Oil Economics and the Auto Industry

by Ruggles - from my Auto Finance News column

Drill Baby Drill has finally worked, but only because OPEC cooperated, at least temporarily. Until just recently, increased U.S. production hasn’t resulted in low fuel prices at the pump. There is no good reason for global oil market prices to have stayed so high for so long in the face of dramatically increased U.S. production UNLESS OPEC had curtailed its own production to provide price/supply equilibrium. That has been their modus operandi for decades. OPEC started off with 5 members and now has 12, yet they don’t produce any more oil now than they did in 1973. In that period of time, global population has doubled and oil consumption has almost tripled. It’s not because OPEC couldn’t or can’t produce more. They operate like a cartel, because they are.

The recent decision to continue production at current levels prompted a steep drop off in oil prices, fuel prices at the pump have taken a dive to the delight of consumers, EVs and hybrid sales have slowed dramatically, and the alternative fuels and high cost oil producers are shaking in their boots. So are some bankers. One imagines the lenders for Trans Canada being relieved they aren’t going to have to extend credit to build Keystone, thanks to the measure being blocked in the U.S. Senate. After all, how would the debt for the pipeline be serviced if there is no traffic on the pipeline due to a lack of financial viability of Canadian oil sand and shale production in a relatively low global market price environment?

So how will the recent OPEC decision to continue production at current levels impact the auto industry. It is clear that with cheap fuel at the pump, the sales of small fuel efficient vehicles will have to be steeply incentivize or many auto OEMs will be paying HUGE CAFÉ fines. That won’t help residual values on the pre-owned versions as Rene Abdallah, Vice President of RVI Group, has been saying for a few years. RVI Group is the leading insurer of automotive residual values in the United States.

Fortunately for lenders and captives engaged in leasing, there aren’t too many smaller vehicles in lease service. On the other hand, sales of “heavies” will boom providing temporarily strong residuals, short term auto industry profits, and setting us up for the next spike in fuel prices…... you know, the type of spike that kills residual values of “heavies,” stops sales of new “heavies, and triggers recessions.

Who knows how long our economy will enjoy these fuel prices? What else could happen? The low fuel prices will help keep a lid on inflation, even though auto fuel isn’t technically a part of the Consumer Price Index. Will the Fed take advantage and raise interest rates, feeling there is less risk in doing so? This is a mixed bag and it is hard to know which element will carry the most weight. A rise in mortgage loan interest rates and auto loans would most certainly result in some consequences. Will those consequences be enough to slow the economic growth spurred on by lower fuel costs, or will the momentum created by the low fuel prices overwhelm the other issues? Who knows? That’s for the economists to calculate through their mathematical models.

The Obama Administration and the “Green Movement” are disappointed that interest and investment in alternative energy and sales of fuel efficient vehicles will wane. On the other hand, the Administration can’t help but be pleased that the sanctions on Russia over their incursion into Ukraine carry extra weight now. There is also rampant speculation that Iran and Venezuela aren’t pleased with this decision crammed down their throats by U.S. ally Saudi Arabia. The House of Saud, Sunni Muslim Arabs that they are, aren’t particularly pleased to see any extra petro dollars go to Shiite Muslim Persians to develop nuclear weapons and spread terrorism through Hezbollah and other terrorist groups, around the Middle East. Many think the Saudis took advantage of the situation to do what they wanted to do along, which is to manipulate the global market price of oil to a level to force many competitors out of business so they can raise the price with impunity down the road. After all, they’re in it for the long term dollars, not the volume. Iran and Venezuela are thinking short term. They can’t sell any more oil under the OPEC pact, but they receive substantially fewer dollars. Who do the Saudi’s see as competitors? Answer: Oil sand and shale producers, frackers, alternative fuels producers, and the EV industry. There are rumors of over 3K unsold Tesla Model S cars parked in some secret location. Sales of PRIUS and other hybrids and EVs have stalled.

For a while U.S. consumers will be thrilled. The moderate oil prices may help the world’s largest economy, the EU, avoid a second recession, which is also good for the U.S. But there is another shoe to drop. We just don’t know when. We should enjoy it while we can.

Takata and The Quality Dilemma

revised version posted by Smitka at The Truth About Cars

The Takata airbag inflator problems illustrate a fine dilemma: quality standards across the auto industry are good, those for safety-critical devices very good. The result is that only things that occur very rarely get through the production process, and many of those either cause no problem or don't get reported. That makes confirming that there is in fact a pattern challenging, and figuring out the root cause (or causes) extraordinarily so. The number of known deaths (the media suggests 5) is a very small fraction of the number of lives saved by Takata airbags. So the other dilemma is that the fundamental robustness of the manufacturing process means the benefits of a recall are also very low, and the quality of work in your local dealer's repair bay is not equal to that in an airbag plant or vehicle final assembly plant. The cure can be worse than the disease.

Anyway, I spent a day this week with an airbag manufacturer, listening to engineering presentations on a new airbag design from the supplier's senior engineers, with a senior car company airbag engineer also in attendance. I won't name the companies, and what I write is based on information that should be available from public sources. (I spot-checked a couple of the points.)

1. First, globally there are tens of millions of Takata airbags on the road. I've not been able to find a number, but I would guess that over roughly 1 million such vehicles have been involved in a collision that led to an airbag deployment. Of those, to date there are 5 known fatalities and several more injuries. Actual problems are exceedingly rare.

2. The cause is as of yet unknown, as there are multiple failure modes. Which one(s) are leading to the observed problems? Small numbers mean (i) this analysis is intrinsically very challenging. It is complicated by (ii) the evidence going up in smoke when an airbag inflator explodes and (iii) other evidence going up in smoke because documents in Japan were sent to the incinerator. The concentration of incidents in very high humidity locales suggests deterioration of the ammonium nitrate "propellant" due to hydration, wich could cause the sheets of material to turn into clumps (sheets go "whoosh," clumps go "boom"). However there are several incidents in areas not known for high humidity. So there could be two different problems, or one systematic problem and the random one-in-a-million manufacturing defect, or all random problems some of which just happened to be clustered geographically. So last week automakers who use Takata airbags got together to decide how to jointly collect and analyze disparate data in the hopes that the combined data would allow meaningful analysis. This was a meeting cleared by the Dept of Justice as not violating antitrust because it was limited to engineers discussing a narrow set of issues. Almost every car company uses Takata for at least a few airbag applications, so it was basically a meeting of the global customer-side engineering community.

3a. If the actual problem is not systematic, then a recall may do nothing at all except cost lots of money, because the same one-in-a-million bad inflator ratio won't change. If anything, a rush to increase production will make monitoring production process compliance more challenging and could lead to a higher number of (idiosyncratic) random defective airbag inflators in cars.

3b. Again, other manufacturers cannot substitute their inflators for a Takata inflator -- they would have to design a product that matched the gas generation profile needed to match the Takata airbag, verify their method of manufacturing produced parts that actually worked to design, test prototypes with the Takata airbag to make sure there was no unforseen interaction (vent angles or orientation slightly different, lots of subtle interactions). Then they would have to set up a production facility, run off a lot of parts coming through the actual production process on the machines and tooling and inspection processes that would be used (rather than the prototype build process), and have these tested and retested. This is necessary because the bag portion is very, very specific (the exact grade of material and how it is folded are all very carefully specified, tested and then monitored during production for exact replication). It would be very hard to do this in under 6 months, and production does not ramp up from nil to full overnight. It would be impossible to do this in 6 months across all of Takata's airbag-inflator-vehicle combinations, because each would need to be tested separately. Engineers can work 16 hour days for a while, but not for month after month. There isn't excess engineering and testing capacity just waiting for a recall to come along, and car companies want their engineers to continue working on new vehicles, they don't want to stop everything under development to re-engineer an old (perhaps decade-old) product.

