't tell the entire story on where Americans really stand today financially.

Many of those who will continue to be shown as gainfully employed will be forced to cut back on their spending even more to offset their newly lowered incomes. Moreover, once this event passes, it is highly unlikely that those lost incomes will be fully restored. More likely, rehired workers' pay in the future will be in line with the recently reduced wages of their co-workers.
This is not unusual for a period of major deleveraging, whether for the debt-covered homes that were overpriced and over-mortgaged or for corporations that mirror that description.

Washington had a choice: Either allow all loans that aren't viable under current economic conditions to be written down to manageable levels, or allow workers and wages to be cut to free up enough cash to make those loans perform. It should be obvious to most by now which strategy Washington chose.

Beacon Score: 500
The other big factor that doesn't favor a substantial resumption of car sales anytime soon is that millions of Americans have lost their credit standing in the massive wave of foreclosures and defaults on credit cards and auto loans. It takes up to seven years after a default to rebuild one's credit score enough to reenter the new car market. This is where speculation arises concerning the future of the American automobile industry.

Given that the nation's economic success has long been built on Americans' personal and business mobility, the positive news is that there are nearly 250 million cars, trucks, and SUVs on the road in this country. Those 250 million vehicles can't be driven forever; at our current rate of annualized automobile sales it would take a quarter of a century to replace the nation's entire automotive fleet. As a comparison, in 1933, in the depths of the Great Depression, the turnover sales rate of our auto fleet was just 14.3 years.

So what are the odds that the next vehicle you purchase you will own for 25 years? If you say that's not likely to happen, then you are one more statistic suggesting that car sales should improve dramatically in the future.

Yet wages for the middle class, historically Detroit's biggest market, have remained stagnant over the last decade and are falling today; this does not bode well for the auto industry in the near term. Of course, this has been happening since 2001, which explains why most car companies could sell vehicles only by luring individuals into their showrooms with near suicidal incentives.

That, more than anything, clearly indicated how the middle class was struggling. From 2000 to 2008 real family incomes fell by $400 to $1,200, (depending on the survey) while prices of energy, food, and gasoline were skyrocketing, which explains why personal debt also rose to unsustainable heights. Bottom line: When income disappears as quickly as it has in the last eight years, one of the first purchases to be deferred is a new automobile. This is the primary reason why Toyota (TM) believes car sales could hit 17.4 million within six years, or stay critical at 11.5 million.

Fear of Loss is Winning So Far
The media has recently discovered that franchised new car dealers are selling lots more used cars, but this trend actually began in 2003 and has grown every year since. Many new car dealers felt forced to expand their used car operations because manufacturers kept cutting the dealer markup on new vehicles; some models were a guaranteed loss even if they sold for list price.

Dealers never knew from month to month what incentives would be offered, another inducement to sell more used cars, which are historically more profitable than new car sales. Carl Sewell, owner of numerous dealerships in Texas and author of the book, Customers for Life, informed his managers six years ago that he wanted 60 used car sales for each 100 new. Two years later, Sewell altered that used-to-new ratio to one to one. Last year, Sewell raised the bar to two used car sales for each new vehicle sale. While that figure has been harder to hit, last month Sewell's flagship Lexus store in Dallas retailed 251 new Lexus models, but delivered 368 used cars.

Sewell's strategy is a broad trend among dealers. A major part of the problem facing auto manufacturers—for which they share much of the blame—is that for years new car dealers have been focused on how to sell higher volumes of used cars A major part of the problem facing auto manufacturers—for which they share much of the blame—is that for years their new car dealer body has been focused on how to sell higher volumes of used cars. However, this situation cannot last. Earlier this year at the local Chrysler auctions, dealers were paying anywhere from $1,400 to $1,700 over NADA (National Automobile Dealers Assn.) wholesale prices to purchase anything for their lots. Such high wholesale prices, combined with lending institutions' refusing to loan ridiculous amounts of money even to individuals with good credit, has cut the profitability of a used car sale dramatically.

Because new car sales have fallen by nearly 6.5 million units over the last 18 months, the supply of late-model used cars will be drying up quickly, an overlooked future problem. Hence the extremely high wholesale auction values today for the best used cars—and it will get worse.

In essence, the entire industry is now trapped in a "lending capped" used car bubble. Caused by a short-term imbalance in supply and demand, the used car bubble will burst when wholesale prices rise so high that one cannot sell a used car for a profit because lending institutions will not advance more than the vehicle's loan book value. That point of no return is close. And when this automotive business cycle has run its course, new car dealers will have no alternative but to find ways to again improve their new car volumes.

This brings us back to the two colliding factors that are determining the fate of the automobile industry in America.
1.) Approximately 250 million vehicles are on the road now, but you can't drive them forever.
2.) High unemployment, millions more Americans with poor credit scores, stagnant or falling wages, and a negative outlook on the near term future of the economy.

If the public's fear cannot be assuaged and wages and employment numbers aren't improved, the auto industry will continue to suffer. If there is real economic growth, the auto industry will ascend with it. We'll know which direction it goes by late this year.

Then again, if it takes years to truly fix the economy and wages and many older cars still will need to be replaced, America just might be the next hot market for the $2,000 Tata (TTM) Nano.

Source;
http://www.businessweek.com/lifestyle/content/jun2009/bw20090623_802671.htm?chan=autos_autos+--+lifestyle+subindex+page_top+stories