Noise, Vibration, and Harshness: Rise and Fall of Consumer Finance

Maybe Adolf Hitler got it right. I don’t mean the part about world domination, the master race, or all the illing and killing for which he’s so justifiably reviled. I’m talking about consumer credit and the way the Third Reich got hard-working citizens to divert a little bit from their pay packet each week to purchase their very own Volkswagen. Theirs to use and enjoy, once they’d finished paying for it. In advance.

The practice seems exactly backward in a world where the idea is to sell as many cars as possible. Compare our U.S. system, pioneered by John Jakob Raskob for GM in the 1920s, wherein John Q. Public gets the car first and finishes paying later, in monthly installments. Hopefully before the car falls apart.

Aggressive consumer financing -not some fascist savings account but real, easy, right-here-now credit-became the great engine of American economic prosperity during the twentieth century. It has sold a lot of cars, agreeable finance being the mother’s milk of car selling, in which immediate gratification is the whole point. The only things meant to concern us about the future are our ability to make payments and our next new car. This has been the American way longer than any of us have been alive.

But lately comes the unsettling news that American carmakers and banks have been losing their shirts giving us what we want pronto-with leases. Leasing-down from past levels but still some 20 percent of the U.S. car market-is installment lending on steroids. By financing only the difference between a car’s sale price and its worth at lease end, the so-called residual value, consumers enjoy lower payments and can, in theory, finance more car for their money.

Buoyant residual values made easy-to-swallow lease deals ($199 a month!) possible. And although leasing often doesn’t make as much financial sense as many think, it can when heavily subsidized by the manufacturer. With whom, it turns out, the real risk lies. Today, truck and SUV makers find themselves answering the question: what happens when the lease expires and the leased vehicle returns home, worth less than we said it would be?

The short answer is, you lose piles of money, as Ford found out when it previewed the industry’s current misery with the Firestone tire/rollover scandal that came to the public’s attention in 2000, shooting the bottom out of Explorer residuals for years to come. But that was nothing compared with now. Years of truck and SUV production are coming back to haunt Detroit in the form of bad leases, a veritable sea of high-riding, go-anywhere debt.

That’s because fuel prices and an economic downturn have caused a dramatic across-the-board decline in the residual values of Detroit’s gas-slurping finest, leaving the world of automotive finance to grapple with the long-looming consequence of an industry that earned its keep building big vehicles vulnerable to gas price inflation. Dormant liabilities with names like Silverado, Expedition, and Durango have turned overnight into angry, cash-eating zombies that promise to cost Detroit billions.

When lessors overstate a vehicle’s likely residual value, innocently or otherwise, they lower monthly payments, but they also take a gamble that the value will be there in 24 or 36 or 48 months. It’s a gamble they seem to be losing with frightening regularity, as yesterday’s profit morphs into today’s loss, each bad lease a nightmare akin to the one average citizens face when they find out they owe more than their car is worth. It’s bad enough when you find your own self upside down, but when hundreds of thousands of leases go upside down on you at once, it’s worse.

How much worse? Last summer, Chrysler announced it would stop leasing. Period. GM declared its intention to halt leasing in Canada. Like Ford, it plans to charge more for its leases in the United States going forward. Times are tough, boy.

The government says it’s not ready to call it a recession, yet, but it doesn’t take a proclamation to know that the balloon has sprung a leak. The sour fruit of plummeting residual values reflects the agonizing descent already in progress for domestic makers, while hastening it, too.

When you won’t lease the cars you make, you’ve said you’re not willing to bet your own money that they will be worth as much as you say they will in years to come. Whether you can’t afford to or you choose not to, either way, you have an effective strategy for not building confidence in your brand. But it’s not only the firms’ self-esteem that’s lacking. Moments after Chrysler announced that it would stop leasing its vehicles, Chase Auto Finance chimed in that it, too, would no longer write leases on Chrysler offerings. And lest anyone get the wrong idea, Wells Fargo let it be known that it didn’t want anyone thinking it was writing Chrysler paper anymore, either.

So, you can’t lease a Chrysler, Dodge, or Jeep for love or money. This can’t please dealers, who got precisely one week’s notice of a radical change in their business plan, or workers, whose livelihoods depend in part on those leases. Nor will it comfort those who could obtain a piece of pentastar magic only via low monthly lease payments. Now you can buy your Chrysler over 72 months if you want to keep the payment low, or you can pay cash. Cash up front for a Caliber? Six years paying for one? Now that’s Mopar madness.

Even mighty Toyota will write off hundreds of millions in lease losses this year, but not all carmakers are hurting. Many whose product lines are more in tune with the current mood continue to offer leases, which should further depress Detroit, as limiting finance options for its customers poses another competitive disadvantage. But for the hurtingest of the hurting, look no further than Cerberus Capital Management, the private equity firm that bought Chrysler last year for $5 billion. If that fact alone doesn’t make you feel sorry for Cerberus, consider this: it also bought Chrysler Financial, the credit arm that wrote many of the leases now immolating cash reserves.

Recent factory discounts on Dodge Ram pickups of 40 percent off list can’t be helping residuals, but that’s only one worry. Shortly before acquiring Chrysler’s portfolio, Cerberus bought a controlling interest in General Motors Acceptance Corporation, the captive finance arm that GM founded in 1919. GMAC has since been burned not just by its vast exposure to truck and SUV leases but also by huge losses in the subprime mortgage market.

So, well done, fellows. Maybe Daimler had the right idea dumping Chrysler. With the residual free fall killing leasing, can regular loans be far behind? They’re risky now, too. People walk out on loans when they’re upside down more often than when they have equity. So, although the disappointment might not be as universal as it is with leases, pencil in more losses from good old-fashioned loans. That is, until Detroit starts building more vehicles that hang on to their value, ones that people want today and will continue to want 24, 36, or 48 months from now.