If you need to find a needle in a haystack, maybe it's not worth finding the needle.

4. Nevertheless, of the inflator manufacturers, as far as I can tell Takata is the only one whose inflator operations did not start out as a division or factory of a rocket engine or explosives company. Instead Takata was a cut-and-sew operation that had expertise in fabrics that then added in-house pyrotechnic capabilities. That adds to the suspicion of a systematic albeit very rare propellant problem, but again, the number of incidents remains very small and there is essentially no ability to cull the necessary information from incident reports or (when they were kept) piles of shrapnel.

5. For reference, manufacturers of inflators include Autoliv (the other really big player), TRW, Key Safety Systems, Daicel and (making only inflators) ARC.

6. Finally, I want to reiterate that the numbers indicate you are much safer in a car with a potentially defective Takata airbag than a car without any airbag. The Takata airbag defect matters only in a frontal collision. Even if the inflator did spin off shrapnel, which is (order of magnitude) perhaps a 10 in a million chance, the chance you will be seriously hurt is lower. If you don't have an airbag, you'll be using your head -- to slow down the rest of your body. That story never has a good ending, and can readily have a fatal one, the latter at a rate much higher than 10 in a million.

mike smitka, from Toronto

How the Pre-Owned Market is Driving Economic Growth

An interesting theory inviting comments: http://www.cnbc.com/id/102186242

Waiting for the stars to align: Japan's Consumption Tax increase

Japan, as does much of the world, has long-run fiscal challenges. Its population aged faster than anticipated. No mechanism was put in place to automatically adjust pension and healthcare revenues.^{Note 1} In addition, the slowdown of economic growth and the late 1980s bubble and its collapse both meant that revenues plummeted, leaving the economy with a one-time buildup of debt as the aging process commenced. The result was a large initial buildup of debt, and an inexorable subsequent rise.

...right now the stars are aligned around the consumption tax...

Addressing the issue required however the proper alignment of stars. First, the political system had to be configured so as to allow decisionmaking. A long era of prime minister of the season meant that doing much of anything has been a challenge. Then there's the economic system: even deficit scaremongers recognize that raising taxes in a recession is a bad idea.^{Note 2} So Japan also needed to have the economic stars align. For the initial decade or so, the aftereffect of their bubble muted discussion of tax hikes. External shocks – the Asian financial crisis in 1997, worries about spillover from the end of the US dot.com bubble, then 9/11 and 3/11 [the Tohoku megaquake], and more recently the sharp recession touched off by what is known in Japan as the "Lehman Shock" provided excuses to postpone, from the perspective of politicians if not economists.

Then came Abe. He is only the second prime minister in many, many years to not face a constant risk of losing his majority support in the Diet; the political stars aligned. Likewise the economy has been recovering bit by bit from the Lehman Shock and 3/11. While the reality may be something less, weak labor markets that kept youth from launching careers, headlines trumpted the rise of GDP and diminishing deflation. The denoument was that on April 1, 2014 Japan increased the consumption tax (消費税) – its national sales tax – from 5% to 8%. That had a predictable negative impact on growth, and so it remains an open question which way Abe and his cabinet will lean for authorizing the next increase in the consumption tax, a 2 percentage point bump scheduled for October 2015. The legislation is in place, but there is still an opt out.

One metric is inflation. Unfortunately a disadvantage of a large bump – in this case 3 percentage points – is that while it will produce a correspondingly large jump in the price level, the base effect will wear off if the underlying wage and other cost dynamics (and firm pricing power) remain unchanged. So we are now at the point where inflation is trending down. The depreciation of the yen helped hide that, particularly as higher import prices have been sufficient to offset lower global energy prices. But that effect too will wear off. Global headwinds now threaten; China, not the US, is Japan's largest trading partner. (Japan's exports to China of computer chips and the like are incorporated into iPhones and similar goods that are promptly re-exported to the US and ... whoops ... Europe. No out there!) So my sense is that if the economic stars are aligned, that is temporary.

All this begs one question on the nature of the tax increase: why large jumps? Instead of raising taxes by 3 percentage points in one fell swoop, why not raise rates by 0.75 percentage points every 6 months over two years? or (given the 10% end point) raise rates in increments of 0.5 percentage points every 6 months for 5 years?

That would have multiple advantages:

1. Incremental bumps would lessen the surge of big-ticket purchases just before the rate increase went into effect, and the subsequent negative rebound. Such volatility serves no good macroeconomic purpose.
2. Maxi bumps make sales data hard to interpret for the private sector – how much of the March 2014 sales surge was because the economy was doing well and how much was due to consumers pulling purchases forward? Such uncertainty serves no good business purpose.
3. Volatility makes macro data hard to interpret for us economists. Yes, readers are shedding crocodile tears in sympathy, but some economists do have politician's ears (such as Koichi Hamada, a friend of Abe and former University of Tokyo and Yale professor whom I've known for 30 years). If such economists are honest – Hamada is not a mere political hack – then they are surely tempering their advice.
4. Frequent mini bumps would add to inflation for some time to come. Surely that would be better if the goal of policymakers is to shift expectations away from deflation.
5. Mini bumps ought to be more robust politically. You can with good reason argue that, in the midst of a slowing global economy, now is not the time to bump the consumption tax to 10%. It would be harder to argue that going from 8.5% to 9.0% should be postponed.
6. Mini bumps ought to be easier to extend. From a fiscal perspective, even at 10% Japan's deficit will remain large, and at 10% the consumption tax is much lower than in many OECD countries. So why stop at 10%? That's surely much easier to sell if it's a continuation of mini bumps rather than a maxi jump.

Tightening loopholes through strict implementation of a national tax ID system may be the most desirable step. Right now though the stars are aligned around the consumption tax.

 

1. Money is fungible and there is no particular economic reason to run retirement programs on a stand-alone budgetary basis. Having separate retirement and healthcare accounts and taxes to match is however to my knowledge universal.
2. Cutting retirement benefits would have the same net budget impact and the same short-term contractionary impact as a tax increase, though with 25+% of the population already benefitting from Japan's programs, that's politically infeasible. It's also morally objectionable, as the twenty-five-percenters paid taxes during their working lives and so fulfilled their end the social contract. Extending the retirement age is a compromise: those near retirement may be treated unfairly, paying in more and taking out less than they anticipated, but at least the ex post adjustment is muted.

Michigan's Anti-Tesla Ban: Bloomberg is Off Base

Bloomberg has an op-ed "Detroit Fights Innovation -- Again" which in fact is not about the Detroit Three of GM, Ford and Fiat Chrysler [the merger was consummated on Oct 12th] or even manufacturers, but about Michigan and (indirectly) automotive dealers. It makes the very tenuous claim that state policy that blocks Tesla from running company stores (in contravention to existing state law) is tacit protectionism that represents a step backward. Indeed, the article implies that the restriction is ultimately aimed at preventing a Chinese invasion. In fact the policy is misguided because history shows that there's no need to fear factory stores, at least as long as they're not set up by a car company so as to undermine their own existing dealers.

