Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Andreas Grunewald (Bonn), Jonathan Lanning (Chicago Fed), David Low (CFPB), Tobias Salz (MIT) NYU Alumni Conference, September 7th *The views expressed are those of the authors and do not necessarily reflect those of the Consumer Financial Protection Bureau, the Federal Reserve Bank of Chicago, the Federal Reserve System, or the United States.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Most auto loans are intermediated by auto dealers .
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Most auto loans are intermediated by auto dealers . Research Question: How does loan intermediation affect consumers?
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Most auto loans are intermediated by auto dealers . Research Question: How does loan intermediation affect consumers? Dealers set price of vehicle and loan, potentially leading to a form of price discrimination.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Motivation Bundling Loans and other Financial Products Auto loan market is large: ◮ About $1 trillion, third-largest debt market in US Cars are typically bundled with loan: ◮ Around 85% of car loans in the US are intermediated by dealers. Bundling is important for dealers: ◮ 2011: > 50% of dealer profit from F&I department. Bundling w/ financial contracts common in other retail markets: ◮ Consumer durables with financing and warranties. ◮ Flights/hotels with travel insurance. ◮ New construction mortgages.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Project Overview 1. Describe market and dealers’ incentives. − Vertical relationships between lenders and dealers.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Project Overview 1. Describe market and dealers’ incentives. − Vertical relationships between lenders and dealers. 2. Use dealers’ incentives to study consumers’ price response − Imposing only supply-side optimal behavior. − Derive individual-specific bounds on responsiveness.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Project Overview 1. Describe market and dealers’ incentives. − Vertical relationships between lenders and dealers. 2. Use dealers’ incentives to study consumers’ price response − Imposing only supply-side optimal behavior. − Derive individual-specific bounds on responsiveness. 3. Interpretation of our results − Not driven by: taxes, default, prepayment, credit constraints/impatience
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Project Overview 1. Describe market and dealers’ incentives. − Vertical relationships between lenders and dealers. 2. Use dealers’ incentives to study consumers’ price response − Imposing only supply-side optimal behavior. − Derive individual-specific bounds on responsiveness. 3. Interpretation of our results − Not driven by: taxes, default, prepayment, credit constraints/impatience 4. Heterogeneity analysis − Who exhibits smaller/larger wedges in responsiveness?
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Motivation Project Overview 1. Describe market and dealers’ incentives. − Vertical relationships between lenders and dealers. 2. Use dealers’ incentives to study consumers’ price response − Imposing only supply-side optimal behavior. − Derive individual-specific bounds on responsiveness. 3. Interpretation of our results − Not driven by: taxes, default, prepayment, credit constraints/impatience 4. Heterogeneity analysis − Who exhibits smaller/larger wedges in responsiveness? 5. Counterfactual exercises − Imposing demand + equilibrium model.
The Market
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects The Market The Setting The Typical Financing Process 1. Consumer chooses make and model of the car. 2. Consumer provides personal data; dealer checks credit. 3. Dealer collects “buy rates” from lenders through e.g. Dealer Track , Route One , or Credit Union Direct Lending . 4. Dealer makes loan offer, including markup over buy rate. 5. Dealer receives payment (“dealer reserve”) from lender. ◮ Payment = (fixed payment) + (share of markup revenue) ◮ Average fixed payment is $137; average share is .66 78% of loans marked up. Average markup is 108 basis points.
Using Dealers’ Problem to Quantify Consumers’ Price Responsiveness
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Quantification Intuition Why do dealers mark up loans? ◮ Charging one extra dollar on the car yields a dollar. ◮ Charging one extra dollar on the loan yields 66 cents.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Quantification Intuition Why do dealers mark up loans? ◮ Charging one extra dollar on the car yields a dollar. ◮ Charging one extra dollar on the loan yields 66 cents. ◮ Explanation: Some consumers respond less to finance charges.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness One-Period Model Dealer’s Optimal Markup Choice Consumer i : ◮ Down payment d i , car price p i and interest rate r i . ◮ Disutility of p i is p i ; disutility of finance charges x is M i ( x ) ∈ C 2 . ◮ Requires utility ¯ u i to buy car. ◮ Can finance the car through the dealer or an outside lender.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness One-Period Model Dealer’s Optimal Markup Choice Consumer i : ◮ Down payment d i , car price p i and interest rate r i . ◮ Disutility of p i is p i ; disutility of finance charges x is M i ( x ) ∈ C 2 . ◮ Requires utility ¯ u i to buy car. ◮ Can finance the car through the dealer or an outside lender. Dealers: ◮ Exogenous buy rate b i and costs for a car c i . ◮ Set p i and r i . ◮ Dealer reserve has slope α and intercept β .
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness One-Period Model Dealer’s Optimal Markup Choice Constrained dealer’s maximization problem : max ( p i − c i ) + ( p i − d i ) · ( r i − b i ) · α + β r i ,p i s.t. − p i − M i (( p i − d i ) · r i ) ≥ ¯ u i � M i (( p i − d i ) · r L ) · g i ( r L ) · dr L − s i , − M i (( p i − d i ) · r i ) ≥ − r i ≥ b i , p i ≥ 0
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Propositions Details and Proofs in Paper 1. Size & frequency of markups in data are inconsistent with M ( x ) = x
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Propositions Details and Proofs in Paper 1. Size & frequency of markups in data are inconsistent with M ( x ) = x ∃ observable bounds on: ′ ( r ∗ 2. Marginal disutility of finance charges, M i , p ∗ i )
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Propositions Details and Proofs in Paper 1. Size & frequency of markups in data are inconsistent with M ( x ) = x ∃ observable bounds on: ′ ( r ∗ 2. Marginal disutility of finance charges, M i , p ∗ i ) 3a. Diff. btwn finance charges & disutility of finance charges, B O ($)
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Propositions Details and Proofs in Paper 1. Size & frequency of markups in data are inconsistent with M ( x ) = x ∃ observable bounds on: ′ ( r ∗ 2. Marginal disutility of finance charges, M i , p ∗ i ) 3a. Diff. btwn finance charges & disutility of finance charges, B O ($) 3b. Diff. btwn markup charges & disutility of markup charges, B M ($)
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Results Population Estimates Table: Summary Statistics of Estimates Variable Mean p10 p25 p50 p75 p90 ′ M i ( · ) 0.86 0.77 0.80 0.86 0.91 0.95 B O ($) 380.12 105.71 186.81 324.33 510.73 721.56 B M ($) 96.16 0.00 16.56 72.09 145.21 228.07 Note : Selected summary statistics of measures of consumers’ sensitivity to fi- nance charges. M ′ i ( · ) and B O i condition on positive markups. B M are derived i for the full sample.
Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects Quantifying Consumers’ Price Responsiveness Interpretation of our Results Some Potential Explanations Sales Tax: Do the calculations with sales tax τ . � Default Risk: Consider only consumers with credit score above 720. Default risk approximately: 0.5%. � Credit Constraints or Impatience Prepayment Risk
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