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More than 80% of car sales are financed with lease or loan agreements. Photo: Jeff Kowalsky/Bloomberg
More than 80% of car sales are financed with lease or loan agreements. Photo: Jeff Kowalsky/Bloomberg

Short-term credit markets keep car sales moving

Researchers study the effects of the financial crisis on short-term credit markets and the fallout for the auto industry

When markets froze during the 2007-10 financial crisis, the effects were dramatic as banks stopped lending and housing prices crashed. Now researchers are returning to take a closer look at what happened with one particular group of markets, short-term credit markets.

Turmoil in these markets had visible effects on consumers, suggests research by Northwestern’s Efraim Benmelech and Ralf Meisenzahl of the Federal Reserve, and Rodney Ramcharan of the University of Southern California, who find that a crisis in short-term credit markets in 2008 and 2009 contributed to a steep drop in car sales.

Short-term credit markets make it possible for consumers to borrow money for large purchases such as appliances and cars, often through non-bank financial institutions such as finance and leasing companies. More than 80% of car sales are financed with lease or loan agreements.

In 2005, more than half of new cars bought in the US were purchased with credit that relied heavily on short-term funding such as asset-backed commercial paper.

The financial crisis revealed what happens when these markets experience a liquidity crisis. When Lehman Brothers declared bankruptcy in 2008, money flowed out of money-market funds and other buyers of asset-backed commercial paper, making it hard for captive lenders (leasing companies set up by automakers) to offer financing.

From 2008 to 2009, total car sales fell from 8 million to 6.5 million. The researchers calculate that the diminished financing capacity may have led to 30% of the drop.

In counties where pre-crisis sales were most dependent on captive lending, sales fell sharply. “We find significant evidence that for borrowers living in counties more traditionally dependent on non-bank financing, the probability of obtaining non-bank credit fell sharply over the 2008-2009 period, becoming zero in late 2009," the researchers write.

Granted, people who borrow from non-bank lenders such as leasing companies tend to be lower-quality borrowers, who during the Great Recession were being squeezed in other ways, too. But by looking at house prices, household leverage, household net worth, and unemployment measures, the researchers find that the falling car sales did reflect the diminished amount of available credit, and that captive lenders cut lending even to consumers with high credit scores.

The US government worked to unfreeze the short-term funding markets with an $80 billion bailout of carmakers.

The evidence, write the researchers, “tentatively suggests that the Treasury and Federal Reserve programs aimed at arresting illiquidity in credit markets might have helped to contain the real effects of the crisis".

This article first appeared on Chicago Booth Review’s website, Review.ChicagoBooth.edu

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