First, there's the red herring: China. The editors – there's no by-line, though David Shipley is listed at the bottom – ignore that GM and VW are the biggest players in China, and that purely domestic firms are in a tailspin (Warren Buffett has thrown away a pile of money on BYD [比亚迪汽车]). Two firms less successful in China, Honda and Volvo, are however already exporting. The camel's nose is well inside the tent: all of China's major players are multinationals who already have dealerships spread across all 50 states. And protecting the Detroit Three? Don't they editors realize they have but 46% of the US market?

Second, multiple automotive firms in multiple countries across multiple decades have tried and failed with factory stores. If you read carefully, you'll even find Tesla talking about defects with their distribution model. A modern dealership is comprised of six interlinked businesses: new vehicle sales, used vehicle sales, used car wholesaling (trade-ins), finance & insurance [including warranties], repair services, and parts sales, both retail and wholesale. (Some add a seventh to the mix, body shops, which in practice are a very different business from service & repairs.) So a manager must handle trade-ins, push used car sales and otherwise place a priority on things other than selling new cars in order to make a profit. On top of that, dealers are in a constant battle over what sort of physical "store" is needed, how much and what kind of advertising is necessary, and many other decisions important from a financial or strategic perspective. All this requires an ability to say "no" to the factory. No company has ever granted the manager of a factory store that level of discretion.^Note

More important for potential new entrants, independent dealers provide billions in financing to a car company, because they hold inventory, not the OEM. The real estate is theirs as well. Any potential new entrant that needs a large distribution footprint -- that is, any company outside of the supercar niche -- can't afford to ignore that. If Elon Musk wasn't so good at bilkingmilking investors, he would need that money, too.

So the Bloomberg editors are accurate that Michigan -- which is far from being in the vanguard on this issue -- should not concern itself with Tesla's retail strategy. They are however accurate for the wrong reasons: factory stores have been a bloodbath for all who have tried, and will remain so. Indeed, they're critical to a car company's financial viability. Contrary to the editorial, it's not incumbent car companies that should be concerned, or existing dealers. It's Tesla shareholders and bondholders who should worry.

---

Note: The factory rep who has actually sold a car to a real customer is the rarest of creatures. To my knowledge there are none with the experience of running an independent dealership. Then there are incentives: a factory rep works for a salary, and their career depends on saying yes to their boss. They are not offered compensation commensurate with what the principal of a (successful) independent dealership can earn. So both corporate incentives and practical knowledge stand in the way.

Espresso and Pizza

photos fixed Jan 3, 2015

The base post lies at Espresso and Pizza on October 7, 2014 on The Truth About Cars.

I don’t normally post about vehicles themselves, but I am endlessly fascinated by the industry, and constantly surprised to learn of new niches. On the finance side, I’m amazed at the variety of vendors that show up at conferences such as those sponsored by Auto Finance News. One of these years I’ll make it to SEMA (the Speciality Equipment Market Association), which by reputation has both the credible and the incredible. But back to my topic: once in a while I do find products – or rather niches, I’m not a “car guy” – that intrigue.

I have fond memories of the local Good Humor trucks, which once made the rounds of Detroit. Then there was the lunch truck at the Chrysler Mack Stamping plant, where I worked some decades ago. Perhaps they’re still in business, but of late I see few such. Yes, the funnel cake van is a fixture at community festivals here in rural Virginia, and at least one of the local BBQs sell their pulled pork from a truck. The vendors of sausages and gyros unload everything from a trailer to set up under a tent, while the Ruritans sell hot dogs and burgers from a modified trailer. Other than the huge step vans on Constitution Avenue in DC, today I seldom see truck-based vendors, and the ones I do see are very utilitarian in their setup.

In Japan the historic model is the pushcart vendor (yatai 屋台). Going back to the 1800s, the Tokyo (Edo-mae) variety of sushi started out that way, a snack food sold on the streets, low not high cuisine. Into the 1970s (but now largely vanished) you could find yatai in the evening outside train stations, selling noodles or yaki-imo (sweet potatoes kept in hot gravel) or tako-yaki (octopus “donut holes”). It was in Tokyo that the phrase “chestnuts roasting on an open fire” first took on meaning for me, because that was another staple of street food. Such are not unknown in the US; you still find pushcarts in Central Park and elsewhere in New York [by which I of course mean Manhattan]. When I worked on Wall Street (well, actually Pine Street) I was fond of hot pretzels. But in Japan the modern version of the pushcart vendor is likewise relegated to the grounds of the local shrine during community festivals (matsuri).

Then I spent a year in suburban Japan. There you encounter a modern version of the yatai of old, imaginative and entrepreneurial. These are (often) young couples in “kei” trucks (mini minivans) fitted out to be one or another sort of mobile restaurant. You encounter them in suburban parks and other places families frequent, or in urban plazas. [In most of Japan parking along the street is not an option. In the areas I frequented the police made no exception in the late evening, when streets were only occupied by the occasional taxi and by drunk sarariman tipsying towards their train home.]

Here and below are photos by Smitka

Entrepreneurial, imaginative. First, the imaginative. To be practical, imagination must be constrained, not given free rein. Keeping things small(er) is one such constraint, pushing creativity in much of the world in directions irrelevant to the US environment. In Japan you find many adaptations to narrow streets and small lots. There are the local restaurant delivery services. At one time that would have been a Chinese restaurant or sushi shop, but tastes have changed and now that niche is dominated by contemporary sorts of foods. In the US delivery is done by employees in their own car. Not so in Japan – it’s by company scooter. In Chiba (a city of 900,000 just east of Tokyo) that might be the local Pizza Hut franchise. [I was never tempted to sample their fare...] Similarly, the backhoe that as I write is digging a trench to improve my driveway’s drainage is small, but it’s a monster compared to the construction equipment at sites in urban Japan.

So I should not have been surprised at vendors in their “kei” minivans, laid out to take advantage of every cubic centimeter. I unfortunately don’t have a photo of my favorite, a “kei” that a couple fitted with a wood-burning oven appropriate for two small pizzas. Not a viable business? Actually, it was about right – they didn’t have much workspace to toss the dough and lay on the toppings, and with the very thin crust they used – something I’ve seen in Milan and Tokyo but not the US – a “pie” didn’t take long to bake. The wait wasn’t bad. Theirs was a one-off, a personal project, but it looked something like this:

My most recent encounter was with a mobile coffee shop. I had a chance to chat with the owner/barrista in between customers. He had designed the layout himself, and helped do the fitting. Water, propane for heat, a grinder, an espresso machine, a sink, a fridge … the whole works, and he roasted his own beans [his logo proclaims that: 自家焙煎]. He wasn’t however in the suburbs but instead near Tokyo Station, taking advantage of real estate laws that set fairly restrictive floor-area ratios forcing newer office buildings to include an off-street plaza. He had a rotating schedule of such locations where he’d negotiated access (presumably for a fee). While he had an awning and some seating, most of his business was take-out. That sultry summer day he was busy enough, though he’s inclined to take the day off in truly inclement weather. Here is the van, with the “master” at work. (Click to enlarge!)

Home Roasted Beans	Master at Work	Service Counter

In my experience restauranteurs are quite finicky about their setup. This entrepreneur may have been willing and able to take a hand in finishing off his creation (see his 大月珈琲店 Facebook page for photos). However, welding and fitting are not part of the typical Japanese skill set, where “do-it-yourself” does not include even the most basic of household repairs. So with a little bit of digging I found several companies that specialize in such, including ZECC, Maku, Aian Cook ["Iron Cook"], and (winner of the best name) Mobil Cafe Mom’s: Production of Customized Car. The used car page on GooNet lists 104 “mobile retail” vehicles for sale, with prices from around $12,500 for a used truck to $25,000 for a brand new one, albeit none of these have appliances. An example from carsensor.net lists one with already equipped with sinks, plumbing and exhaust fan at $17,000. Yahoo Auctions Japan likewise lists numerous vehicles, so it appears to be an active segment. (I didn’t check Rakuten; in Japan eBay botched its initial entry and is not a player.)

