The Volkswagen Car "Buy Back" Just Unleashed Havoc On The U.S. Car Market

When it comes to the US manufacturing sector which as a result of the oil sector collapse recently entered a recession, for years it was the US auto industry which was presented as a shining example of how "things can go right" and how US manufacturing workers have benefited when year after year domestic auto production rose and recently hit a record high annualized production rate.

But while recently there has been a rather steep decline in new car sales  (as a result of soaring inventories and shrinking credit) the real canary in the coalmine when it comes to consumer end demand for cars emerged in recent months when used-car prices began to leak lower slowly at first, and then very fast. In fact, as we showed recently, used-car-prices are plunging at a pace comparable to 2008, as a result of what is a record glut of used cars sitting on dealer lots, unable to find a willing buyer.

 

It all culminated with a recent RBC research report in which it asked if this is "the card that brings the whole house down" because, it added, "the reason for concern is lower used vehicle prices have a potential spillover effect to many other industry factors. If we think about volume, price, mix, credit – all have been incredibly positive and supportive of the recovery. All are also no doubt related, but that’s what makes it a bit scary."

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Fast forward to today when Volkswagen took a massive $18.28 billion charge related to the emissions-cheating scandal, forcing it to slash its 2015 dividends and post a deep loss. The largest German company announced earlier today a net loss of €1.58 billion for 2015, compared with a net profit of €10.85 billion a year earlier. The company posted an operating loss of €4.1 billion for the year.

For the current year, Volkswagen said group revenue would fall as much as 5% partly because of the emissions issue, though overall deliveries should be around the level of 2015. It expects a “sharp decline” in passenger car revenue, the company said, which is to be expected for a company that has blown through years of goodwill with one silly emissions-rigging scandal. 

But much more important than VOW's financial results, was that as part of the company's settlement in the U.S., it agreed to offer U.S. owners of nearly 500,000 vehicles a blend of car buybacks, repairs and compensation.

Specifically, Volkswagen has pledged to give drivers of about 480,000 2-liter diesel vehicles the option of selling the cars back to Volkswagen, or having them modified to meet emissions standards, the judge said. Those with a lease can cancel it and return the vehicle to Volkswagen. Consumers also will get “substantial compensation” on top of that, according to Judge Charles Breyer, overseeing the lawsuit against the German car-maker, who has pressured Volkswagen since February to produce a fix for the cars. He made it clear last month that if no solution was offered by this week, he would consider a request by the plaintiffs to set a summer trial the WSJ reported.

Needless to say, given the option of a hassle-free buyback leading to cash in hand, or waste weeks in some dealership, everyone will pick the former.

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Which takes us back to the original point: the near record glut of used cars.

Because the immediate result of Volkswagen's settlement to placate buyers following its emissions-testing scandal, could send a shock wave across the US auto industry.

As Market Talk correctly notes, offering hundreds of thousands of buyers a chance to sell back their old VW or end their lease early (in lieu of fixing the car) will almost certainly flood the used-car market that is already on pace to hit record inventory levels in 2016.

Once the German auto maker fixes the emissions problems on those cars, it will put them back into circulation, and the the availability of repaired models will add even further pricing pressure on used-car prices "that are sagging amid a glut of gently-used vehicles being turned in after leases or as trade-ins for new car purchases."

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Volkswagen may be just the tip of the iceberg.

Following Wednesday's emissions rigging scandal at Japan's automaker Mitsubishi - because if Volkswagen was abusing its emission standards tests, everyone else was too - the Japanese Transport Minister Keiichi Ishii said on Friday he wanted Mitsubishi Motors Corp to respond "with integrity" after revelations that it cheated on test to measure fuel economy, including by possibly buying back the cars in question, Kyodo news reported.

In other words, even more buybacks, even more fixes and even more used cars about to push the record used-car glut to never before seen levels. How long until car dealers, stick with hundreds of thousands of used cars, are forced to start dumping.

RBC may have been premature with its observation of the "card that brings the whole house down", but what happens when there is suddenly a whole lot of cards?