I. My Landscaper Drives a Mercedes

I live in Scottsdale Arizona and I will say with absolute certainty that there are multiple bubbles in the economy. To name a few of them:

  • There is a home refinance bubble: individuals who had 6-8% rates on 30/yr mortgages from the mid-2000’s being refinanced (mostly with cash out) to <4%. This is also creating excessively high commission jobs for young adults at places like Quicken Loans, Loan Depot, Paramount Mortgage, etc. Employees who don’t understand the job boom is temporary.
  • There is a student loan bubble: anyone under 30 who went to college is drowning in loan payments for the obscene costs of their “education”, which in reality consisted of drinking beer and taking a bunch of useless intro classes for the easy-A.
  • There is a corporate debt bubble: junk bonds issued to attract yield starved investors, mostly for fracking oil companies. A majority of these companies don’t have a bright future – especially in a time where profit margins are shrinking and debt burdens increasing. Investors in these companies, along with debt fueled share buybacks, rocketed these struggling companies to record high stock prices. However, these investors forgot what to analyze. The I in EBITDA stands for interest, remember? When interest goes up, profit margins plummet.

Most importantly and most obviously exuberant is the auto loan bubble.

I don’t simply mean an excessive boom in sales and financing. Shouted offers from manic salesmen of 9 years at 0% interest; cheap money, courtesy of the Fed.
Rather, I am positive there is a subprime auto loan bubble that is parallel with the 2002-2007 housing bubble.

I graduated from a high school in 2009 that was on the rim between Phoenix and Scottsdale – the difference in quality of cars, homes, shops, and people was surprisingly noticeable.

Especially in 2007. Witnessing my own neighborhood go through a luxury construction boom, and my own father adding to our house. I remember our neighborhood would have a BBQ every other month and all the neighbors would come out and eat and gloat about how much their houses are worth. The man across the street, Bob – who was also my fathers life insurance handler, had bought his house for $185,000 in 1997 and he just sold it for $525,000 in 2005. On top of that, I remember him telling my father days before he moved, that his family is borrowing another $500,000 on top of the sale proceeds to buy a $1 million dollar home in Cave Creek.

“Dad,” I asked, “why is our home price suddenly going up so much?”
“Because its growing in value,” he answered.
“But we didn’t remodel. We didn’t paint. We didn’t even wash the carpets, so why does the price keep going up so much when my car (I was 17 at time) loses money every year?” I said.
“Well, Adem, car prices depreciate and have more supply. But homes need more time to be built and everyone needs a home.” he said.

I was still in high school and didn’t know fundamentals of the economy.  The one semester of economics they offered at school consisted of our teacher passing out candy and watching movies about hot dog factories and Bill Nye (nothing even to do with economics).
But one thing was for sure – being a natural born skeptic and contrarian, I did not feel right about the home boom lasting.
And in hindsight, my gut was right. If only I knew what I know now and had the funds I do now to have bet against it’s inevitable collapse.

As everyone across the globe knows, after 2008 struck, there were severe crisis and collapse of construction and house related companies. Realtors, which was once the prestigious career to have, became extinct. Over-leveraged families began sweating bullets. Foreclosures soared (my neighbor Bob eventually defaulted on his Cave Creek home and lost his families equity also).

What was the governments and central banks solution for the problems? Even more debt and lower interest rates.

Eight years later and still living around Scottsdale I will say with certainty now there is a subprime car bubble that will make 2008’s home bubble blush. Associates of mine with degrees in psychology, business admin, sociology, and public relations that were bartenders, personal trainers, and servers now work in car sales (or Quicken Loans – everyone has a close friend/family member that works or has worked there).
They are selling cars to whomever has a pulse. Don’t be confused – none are sold for cash (a thing of the past), all cars are being sold with 5% down. The rest are financed, with some as high as 100 month terms.
A close friend of mine, who had just gotten a job at Quicken Loans, never had a credit card, no assets or no tax returns (he worked in a bar). He was sold a brand new 2015 bright red Dodge Ram truck for roughly $50,000 with 5.5% financing terms and only had to put down $2,500.

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It has gotten so incredibly bad that when I drove last week to my doctor appointment, I saw 11 cars with “deal tags” (the paper “plates” used on new purchases until license plate arrives in mail) in the 20 minute car drive to and from.