Now I’m sure there are similar specialized firms in the US, and maybe on the West Coast mobile vending remains a lively business model. Yes, there are unusual promotional vehicles, such as the Oscar Mayer Wienermobile – there’s one on permanent display at the Henry Ford Museum in Dearborn. But I’ve not seen such whimsical “mobile kitchens” outside of Japan.

Links to (Japanese) pages with photographs:

1. Pizza Boccheno
2. ZECC, which specializes in making “mobile retail” vehicles. Lots of photos.
3. Pizza Ci Vediamo [note the Coleman brand tent!]

[Note: max "kei" dimensions are 3.4m x 1.48m x 2.0m with an engine of 360 cc - a Smart is too wide and has too big an engine.]

Labor Market Update: little bad news, but no acceleration

I post below a series of graphs on the US labor market updated through September 2014. As I read it, the latest CES (Current Employment Survey) and CPS (Current Population Survey) releases from the Bureau of Labor Statistics show more of the same – job growth a bit above population growth, little bad news, but no hint of an acceleration in the economy that might soak up what I estimate to be a 7.6 million shortfall in total employment, and 8.7 million gap if we subtract the rise in those working involuntary short hours. All this is calculated correcting for demographic effects including baby boomer retirement. As the graphs indicate, there's been no drop in participation by older Americans; the brunt of our recession was born by prime-age workers and especially new school leavers.

Changes in Basic "Headline" Employment Number

Changes in Employment less those working involuntary short hours

Jobs Shortfall relative to demographics-corrected normal level

How long until we return to normal??

Total U + Discouraged + Short Hours Remains at Historic High

Drop in Employment Levels Was Younger and Prime Workers

Participation by Older Workers Has Risen

Before the Recession those 55-59 stayed in the LF longer, so some evidence of early retirements

Warren Buffet's Berkshire Hathaway buys auto retailer VT Inc.

From Slate Magazine: "Warren Buffett's Latest Deal Has Officially Made Car Dealerships Cool"

I don't think so. I have a LOT more to write on this as someone who has spent a career life in the retail auto business AND worked in the van Tuyl organization. This time, Warren might have bit off more than he can chew

This is a REALLY BIG DEAL!!!!

Ford Poised to Realize an Upturn in Margins?

http://seekingalpha.com/article/2538735-is-ford-on-the-cusp-of-an-upturn-in-margins?app=1&uprof=53

A good piece from Seeking Alpha on Ford, instructive in the importance of margins, or as we call it in the retail auto business, "Gross Profit," what consumers hate to pay. "Success for any company begins with gross margins as this tells you how much it costs a company to make whatever it's selling. This is a pure look into a business' ability to show pricing power with its suppliers and demand from its customers."

In For The Long Haul

The original for this post is at TheTruthAboutCars.com, which in turn draws upon a post by Alexander Dawejko done for my Economics 244 course. I have added another paragraph here.

ZF Friedrichshafen is buying TRW; JCI sold its automotive business to Gentex and Visteon. Are we in a new era of supplier M&A activity? The previous wave didn’t work out well – Dana, Tower, Dura, Lear and others ended up in Chapter 11.

So how about Federal-Mogul? They too went on an acquisition binge in the late 1990s, including the British firm T&N. In the process they took on debt, with a $2.75 billion package just for the T&N purchase. As with others, they bit off more than they could chew. Federal-Mogul’s downfall however wasn’t operational issues but one T&N factory that had used asbestos. The accompanying $1 billion-plus in costs tipped them into Chapter 11, and it took until 2007 – 6 years – for them to emerge. So where are they heading?

Now back in 1999 Carl Icahn, a corporate raider, started buying shares in Federal-Mogul. The value of his initial holdings vanished in Chapter 11, but he also bought Federal-Mogul debt, a lot of it, and in 2007 emerged as the dominant shareholder in the new firm. Icahn’s modus operandi had been to acquire a majority stake in a company – the list includes Viacom, Marvel Comics, Blockbuster and Time-Warner – and then replace management with his own associates. They then would dismember the company in search of cash, with Icahn unloading his holdings as soon as practical, to make way for the next target.

Obviously 2008 was not a good time to unload anything automotive, and overall profits have since been spotty. But by 2012 profits were looking up, and Icahn split the firm into two pieces, separating powertrains (a $4.2 billion business) from aftermarket ($3.1 billion). This made sense only as a prelude to Icahn’s selling one or both of pieces. Consistent with preparing for a sale, he appointed an associate, Daniel Ninivaggia, as co-CEO of the aftermarket portion. [See a Sept 3rd Automotive News story.]

In a visit to a Federal-Mogul R&D center in Plymouth, Michigan we [Dawejko and the rest of the class] saw how focused their people were on designing and manufacturing new products. Most of the class had never heard of the test equipment we saw. Unlike the tribology labs, some of the products under development were self-explanatory, such as the corona discharge spark plug about which TTAC reported in 2011. What became clear is that Federal-Mogul is in fact a high-tech operation that spends 5% of revenue on R&D. They have been a PACE supplier innovation finalist 32 times, and an award winner 11 times. In the context of the automotive product cycle, however, technology is not a route to quick profits.

[In autos] technology is not a route to quick profits

Back to Icahn. The new co-CEO of the aftermarket half of Federal-Mogul may be an Icahn executive, but unlike the people Icahn installed on the board, Ninivaggia previously spent 6 years at Lear. He is an industry person, and not just an M&A specialist. In the same vein, Rajesh Shah, named CFO in 2013, has a long career working for auto suppliers, and came from another supplier rather than from Wall Street. Looking forward Ninivaggi noted, “There’s been a significant consolidation in the industry and as our customers have become very large companies, we need to do the same thing; we need to grow fast, improve our capabilities and expand our product lines”. It will take some years to show that the newly autonomous aftermarket operations are firmly profitable.

M&A may be a useful tool as major suppliers work to adjust their portfolio to match their global footprints, selling pieces that don’t fit to erstwhile rivals and buying similar operations from their competitors. Federal-Mogul is itself an assemblage of such pieces, cobbled together over the past 20 years. (An aside: one engineer the prof knows worked for five different firms, while never changing his desk at what is now a Federal-Mogul facility just outside Ann Arbor.) At the Plymouth tech center we were presented with their R&D roadmap, shared with their customers. They’re looking a decade down the road, 3 product cycles, for what future drivetrains will require. If they get that right, they will be one of 2-3 global players left in each of their product segments, with profits to match.

Pension fund managers operate on a 60 day cycle; the customers of hedge and restructuring funds take longer to get restive. Neither is compatible with the auto industry. History suggests that buying and selling automotive firms is not a quick route to riches for anyone but the lawyers and investment bankers who participate on a fee basis. Wittingly or not, Icahn is in this one for the long haul.

...there's irony when corporate raiders turn into stable shareholders...

Icahn isn’t alone in holding onto things; Wilbur L Ross with International Automotive Components has been “in” for a long while as well. Is there not irony when corporate raiders turn into stable, major shareholders, so that these firms look more like privately held firms investing across the business cycle than ones whose strategy is driven by the stock price of the moment?

