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The used-car bubble has burst

The multi-year trend of increasing used-car prices in the U.S. has reversed, with steep declines now being recorded at wholesale auctions and in private transactions.

That’s not great news, of course, if you’re selling a used car; but it’s also potential trouble for the automakers, since shoppers routinely apply the equity in their used cars against the purchase of new vehicles. Forecasters are predicting that automakers will be forced to offer steeper discounts in the coming months to maintain the pace of new-vehicle sales.

According to the Manheim Used Vehicle Value Index, wholesale vehicle prices declined 1% in July, the third straight month of falling prices. Manheim, which operates vehicle auctions nationwide, called talk in some quarters of a “free fall” in used-car prices “premature.”

“There should be a modest fall this year, next and the year following,” said Tom Webb, Manheim’s chief economist, in an interview. “But they’re coming off an all-time peak in 2011. The prices are still strong.”

The relationship between the prices of new and used cars is tracked closely because it can yield clues about the expected behavior of shoppers. Automakers use such clues to help forecast more accurately how many vehicles they may sell and at what price.

TrueCar, an online vehicle buying service, told Reuters that the average transaction price of a new vehicle reached $31,262 last year, due to the addition of many new features and gadgets. That average should rise 2 percent this year and 2 percent next year as well.

New-vehicle sales are on track to reach this year to reach about 16.5 million vehicles, which would be the highest total since 2007. Transaction prices have been strong, as have automaker revenues and operating profit. But as demand for new vehicles softens – as it can for a variety of reasons, including weak equity in used cars – automakers will face the choice of cutting back on production or increasing discounts (cutting prices).

In previous sales cycles, some automakers have preferred to keep production strong and sacrifice profit. A disadvantage to this strategy is that it tends to weaken vehicles’ resale value. Customers may respond by defecting to brands that exhibit more discipline with regard to overproduction. Webb said he thinks automakers “have learned their lesson.”

Perhaps. Last week General Motors (GM) said it was temporarily shutting down its Lansing, Mich., plant that produces Cadillac CTS and ATS models due to slower than anticipated customer demand. The plant employs about 1,600 workers. The shutdown began Aug. 18 and will last for about three weeks. GM is sacrificing the revenue from three weeks worth of CTS and ATS models – but it will be incrementally strengthening the resale value of CTS and ATS models currently on the road – a very important consideration to luxury-car shoppers.

Since the collapse of new-vehicle sales in 2009-2010, when annual sales dipped below 11 million in the U.S., the average age of a car on the road has risen to 11 years. Analysts believe that there remains substantial consumer demand for new cars: employment is getting stronger and many shoppers are itchy for new wheels after an extended period of uncertainty.