Cliff Sosin
speaker
323 appearances
1 recordings
1 series
first heard Apr 2025
last heard Apr 2025
Cliff Sosin’s voice in public audio — every appearance, attributed to the second.
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it was about 39 and change in 2021, fell to about 36 million cars or 34 million cars. I think it got as low as 34 annualized and sort of did 36 for the year or something like that. I might have my stats slightly off, but it fell.
And this doesn't seem like a huge negative effect, but it was bigger than you might realize because what happened was franchise dealerships, I think you're Ford or Toyota dealership, when a lease vehicle is returned, unless the customer exercises their buyout, the landing dealership, the one you return it to, gets the car at a price that's been set at the time the lease was created.
And so when car prices rise, if the... lease returning person, of course dealership has no incentive to tell them that they have the right to buy the car, doesn't know this, which many people haven't read the fine print of their leases, and they return the car. The dealership gets basically a really cheap car. What this turns into is a big subsidy for franchise dealerships.
And those dealerships would then turn around and sell this car. It would look to them like a big profit, but was actually really cheap relative to wholesale prices. But what that's doing is putting enormous pressure on non-franchise dealerships who don't have access to the super cheap inventory. Oh, by the way, that's us. We're a non-franchise dealership.
And so the best example to understand the magnitude of this is CarMax. So if CarMax... In the Great Recession, CarMax briefly saw nearly a 20% decline in comp store sales for a few months. And then it was back up to low double digits. CarMax's comp store sales were down 20% for the whole year in 2022. And they, by the way, still haven't recovered. I think they've clawed half that back.
The reason was in part because cars are more expensive, and interest rates also made cars more expensive. And the other thing was this weird effect where franchise dealerships were being unusually competitive because they had access to this unusual source of cheap supply.
So as a starting point, you had the biggest decline since the Great Recession, including the Great Recession, bigger than the Great Recession, in the number of used transactions at an independent dealership, which is a rough place to start. To make matters worse, that was the used vehicle market. Carvana was facing that.
The second thing that happened, when interest rates rose, the sort of naive thing you would think, which is certainly what I thought, was it wouldn't matter all that much to Carvana. OK, so interest rates will rise. That could affect the overall market a little bit. It will probably affect car prices a bit, so the depreciation curve of a car.
But in the end, people's propensity to swap cars shouldn't change that much. And yes, to Carvana's financing business, they just finance spread off of rates. So whether rates are 1 or 4 shouldn't really matter that much. And that's totally correct. And that's exactly where we got to. But there was a catch. You see, what I didn't know.
You see, what I didn't know was that when rates would go up, so the auto finance markets made up of a bunch of credit unions and small banks and then a bunch of larger banks who compete and then independents like Carvana who compete. The credit unions price their loans, I mean, it depends on the credit union, but like off of deposit rates or off of Fed funds or off of a, you know, a napkin.
The two-year went up and Fed funds were low and deposit rates were low. And the credit unions, and when I say the two-year, it's worth pointing out that the average duration of a pool of auto loans, including prepayments and defaults, is about two years. So the two years are a reasonable proxy for the appropriate kind of risk-free benchmark.
So in late 21, as the two-year goes racing up, as people expect Fed funds to rise, all these competitors just didn't raise rates because they didn't. There's no academic reason why they shouldn't have. They just sort of didn't. And then even as Fed funds began to rise, they were super slow.
You know, I remember there was a long period of time where like Navy Federal was offering car loans at a discount to the treasury of the comparable duration. And this is a big problem for us. This is funny, except for the fact that we have to compete with this every day.
Industry-wide, auto loan spreads by late 2022 were at the lowest levels in the whole time series I have, going back to before the crisis, before the financial crisis in 2008. And it was a wild time for that to be the case because every other consumer credit spread was wide for a whole bunch of really good reasons. And the underlying auto collateral was the most kind of overpriced it would ever be.
So auto loans should have been really expensive on a spread basis. But instead, they were at their all-time tights. And the reason was that there was just all these dumb competitors. And then you'd call these – we did research into what was going on. And you'd be like, well – Our asset liability management committee meets like once a quarter.
And then we try not to raise rates more than like 25 bps at a time. And then it takes us 60 days to implement the rate changes because our systems, blah, blah, blah. And you're just like, but guys, like...
Right. This is definitely not in the textbook. But so the problem, so CarMax, they just ate it. They just originated at low spreads. And then the next year, and even to somewhat, it's getting better now. But if you look at their financials, you can see they paid for it a year or two later, but they ate it at the time. They sacrificed a bit of the future for the present.
Carvana was not in that position, right? Like we, you know, the company needed the money. So Carvana had to price to reality. And That meant that Carvana was in the market with loans that were like meaningfully more expensive than competitors, which did not help. And to just put this in context, Capital One also pressed to reality because they're smart.
They saw their auto originations fall 50, five zero percent. So Carvana is dealing with both of those things. The other thing, which I think is more subtle, but I also think is true, has to do with early adopters. And to explain this, I need to go back and explain a little about how Carvana grows.
And this is the part that I was least aware of at the time, but I've done more work on and I've come to understand a lot better.
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