By Alexander Dawejko ’17 and Michael Smitka, Economics Department, Washington & Lee University

Does Car Racing Make Cents?

Here is a post that draws upon questions posed by students that appears on the Economics 244 Auto Industry blog. However, instead of posting it in full here, I encourage you to go to it on The Truth About Cars item Does Racing Make Cents?, in part for the occasionally thoughtful comments that appear on that site.

Mike Smitka

Interest rates, inflation and growth

I go through US data periodically for a weekly radio show on W3Z - WREL in Lexington, Virginia. Unfortunately they don't stream their locally-produced content, probably because most of what they broadcast is syndicated and they aren't licensed to do so.

I've talked in recent weeks about the low returns available on savings. Let me trace that logic in more detail. In the end, I'll tie this to the discussion going on in economics circles about secular stagnation. (Since this is a blog, here's a link to VoxEU, which has just released a free eBook with essays by 19 economists, arguing the empirical strengths, weaknesses and implications of "staganation.")

Long-term rates are generally down since December: 30-year bonds fell from 4.0% to 3.2% and 20-year bonds from 3.0% to 2.4%. Those are drops of 0.8 percentage points and 0.6 percentage points, respectively. (Meanwhile-year rates are flat at 1.6%.) That is not necessarily good news, as it means that the serious money crowd think that growth will be weak for years to come.

Let's look at the numbers over time and see what they imply. If you're an investor, you can buy a 1-year bond today and another 1-year bond a year from now. Or you can buy a 2-year-bond today. Since there are lots of players in this market trading minute-by-minute, those two returns ought to be comparable. Here are calculations of future rates consistent with today's bond prices. (There are other corrections, such as for risk, but I don't think that changes my results in a qualitative manner.)

The first column is actual rates. The second column are rates in the respective years that are consistent with the actual rates. The third column is the year, and the final column is the implied 1-year bond rate that year consistent with today's rates. As you can see below, when I do these arbitrage calculations, we don't get "normal" 3+% interest rates until 2019. (In fact, over the period Jan 1990-Dec 2007 one-year interest rates averaged 4.5%) In other words, we will have had 10 years of well-below-normal interest rates.

The total return after (say) 3 years of buying 1-year-bonds 3 years in a row should equal the return on a 3-year-bond. In algebra, we have (1+i_{3 yr})³ = (1+i_{yr 1})*(1+i_{yr 2})*(1+i_{yr 3}). Excel lets you find the future rates consistent with todays rates; I used rates in 0.25 percentage point (25 basis point) increments to get close.

Maturity	Interest Rate Aug 19, 2014		Year	Implied 1-year bond rate
1 year	0.11%		2014	0.11% (actual)
2 years	0.46%		2015	0.75%
3 years	0.90%		2016	1.75%
4 years	1.1% (implied)		2017	2.00%
5 years	1.59%		2018	2.00%
			2019	3.75%
7 years	2.05%		2020	4.00%
			2021	3.25%
			2022	3.25%
10 years	2.40%		2023	3.25%

In the background 3 components are operating::

• Growth will remain low. Unfortunately, the 2019 date is consistent with my calculations of when labor markets return to normal, based on jobs growth versus population growth, corrected for baby boomer retirement, updates of which I post here from time to time.
• We will not have inflation in the foreseeable future. None. (Remember, short-term interest rates should be approximately the growth rate plus the inflation rate.)
Yes, there's lots of noise from gold bugs. There are the "old dog" monetarists (those who blindly apply a single, simple-minded monetarist equation, as fitted to data from the 1950s). They play with a few billion dollars. In contrast, the real players, pension and insurance fund managers, mutual fund managers and the Saudis and Chinese have invested a few trillion dollars on the belief that there won't be inflation. I believe money talks.
• Stock prices will remain high and returns low. Low growth means that profits won't rise much, while low interest rates mean that stocks will still look attractive relative to bonds and bank accounts.

Now slow but steady isn't bad, unless you're job-hunting. But low interest rates impose a risk, because interest rates that are near zero can't be pushed down. In other words, as we've observed these past several years, monetary policy has no power, and aggressive "quantitative easing" only a little. If we have another recession – there are lots of scenarios in which something goes wrong over the next 5 years – then we're powerless to do anything, unless we can engage in fiscal stimulus. Will Congress be prepared to act? I fear not.

But let me return to stock prices: Robert Shiller, the Nobel laureate who discussed the housing while it was developing and predicted its collapse, argues that stocks are overpriced (see here on MarketWatch). If growth will indeed remain low, however, interest rates will stay low, and stock prices high by historic norms. That would also make sense from another direction: the returns to buying stocks were unusually profitable for decades. As savers adapt to that and hold more stocks, prices should be high – but then not rise further. So either way – overprice or not – don't look to buying stocks as a reliable way to make money. And certainly don't believe anyone who tells you they can beat the market, or generate good returns. The best you can aim for are comparable returns, and those returns are low.

Finally, we have a reality check in the most recent consumer price data, released yesterday (August 19th). The headline number remains 2.0% and the rate excluding the volatile components of food and energy is at 1.9%. The biggest rises at the detailed level remain medical commodities at 3.0% and medical services at 2.5%. (Actually, these have fallen a bit.)

Oh, and since this is an auto blog, new car prices were up +0.3% in July, but bounce around quite a bit. Over the last 12 months there were up 0.2%, so well below average inflation. The same is true of used car prices, up 0.2% over the past year. However, they have been falling over past few months, and Tom Kontos, the Chief Economist at Adesa, one of the two big auto auction companies, thinks they'll continue to fall: the normalization of sales and leasing over the past few years is leading to a rise in the supply of off-lease vehicles and trade-ins. He doesn't see demand rising so as to offset that. That's consistent with my above analysis of the economy as a whole.

Who is Number One?

Auto sales are not the only measure to assess an auto OEM's relative health. This piece from the Detroit Bureau lays it out:

• GM slid to third when it comes to units sold for the first half of 2014. And focusing on just the most recent quarter, the Detroit maker fell to fourth when it comes to gross revenues.
• GM reported gross sales of $39 billion for the April to June quarter, noted Autoline: Detroit Editor John McElroy, putting it well behind Germany’s multi-brand Volkswagen AG, at $68 billion. That was well ahead of even the industry’s leader from a unit sales standpoint, Toyota, which managed a still-hefty $62 billion in revenues.
• The big surprise was Daimler AG, which managed to nudge past GM with $42 billion in second-quarter revenues. GM, in turn, managed to squeak past the Euro-Asian Renault-Nissan Alliance by just $100 million.
• Ford Motor Co. delivered $37 million in revenue, with fast-growing Korean siblings, Hyundai-Kia reporting $33 billion. The newly merged Fiat Chrysler had combined revenues of $31 billion. Rounding out the list of major global plays, Honda revenues came in at $29 billion, with BMW in the industry’s 10th spot at $26 billion.

Auto Finance Sub Prime Bubble?

I don't think so. For some reason, the New York times jumped on an Equifax report, cherry picked data to suit a sensationalistic agenda, and published the piece on Dealbook (link). Many have weighed in since, including myself – see below! Other examples are Marketwatch and a NYT Op-Ed

Written for Auto Finance News

By David Ruggles

A recent report from Equifax Inc., which noted that originations and total outstanding balances for subprime auto loans have hit recent highs, triggered an alarmist article on subprime lending in The New York Times. In the July 19 piece, authors Jessica Silver-Greenburg and Michael Corkery cited anecdotes that leave the impression that fraudulent practices are widespread. They castigate the “high” interest rates on subprime loans without mentioning the high rate and expense of default and repossession. Repos can reach a third of originations, and collection practices ― which are expensive to begin with ― are a challenge on these loans.

