Boxed In On The Car Lot

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Written by Jimmy D. Moody
Monday, 09 February 2009

In the late 1990s, auto makers, their finance companies, and banks pumped up vehicle sales with great deals on leases. In the past year, the industry kept sales roaring with 0% financing deals. Both schemes helped move plenty of metal, but they also have caused a flood of trade ins and off lease cars to dealers' lots this year. The influx of cars — combined with a soft economy — has sent used car prices tumbling 4% this year, to below the average for 2000.

That's bad news for carmakers, for several reasons. First, the industry will be stuck with 3.3 million cars coming off lease this year, many of which the carmakers and finance companies will have to sell at a loss. Second, manufacturers have to stick with profit eating 0% financing and rebates to keep buyers from snapping up the good deals on used cars. Finally, the losses on reselling cars have forced the Big Three to pull back on leasing. That means some would be lessees are now buying and probably won't be in the market for a new car again soon. "There will be a giveback," says Bank One Corp. economist Diane Swonk. "The U.S. car market will be downsizing."

Already, falling used car prices appear to be playing a major role in the softening of the new vehicle market. Since August, sales of new cars have fallen from an annualized rate of 18.7 million to an estimated 10 million in October. One big reason: Buyers are being offered less for their trade ins, so some have postponed buying a new car. With 91 days' worth of used cars on dealer lots, vs. a more desirable 70, dealers are accepting fewer used cars.

It's becoming a vicious circle for auto makers. If they low ball a trade in, they must lower the price of a new car or risk losing the customer. "That's why everyone is offering cash and 0% financing," says William J. Lovejoy, General Motors Corp.'s group vice president for sales, service, and marketing, "to make consumers feel better about the [low] trade ins."

Making matters worse, carmakers are having a hard time getting rid of the millions of formerly leased vehicles pouring hack into dealers' lots. Auto makers count on reselling these cars at a decent price and factor into their accounting what the car will be worth when the lease ends — its so called residual value. But in an effort to lease more vehicles two or three years ago, companies pumped up the assumed residual value so the lessee would have to finance a smaller share.

Now, the bill for such games is starting to come due. Because auto makers can't find buyers, they are being forced to auction off the vehicles for less than expected. As a result, says Art Spinella, president of CNW Marketing/Research Inc. in Bandon, Ore., an auto industry consulting firm, auto makers are losing an average of $2,400 on every off lease vehicle that they sell. The money comes straight out of auto makers' marketing budgets and the reserves of the finance companies.

The problems have carmakers scrambling to limit the damage. More and more, the auto companies are sending their used cars in for a 100 point inspection; those that pass get a certification of reliability which can bring a higher price, says Jeremy P. Anwyl, president of Edmunds.com Inc., a consumer Web site that tracks car pricing. GM has also set up an online auction that matches off lease cars with used car shoppers. Still, "two years ago, I made money on every one of these cars," says Lovejov. "Now, I'm losing money on a lot of them."

What happens next? If used car prices keep falling, as analysts expect, that could hurt future sales. Further complicating things, Detroit's pullback on leasing means that only 20% of car buyers are leasing these days, down from 30% in the late 1990s. This means two or three years from now, roughly 1.6 million fewer buyers with expiring leases will need to buy new cars. Instead, they'll own cars purchased with dirt cheap interest rates. The inevitable result, warns Bank One's Swonk: "Auto makers will have to pull out new incentives." Not to mention the lower profits that generally come with such deals.

Last Updated ( Monday, 09 February 2009 )