No Easy Jumpstart To Get Small Business Hiring Again

As 130 business, labor and thought leaders converge on the White House today to discuss ways to create more jobs, the nation's main engine for job creation -- small businesses -- is stalled out.

Suffering from a lack of available credit, low demand for goods and an uncertain economic environment, small businesses are hurting even more so than larger firms.

A variety of proposals to help small business are floating around Washington. They include funneling unspent TARP funds into banks on condition they lend the money to small businesses; pushing the Small Business Administration, a federal agency, to increase its lending and guarantee more loans; and using other TARP money to provide cheap financing for investors to buy securitized small business loans.

One proposal championed by Sen. Mark Warner (D-Va.) and endorsed by 32 other senators calls for up to $40 billion in unspent TARP funds to be channeled into smaller banks, only to be used for small business loans -- a "use it or lose it" source of funds. The Obama administration supports elements of the plan, which doesn't require congressional action, but hasn't made any public steps toward actually implementing it.

But pushing banks to lend more in an uncertain economy to perhaps non-credit-worthy borrowers may not really solve the problem.

"Community banks aren't lending more not because they don't have the money; they're not lending more because they don't see good lending prospects out there," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. "I don't think the issue here is one of bank lending. You have a falloff in lending as you always have during a downturn because there aren't any good lending opportunities."

He says the reason behind the lack of available credit is due to plummeting real estate values in the commercial and residential markets, as well as significantly decreased consumption. Simply put, consumers aren't spending as much so businesses don't have much reason to grow.

"I really think the lending [issue] is sort of barking up the wrong tree," Baker said. "I don't know what force-feeding banks money is going to do. As much as we might want to give more money to them I don't think they'll have anything to do with it if we did."

The two leading small-business advocacy organizations - the National Federation of Independent Business (NFIB) and the National Small Business Association (NSBA) - have differing views. The NSBA points to the lack of credit as one of its top priorities. But in a report released last month based on survey data, the NFIB noted that while its members were having difficulty getting loans, it was far from a top priority. "Too many [business] owners have no reason to borrow," the authors wrote. "The biggest problem was a dearth of customers."

Some small businesses are clamoring for more credit, but others are reluctant to take on more debt, particularly considering the uncertainty of the economy. As Mark Zandi, chief economist with Moody's, put it Wednesday in a meeting with lawmakers on Capitol Hill: "The odds that the economy will backtrack into recession remain uncomfortably high."

Tim Duy, a former Treasury Department economist now at the University of Oregon who runs a popular blog chronicling the Federal Reserve, says that banks have plenty of cash to lend.

"I would start with this question: are banks really having that much trouble getting cash right now? Deposits are up, so it's not as if there's no cash for banks to lend. And it's not as if the cost of funds is very high right now," Duy said.

Indeed, domestic deposits at banks are up $331 billion since last year, an increase of about five percent. And the federal funds rate -- the Federal Reserve's interest-rate target for overnight loans between banks -- is at record lows, averaging 0.12 percent in October. The lower the rate, theoretically the more incentive exists for banks to borrow and invest (like in loans to small businesses). Two years ago the rate was 4.76 percent.

In addition, as of October banks were holding nearly $1 trillion in excess reserves, according to the most recent federal banking data. That figure is in excess of what's mandated by government regulators. By contrast, in the decade before the financial crisis blew up in September 2008, the nation's banks held an average of $1.7 billion in excess reserves.

Nevertheless, lending continues to decrease. Commercial and industrial loans have dropped 16 percent since last year, according to the Federal Reserve. Loans through credit cards -- which many small businesses use to finance their operations -- have fallen nearly five percent since last year, according to the Federal Deposit Insurance Corporation. And unused lines of credit, such as a credit card line or loans secured by commercial real estate -- two other popular forms of financing for small businesses -- are down a whopping 22 percent since this time last year.

Economists Baker and Duy say the demand for loans isn't really there. Survey data from the Federal Reserve backs them up. In the third quarter, nine percent of banks reported "moderately stronger" demand for commercial and industrial loans from smaller firms (defined as having less than $50 million in annual sales) compared to the second quarter. But nearly 45 percent of banks reported "moderately weaker" demand.

In the previous quarter, three out of five banks reported weaker demand from smaller firms for these loans; in the year's first quarter, two-thirds of banks reported lower demand.

"It's hard to force banks to make loans they don't want to make," said Allen N. Berger, a former senior economist at the Federal Reserve, now at the University of South Carolina. Berger has published several research papers on bank lending, credit availability and small businesses. "Business conditions are riskier...not a lot of small businesses are in good enough shape to get loans. It makes sense for banks to be rejecting loan applications," he said.

The Independent Community Bankers of America (ICBA), the country's leading small-bank advocacy group, supports increasing loans to small businesses, says Paul Merski, the group's senior vice president and chief economist. "Small businesses don't do well if community banks aren't doing well, and vice-versa," he says.

But Merski traces much of the problem to the broader economic conditions. After all, when unemployment is at 10 percent and consumption and income are down, the viability of many small businesses comes into question.

Merski adds that bank lending is based on collateral and with about 45 percent of all small business loans backed up by real estate collateral -- and with real estate prices down by roughly a third from their peak -- smaller firms have been disproportionately affected.

Bank regulators are forcing banks to reduce the risks to their balance sheets, he said. "Unless you have bank regulators ratchet back the pressure they're putting on banks, it's not going to be easy to make those loans."

Zandi said federal money instead should be used to bolster the securitization market for small business loans, partly because it's not clear that the banks would want the TARP money if there are too many strings attached. That would reduce the risk posed by individual loans.

Christina Romer, chairwoman of the White House Council of Economic Advisers, remains hopeful, writing in an opinion piece regarding job creation in Wednesday's Wall Street Journal that "a moderate and targeted investment by the government" in the form of "measures to restore the flow of credit for small businesses and targeted tax cuts... might be leveraged into significant employment gains and purchasing power by small businesses."

But thus far, none of the major proposals to boost small business lending calls for more than $50 billion. Merski says they would only make an impact "at the margin." James K. Galbraith, an economist at the University of Texas at Austin who's called for a second stimulus package, agrees.

"Although I would give all of these efforts points for trying, I would say that they're at best functional as part of a much larger effort to turn the macroeconomic environment around. The situation calls for something much larger."