Through April, 2.6 million subprime loans were originated, representing 32% of all auto loan originations, according to Equifax. The outstanding balance of those subprime loans totaled $46.2 billion, an eight-year high. Equifax defines “subprime” as loans to customers with credit scores of 640 or below. As a matter of record, though, in some circles, a loan is deemed subprime when the credit score drops to 580.

The American Financial Services Association and other industry professionals have since weighed in on the NYT article, noting that it enflames already-riled regulators. And Derek Kreindler, managing editor of TheTruthAboutCars.com blog, writes: “Don’t expect that 32% figure to let up anytime soon. The glut of credit available for auto financing ― driven by securitized subprime auto loans being sold as investment-grade instruments ― is going to keep the auto financing business alive and kicking for the foreseeable future.”

I have seen many articles trumpeting the danger of the expansion of subprime without proper context. It is one thing to have data, but quite another to interpret it properly. In the Equifax report, Deputy Chief Economist Dennis Carlson called the increase in subprime lending “good news,” adding that “a fully functioning second-chance market is essential for a healthy economy.”

I would be pleased if people would stop acting like subprime auto financing had a damn thing to do with the global economic meltdown in 2008. It didn’t. Subprime auto financing is nothing like the subprime home lending issues of the past decade, and $46 billion of total outstanding balances on all subprime loans is miniscule compared with the size of the overall economy and a drop in the bucket compared with the mortgage market.

Meanwhile, the ratio of subprime auto originations, including the buy-here, pay-here sector, has hovered around the 30%-to-35% mark for more than a decade. After all, more than a third of the population has a credit score below 640. Kind of makes sense, right? People need cars, and those originations include new and used loans, although they are mostly used.

To be clear, despite the sky-is-falling tone of the NYT piece, Equifax said “serious” delinquencies of 60-plus days remained near all-time lows, and represented less than 1% of total outstanding balances.

A quick call to Melinda Zabritski, director of auto finance at credit bureau Experian, revealed the following: First, the Great Recession spurred the average credit score of U.S. consumers to take the hit one would intuitively expect. Second, when credit dried up, many people ― except for the highest credit score consumers ― turned to BHPH or subprime finance, as one might expect. The stat cited in the NYT article compared subprime originations today with the dark days of the credit crisis, when capital for that kind of lending was completely dried up. Why pick a point in time that is obviously an anomaly, if one is trying to tell a story in real context?

Third, lenders are looking at the near-prime and subprime markets in a search for yield unavailable in the highly competitive prime lending space. Fourth, fast-track credit ― the point at which a dealer can send a contract to a lender without first calling it in for formal approval ― is now 720, up from 690. There are more strict debt-to-income and loan-to-value parameters, as well. Fifth, and perhaps most importantly, millions of consumers have been able to rehabilitate their credit through subprime financing ― and there will be millions more. An accurate portrayal of the Sub Prime market would have at least mentioned this.

There are some who equate subprime auto lending to with mortgages made under the Community Reinvestment Act. Nothing could be further from the truth. CRA mortgages are NOT inherently "Sub Prime." According to the Federal Reserve, CRA mortgages have outperformed the mortgage market overall.

Also, as a matter of record, most of the mortgages that soured during the mortgage crisis were not subprime. Many people with excellent credit walked away from mortgages where they were paying off, for example, $450,000 on a $250,000 home. Yes, their credit score took a hit, and they might have had to get a subprime auto loan to buy a car. It will take some time to repair all the damaged credit. This has played its own part in the slow economic recovery.

Despite the NYT piece, clearly fueled by a desire to create controversy where the facts don’t indicate controversy exists, it’s time for everyone to take a deep breath and keep both feet firmly planted on the ground. There is no subprime bubble.

Mitsubishi Motors Future: Summer Guest Post #1

This post was written May 12, 2014 by Anton Reed '14 for Economics 244. The Prof edited it and appended comments by others in the class.

I will revise and reblog the best posts of my students over the coming weeks.

In April, when they released their FY2013 annual results, MMC (Mitsubishi Motors Corp) reported record profits. Don't get too excited.

Mitsubishi Motors' North American operations are struggling; MMC sells far less than any other Asian car company in North America. The next smallest, Mazda, sold almost three and a half times as many vehicles in April 2014. Only six firms sold fewer cars, and of those only Volvo is not a niche luxury marque. (The other five, in decline order of sales, are Jaguar/Land-Rover, Porsche, Tesla, Maserati and Ferrari.)

There are positive signs, with April sales up 46.6% over 2013 and year to date sales up 29%. Only Maserati had a larger increase, but they sold 753 vehicles last year, so that shift represents only a few additional cars. On the other hand, among manufacturers building cars for mainstream customers, Mitsubishi sells the least, so its percentage increase likewise represents only a modest absolute change. Nevertheless Mitsubishi has been improving its North American operation, with net sales up 53% from 2012 to 2013.

Such sales however mean that MMC's Illinois plant – begun in 1988 as Diamond-Star during the era when Chrysler was a major shareholder – continues to operate in the red. Whether or not Mitsubishi will be able to mount a comeback from the brink of essentially complete failure in North America will depend heavily on the continued expansion of their share and the overall vehicle market. Summer sales are expected to be substantial enough to grow the car market in 2014 over 2013, but that increase won't be enough to float MMC. Mitsubishi will likely see its sales cannibalized by the other automakers and go the way Suzuki, Isuzu and Daihatsu, Japanese firms that have completely withdrawn from North America.

Sources: www.motorintelligence.com and www.mitsubishicars.com. Sales graph on right added by the Prof.

STUDENT COMMENTS / DiSCUSSION

Louis Ike · 
I do not see Mitsubishi making much of a resurgence in sales here in North America. The number of dealerships around any one geographic location is much lower than its competitors, and this only mimics the pattern of low sales volume. The cars that Mitsubishi is currently making, to put it simply, do not fit the consumer preferences of the modern North American. In my opinion, Mitsubishi needs a serious rebranding because its public image is one of cheap, ugly, and obsolete vehicles.

Jier Qiu · 
I think an important reason that Mitsubishi is making profit right now is their new Mirage, which is a reliable, affordable, and fuel-friendly vehicle. I am personally very fond of the brand because their good designs. Although it is pretty easy to get an operating profit from cutting backs and fewer newe investments, I still think Mitsu has the potential to compete in light vehicle sector in the future with Mirage as a good start. They also need to deal with their dealership issue in North America.

the prof · 
Isn’t it the weak yen? It was ¥75 per dollar, now it’s ¥101 / US$. That’s a huge benefit to exporters.


Kade Kenlon · 
It would be interesting to know on the pie chart what percentage of the market that the Asian car companies control. Not only would it put the Mitsubishi market share in perspective, but it would tell you what the potential is for Asian cars. The higher the percentage of Asian cars controlling the market, the better chance Mitsubishi has to succeed. Mitsubishi would have a much easier time overtaking another asian car company rather than an American car, mainly because the Asian cars share the same concept, they are meant to be appliances.

the prof · 
At one time "Asian" might have mattered. As Toshi Amino [retired VP Honda Mfg of America] noted at our lunch table in Ohio, the Marysville plant ranked equal or higher in quality on internal audits than Sayama in Japan, but in the early years [1980s] American consumers wanted a “Made in Japan” vehicle.

