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Monday, January 12, 2009

Auto Bubble Breakdown

Cheap financing led to soaring loans.

The same chart with the financing rate axis reversed shows the strong correlation between the financing rate and size of the historical loan value.

This created an environment in which the consumer could borrow more, but pay the same amount (i.e. cheap financing meant monthly payments stayed relatively flat after accounting for inflation).

This has unraveled in recent months as consumers not only realized they didn't need a new car every 30,000 miles, but they also found it difficult accessing cheap credit as lenders reigned in lending (i.e. GMAC refused to lend to any borrower with a FICO score under 700). The obvious result... auto sales collapsed, which in turn led to the GMAC bailout to pump the bubble back up (per PoAC):

At the start of last week, the U.S. Treasury bought $5 billion in GMAC stock and loaned GM $1 billion to invest in GMAC Financial Services LLC.

The next day, GMAC announced zero percent financing on some models of GM cars and doubled the number of potential buyers qualifying for loans.
Source: Federal Reserve