Deconstructing Cash for Clunkers

Rarely has a program as small as cash for clunkers received so much attention. Yet, the cash for clunkers program has received more attention than much bigger programs like the Public Private Investment Program which started out as a $1 trillion program. So, how does it work and is it a good idea?

Cash for Clunkers (Cash Allowance Rebate System) works like this. An individual brings in their older car and trades it in for a new car that meets new mileage standards. The mileage standards are 22 miles per gallon for a car and 18 miles per gallon for a truck. The dealer checks with the National Highway Transportation Safety Administration to make sure your vehicle qualifies under the program. There are all sorts of rules like the car or truck you trade in can't be more than 25 years old. When you come into the dealership, you will receive a credit of $3500-$4500 toward the payment of your new car. Then, the dealer fills out all the necessary paperwork and then receives the credit amount back from the government. That process was supposed to take no more than ten days. Then, the car you traded in gets scrapped immediately and becomes unusable for anything including spare parts.

The problems with the program are several. First, the one billion dollars that was set aside was clearly not enough. The program was supposed to run through November 1st and it's already run out of money. Yet, dealers and car makers have already made commitments for advertising that was supposed to run through the fall. Second, the paperwork for this program has turned into a nightmare.

CARS provided the rebates in the form of electronic funds transfers to dealers, to repay them for the clunker discount they gave buyers. Buyers never saw the cash and didn't have to deal with the federal website.

Rules governing the program totaled 135 pages. They required dealers to register, then to fill out electronic forms after each transaction. Dealers had to guarantee that they gave the customer the appropriate discount, that they wrecked the engine in the clunker so it never could be reused, and that the non-running junker went to a scrap dealer.

"They keep coming up with new forms to sign," says Churchill.

In the Queens borough of New York City, Paragon Honda already hauled away nearly 60 clunkers to a junkyard before it found the rules require them to be disabled on the auto lot. Now they have to be brought back, have their engines destroyed and hauled back.

"Killing cars is not something that I'm used to doing," says Brian Benstock, the dealership's general manager.

Furthermore, by destroying cars that can still run they're not only taking cars that run off the road but destroying parts that could be used in junk yards and by resellers.

But one of the most asinine parts of the plan is that they take old cars, many of which were being used as functional day-to-day transportation the day before, and destroy them. A perfectly good and useful machine destroyed for political reasons.

In a normal world, you take your trade-in to the dealer, he buys it from you, and then he resells it at the auto auction. It is the most efficient allocation of resources for the product. In this case, the government buys your trade-in and, instead of using it for its full value, it destroys the vehicle.

All this does is create less supply in the used car market, used parts, and used metals. That increases the prices in all those markets.

Finally, any stimulative program should be measured by whether or not it increases the velocity of money. Now, by giving an incentive to buy, it certainly creates business. Yet, the dealers are losing money until they receive the credit back from the government. So far, that has turned into a nightmare. Not only does it require filling out more than 100 pages of paperwork but at least for now, that process lasts a lot more than ten days. Without that credit, dealers are losing money. As such, for now at least, all it's done is create a short term cash crunch for dealers. Furthermore, by creating mountains of red tape, dealers must use up resources on bureaucratic paperwork rather than on selling more cars. So, it's really unclear if the initial transaction will lead to more transactions which would increase the velocity of money. Instead, the bureaucratic nightmare of this program only bottlenecks business.

Finally, the government has already bailed the auto makers to the tune of nearly $100 billion. The president said that the government would be a passive owner in GM and Chrysler and then they immediately created a government program that would help their sales. This program isn't free. That $1 billion has to be borrowed or taxed. As such, all taxpayers that don't take advantage of the program will end up paying for everyone that does take advantage. All this program does is redistribute wealth yet again. This time from all those not in the auto industry or has a clunker to all those that are.