Now however do consumers even know (much less care!) that MMC is a “Japanese” company? Or that the vehicle was made inside NAFTA, or imported from Japan / Korea / Europe? It’s an empirical question, and the surveys I've seen suggest consumers no longer care about national identity and import status, though "Munroney sticker" legislation mandates manufactures provide those details on the window sticker found on all new cars.
 
See my thoughts on MMC here: Mitsubishi Motors: going, going … gone?

Google's Autonomous Car: Don't Drink the Kool-aid

Google's senior executives are busily touting the wonders of autonomous vehicles. There's the technological marvel, at least in the eyes of Silicon Valley. There are the economic benefits - no more congestion, no more accidents. Wonder of wonders! – and great for the Google empire, and for its stock price.

The PR machine is a marvel to behold, and the gullibility of the audience – well, it's Google! Is their part in this really that much of a marvel? Will economic benefits be as great as they claim? Will they even be a player in future vehicle technologies? Their PR machine is not paid to probe such issues, much less point out that alternative technologies may bring almost all of these benefits more quickly and at a very modest cost.

First, the core innovations necessary for an autonomous vehicle are already on the road, the result of decades-long engineering efforts alongside which Google's investment and expertise pale in comparison. Blindspot detection, lane departure warnings, backup "assist" (outside the US that is surely called a safety feature) and adaptive cruise control are all necessary for an autonomous car. Now some of these aren't cheap, but they're falling in price. So we don't have to await an entirely new generation of vehicles to begin reaping the benefits. Crucial to Google's vision is that these are all partial solutions. However, I am not at all convinced that what Google offers will be a sufficiently big increment to offset the additional costs of full autonomy. Nor is it at all obvious that Google will have any role short of autonomy – their presence is not needed for these existing tools.

Second, Google's is not the only approach. In particular, connected vehicle technologies promise most of the benefits at a far lower price point and with a faster rollout. Such systems are inexpensive because they can use the copious computing power already in car, while the hardware consists of inexpensive RFID transponders (though not as inexpensive as the tags retailers use to deter shoplifting). The pieces of such systems are now being tested on the road, with a large test facility – the Michigan Mobility Transformation Center – an artificial cityscape – under construction in Ann Arbor, adjacent to the University of Michigan Transportation Research Institute. Such systems don't require the panoply of sensorts of an autonomous vehicle. Indeed the core components could be sold as an aftermarket item, albeit with lower functionality. Such connectivity could be rolled out in the course of years.

In contrast autonomy will require decades. First "real" vehicles need to be out in sufficient numbers to overcome regulatory fears and start the path to consumer acceptance. I can't see that happening before 2020, given the lead time for vehicle development when new systems are involved. It's not just that the hardware and software have to be integrated into existing vehicles, it's also that test procedures need to be developed for both the hardware and the software. Then production capacity has to be ramped up, while successive generations of vehicles are designed. That's another 10 years. And then the fleet will gradually turn over; with the average age of vehicles now over 11 years, that's another decade for half of all vehicles to be autonomous. We're thus looking at 2040. A combination of aftermarket and designed-in RFID systems could be on every vehicle by 2025, offering varying levels of collision avoidance and traffic flow smoothing.

Google likes to trumpet the elimination of accidents and the end of congestion. Perhaps. However, the restructuring of where people live versus where they work is a process that will take decades; in many cities, particularly in the US, the housing stock is widely dispersed, and so we really won't be able to get rid of all those cars, another claimed benefit of autonomy. Will connected vehicles deliver all of the same benefits? No, at least not initially; any aftermarket device could only offer warnings, nor take over steering and braking. Still, the price point and the time horizon are quite different from the drink Google wants us to imbibe.

Will there be a role for autonomous vehicles? Certainly truck trains are one application, and off-road uses in mining and construction. The Department of Defense is surely a potential customer. Don't look to these to drive Google's stock valuation, or you will have drunk the Kool-aid.

Call for Entries: 2014-15 PACE Supplier Innovation Competition

Time for suppliers to apply for the 2014-15PACE COMPETITION! (Links to PACE web site)

Autosaurus Rex: Car Death in Japan (revised)

Iwao Corp: After the last auction

Thanks to Prof. Shioji of Kyoto University for arranging this tour in conjunction with the 22nd GERPISA Conference, June 2014

Car's don't last forever. Auctions provide one intermediate step, helping set a market in used car prices and facilitating the reselling from the original owner. But what happens after that? One place is the Mogitori Center of Iwao Corporation [リサイクルセンター有限会社イワオ] in Yawata City, Kyoto.

Now as noted earlier this June in the post on auctions, the average life of cars was at one time extremely short, driven by the escalating costs of vehicle inspections, which included mandates for replacing items that might fail with age, at least when the system was set up in the 1950s. Until 1995 inspections were annual from the 10th year, and since they were costly (US$1,000 at a dealer, including biannual vehicle taxes), the result was that few cars were kept longer than 10 years. Indeed, through 1997 the average life of a passenger car was stable at 9¼ years. Thereafter it rose steadily to hit 10 years in 2000, 11 years in 2005 and 12 years in 2010. (The chart in the post on auctions gives a stable 4.7 year average age through 1995, then rising monotonically to 8.1 years in 2013. I do not know the source of the difference – given the context I think it is age at auction, but the underlying source does not make that clear - literally, in that the relevant footnote is too blurred to read.)

Still, cars don't live forever. Accidents happen; depreciation is inexorable. So while about a third of cars sold at auction are exported, most eventually are scrapped. That's what Iwao does.

Disassembling a car takes less time that putting one together. The key is to extract value – and stay legal. Typically the tires and wheels have been removed before Iwao receives the car; sometimes the engine and other replacement parts have already benn removed. For what they do get, they pay by weight – trucks hauling in cars get weighed before and after unloading. Once that's done, the fluids must be removed. The gas tank gets emptied, and cut open to release residual vapors and prevent an explosion. The freon (or other refrigerant) gets recovered, to prevent the release of greenhouse gases. Then the airbags are set off – once the appropriate wire harness is exposed, all that needs to be done is to run a current through it, from a safe distance. The battery's removed, oil and other fluids drained. That all takes maybe 15 minutes, at least for an older car that only has a basic battery and a driver and a passenger side airbag. (Modern cars must be more challenging, with more airbags, multiple batteries, and plastic gas tanks. But for the time being most predate that era.)

Then the fun begins. A forklift is thrust through the windows, and the car moved to the initial disassembly location. A quick flick and it's on its side, so the axles and gas tank can be cut loose with a torch, any underbody wire harnesses cut, and bolts holding the engine removed. Another couple torch cuts and the engine flops out, and is moved to another station where the various appurtenances attached to the block are pulled off, leaving a large chunk of aluminum. The exhaust system (and particularly the catalytic converters) are then cut off and put in the relevant pile, and if they're still in the vehicle, the radiator and air conditioner condensor are removed. (Of course they'll also salvage parts from recent vintage vehicles, but so few remain on the road after year 10 that Iwao makes no particular effort to resell individual pieces of older vehicles.)

