The Dark Side of CARS

The recently approved refunding of the Car Allowance Rebate System (CARS) has raised concerns among those who believe that the effects of the program, although undoubtedly profitable, will be perhaps even more severe on the industry than the ones of the ongoing economic crisis.

According to a study by Kelley Blue Book (KBB), the used-cars industry will take the most severe beating. The prospects of a flood of some 750,000 new vehicles on the streets in just under three months (250,000 from the initial CARS wave and the extra 500,000 from the current funding pool) will determine dealers to pile up stock in anticipation of the increased demand.

"Dealerships have reported increased foot traffic, creating a false sense of automotive market recovery," Alec Gutierrez, KBB senior analyst of vehicle valuation said. "As a result, dealers are going to auction to restock inventory, driving up used-car values. However, the effect of a supply reduction of this magnitude could have an immense impact on these values in the short-term, exacerbating the already-limited supply at auction."

According to the KBB study, 1-in-10 new-vehicle shoppers are likely to go to the dealer sooner than they intended if a government sponsored program is in place. This basically means that CARS has created a need sooner than it would have come on its own. The effect of this accelerated purchase may have negative effects in the months to come.

"If this bubble comes to pass, dealerships will end up with excess inventory of both new and used vehicles and be forced to offer deep discounts to remove surplus inventory, driving values down. Ultimately, there will be the possibility of a severe contraction in auto sales as soon as the Cash for Clunkers program runs out of funding," concluded Gutierrez.