Auto Industry's Problem Child

First leasing was good. Good for the auto industry, because it moved product. Good for consumers, because it offered an alternative to outright vehicle ownership.

But as with many good things, it got to be too much.

“Unfortunately, in the mid-1990s, a lot of manufacturers started using it strictly as a price promotion,” Rob Rewey told me a few years back.

He is a retired Ford group vice president and considered the “father of leasing” because he pioneered its retail application in a big way in the 1980s, while general manager of Ford's Lincoln Mercury division.

But his progeny became a problem child at about age 10. In the late 1990s, leasing was spinning out of control.

A lot of auto makers got in trouble because 75%-80% of some model lines were being leased. That's a lot of vehicles to remarket.

The residuals got out of whack. At first, residuals on off-lease vehicles were coming in higher than forecasted. That didn't last long, as remarketed off-lease vehicles flooded the market and sank prices of new- and used-vehicles alike.

Vehicles were coming off-lease with residual values consistently below what was forecasted at the beginning of the leases. Back then, it was easy to know which vehicles would be residual losers. “They were all upside down,” residual analyst Philip Sampieri once told me.

Facing that, many banks left leasing and many auto makers backed away, offering instead sweeter purchase incentives. Zero-percent financing was as much an effort to curtail leasing as to jump-start vehicle sales after 9/11.

So bad-boy leasing was sent to the corner for a long timeout.

Consumers could still lease cars. But terms weren't nearly as attractive as before and dealership sales people weren't pitching it as much. Lease originations dropped nearly 50%, from 3.8 million vehicles in 1999 to 2 million in 2003, according to Manheim.

But then leasing began making a comeback, with needed discipline this time around.

Residual predicting got better, although no one has the magic formula to correctly forecast residual values every time. “You can be dead wrong, because it is a volatile market,” says Bruce Harris, a vice president at VW Credit Inc.

Leasing matured by relying less on bargain-deal subvention from auto makers and more on putting the right customers in the right vehicles.

Leasing was touted as an alternative to consumers buying vehicles with too-long loans of six, seven and even eight years; terms that can spell equity problems for borrowers and undue risks for lenders.

Leasing is “a great product” when done right, says Manheim Consulting's Chief Economist Tom Webb.

It seemed like leasing, given a second chance, had made something of itself. Then Chrysler Financial last month stopped leasing, citing residual uncertainty for certain vehicles, such as big SUVs and pickup trucks. Other captive financing firms subsequently curtailed their leasing.

This prompted the National Vehicle Leasing Assn. to ask: “Is auto leasing really dead?”

The association says no. It sees opportunities for banks and others to capitalize on the sudden gap in the market. But if Chrysler, General Motors and Ford won't lease their own vehicles because of residual doubts, why would banks?

Asked what advice he might give banks thinking about entering or reentering leasing, Harris says: “Get psychiatric treatment.”

The leasing association predicts a lack of leasing options will send many customers to import brands; force dealers to extend terms; increase floor-plan costs; and slow new-car deliveries by prolonging trade cycles.

It's too bad. Vehicle leasing has grown up, but many people in the auto industry still treat it like a little brat.