Meanwhile, the body is lifted over to face the jaws of death. This tyrannosaurus rex of the automotive world punches through the roof and rips it away. The monster might shake and throw a recalcitrant car around, playing with it until can rip enough roof off. Then in a couple gulps it dispatches the instrument panel, tossing those bites aside. It then punches through what's left to grab the main wire harness: copper's valuable. Once that's done it tosses it to one side for a quick scan for any other easy-to-remove wiring. Then it's to the crusher, and the cube stacked with others awaiting its turn in the shredder. [In Japanese it's a "nibbler" crane [ニブラ重機], though the bites it takes are pretty big! – here's a YouTube link, though it's not the same facility.]

What goes on in the shredder isn't visible, but the noise and dust make it clear that violence reigns. (I didn't ask whether it is a toothed roller or hard steel balls swinging on chains.) Not everything gets shredded sufficiently; a crane picks up big pieces and stacks them for reshredding. For the remainder, a magnetic separator pulls out the steel; a "cyclone" uses air to separate out lighter components, such as the fabric and foam in the seats, carpets and headliner, that then gets compressed into burnable chunks that can be sold as an alternative to coal. Two workers in full suits and breathing units pick out rubber tubing in an enclosed shed through which what's left. Of course that's a function of the resale price of various types of scrap. At present about 20% remains as "shredder dust" headed for a landfill; potentially that could be reduced, if Iwao can find a market for additional types of material.

Back to cars as durable goods. For a given rate of depreciation, the higher the value of recycled components, the sooner a car will get scrapped, by Iwao Corp or one of 3,000 other small-scale operations. However, the advent of auto auctions facilitated more used cars being exported, driving down the number scrapped domestically. At it's peak Iwao handled 150,000 vehicles a year; it's the largest and most vertically integrated firm in the industry. But now it's down to about 70,000 per year, or 50% of peak, though most it buys already compacted; only about 10 per day start as complete vehicles. Still, the scrapping facility we visited generates about US$5 million a year in revenue, with 10 workers, 2 bookkeepers, 2 truck drivers and Mr. Iwao.

In Europe environmentalists have seen that OEMs face mandates that cars be made capable of recycling. Despite high prices for steel scrap, copper and aluminum the labor involved means that only some can actually be profitably culled. Of course if the workers know the layout and composition of each and every model they face in their dirty, noisy shops – but these are not the sort of jobs to attract those with analytic skills and an attention to detail. Watching this operation suggests less may become recycled, because the mix of materials – aluminum bodies, magnesium liftgates, and a wide array of plastics – will be harder to sort through.

Mike Smitka

Janet Yellen's Dashboard

Once a quarter, Federal Reserve Chair Janet Yellen and her colleagues on the Federal Open Market Committee take a thorough look at where the U.S. economy has been and then make projections for where they think it’s going. The next batch of those predictions—for unemployment, inflation, growth and interest rates—will be released on June 18. Ms. Yellen will discuss them at her quarterly press conference. (Brookings link)

David Ruggles

Auto Auctions, Japanese Style

Here're just a few notes on a visit to the Kinki branch of Toyota Auto Auction on a day when they were offering 1,700 vehicles (of which 10% or so might not hit the reserve price). This was arranged by Prof. Shioji of Kyoto University who helped host the first meeting in Japan of GERPISA, an international consortium of (mainly social science) researchers on the global auto industry. Now I've yet to see a Manheim or an Adesa auction so I can't compare and contrast. Perhaps later this summer I can rectify that...

At the Kinki site there's a massive multi-floor garage; land's too valuable close to Osaka for a massive open-air parking lot. We watched one of their evaluators go through a vehicle with a long checklist, from spots of corrosion to paint that suggests a repaired ding, including pulling away the fascia in a couple places. Most purchasers don't look at the actual vehicle but rely instead on the (target) 7 minutes that an inspector spends on a car.

Indeed, when we moved inside it was apparent that many purchasers are remote. While there is a large room of people bidding, many others are at computer screens elsewhere, while those at the Kinki site are watching simultaneous auctions held at other TAA sites. For that matter, Kinki TAA itself runs two lanes simultaneously; each computer in their bidding room has a red button on the left, a blue on the right. So first the screen updates as pre-bids are sorted out, and then the live bidding begins as those sitting in the auditorium or elsewhere click the bid ¥1,000 higher. The screen changes color once the reserve is hit – most of the cars are from trade-ins at Toyota dealers – and sellers can negotiate with the highest bidder when the reserve isn't hit. (I will check my notes later, but recall the no-sale rate is about 10% or, to put it the other way, the conversion rate is 90%.)

Now several larger trends in the Japanese market and in used cars showed up in our discussions. One is the role of cars as durable goods. Japan raised its consumption tax from 5% to 8% on April 1st and given that processing paperwork for a new car purchase takes several days (you have to file proof of a parking spot, which must be vetted by the relevant local government), sales plummeted in late March and are only now starting to recover. The result was a short-run dearth of vehicles coming to auction, and a modest bump in prices. Now at one time cars were kept but a few years, typically being scrapped before vehicle inspections became annual in year 10. That in turn meant low prices for used cars in year 8 ... so the prospect of even a minor repair could lead to a vehicle being scrapped. However, in the early 1990s the vehicle inspection system was relaxed, with less frequent inspections, fewer mandatory parts replacements (reflecting the abominable quality of Japanese cars in the 1960s, brake lines were one mandatory item), and allowing non-dealers to do the inspections. As a result the average age of vehicles is higher, and with a more vigorous resale market, well, that's when TAA switched from a way for Toyota to help dealers by buying trade-ins at an artificially high price as a quiet, off-books subsidy to a real entity. Of course the fact that one friend drives a 13-year-old vehicle that he's in no hurry to replace is not necessarily good news for those selling new cars. Even so, the market remains thin at older ages, where roughly one-third of cars are bought by foreign traders (many in evidence at TAA that day) for export to Russia, Pakistan and West Africa.

The group also visited a shredding operation; more on that later. The key link to TAA is that their business is down by about 50% as vehicles are on the road longer and more are exported (including some apparently exported to be scrapped). As noted in earlier posts on this blog (The Decline of the Japanese Auto Industry), it's going to be really interesting to see how all of the loss of a large domestic market interacts with the product mix of Japanese car companies and particularly the survival of Japanese parts makers.

The Supplier Auto Parts Fixing Scandal is Just Getting Started

Auto parts price-fixing probe rattles industryStar-Telegram, May 16 By Eric Tucker, Associated Press

WASHINGTON — An investigation into price-fixing and bid-rigging in the auto parts industry has mushroomed into the Justice Department's largest criminal antitrust probe ever, and it's not over yet.

As noted in the article, we're 4 years into the price-fixing investigations, with total fines to date (including ones levied in Japan and Germany, not just the US) of $2.3 billion. On the criminal side it's not clear whether there's much left in the pipeline.

The more interesting part is what whether any private anti-trust suits. In the US antitrust law provides for treble damages to private parties. My strong assumption is that antitrust settlements are set high but well below the maximum to garner guilty pleas and fines paid without chewing up staff time – otherwise the Department of Justice doesn't have enough people to prosecute everyone. If that's the case, then actual losses to consumers are far higher than $2.3 billion ... and the private penalties are thus $10 billion or more. That would be enough to push some suppliers into Chapter 11 (or its Japanese equivalent).

Now ... because all cases have resulted in guilty pleas without trial, no evidence has been made public. That may stymie the ability of lawyers to pull together a plaintiff or two and pursue a case. In any event, if private suits move forward, we're looking at years more. But if they go nowhere, then we may finally be nearing the end.

I know lawyers involved in one or another manner in these cases, and they take confidentiality very seriously. None have been willing to give me "deep background." Knowing how strict the rules are, I now don't ask. the prof