A `Warning Flag' For Detroit

Will its leasing strategy backfire?

Economist Tony Riley of A. Gary Shilling & Co. thinks it could mean big trouble for Detroit. After rising by an average of 7% to 8% a year since 1992, used-car prices this year have shown all the resiliency of a dead-cat bounce (chart). At the very least, agrees economist Diane Swonk of First National Bank of Chicago, the recent deceleration in used-car prices is a "warning flag" for the auto industry as it looks toward '97 and beyond.

The big question is whether the trend reflects a long-feared payback from Detroit's reliance on leasing to bolster sales. When consumers balked at high car prices in the 1980s, carmakers lengthened loan maturities to five years to keep autos affordable. When that strategy ran out of gas in the late 1980s, Detroit turned to auto leases, which required even lower downpayments and monthly outlays. From 13.5% of retail vehicle deliveries in 1990, leases shot up to 32% last year.

All along, industry observers have warned that leased cars could come back to haunt carmakers when the leases expired and two-year-old vehicles flooded the market. But thus far, such predictions of doom have failed to materialize. With strong demand keeping used-car prices high, dealers have made money on both new- and used-car sales. And auto makers have profited from high resale values of returned lease vehicles.

Now, however, the collapse of used-car price inflation could mean that a painful moment of truth is fast approaching. Weaker used-car prices, notes Riley, hurt auto makers' profits by forcing them to offer competitive deals on new cars and by lowering the value of cars coming off leases. Meanwhile, lower trade-in values inevitably undercut new-car purchases by car owners.

With industry experts already projecting slowing new-car sales next year, the big danger is that a rising tide of used cars will undermine the market even more than expected. By the end of 1996, a record 3 million cars are scheduled to come out of leases, with the number climbing sharply in 1997 as well.

"The message of used-car prices," says Riley, "is that the down cycle for the auto industry could turn out to be a lot more traumatic than it anticipates."

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