When the banking system imploded in September 2008, commentators immediately
feared that the result would be a credit crunch, leading to a major downturn in
gross domestic product (GDP) and a rise in unemployment. The US government,
however, deployed all its resources to ensure that housing did not suffer the
credit crunch it deserved, while taking its own borrowing to unprecedented
heights.
The result has been a credit crunch, hitting especially hard the sector of the
economy that is almost entirely the victim rather than the beneficiary of
government programs - small business.
The Federal Reserve Bank's Senior Loan Officer Survey, which appeared on
February 1, demonstrates this fairly clearly. Loan officers reported that the
outlook for delinquencies and charge-offs
was considerably worse for small and medium-sized firms than for other
businesses.
At first sight, their other observation - that demand for loans from small
firms was well down - would appear to indicate there was no problem. However,
you should consider in this case what "demand" means. If your local bank has
tightened lending standards sharply for small business, as they have, and if it
believes small business loans are exceptionally likely to default, then as a
small business owner what do you think your chances are of getting the loan you
need? Unless you have pictures of your bank manager in flagrante delicto,
not too high - and probably not even if you have such pictures, such are the
lowered moral standards of our times.
Given that getting a loan is likely to be pretty well impossible, most small
businessmen, not being fools, won't bother asking for it - after all, the way
credit scores work, applying for credit unsuccessfully itself lowers your
credit rating. That will cause a dearth of small businessmen walking in through
the door of the bank asking for loans. The "senior loan officer" will then sit
smugly and report that there appears to be little "demand" by small business
for loans but that, oddly enough, all the small businessmen in his neighborhood
(being unable to get the finance they need) are going belly-up. He will then
profitably deploy the bank's resources into government-guaranteed home mortgage
debt, mixed with a few Treasuries, which, thanks to Ben Bernanke's ultra-low
short term interest rates, will give him a nice profit.
You can see this in action in another Fed report, the Assets and Liabilities of
Commercial Banks in the United States (H8). Since December 2008, bank credit
has declined about 4%, an acceptable figure in a year when the banks have been
deleveraging.
However, within that total, the statistics are not so pretty. Treasury and
agency securities (included in "bank credit") are up 18%, with mortgage-backed
securities up about 2% and non-MBS (mortgage-backed securities) - presumably
mostly direct Treasury bonds - up 23%. Other securities, corporate bonds and
such, are also up 5%.
Loans and leases, the non-securities part of "bank credit", were down 8%.
However, real estate loans, half of that total, are down only 1%. Of the real
estate loans, home mortgages (presumably mostly again government guaranteed)
were up 3%, home equity loans (mostly utterly economically unproductive
credit-card refinancings, I suspect) were up 1% and commercial real estate was
down 6%. Credit-card lending is down 15% (some of it having been refinanced
through second mortgages), but other consumer lending was up 2%.
Finally, we come to commercial and industrial loans, in many ways the main
purpose of the banks' existence, now that security of deposits is rendered
nugatory by the Federal Deposit Insurance Corporation guarantee. Even in
December 2008, these represented only 17% of "bank credit". However, since
then, their total has declined by 19%, more than any other major category of
loan, and they now represent only 13% of bank credit.
These are the loans to small businesses - along with a few loans to leveraged
buyouts, a market that is still open and must absorb some of the total. They
represent only a small part of commercial banks' business, and their level is
shrinking rapidly.
Banks have too many other profitable things to do with their money, in
particular lending it to government and to government-guaranteed mortgages,
both at high long-term rates that yield a handsome spread over short-term
funding costs. All the jawboning of banks to increase small-business lending
has been completely ineffectual; they are reducing it as fast as they can
because in risk/reward terms there are more attractive things to do with the
money. Needless to say, since small businesses cannot get financing, they tend
to fail, increasing their perceived risk.
Thus "crowding out" of small business, the economists' main worry about large
government budget deficits, is most certainly happening. Government is spending
more money than it takes in, so small businesses can't get finance and instead
go bust. If that creates jobs, I'm a Dutchman. The most fruitful source of new
employment is small new businesses that are in fields not yet tapped by the big
behemoths. By suppressing small businesses while preserving large businesses,
the Barack Obama administration is suppressing the creativity of the US
economy, which is the only thing that economically justifies US living
standards being higher than China's.
Given Obama's 2011 budget, the prognostication for the next couple of years is
thus a gloomy one. However much money Federal Reserve chairman Ben Bernanke
prints, it will simply go into asset price inflation or old-fashioned consumer
price inflation. This is already apparently helping the housing market, which
brings some benefit since the loss of wealth to both sides from foreclosures
and mortgage defaults is very real indeed. However, if stabilization in the
housing market is bought at the cost of entrenching substantial or even high
inflation in the US economy, the price is too high.
Meanwhile, Bernanke or no Bernanke, the huge budget deficits will reduce still
further the finance available for small businesses and increase still further
the percentage of US jobs that have been lost forever to cheaper Asian
competitors.
The solution is a simple one, and it is not even all that painful. Short-term
interest rates must be increased forthwith to the 5% to 6% level, at which they
are above the current and impending rate of inflation. At the same time, fiscal
discipline must be restored, both directly in public spending and through
closing down the housing finance behemoths Fannie Mae, Freddie Mac and the
Federal Housing Authority. Huge amounts of current public spending are either
wasteful or outright harmful - the gigantic subsidies to "green" fuel
technologies, based on a global warming theory that now seems to have been
almost entirely a scam, are examples of the latter since they divert valuable
private sector resources and people from more useful, wealth-generating
activities.
The short-term pain from a renewed housing downturn will be finite; with those
moderate interest rates, the equilibrium price level for housing is only some
10% to 15% below current levels, and financing will be readily available on
"jumbo" mortgage terms, which will quickly reduce towards "conforming" levels
as government-guaranteed paper ceases to be available. While the foreclosures
will be worse than on the current track, the housing pain will be bearable and
the wasteful diversion of resources into housing reduced.
However, the real benefit of removing monetary and fiscal stimulus will come in
the banks' attitude to their local small businesses. They will no longer be
able to make money from investing in Treasuries because short-term rates will
be as high as long-term rates. Mortgages and mortgage bonds, as well as being
only modestly profitable, will now carry a degree of risk. Local small
businesses, where the lending officer is aware of the businessman's competence
and integrity through the community network, will become the most attractive
way to make relatively secure lending returns at an attractive level.
The word will soon get out through the community that small-business loans are
again available. At that point, "demand" for small-business loans will
magically reappear, and small-business bankruptcies will equally magically
decline to more normal levels.
The US economy will then recover and move onto a more innovative growth track
that supports US living standards - which is what the "stimulus" was supposed
to be about, wasn't it?
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-10 David W Tice & Associates.)
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