The "cash for clunkers" program, which offers $3,500 to $4,500 to buyers trading in older cars for newer, more fuel-efficient models, is a turning point in the government's plan to bailout the economy. The success of the program -- which ran out of $1 billion in funds after only one week -- led to it gaining approval from the House of Representatives for another $2 billion, a decision that now awaits approval from the Senate.
What makes "cash for clunkers" unique is that it will become a multi-billion dollar bailout of a favored industry with the enthusiastic support of Congress. The program creates none of the anger seen by giving money directly to, say, financial services or auto companies. Congress has wised up, and is now handing money to voters to accomplish what otherwise would have made for a messy public display. It's scary to think that the only thing learned in Washington, D.C., since Lehman Brothers went under is that bailouts should indirectly go to manufacturing companies, because the government can subsidize voters' purchases.
There's no denying that the auto industry is hurting. Even in good times, auto manufacturing -- at least as far as Detroit is concerned -- has been one of the most effective destroyers of value for shareholders. Year-to-date sales of passenger cars and light trucks are down 35 percent from the comparable period in 2008 according to Motor Intelligence data, and even sales of the best-performing brand (Subaru) are still off almost one percent. But what should be a scenario to correct an overbuilt industry has instead become a great experiment in seeing just what the government can purchase for citizens to artificially stimulate the economy.
Traders, of course, love the creeping socialism that's reaching into auto purchases. As word of the program's implementation and appeal gained traction, shares in automakers and parts suppliers took off. Manufacturers and suppliers like Ford (F), Johnson Controls (JCI), Magna (MGA), Gentex (GNTX), Toyota (TM), Honda (HMC) and retailer AutoNation (AN) have all risen more than 10 percent in the last two weeks, more than doubling the S&P 500's gain.
Don't be so quick to buy into the rally. Automobiles are a long-lived item, and using the government's borrowing power to encourage purchases today are only going to result in lower future sales and a higher deficit tomorrow. Policy actions today all favor playing for additional time, and that mainly serves to prop up marginal companies, resulting in more competition and less profitability for everyone else. Keeping the momentum going will require increasingly larger subsidies over time to boost sales, much like a company that improperly records revenues -- at some point, there's no more business, and the shell game is revealed for what it was.
Remain skeptical of the actions of policymakers offering subsidies to certain industries, and recognize the slippery slope Congress wanders down in helping voters to buy things. The urge to take action with other people's money is strong, even when action proves ineffective, or counter-productive. Today, it may be $4,500 for your "clunker" or $8,000 for a down payment on a house -- but what will it be next if we don't remember that the money has to come from somewhere?
James Cullen edits and writes at CollegeAnalysts.com. He has no personal position in the stocks mentioned above.