The American economy stands on a precipice the true nature of which is scarier than you are being told. You aren't hearing about it because it doesn't trigger the immediate emotional reaction of new Bushvilles and the increasing numbers of unemployed, nor does it carry the daily drama of the fickle Dow Jones index, or the shocking 12-digit sums of vanished "wealth".
But it is, in the long run, more fundamentally important than any of these things. Perhaps it is poignant to me simply because I am close to it, but I suspect my position as a small business owner, and my familiarity with many other small business owners, lends me enhanced clarity of perspective rather than distorts my view.
The crisis, simply put, is this: if the credit crisis is not resolved quickly, millions of small businesses across America are going to fail within months because they can't get the usual short-term loans to keep their businesses running. If that happens, it will be an economic catastrophe that makes the current crisis pale in comparison.
The small business owner often gets a bad rap in progressive circles. Small business owners tend to be Republican, and are often just as greedy as their corporate counterparts and lacking in transparency to boot. But small business owners are the backbone of the American economy. Some stats to consider:
- represent 99.7 percent of all employer firms
- Pay nearly 45 percent of total U.S. private payroll
- Have created 60 to 80 percent of net new jobs annually over the past decade
- Hire 40% of high tech workers
Without a strong small business sector, the American economy falls flat on its face. Unfortunately, small businesses, like small boats on an open ocean, are the most vulnerable to economic storms. Most do not survive their first five years as it is, and recessions tend to hit them hardest. Most importantly, patient investors can wait for their portfolios to rebound; the regular workforce adapts to the economic climate by finding what employment it can, then finding better employment when times are better; but once a small business dies, it's much more difficult for the entrepeneur to return things to where they were before. It is critical for the overall economy that the small business sector be able to maintain itself on life support during tough times, to fuel the growth curve coming into boom times.
Those that do survive the difficult periods do so by taking out lines of credit. It's a simple problem of cash flow: most small businesses live literally month to month, paying their overhead and employees as possible. For small businesses that work on a contract basis, this means hoping for the checks to come in for those outstanding invoices so that you can actually make payroll. And because it takes time to get paid for work done, a company can be incredibly busy and successful in a given month, but be unable to meet its current obligations because it wasn't quite as busy two months earlier. This happens all the time--even in good times.
That's where the line of credit comes in. In short, a moderately successful small business owner with any significant overhead takes out a steady stream of fairly small, short-term loans that allow him/her to pay their employees and their benefits. And unlike their big business counterparts, small business owners actually have skin in the game: it's their entire livelihood, their baby, the sum total of their blood, sweat and tears. So if the business lines of credit are insufficient, they will often take on personal debt and personal lines of credit to tide them and their businesses over until the economic sunshine returns.
The problem? Because the banks screwed up so badly, they have drastically reduced credit limits on consumers and small businesses. I know personally people who run companies that used to draw on credit limits of $50,000 or $100,000 that have been slashed to just $5,000. The result? Those companies are going under or engaged in huge layoffs because they simply can't make payroll: there's simply no money. As Tim Barry says in the Huffington Post:
As a business owner, with 40 employees and 25 years in business, I don't see a credit crunch as a political football. It's businesses not started, businesses not growing, and businesses failing.
- Take the businesses not starting: in a good year this economy generates somewhere between half a million and a million new businesses, and if we don't have that flow going -- and for the last few months, we don't -- then a lot of people who would have jobs don't; and a lot of people who would have been self employed aren't.
- Many businesses need financing to survive. Just to put numbers to it, a business that sells $5 million a year through retail channels probably needs about $2 million in borrowed money just to support waiting for channels to pay up. That's just one example, but a real one, one that I've lived through out in the real world.
- Some businesses need financing to grow. Investment is notoriously scarce these days as angel investment and venture capital are both cutting back, but there are still new ideas and new opportunities.
Just read the comments section in that piece, and you'll see some of the drastic steps many small businesses have already had to take. It's not pretty, and many will not survive at this pace. Here's a typical case from BusinessWeek:
In Ohio, banks are refusing to renew lines of credit and calling in loans made to decades-old family businesses that are current on payments, according to Dayton bankruptcy and workout attorney John Rieser. He says it's the worst borrowing environment he has seen in 20 years. The pullback began early in 2008 and accelerated in the last four or five months. "They're pulling the triggers and saying you're done," Rieser says. "It's not just sick businesses. These are healthy businesses, and that's the surprising thing."
One of Rieser's clients, Tom Rajkovich, says he had a $340,000 balance on his commercial mortgage and $260,000 drawn on a line of credit from Chase (JPM) when the bank demanded repayment in the summer of 2007, saying he had failed to send financial reports required by his loan agreement. Rajkovich's six-employee company, Comet Automation Systems in Dayton, manufactures and imports plastics machinery and is heavily tied to the auto industry. While Comet, founded in 1974, has not turned a profit since 2005, Rajkovich had sales of $1.6 million in 2007 and says he is current on all his payments. He is now embroiled in a court battle with Chase, which declined to comment on the case. Rajkovich was turned down when he tried to get another bank to take over the loans, and he's trying a credit union now...
The lockdown has been clear at Business Credit Services, an eight-year-old Las Vegas firm that helps business owners obtain credit. David Gass, the company's president, says he used to have little trouble getting $50,000 credit lines for new business owners with 640 FICO scores. Now banks want to see scores of 720 and companies at least two or three years old, and Gass says the options for borrowers have narrowed severely in the last six months. "We used to have 50 or 60 banks we could send people to with the basic $50,000 or $100,000 credit line. Now there are maybe five or six."
With each passing month, the problem gets exponentially worse. As business slows, the months of negative cash flow pile to the point where, even if the economy were to rebound tomorrow, these companies still will not be able to stay afloat due to the lag time between taking on and finishing a job, and getting paid for that job. The end result of the cutbacks in lending to small business is that many tens or even hundreds of thousands of small businesses like Rajkovich's are going to go under soon, taking all their employees with them.
It can be argued that credit was too easily extended to to home buyers and to consumers, and that current lending limitations are a needed correction to the system. But when drastic cuts are being made to small business lines of credit, the result is that small businesses will hobble on for about six months to a year before folding completely under the weight of what amounts to temporary debt. And for many small business owners who unwisely take on personal debt in an attempt to save their businesses, it can mean personal financial ruin for them as well.
In my personal acquaintance, I know several small business owners whose businesses are already essentially dead: they're simply limping along on vastly reduced lines of credit until they're completely maxed, and then the businesses will simply fold. This will happen in somewhere between 3-6 months. These are businesses that would have survived a 2-3 year recession under old lending standards.
That is why the Obama Administration is desperate to prop up the banks, and why the government is throwing trillions of dollars at the problem. Personally, I would like to see the Federal Government itself become the lender of last resort, providing lines of credit to consumers and businesses alike, rather than continue to prop up an intermediary banking system that has shown itself to be a completely irresponsible failure. Providing universal healthcare to reduce the benefits burden on small business owners who are already being forced to eliminate health coverage for their employees would be a huge help as well.
But let's be clear about the stakes if we do nothing, as the Republican leadership claims to want: investors in the Dow Jones index don't need a bunch of banks to provide them emergency loans, and too many homeowners got easy loans as it is. But if small businesses don't start getting credit to make basic payroll and other expenses, the future of the American economy as we have known it can be measured in months, not years.