Banks and small businesses - For want of a loan

Dec 10th 2009 WASHINGTON, DCFrom The Economist print edition
America’s best job creators are being hit by a credit crunch

IT IS basically a second stimulus, though no one wants to call it that. On December 8th President Barack Obama announced a set of proposals to address unemployment and made it clear that he wanted to use some of the unspent TARP funds (money set aside to support failing banks) to help pay for them. No precise figure was given. Some $50 billion will be spent on infrastructure projects; there will also be new rebates for home insulation and other energy-saving incentives. But the linchpin of the administration’s effort is a broad push to support small businesses.

That sounds reasonable. Small businesses (firms employing 500 workers or fewer) have accounted for 64% of net new job creation over the past 15 years, according to the Small Business Administration (SBA), an independent government agency. And a recent economic study found that cities with more small firms have done better at creating jobs over the past 20 years. But America’s most recent recession has hit small businesses hard. The very small, with fewer than 50 workers—employing almost one-third of working Americans—have suffered around 45% of the job losses of the downturn.
Unfortunately, helping small businesses has not proved easy. The stimulus package passed last spring offered tax benefits, including capital-gains tax exemptions and increases in the amount of business expenses that could be claimed for tax purposes. The bill also targeted the flow of credit to small businesses. Money was set aside to cut fees and provide guarantees for major SBA lending programmes. The results were disappointing. Although lack of access to credit inflicted huge damage on small businesses last autumn, lending (or lack of it) has not been the main problem for most of 2009. Rather, it was the weak economy that devastated profits and loan demand (see chart).
That is now changing. As economic activity has picked up, so has demand for small-business loans—so much so that remaining stimulus funds ran dry in November. Small firms are being hit by a credit crunch. Two common sources of financing, credit-card debt and home-equity credit, have become less useful; months of poor economic conditions have eroded credit-worthiness, while the housing bust has left a quarter of mortgage borrowers with negative equity. Smaller regional banks have long been a third option, but the looming commercial-property bust is diminishing their usefulness.
That bust may not cause the financial panic that rotten home loans did. But nearly 40% of outstanding small-business loans are held by banks with the greatest exposure to commercial-property risk. In 1993, the figure was only 11%. As commercial-property losses grow, banks will be forced to curtail lending.
Will Mr Obama’s latest ideas help? Most are extensions to current stimulus measures. The one exception is a new small-business tax cut for job creation, details of which have not yet been released. Mr Obama intends to provide a booster to the SBA loan programmes, offering more money to cover fee reductions and SBA guarantees for small-business loans made by commercial banks. All this is good. But lending is the chief problem. If regional banks are fighting to survive, lower fees will not be enough to get small-business finance flowing again. Ironically, it might have been better to use some of that TARP money for the banks after all.