Amid the unending and thoroughly confused debate out of Washington on imposing an austerity agenda on federal government spending, one crucial fact that is being consistently ignored is that small businesses throughout the country have been starved of credit since the onset of the 2007-09 financial crisis and Great Recession. That is, small businesses already have been on an austerity budget for more than four years.
The fact that basically no new credit has flowed to small businesses as a whole for that time has prevented small businesses from expanding their operations and hiring more workers. And the economy’s overall unemployment rate cannot fall significantly until small businesses do start hiring again.
The reason is simple. On balance, small businesses spend a larger share of their overall budgets on employing people than do large corporate businesses.
The evidence here is straightforward. Overall noncorporate business borrowing (which is a close proxy for small-business borrowing) first rose sharply over the financial bubble years, from $223.2 billion in 2001 to $530.1 billion in 2007 (in real 2012 dollars) before plunging to negative $135.1 billion in 2009 and negative $201.7 billion in 2010. In other words, in 2009 and 2010 small businesses did no net borrowing, but rather paid back $337 billion in outstanding loans.
Put another way, over 2009-10, smaller businesses made repayments at a level of more than 2 percent of total U.S. GDP, rather than borrowing to inject new spending into the economy. This pattern has basically continued through 2011 and 2012. Thus, four years after the Wall Street collapse, small businesses overall are getting almost no credit out of our banks and other financial institutions. This translates into a massive contraction of job-generating spending in the economy.
This credit lockout for small businesses is occurring while U.S. commercial banks have built up unprecedented cash hoards, now equaling $1.6 trillion, or fully 10 percent of U.S. GDP. Of course, the banks say they would be happy to make new loans to small businesses, but that they just don’t see enough good opportunities for themselves. They say that risks are too high and profits would therefore be too low.
The 2012 Report to the Congress on the Availability of Credit to Small Businesses published by the Federal Reserve cites survey evidence that one-half of small businesses applied for some type of credit in 2009, and roughly half of the applicants were denied. The overall pattern didn’t improve significantly through 2010 and 2011. Moreover, the survey also found that there were a large number of “discouraged borrowers” among small businesses – businesses that had foregone applying for needed credit because of the expectation of denial.
Here are two not-very-costly initiatives – one carrot and one stick – that our Washington political leaders could put in place to counteract austerity and deliver lower risks to banks and affordable credit to small-business owners. The carrot is an expansion of existing federal-loan guarantees, focused on benefiting small businesses. The stick is a 1 percent to 2 percent tax on the excess cash reserves now held by banks, to push them to become more bullish on loans for job-creating investments. If Congress won’t pass such a tax on banks’ cash hoards, then the Fed can establish a maximum requirement on banks’ cash holdings to achieve the same end.
Loan guarantees have no impact on the government’s budget unless the loans go into default. And even if we assumed, implausibly, that the default rate on, say, $300 billion in new loans per year to small businesses ended up being twice as high as 2007, i.e. before the Great Recession, I have calculated this would increase the federal budget by only 0.6 percent of 1 percent.
It would be much better if these policies were implemented in conjunction with a new government stimulus program. We would then have jobs growing in both the public and private sectors, which in turn means people would have more money in their pockets, making them better consumers for small businesses, among other things.
But given that the federal government is clearly not about to enact a new stimulus program, the Federal Reserve and Congress can still act now to stop the credit starvation for small businesses and create millions of new jobs as a result.