Is Ford Just Junk?

Oh, how the mighty have fallen.

Last year, one of the major headlines in the automaking world was that No. 2 U.S. seller Ford (NYSE:F) had its credit rating cut to "junk." This July, the firm lost its second-place slot in U.S. auto sales to Toyota (NYSE:TM). Earlier this month, with car buyers apparently agreeing that its cars are as junky as its credit, Ford again took the headlines when it announced dramatic production cuts.

And today, the company detailed another plan designed to clear out unsold inventory and boost market share in one fell swoop -- a plan that, sadly, is also based on junk.

Management intends to clear out its bloated inventories of 2006 model-year cars and trucks by targeting buyers with lousy credit histories. Ford intends to offer everyone, including so-called "subprime" borrowers, 0% financing for up to six years.

For those of you keeping score, automakers Ford and GM (NYSE:GM) first introduced the concept of large-scale 0% financing in response to flagging sales trends in the wake of the twin disasters of the 2000 bubble burst and Sept. 11. But back then, the deal was much more limited in scope, being extended only to buyers with strong credit histories, and for no more than three or four years' duration. Ford's latest gambit breaks the rules in both respects, targeting buyers who are huge credit risks, and enticing them with longer interest amnesties.

Let me risk understatement and point out that Ford's latest junk plan raises serious risks. We've already seen in the housing market what happens when generous loan terms are extended to subprime borrowers: They default at higher rates. In a May column from The Wall Street Journal, analysts from Bear Stearns (NYSE:BSC), First American (NYSE:FAF), Lehman Brothers (NYSE:LEH), and Credit Suisse (NYSE:CSR) were unanimous in blaming the "relaxed" lending standards and "aggressive" extending of loans to subprime buyers for the rise in residential mortgage delinquencies to 4.7% in Q4 2005. (That may not sound like much, but it's a significant rise from 4.38% in Q4 2004; what's more, the Bear Stearns analyst noted that certain categories of high-risk loans were showing year-over-year increases in delinquency of as much as 208%.)

What happens if Ford's buyers track this trend? Many will default on their car loans, and the company will wind up repossessing their cars. Which would: (1) defeat the purpose of the initiative, by putting repossessed inventory right back on Ford lots; and (2) exacerbate the damage, as American cars are (often wrongly) judged to be worse in quality than foreign makes, and therefore lose resale value more quickly. Ford may well boost its sales, and its stock price, with this new initiative. But as pretty as the numbers may appear over next few months, beware: They could be headed for the compactor down the road.

Then again, all this may prove moot to the company's current investors. Find out why in "Ford's Private Thoughts."

Fool contributor Rich Smith does not own shares of any company named above. The Fool has a disclosure policy.