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As used-car prices drop, deflation ahead?

March 11, 2016
Vehicle leasing as a percentage of monthly light-vehicle sales hit a record in February at 32.3 percent, indicative of what is a long-term trend: Since 2009, the share of monthly auto leases as a percentage of vehicle sales well more than tripled.
The thing about leased vehicles is that they come back, and about 3.1 million units will return to dealer lots of leases this year, up 20 percent from 2015. The number will climb to 3.6 million in 2017 and 4 million in 2018.
So what does that mean for dealers? Zero Hedge, a financial blog that aggregates news and presents editorial opinions from original and outside sources, thinks it means deflation. And what does that mean for the automakers? Hefty losses, said Zero Hedge.
This has happened before. The auto industry expanded the use of leasing in the mid-1990s, helping to fuel retail sales of new vehicles. Eventually, a glut of off-lease cars sent resale values down and auto lenders who had bet residuals would remain high ended up racking up billions of dollars in losses when they had to sell the cars for much less than they anticipated.
But the silly thing about the dynamic with auto leases is that it was the dealers and the automaker-affiliated financing companies that made the leases in the first place. In other words, it’s not like this was some supply shock that couldn’t have been forecast ahead of time. In fact, they knew exactly when the off-lease deluge would start, so it’s not entirely clear why they would have set optimistic residual assumptions.
Anyway, the cracks are already starting to show. 
The Manheim Used-Vehicle Value Index posted its largest year-over-year decline in over two years last month, falling 1.4 percent, to 3.5 percent below the peak. 
While improving inventory acquisition cost for the dealers, it may put downward pressure on the value of existing dealer inventories, which can be negative for used margins.
And falling used-car prices means pressure on new-car prices as well, which would be a shock to America’s booming auto market.
Obviously, the scariest part about all of the above is that consumers still have the pedal to the metal (pun intended) when it comes to leases, which means there’s no end in sight to the off-leases and thus no way to determine, at this juncture, how big the residual writedown wave and deflationary auto industry calamity will ultimately end up being.