Real Cost Analysis - Cash for Clunker

Cash for Clunkers. And no.......we're not referring to investing in stocks in today's market. We're referring to the cash for clunkers program offered by the US government. Trade in your clunker and get $4500 cash. Cash for Clunkers. Are well-running cars that are paid for really considered clunkers? Some are, Joe's car is a clunker, and he is very excited about this new program since his '85 Ford truck backfires and stalls out in busy intersections. However, the cash for his clunker comes at quite a cost. (Joe turn out the pockets)

The cost ultimately paid by the taxpayer for Joe's clunker is actually well above $4500. How so? Economists always include opportunity costs in the total cost analysis of any project. What are opportunity costs? The cost of not doing something. For example, if last fall Joe Shareholder wanted to invest $1000 in a US car company, he had two choices - GM and Ford. GM's clunker stock price was trading at about $5, while Ford's clunker shares were trading at about $2.

If Joe invested $1000 cash, here's what his investment would be worth today under the two scenarios.

Invested in Ford = $4000 (Ford stock ended at 8.03/share on Friday 8/7/09)
Invested in GM = $100 roughly (Clunker company went bankrupt)

Suppose Joe invested in GM - his actual loss would have been $900. Because he could have made $3000 if he invested in Ford (opportunity cost), his true cost would be the sum of these two, or $3900.

Now, back to cash for clunkers. The government - inefficiency and bureaucracy clunker extraordinaire - is paying $4500 cash for Joe's clunker. Since the clunking government is broke, this $4500 comes from debt auctions (see this post on treasuries) with interest. Right now the US 10 year treasury yield is running about 4%. This 4% interest is paid yearly to the owners of the debt. So the new cost is $4500 plus $1800 for interest over the 10 years, and you have an actual cost of $6300. (Joe - this is not all)

Suppose the government did something else with the $4500, like invest it in a fund earning 4% interest each year. Now the $1800 is also an opportunity cost, and the total cost of paying cash for Joe's clunker is $8100. Wow, this is a large cash payout for Joe's clunker. Add in the other costs of car disposal, lawmakers' time, program maintenance, website support, paperwork, government inefficiency multipliers, etc, and the total could be easily over $10,000 cash per clunker. (Digital Camera Joe, rummaging the garage for possible eBay listings)

So how does this affect Joe? Joe drives off the lot with a brand new car and heads directly over to JoAnn's house to show off. JoAnn is deeply discouraged, however. Not only did she love Joe's '85 Ford pick up truck, and the excitement it provided her when it stalled out in intersections, (remember, she's a trader, she loves the thrill of risk) but she also realizes she's going to help pay back this loan for Joe's new car.....via her taxes. (Backfire Joe………ironically in his new car)