Auto Manufacturers Come to Their Senses

Chrysler announced last week that  it’s exiting the auto lease business following recognition of soaring residual losses. The news comes a day after Ford (F) said it took a $2.1 billion charge at its credit unit—largely related to overstated residuals. Can G.M. (GM) be far behind?

All this is great news for banks. For years, they’ve been shut out of the auto finance business as automakers fooled themselves (and their shareholders) into thinking they were making money offering auto buyers financing via long-term lease agreements.

Only now we know they weren’t. To lenders, the auto lease may be the most tempting, dangerous of consumer finance product of all. Its profit or loss depends hugely on the lender’s estimate of the vehicle’s value when the lease expires four or five years down the road. Who can accurately forecast that? Nobody, it turns out. So, too often, the automakers’ finance units would come up with overly optimistic residual guesstimates in order to get transactions done—and cars sold—here and now. The bogus residual values wouldn’t become apparent for years, and would be somebody else’s problem. And they’d cost billions.

Thankfully, that game seems to be over. The automakers at last seem to be realizing that their leasing schemes (and 0% financing plans, for that matter) are unsustainable and only add to eventual losses.

If, as, and when sanity does return to the auto finance business, the banks will have a huge opportunity make money by underwriting well and offering fair rates. If the automakers would just stick to making cars, everyone would be better off.

Comments

[Paul Killinger:]

Sorry, but I disagree. Leasing has been a proven money maker for the auto companies for many years. No one can predict the future correctly all the time. But their proven expertise far exceeds that of commercial lenders, who rely on their numbers in any event.

2008 Jul 29 10:08 AM

[Paul Killinger:]

The worst part for the auto finance arms is that their success is tied to that of their host manufacturers, and cannot be counter cyclical by its very nature to help them weather a downturn. That said, what would you have them do, invest in Treasuries? Maybe they could find a way to hedge potential losses, which they very likely do already.

2008 Jul 29 10:18 AM

[Paul Killinger:]

This downturn has been unprecedented, and the equities of commercial banks have fared NO BETTER than those of the auto manufacturers. If banks and credit unions had greater exposure to vehicle loans and leasing, it would only have made their losses that much worse. And if they were so smart, they wouldn't have been caught so long in real estate.

2008 Jul 29 10:34 AM

[User 208427:]

the attractiveness of leasing (lower payments) depends on the residual value. having a higher estimated value at the end of the lease life cycle works to the benefit of the consumer only, and plays upon the hopes of the auto manufacturer. Regardless of who sells the lease, if the residuals are declining, the leases will be less attractive thus a decrease in the number of leases. in short, it has less to do with the source of the lease, and more to do with the residual value which the auto makers should have better insight on.

2008 Jul 29 11:15 AM

[miketobias01:]

Leasing grew in popularity as Car prices grew out of reach of the average middle income family. I have never leased a vehicle. my credit has never been good enough, sorry!!! I just buy GM stock great buy right now!

2008 Jul 30 10:02 PM