November 2022
Patrice says because of the car chip shortage, the demand for cars has outweighed supply, thus increasing prices. As the Fed continues to hike up interest rates, some used car loans have gone up to 10% APR.
Some borrowers may not have stable credit or the ability to pay these high-interest loans back, causing some to believe the subprime auto loan market may implode. Patrice says even if interest rates do level off, they will still be higher compared to the low-interest-rate environment of the past decade, and this will most likely affect the car market and auto loan bonds. Patrice and Chris advise those who are looking to buy a car to consider waiting for the market to cool.
Chris and Patrice think that keeping zero-interest-rate policy for as long as the U.S. did might have pushed investors to take more risks than they should have with volatile assets like crypto. It is important to stay level-headed and avoid giving into emotions or the fear of missing out when making investment decisions.
Listen to our previous episode to learn more about FTX’s downfall and how FOMO impacts investors.
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Check out past episodes of The Financial Commute below:
Ep. 7 Restoring Stability in the UK
Ep. 8 Recency Bias When Investing
Hello, everybody, and thank you for joining us for an episode of The Financial Commute. I'm Chris Galeski, your host. I'm joined by Patrice Benning, one of our wealth advisors here at Morton. I'm excited to have you, Patrice. Thank you.
Thank you for having me.
You know, the purpose of this podcast is to talk about what's going on in the world. How does it affect our investors and what they can do about it. Over the last 15 years, we've had zero interest rate policy, meaning you can borrow as much money as you possibly wanted at very, very cheap interest rates.
And then we had the pandemic in 2020. A lot more stimulus measures were kind of thrown out there, you know, money all over the place and rates down, down close to zero. It caused some really interesting issues, especially within supply chains, too. And one of the things that came out of that or early on in the pandemic was there was a chip shortage for cars and it caused used car prices to skyrocket.
It really did.
But you came across an interesting article this week that was talking about this sort of burst of that bubble and used car prices are falling dramatically. You've got car companies like Carvana where that dropped by 24, 30% after posting earnings. So tell me a little bit about what that article had to say about used car prices.
Well, I think what's interesting to even think about the used car market is that when you go to even get a loan for a used car, you're talking different guidelines and different parameters of lending. So a lot of the traditional banks hold that on their balance sheet. So when to your point where interest rates were very low and a lot of the dealerships were able to actually, because of the supply chain disorders, were able to create almost this inflated type of demand.
And because of the cars, because there was a shortage of cars being on the market, people the demand went so up. And then the prices were just huge.
Right. And so now the Fed has started to raise interest rates. So instead of getting a 2% car loan for five years, buying a new car, the average car loan was like 6.5%. And if you're buying a used car, you're the average price was like 10%. I mean, that doesn't make financial sense to borrow money for five years, at 10% interest rate to go buy a used car.
And so what that's causing is more and more inventory of used cars out there. And there was an auction recently where, you know, very few cars got sold, if any, because they weren't reaching the prices that they wanted. A car might be, you know, trying to get bought for $70,000, but the bids were down at $60,000.
So used car prices are falling through the roof. The Fed is kind of getting what they're wanting in terms of raising interest rates and bringing down inflation. Don’t you think?
I think so. And I think the other point is, like we remember in 2008, the subprime mortgage market and what happened is when that imploded and there's a subprime car loan market because some of those borrowers that are going for those 10% interest rates may have less than stellar credit. Right. So if you think about if interest rates are going up.
There's a possibility that that market is about to implode as well.
Yeah, it's interesting. I mean, some of these companies that, I’m not picking on any of them, but, you know, that make our lives easier. Right? Airbnb, VRBO, Uber, whatever. They're incredible technology companies and they're trying to disrupt traditional business models. Carvana was the same way they wanted a direct to consumer type atmosphere with purchasing no haggle prices, things like CarMax.
But it seems like it's somewhat backfiring in their face right now because there is so much inventory, the cost to borrow is so much higher and people have fears of recession. And the Fed continues to raise rates, that these companies are getting hurt pretty bad.
It's going to be very interesting to see how that plays out in the coming year. Just because you can't have, even if interest rates level off, we’re probably going to have a higher interest rate environment for quite a while. So what that's going to do to the bottom line of those car companies, it's most likely going to affect them.
If you were in the market for purchasing a car today, what do you think you would do?
It's a great question. I think if you have great credit or decent, good credit, there is, I think, still a lot of incentives to go get a new car. It's that whole story. Do I buy? Do I lease? Right. How does that play into my life? But I bought a used car during the pandemic, but it was from friends and that kind of was looking back, we lucked out because I did not have to go through a dealership and we just were able to negotiate. It was their third car. They didn’t need it anymore. But I have friends right now looking for used cars and they are really having a hard time and they don't want to go get a loan because of the really high interest rates and they want to be able to pay cash, but they don't want to pay $15,000 for a ten year old car.
Right. Well, they may, if they can be patient from what the data showing, if they can wait three or six months, they might be able to get that $15,000 car for $10,000 or $11,000. Yeah. And that could be more attractive for them to be able to pay cash.
That's kind of what I've said to some of them. I'm like, just wait a little bit. It's hard. We live in L.A., we need a car. So when you're desperate for a car, sometimes you'll bite the bullet. But I would say to your point, I think it's worth the wait.
Another interesting thing that's come about this last week is the FTX, the cryptocurrency exchange. It went from being valued at close to $35 billion, down to zero, basically overnight. There was not so much of a Ponzi scheme, but definitely misappropriating client moneys to then secure being backed by secured loans for these companies. And so misappropriation of dollars is a huge issue.
But why do you think some of these things happen where you've got the boom and bust with used car prices, you see something basically created out of thin air like this cryptocurrency brokerage firm, created out of thin air skyrocketed valuations and then down to zero. What do you think? Why do you think things like that happen?
You know, it's interesting. There might be I think crypto is a very different space. I would say that it's not as tangible as a car or real estate. So I think you've got people with FOMO that wanted to get into something like crypto with zero knowledge on, on how to tackle that and being such a volatile type of asset class or currency, when you've got when things are not going the way that are supposed to go, then you will have those things that will just fall off the cliff and there's really no backing for it.
So I think the biggest cause is keeping interest rates at zero. For as long as we did, it forced investors to go farther and farther out on the risk spectrum to try to earn a decent return. There was this fear of missing out like, oh, everybody else is making money. Maybe I should to without really understanding the fundamentals of what some of these businesses are and then how they're collateralizing those businesses or using assets to get loans and then when the Fed starts raising interest rates and you need to pay off that debt, all of a sudden if you're not cash flow positive as a company, you know, you can run into some serious issues. Yes. So it sounds like the best advice that you have for people is that if you're in the market for a used car, probably wait about 3 to 6 months, you're likely to get a better, better price.
Maybe you could pay out cash. Yeah. If you've got a good credit score, you still probably get a decent deal on a car loan and then stay away from some of these esoteric investments that don't generate real cash flow or help protect clients that you that you truly understand, like make decisions for yourself.
Unless you want to go to Vegas and play with your money like that.
No, I don't think any of us want to do that. Patrice, thanks for joining us today.
It's been a pleasure. Thanks.
Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your attorney, finance professional or accountant before implementing any transactions and/or strategies concerning your finances.