Look for yourself at the 6 I was able to snap photos of (I blurred out the license plate numbers for privacy):
imageCar5imageCar6imageCar4imageCar1ImageCar3ImageCar2

Remember, individuals are only supposed to use those paper plates for a couple weeks at max until their metallic plates arrive. This means that every time I go out, and believe me I have seen at least 50 since I started counting 2 weeks ago, there are new right-off-the-lot cars being bought.

I challenge you: next time you’re out and about, start observing the cars on the roads and in parking lots. It’s ridiculous when one spots a Walmart parking lot packed with Maserati’s, Bentley’s, and Mercedes Benz’s.

II. Is This Time Different?

What is worrisome to this author is a couple things: who is buying them and can it last?

To start – interest rates are planned to be increased by the Fed (I expect negative rates before higher rates, but the Fed may raise to save what little credibility they have left). That already means higher auto loan payments are coming.

Also – car companies, due to higher sales from lower borrowing costs, realizing huge profits have all been producing at max production.

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Source: IOCA

When there have been years of over-production (increasing supply) followed by a period of tight credit (decreasing demand), the timeless truths of economics are shown and prices collapse. This is similar to what occurred in the Roaring 1920’s and during the Great Depression. An Austrian Economic law is the bigger the boom, the harsher the bust. It’s no coincidence that the “roaring” twenties was succeeded by the “Great” Depression.

I googled mapped Car Dealership within a 5 mile radius and two things I noticed: there are so many dealerships (24), and a good amount of them sell luxury vehicles (Ferrari, BMW, Audi, Infiniti, etc).

dealership

There is clearly no shortage of car dealerships.

It is important to note that car dealerships have to pay two “lot fees” a month for idle cars. This means the longer the car is on the lot, the more the dealership has put into it. Eventually it becomes a burden as their cost for the car exceeds it’s profit – that’s when bargain buyers should pounce.
“Ask for the cars that have been on the lot the longest. After a few months they just want anyone to take it off their hands,” said a now retired, former GM Finance Director (he was actually my Uber driver and we got on the topic of the car bubble – which he openly agreed).

How will it end? In my opinion, from what I have seen first hand, this is what I expect:

The economy is weakening (First quarter 2016 GDP was .05% – GDP has dropped consecutively for the last 4 quarters straight). The Fed claims it will raise rates (again, doubtful) and if they do, borrowing costs will increase and the economy will stall. Unemployment will increase, leaving more recent college graduates with less opportunities. Burdened by increasing credit card debt, student loans, mortgages, corporate debts, and auto loans – individuals will have less disposable income (over 50% of Americans live paycheck to paycheck as it is now).

In a recent survey, 56 percent of Americans said they have less than $1,000 in their checking and savings accounts combined, Forbes reports. Nearly a quarter (24.8 percent) have less than $100 to their name, says Esquire.

This is where being creative comes in, if individuals are losing their jobs and drastically cutting costs – what would they rather do? Have a roof over their head and food or drive a fancy car? Thus expect individuals to commit mass defaults on car payments (missing car payments is already at highest level since the 08′ recession). Dealerships will have inflows of older defaulted cars coming in at the same time the 2017 models are arriving.
“What the hell,” the dealership manager will say, “we have limited space on the lot, where are we going to put all these? With the new 2017 models in the front we can’t have 2010, 2011, 2012, etc. taking up space.”
On top of that, these cars are older and will need too be touched up and repaired. Remember, the longer the car is on the lot, the more Lot Fee’s dealers pay. Expect a fire sale on used cars (new car fire sales will come later) for anyone who can simply take it off their hand’s.
And living in Scottsdale, that is a disgusting amount of used cars needing to be resold.

Look at the inventory-to-sales ratio of the auto market. They keep building while they aren’t being sold.

InventorySales
The automotive inventory-to-sales ratio has never been this high outside a recession.

What went up will crash down: I am fully expecting that soon. The laws of economics dictate that, but also from my experience witnessing unemployed college students taking out student loans to finance luxury cars (Porsche I see the most).

As I drove past dealerships on every major road and saw countless cars speeding past me with paper plates, I muttered to myself, “short it – short it all to hell.”