Auto finance symptom of bigger problem

David MoonBlog

By David Moon

A friend of mine recently bought a car, reminding me why the term “car salesman” has, in many instances, earned its pejorative reputation. It’s also a reminder of much larger problems in our economic system.

New car dealers sell a completely homogeneous product, identical to those available at other dealerships, yet use a pricing mechanism that is explicitly designed to manipulate the buyer into paying higher prices than necessary. Even though it makes no sense, we all know and accept horse trading as part of the process.

What you may not know, however, is that dealerships earn as much as a third of their operating profits from the sale of finance and insurance products, more than they make on the actual sale of cars. In most cases they don’t disclose this and, in the case of my friend, repeatedly “misspoke” about the issue.

Armed FBI agents raided Knoxville-based Pilot for essentially doing the same thing. But we just expect and accept it from some businesses.

The salesman working with my friend produced a document on a local lender’s letterhead, purporting to offer the lowest available rate from this lender, 2.89 percent. A quick phone call to the lender, combined with knowledge about the industry, revealed that the car dealer was receiving most or all of the difference between the bank’s actual lowest rate (2.39 percent) and the dealer’s marked-up rate of 2.89 percent.

Employees of the dealership twice falsely denied receiving any revenue related to the financing.

The receipt of undisclosed kickbacks is common in the car industry. And because dealers have the flexibility to adjust the interest rate markup they charge (the kickback,) unsophisticated buyers end up paying much more than people who question and understand the system.

After my friend revealed his understanding of this process, the dealer “discovered an error” and finally offered my friend the actual lowest rate.

“Whoops; I got caught.” But still, no FBI.

The flaws in the car-buying process expose a much bigger problem: flaws in both our economic and justice systems.

Many of the problems people ascribe to free markets are actually the result of violations of free market principles. Free markets require full and complete information among buyers and sellers. Like most complicated purchases (financial services being among the worst offenders) sellers work very hard to unnecessarily complicate the process.

Different industries are regulated in different ways, with the same immoral act being illegal in one industry and an accepted practice in another. The Consumer Finance Protection Bureau is working to address the unequal pricing of car loans, but it only has leverage over the lenders, not the dealers.

Like malfeasance in many industries, this system of kickbacks is completely legal.  But to paraphrase Samuel Johnson, the law is the last refuge of the scoundrel.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).