I’VE SEEN THIS MOVIE BEFORE. IT NEVER ENDS WELL.

By Peter M. De Lorenzo

Detroit. You have to admire human nature at times, because with all due respect to Mr. Bob Dylan’s “A Hard Rain’s A-Gonna Fall” - no one really wants to believe that the good times are gonna end. Everyone wants to believe that if the good times emerge, they will last forever. If a football team wins the Super Bowl for instance, it takes about five minutes before media chatter surfaces speculating about whether or not this could be a new dynasty, even though repeating in the NFL championship game has proven to be a tall order.

You could say the same about other sports as well, because it’s human nature to believe that the good times will go on forever, no matter what the endeavor. You could also say it about the car business, too, because despite all of the indicators and the fact that this business plays out in about seven-year cycles, and despite the decades of cumulative experience at the top of these car companies, there is a steadfast refusal by top executives to admit that we are, in fact, at the peak of the business at this very moment, and that the whole thing is headed downhill.

Actually, this business started to reach the peak last fall, when the first signs of difficulty started to emerge in the luxury market. Dealers started having trouble meeting profitability targets per units sold, and the burgeoning incentives that were necessary to move the metal weren’t helping. And we’re talking the big brands too - Audi, BMW, Mercedes-Benz, et al.

There are many reasons for this, of course, the primary one being that these luxury manufacturers are all battling for the same market turf, that elusive $40,000 to $60,000 sweet spot. And the fact that these luxury brands are trying to cram too many models and nameplates down consumer throats, while thinking that they will always be able to not only find buyers, but to do so profitably, which is simply delusional, at best.

There are plenty of smart executives who have been around a long time and who have suffered through the roller-coaster nature of this business repeatedly, yet they still are getting up and telling the media right now that 2016 is going to be good, even though that there are plenty of signs indicating that the pendulum has not only slowed, but is swinging back the other way – and in a hurry.

I chalk that up to human nature, as well as to the fact that when it comes right down to it, what are they supposed to say? That everyone should run for their lives because we’re all gonna die? No, of course not. But I’m talking about managing expectations here, something that this business has never done well.

Listen, at this very moment this business is flat-out oversold, overblown, overheated and overextended. Does anyone actually believe that 17 million-plus in sales per year is actually sustainable? For the realistic among us the answer is an emphatic “no.” But there are too many executives in this business right now who are saying that it is, with some even insisting that it will be the case indefinitely too.

And they do this while dismissing the gathering storm clouds with a level of derision that’s borderline unfathomable. And the excuses? There are a million of ‘em. Let’s see, do any of the following approximations sound familiar?

“We didn’t anticipate the dramatic shift to crossovers and SUVs so we’re overloaded with cars at the moment.”

“We really don’t see any problems with the size of the incentives we’re offering, we’re merely keeping up with the market.”

“Our incidents of auto loan defaults are within our expectations, so we don’t see any problem with it. We have it under control.”

“All of our economic indicators and internal research suggest that we’re good, and that we’ll be good well into 2017 too.”

And it goes on from there, as you might imagine. But the slowdown in profitability in luxury auto sales is not only alarming, it’s a bellwether for the entire industry. If the luxury automakers start straining for profitability, how long before the mainstream automakers start having trouble?

Not long, as it turns out. In fact, it not only has already started, it has been well underway for over a year.

On January 8 of last year, The Wall Street Journal published an article entitled, “Car Loans See Rise In Missed Payments - Uptick Comes Amid Rise in Loans to Subprime Borrowers.”

Now, for many in this business this was merely an annoying blip on the radar screen, a minor irritant of negativity in a red-hot, slam-dunk, “this is going to last forever!” market. But for others, it was not only more than a little alarming, it brought on a sense of dread accompanied by a big sigh as in, “here we go again.”

The main gist of the article? That “more than 2.6% of car-loan borrowers who took out loans in the first quarter of last year had missed at least one monthly payment by November, the highest level of early loan trouble since 2008, when such delinquencies rose above 3%.” Or, as Mark Zandi, chief economist at Moody’s Analytics was quoted: “It’s clear that credit quality is eroding now, and pretty quickly.”

That for me, and for a lot of others in this business was the quintessential definition of Not Good. And it continued on through all of 2015 as low interest rates, sub-prime loans and massive incentives powered this business to an impressive annual sales rate.

But there was something particularly telling in that article that has nothing to do with the current slowdown in per unit luxury profitability and has everything to do with the ugly underbelly of this business that continues on unabated, despite the insistence that this business has cleaned up its act on the retail level.

One buyer anecdote the WSJ article mentioned concerned Patrina Thomas, a 48-year-old woman from the Syracuse, N.Y., area. Ms. Thomas was persuaded by a local car dealer to trade in her 2002 Jeep in the summer of 2013 in favor of a used 2008 Chrysler Sebring that sold for more than $17,000, and that was financed at an eye-popping 20.4% interest rate. As you might imagine, she was unable to make the $385-a-month payment and the car was repossessed. “Now my credit is ruined,” said Ms. Thomas to The Journal, and at the time she still owed more than $7,600 on the car. “I can’t buy a house for a while.”

Who financed that usurious auto loan, you’re probably wondering? None other than Chrysler Capital, a joint venture between the automaker and Santander Consumer USA Holdings, a unit of Banco Santander SA. It should surprise no one that a notable percentage of the “feel good” FCA sales story has been powered by the writing of sub-prime loans. In fact FCA is one of the most egregious ringleaders of this practice in the business and frankly, it stinks.

David Stockman, in commenting on that same WSJ article, had this to say: “Here’s the thing. On the margin, much of the recent growth of auto sales has been attributable to sub-prime borrowers, which are now up to 31% of all loans. These loans carry onerous interest rates — often 20% or more — and are available primarily due to junk debt financing of non-bank lenders. That is, fly-by-night start-ups organized by Wall Street and private equity funds. Eventually, the soaring default rates described in the attached WSJ article will infect the entire auto market — just as did the implosion of sub-prime mortgages last time around. When the volume of defaults and repossessions gets high enough, the used car market will falter, and the food chain of auto sales will fail.”

Remember, this was written one year ago.

On the one hand, I can applaud industry executives for sticking to their “stay the course” message about where this industry is headed because it signifies a reasoned calmness and a belief that they’re not going to make the same mistakes as they have in the past.

On the other hand, these executives and this business are making the exact same mistakes that they have in the past. Too many models and too many nameplates all jostling for the same piece of the pie, with no one pausing and reevaluating, instead just heading into the “business as usual” Abyss. And to sustain the faux sales rate heat in the market the manufacturers are spending too much money on incentives and writing too many sub-prime loans.

And the warning signs are all over the place. The profitability of the luxury brands is eroding. Incentive spending is crushing everything in sight, including future resale values. Sub-prime lending and the subsequent loan defaults are going up by the month. And the overriding tone of the business is “What, Us Worry?”

I’m sorry, but it’s just nonsensical and stupid, and this business – and the executives tasked with running it – should know better.

I’ve seen this movie before. It never ends well.

And that’s the High-Octane Truth for this week.

Check out the latest episode of The High-Octane Truth on AutoextremistTV below. -WG

Note that this week's episode is a two-parter...you can see Part 2, plus all episodes of AETV, here!