Browsing the blog archives for August, 2014.

Revisiting Cash for Clunkers

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In 2009, President Obama and the Democrat Congress colluded to pass the Car Allowance Rebate System (CARS)—better known as CASH FOR CLUNKERS. As part of this economic/environmental stimulus program, car buyers who traded-in their gas guzzlers could get a $3500 or $4500 government cash voucher, depending on MPG ratings. The program was supposed to get inefficient polluters off the road and “jumpstart the economy.” Several studies, including one just published by Mark Hoekstra and colleagues at Texas A&M (http://papers.nber.org/tmp/22808-w20349.pdf), should put the final nails in the coffin of this ill-fated idea.

CARS was discussed extensively on this blog. There were several problems from the outset

  • CARS was arbitrary. Only those who owned a vehicle worth less than the $3500/$4500 voucher amount would benefit from the program. Cars worth more could be sold outright or traded anyway.
  • CARS encouraged debt with marginal buyers. By providing an inflated trade-in value of $3500 or $4500, low-income consumers were encouraged to purchase a new car. Dealers and banks are eager to provide financing because the vouchers provided a sufficient down payment, even though low-income buyers were more likely to default down the road.
  • Only certain new cars qualified, so most buyers had to incur debt to benefit. Consumers only received the voucher if they purchased a new car, something less desirable for low-income Americans.

Many on the left (and sadly a few on the right) initially called this program a success because many Americans predictably took the free money. U.S. Transportation Secretary Ray LaHood called it a “wildly successful run.” But clear evidence points to the failure. The Hoekstra study—and others—underscores the flaws.

  • About 677,000 vehicles were sold in the U.S. as part of the $2.9 billion CARS program. Vehicle sales to buyers with marginal incomes rose about 50% during the period, but according to a University of Delaware study, each vehicle traded in actually cost the government a net of about $2000.
  • Some dealers appear to have raised prices on eligible vehicles because the subsidy was sufficient to attract buyers. In other words, part of the subsidy benefitted dealers, not consumers.
  • According to the analysis by Hoekstra and his colleagues, most of the sales were “pulled forward” and would have occurred anyway, and the entire increase due to CARS was actually offset by declines 7-9 months after the program ended. Not surprisingly, U.S. auto sales declined by 23% the following month, led by GM and Chrysler with drops of 45% and 42% respectively.
  • Because CARS encouraged buyers to purchase higher MPG vehicles, most of the cars sold in the program were less expensive, low-margin models. Customers spent about $4600 than they would have if the program did not exist, resulting in an annual decline in auto industry revenues by about $3 billion a year.
  • CARS resulted in an increase in used car prices. Older vehicles with values in the “clunker” range rose in value because they could be exchanged for government vouchers. As more Americans participated in the program, the supply of “cheap cars” declined, raising prices on the market.
  • The program destroyed functioning vehicles. Typically, low-MPG vehicles are not driven as much anyway, but they provide essential transportation to low-income, occasional drivers. These vehicles were eliminated from the market, forcing prospective customers in the used car market to spend more.

CARS was a classic attempt by central planners to “fix problems” in the market, pick winners and losers, and stimulate the economy overall. Washington has passed many such programs, including the infamous “shovel-ready jobs that ended up not being shovel-ready.” Their proponents always claim success when the funds are flowing, but usually disappear when the unintended consequences become apparent. These programs squander tax revenues (or create more government debt) in the short term and disrupt markets over the long term. Fundamentally, they are part of the cronyism that is plaguing our nation.

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FRAT, the Fed, and the Stock Market

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Why does the stock market rise or fall? The prospects of individual firms included in the Dow, the S&P 500, and other indexes move on their own, but up and down swings in an entire index are usually based on broader perceptions about the economy. If reports suggest that people expect a stronger economy, you would expect these indexes to rise. The Fed often inverts this expectation, however, making it more difficult and risky for investors.

For example, if an economic report suggests that businesses expect a more robust economy, markets may actually fall because investors worry that this will bring about inflation and a tighter Fed policy. In contrast, if an economic report suggests weakness, markets can rise because investors anticipate looser Fed policy. Hence, producers in our economy and the investors who provide them with needed capital are often less interested in legitimate market news and more interested in how the Fed will respond to it. Stocks and other securities are only partially market-based, leading to all sorts of misperceptions about how they should be priced and resulting in stock market volatility.

In an efficient market economy, private investment is channelled to the most capable firms, and business and investment decisions are based on market factors. Basing decisions on guesses about government or Fed policy disrupts this process and misallocates these resources. Firms best positioned to deal with government regulations or changes in Fed policy–not necessarily those best able to produce what consumers want–get more resources when this occurs. In this way, central planners in Washington are indirectly picking winners and losers. Ultimately, this hampers the ability of our firms to compete globally, expand their operations, and hire more workers.

Measures designed to limit Washington’s control of our economy are essential if it to be strong over the long term. FRAT is a move in the right direction.

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FRAT part 2: The Fed and uncertainty

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In my last post I expressed my support for the Federal Reserve Accountability and Transparency Act (FRAT). Thursday’s 317-point stock market decline underscores my point.

I don’t think it’s possible for Fed intervention to stabilize the economy. Even if I am wrong, the right intervention could only occur if economists at the Fed could actually determine where the economy is going. Describing yesterday’s economy is not very difficult, but understanding today’s and predicting tomorrow’s is very complicated, if not impossible. Investors and business owners often base their decisions on “economic indicators,” which tell us more about the past than the future. Thursday’s stock market decline illustrates this point. Just one day earlier, investors had a different view on the economy.

While the Fed attempts to predict and influence the future state of the economy, investors, business owners, and everyone else are left to predict the future actions of the Federal Reserve. For example, if the Fed raises interest rates, anyone associated with the housing business will likely suffer, and anyone planning to buy or sell a home will find it more costly. For this reason, many analysts are more concerned with the Fed’s reaction to its perception of the economy than with the actual economy. This adds to uncertainty, giving business owners more reasons to stay on the sidelines and not grow the economy.

Just to be clear, I am not arguing that a stock market decline is imminent. Rather, the volatility of the market tells us how investor sentiment changes daily. My point is that the Fed’s overzealous intervention into the economy adds more uncertainty to the economy than it reduces. If we are going to have a federal reserve bank, its actions should be much more subdued. This is only possible if we actually know what the Fed is doing, which is why legislation like FRAT is sorely needed.

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