How car finance is holding back a just transition

Abstract

Studies on how to decarbonise our transport system usually focus on technical solutions, and economic, social and political barriers. Very few have investigated the relationship between consumer finance and car dependency. This article focusses on how new retail car financing models have deepened car dependency and indebted consumers, to the benefit of a crisis-ridden car industry, and to the detriment of everyone else. It suggests that recognising the importance of car consumption financing is an important step in building the necessary political coalitions to achieve a ‘just transition’.

Most progressive commentary on transport and the environment recognises that we need to reduce car use, in order to reduce carbon emissions to safer levels and tackle social inequality. Although electric vehicles (EVs) undoubtedly play an important role in a just transition, the wholesale electrification of the car fleet would require enormous energy resources, a wholesale upgrade to the energy grid, and would deplete global lithium supplies. Moreover, the electrification of vehicles has enabled consumers to buy bigger and heavier cars; EVs – whether full EVs or hybrids – make heavier cars cheaper to drive, because electricity is cheaper than petrol or diesel. Maintaining high levels of car ownership and car usage, and allowing vehicles to increase in size, would have a detrimental impact on more vulnerable road users, especially those that, whether by choice or economic necessity, move around much more sustainably by walking and cycling.1

Recognising many of these factors, governments have made some limited policy decisions to prioritise active travel modes in recent years, whether through segregated bike lanes and ‘low traffic neighbourhoods’, or experiments in pollution charging with clean air zones.2 In many cases, these have generated considerable opposition. While these movements have not necessarily reflected the majority of public opinion, they have been sufficient to reduce the scope of schemes both locally and in terms of national policy.3 This has resulted in ‘culture wars’, seemingly dividing the population with motorists and the car industry on the one side, and environmental crusaders on the other.

Such patterns reveal the persistence of a strong ‘culture of car dependence’ in society, where support for car use, whether through, for example, tax breaks on consumption or increasing road capacity for cars, is commonsense and is broadly supported. As Mattioli et al argue, explaining the strength of this culture requires a deep understanding of the car industry.4 They show that car manufacturing is characterised by its huge economies of scale and high capital intensity. This gives the car industry considerable political clout. The increased provision of road capacity by politicians, and the travel habits that car owners establish, lead to ‘lock in’ mechanisms that continually reinforce car dependency and its political apologists. But the industry also tends towards overproduction and low profit margins, meaning that manufacturers must continually find ways to expand consumption.

I worked with Mattioli and his co-authors on the Living Well Within Limits project,5 under the leadership of the ecological economist Julia Steinberger, in 2019. Around that time there was a slew of media reports concerning the personal contract purchase (PCP), which had quickly come to replace hire purchase (HP) as the principal method of financing new car retail transactions in the UK.

PCPs have become associated with a new kind of car consumption. Under HP financing, consumers repay the balance of the sales price plus interest over a three-or-four-year contract, attaining full ownership at contract expiry. With PCPs, under similar length contracts, consumers only repay around half of the purchase price, but, unlike with HP, do not attain ownership of the vehicle unless they pay an ‘optional lump sum’, which represents the other half of the purchase price.

This makes the monthly repayment costs for new cars considerably cheaper, allowing consumers access to higher value vehicles (see figure 1, for an illustrated comparison of a PCP and HP deal for a £22,000 car). Rather than pay this lump sum, which most could not afford, the vast majority of consumers choose to instead return the vehicle to the manufacturer without financial penalty, in return for a new car on another PCP deal.

The rise of PCPs has corresponded with a new short-termism in car consumption. The trade press and newspaper articles have tended to explain these consumption patterns with reference to wider cultures of consumption. A popular referent is throwaway culture associated with mobile phones, in which consumers partake in endless rounds of ‘upgrading’ when they renew their contracts. In other words, PCPs are framed as responding to consumer preferences, rather than shaping them.

But I was not satisfied with such explanations. Returning to Mattioli et al,7 we know that the car industry has long-term structural problems of overcapacity and low profitability. I wanted to understand how PCPs could have helped manufacturers overcome these problems – to see what the relationship was between the needs of producers and the needs of consumers.8

The market for new cars in Britain has shown signs of saturation common with other wealthy countries of the global north. Using new car registrations as a proxy, we can see that – abstracting from periods of recession – new car registrations were on the decline in the late 2000s, just as PCPs began to come to prominence (see figure 2, 3).

Furthermore, as PCPs replaced HP as the primary form of consumer car finance, the average amount financed per car rose 50 per cent, in real terms, between 2009 and 2021 (see figure 3). This represents a huge increase in consumer indebtedness through the consumption of new vehicles.

