Dealer Reserve is Here to Stay -- and for Good Reason
McLEAN, Va. (March 7, 2005) - NADA Chairman Jack Kain's response to the recent opinion piece by Consumer Federation of America's (CFA) Stephen Brobeck on dealer financing was published in the March 7, 2005 issue of Automotive News.
The recent opinion piece by Stephen Brobeck of the Consumer Federation of America (Automotive News, Feb. 21, "Dealer finance reserve should be dumped") demonstrates a fundamental misunderstanding of the very nature of dealer financing. In fact, Brobeck's arguments are based on a series of false assumptions that inevitably lead to flawed conclusions. Let me explain.
First, Brobeck assumes that retail car buyers can borrow funds at the same wholesale interest rates that are quoted to a dealer if those buyers would only go directly to lenders. But this is simply not the case. The wholesale or “buy” rate that finance sources quote dealers cannot be made available to consumers on a sustained basis. This point can be seen most clearly in the case of the manufacturers' captive finance companies. The captives have no retail infrastructure at all; the dealers are their retail outlets. The buy rates of the captives could not be offered to consumers without dealers because there would be no one to do so. Of course, the captives could build branches and hire and train staffs, but then their cost of doing business would increase, and those costs would have to be recovered somehow.
Indirect auto lending - making auto credit available through dealers - generally allows a dealer to add a retail credit markup and still quote a lower rate than the consumer would find for a direct auto loan offered by the same bank. This was recently confirmed by comparing the buy-rate sheets of indirect auto lending banks and the retail auto loan rates offered by the same banks in the same geographic areas through their branches, as quoted in the Greenbook Lender's Guide and the Roberts Report. (Both of these publications are considered authoritative reference sources by the financial industry.)
Not unexpectedly (but contrary to Brobeck's assumptions), economic evidence confirms that auto dealers are not charging higher interest rates on loans to customers than those charged by banks or other financial institutions. In fact, retail auto credit rates offered by an auto dealer are generally comparable to, and frequently better than, those offered directly by a credit union or a bank lender at a branch. Thus, Brobeck's conclusion that buyers are somehow paying “more” as a result of the dealer reserve system is unfounded.
Brobeck's arguments also assume that the average consumer today is helpless and uninformed. This is, at best, misleading. Never before has more information about auto financing been available to the consumer. Consumers have the ability to compare auto loan rates from numerous sources. There is extensive advertising in newspapers, magazine, television and radio. And, of course, information is readily available on the Internet. Auto sites, for example, are receiving an incredible 60 million hits a month.
Furthermore, consumers themselves report that they have sufficient information to make informed decisions. In a study by Wirthlin Worldwide, commissioned by the industry consortium Automotive Retailing Today, 90% of non-minority and 78% of minority respondents who had recently purchased a vehicle said that the dealer finance office provided them with enough information to make an educated and informed auto financing decision.
What it really comes down to is whether the consumer is being treated fairly, and the best guarantor of fairness is a competitive marketplace. Because of today's fierce competition among many auto credit sources, the bargaining power of the consumer has never been stronger. Auto dealers face constant competition not only from other financing institutions, but also from other dealers in their markets.
And the existing auto financing system offers one additional feature that virtually no other market has - the penalty-free option to refinance. This feature contributes mightily to the system's level of competitiveness. If car buyers conclude that they don't like the interest rate charged by a dealership, they can refinance at any time - with no penalty. Very few products carry such a liberal return policy. The fact that other finance sources are not actively soliciting customers to refinance their dealer financing is further evidence that the rates customers are getting from dealers are competitive. After all, those sources have no difficulty promoting mortgage refinancing when they can offer lower rates than people's existing mortgages are carrying.
The fact is, the current auto credit market serves consumers very well. It's competitive; it's accessible to even the most credit-challenged; it offers the convenience of one-stop shopping, and it's increasingly transparent. Rather than tear it down, what we all should be focusing on is making it work even better. And the best way to do that is to continue to increase public understanding of auto financing through consumer education campaigns similar to the one developed by NADA, with auto-financing guides that have been distributed to millions of consumers and an on-going campaign to raise the level of financial literacy among young people.