The decline of the American auto industry is something that’s fresh in the minds of many Americans. It’s what turned eastern Michigan from a thriving industrial center into the buckle of the Rust Belt. You can argue that Detroit is making a gradual comeback, but that’s in spite of, rather than because of, the auto industry. While the European auto industry was going strong for a long time, I recently read an article that discussed how a plunge in sales of diesel cars in two of Europe’s biggest markets could drive down the value of used vehicles, and in turn hinder the lucrative financing plans that major carmakers use to sell millions of automobiles.
After Volkswagen’s emissions scandal, authorities across Europe are trying to raise taxes on diesel vehicles that are polluting more than previously thought, and in some cases restrict or even ban them in some cities. This has decreased demand, with new diesel car registrations this past month dropping in both Germany and the UK, in turn weighing on used car prices. In addition, the shift to cleaner vehicles doesn’t hint at any sort of recovery.
In Britain, where car sales hit a record high last year thanks to finance packages accounting for 90 percent of sales, this is particularly disconcerting. Customers under “personal contract plans” pay a small deposit toward a new car, then make monthly payments for the next two to three years. They can then choose to either buy the car outright or return it to be sold second-hand, then use the equity to take on a new car and start this cycle of monthly payments over again. The finance company then determines how much they can borrow by determining how much they think the vehicle will be worth at the end of the payment period. If it falls more than expected, then customers won’t have as much money to buy a new car, hurting demand for all new vehicles.
In recent years, the US has seen a sharp fall in residual values as demand decreases and automakers try to keep up by slashing prices. Both leasing and finance contracts are priced through an assumption of stable residual values, and a similarly sharp fall across the Atlantic could trigger a spike in leasing prices that in turn could hurt demand and increase defaults. A mere 5 percent cut in residual values in Europe could equal 1.6 billion Euros. This would hit the “big three” German carmakers – Volkswagen, BMW and Daimler – the hardest. Concern about how finance packages are sold has led to the UK’s Financial Conduct Authority to conduct a review due to a potential “lack of transparency, potential conflicts of interest and irresponsible lending”.