The benefits for manufacturers are clear – more consumers spending more money on new cars more frequently helps them overcome their long-term profitability problems. But I was also interested in the potential risks and downsides of this business model. To explore these further, I gained access to credit ratings reports of PCP providers. These are produced by credit ratings agencies, who scrutinise the financial viability of companies who issue debt. PCP loans are originated by special purpose vehicle (SPV) companies that attract bespoke credit ratings, separate from that of their ultimate parent companies, which are often the manufacturers themselves. Gaining a strong, ‘investment grade’ rating is essential to allow providers to attract international financial investment in their car finance SPVs.

The way it works is that investors buy tranches of ‘securities’, or tradable financial instruments, which derive their value from the repayments of PCP loans for consumers. Much of the work of credit ratings agencies is to estimate the likelihood of consumers defaulting on their PCP loans. These considerations cover a number of variables, including underlying interest rates and the overall state of the economy. Also crucial to these calculations are the stringency of PCP providers’ collections regimes.

The credit ratings reports I uncovered described these processes in considerable detail. A key component of their stringency is how quickly they move toward repossessing the vehicle in the event of a customer missing a monthly repayment. Indeed, a recent report by the Financial Conduct Authority (FCA) has highlighted the severe impacts of such collection techniques in its investigation into Volkswagen Financial Services’ treatment of vulnerable customers. In one example, a customer, who had not missed a payment for two years, found themselves in a very difficult situation following a mental health breakdown, increased caring responsibilities and financial difficulties. Instead of following procedures recognising the customer's vulnerability, they quickly moved to repossess the vehicle – a situation that could only worsen the customer's personal circumstances, not least because they needed the vehicle to get to work. As the customer recalled, ‘They have not treated me with due courtesy of trying to sort something out just point blank: “now it's terminated”’.11

The FCA have imposed a fine of £5,397,600 on Volkswagen for breach of financial regulation requirements, relating to 109,589 customers who suffered a detriment as a result of its debt collection practices.12 So far, the FCA has not taken actions against other manufacturers in this way. Yet, these revelations, considered alongside the credit ratings agencies’ reports, and in the context of the car dependency literature, lead to a disturbing conclusion: car dependency is a credit positive for lenders. It ensures that most will prioritise their car finance payments above other life costs – because, to lose one's car could mean losing access to employment, education, healthcare, or other essential activities. This financial leveraging of car dependency is undertaken to keep car manufacturers from having to reckon with the inherent economic contradictions of their own industry.

This strategy is not without risk. In a situation where wage rises have been sluggish or stagnant, manufacturers cannot simply increase consumer debt in perpetuity. Unless we are to see a sustained increase in real wages, this house of cards must fall. The recent ban on ‘discretionary commission models’ for consumer car finance are part of this story, because they were essentially in place to incentivise brokers to extend as much credit as possible to consumers. The ban, and subsequent legal rulings, may cost car finance companies £16 billion in compensation claims.13

Increasing default rates is only one of two principal ways PCPs could undermine the financial viability of car manufacturers and the holders of PCP securities in international financial markets. The other is a reduction in used car prices. PCPs are designed to increase the rate of new car purchases. However, today's new vehicles quickly become tomorrow's second-hand vehicles. The increased throughput of new car sales increases the supply of nearly-new vehicles into the used market, which, all other things being equal, should depress the cost of used cars. That is a problem, because manufacturers rely on the vehicles financed under PCP to not depreciate in value below the rate predicted at contract outset. In other words, the ‘PCP solution’ to manufacturers’ profitability problems could, in the long term, undermine itself, quite apart from concerns surrounding consumer default levels.14

Of course, given the importance of the car industry to the economy, any such increase in sectoral risk also implies a risk to public finances: governments have a tendency to protect sectors, such as the car industry and finance, deemed ‘too big to fail’.

So, what can be done? Here, it is tempting to argue for ‘better regulation’, especially to protect consumers. But that is a sticking plaster. Manufacturers and their financial backers have a clear material incentive to push consumers into debt, and increased regulation is only likely to make them more innovative in their attempts to do so, as regulation usually trails financial engineering.

The central problem is a political one: most people need, or perceive to need, to use their cars. A more radical consumer education, which made clear that the motor industry is saving itself by putting its most loyal customers in financial harm's way could help turn the ‘culture war’ on its head. Rather than investments in public transport and cycling infrastructure being framed as a waste of money that could, for example, be diverted to fixing potholes and the next round of motorway widening schemes, they could instead be cast as financial safety nets – public infrastructure that helps us all get around without worrying about how to feed the car industry's insatiable appetite for our hard-earned wages. In turn, this would help build public opposition to the government bailouts that will surely be required if the car industry continues to expand consumer finance.

Ordinary people are not stupid: they can see the environmental collapse all around them, they understand the fundamentals of global warming, and they perceive that giant corporations often act in ways that only serve their own interests. If a ‘just transition’ is ever to become more than a meme propagated by environmental activists and progressive civil society institutions, and morph into a rallying cry for a movement strong enough to change our political direction, then we need a consumer education that moves beyond individual rights, to one that spells out vested interests and vulnerabilities and empowers the creation of common strategies to overcome them.