End of the Cheap Lease Era

July 30, 2008
Car Dealer

Car Dealer

If something seems too good to be true…maybe it is. Yet for the last two decades, automakers have swallowed a bit of pixie dust (or was that electric Kool-Aid?) and convinced themselves the lease is the industry’s best friend.

There seemed to be plenty of reasons why automakers and auto buyers alike loved leasing. You, as a car-buying consumer, might have used a lease to buy a fully loaded luxury SUV on a monthly budget more suited to a mainstream sedan. Perhaps you got your teenage child a brand-new car, instead of a rusty heap from the corner used car lot.

Automakers not only got buyers who might not have been able to afford a new car, but millions more motorists moved up-market. And, contended the early lease proponents, brand loyalty would surge, as well. Why? Because a manufacturer would know precisely when a customer would be required to turn in their vehicle, explained former Ford marketing czar Bob Rewey. And if you knew that, you could ramp up your marketing efforts, targeting a specific customer more effectively than ever before.

So it worked – in theory. But there was a catch.

Leasing has actually been around for decades. But in the past, it was “open ended.” That meant that a consumer never really knew what the final costs of the deal might be. Let’s say you leased a Ford Explorer and it’s come time to turn it in. With an open-ended lease, if the value of that vehicle has dropped since the deal was written, you might have cover the gap – much as you’d lose out if you bought a car that dropped more than anticipated when you traded in.

With today’s closed-end leases, however, the manufacturer assumes that risk. And knowingly so. In recent years, automakers have taken a “let’s pretend” approach to residual value, the technical term for what a vehicle is worth at the end of the lease. Sometimes they consciously inflate that number, and count it as an incentive – sort of the lease alternative to a rebate. Other times they simply ignore facts and come up with a number that they should know better than writing into a contract.

Either way, the lease bubble has burst. The residuals forecast for SUVs and light trucks, in particular, are coming in nowhere near what was predicted just a couple years ago. Add a rising number of defaults, and you have a full-fledged mess, one that will cost the industry billions, considering that leases currently account for 20 percent of new-vehicle business among Detroit Big Three. (And for some import luxury marques, it’s substantially higher.)

If you thought the industry was worried about the general downturn in the U.S. auto market, add in the leasing situation and you’re starting to see signs of panic.

This past week, Chrysler announced that its captive financial subsidiary will halt automotive leasing. Now, Ford and General Motors plan to sharply trim back their leasing programs. And a number of banks, including J.P. Morgan Chase’s Chase Auto Finance unit, are scaling back or are cutting leasing out, as well.

Who loses? That’s a good question. Certainly, there’ll be a lot of consumers forced to downsize their aspirations. And plenty of others might be driven out of the new vehicle market entirely. For manufacturers, that’s lost business and lowered expectations, as it’s another reason why the ongoing market slump might continue.

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