Small Businesses Need Customers, Not Credit

In a recent Wall Street Journal Opinion piece (10/2), Meredith Whitney correctly identifies the importance of small business in the economy, but “following credit” from Wall Street can result in a biased perspective on what is happening on “Main Street”. Asserting that “Large, well-capitalized companies have no problem finding credit.”, Ms. Whitney then asserts that “Small businesses, on the other hand have never had a harder time getting a loan”. Many small businesses are “well capitalized” enough to operate without the use of credit (about 40% have no loans). The National Federation of Independent Business has surveyed its hundreds of thousands of small business members for 35 years, covering recessions starting with 1974. The most difficult period for credit availability was 1980-82, not the current period. Then, as many as 28% of regular borrowers (those accessing credit markets at least once a quarter) reported loans harder to get than the previous attempt. In the 1983-91 expansion, complaints started at 2% in 1983 and rose to 12% in 1991. In 2003, only 3% reported loans harder to get, rising to 15% in 2009, the highest since the 1980-82 period, but only “half as bad” based on complaints. There was no “spike” in complaints that corresponded to the “credit crunch” on Wall Street. Owners were also asked to identify the “most important business problem” facing their firm. In 1979, 39% cited financing and interest rates in contrast to no more than 5% in the current credit episode. Over 30% reported this as their top problem for nearly all of the 1979-80 period. Clearly, by these measures, the 1980-82 recession period was a far more difficult credit period for small firms.

Over the past 12 months, we have addressed a number of bank conferences from Florida to California. By show of hands, very few Main Street banks have tightened their credit standards over the past 12 months and virtually all report that they have money to lend. Most report that they have experienced a decline in applications, consistent with NFIB survey results showing record low plans to invest in inventories and new plant and equipment. The demand for credit is down, not its supply on Main Street. Increased consumer saving is increasing the supply of loanable funds.

Over 80% do use credit cards for business purposes. Nine percent reported some sort of adverse change in terms, less than 1% reported a cancellation (survey taken late in 2008, some further deterioration likely occurred). Most use the cards as a financial convenience, paying balances in full each month (about 75%), not as a source of credit to finance business operations. Although widely used, they are not a “major” source of credit (confirmed by both the NFIB national samples and Federal Reserve surveys). Banks are the primary source of credit, once the firm has a track record (only about 1% of all small businesses have a government sponsored loan). Banks are not venture capitalists that provide loans for new start-ups. Such loans must be secured with personal assets and guarantees (somewhat more problematic recently with the declines in house values, but it appears that this process has bottomed out according to Case-Shiller data).

The biggest problem faced by small businesses is not access to credit but a shortage of customers. After overspending disposable income for years, consumers are now under-spending, and repaying the debt they used during the expansion (record reductions in consumer credit). At some point, they will restore the percent of their disposable income spent to a “new normal”. Just when that occurs and at what level (percent of income) is less clear. The average ratio of consumption to disposable income from 1970 to 2009 is 90%, 94% from 1995 to 2009. One percentage point of disposable income (about 70% of GDP in magnitude) represents a lot of sales. When growth resumes, firms will want to borrow to replenish inventories and acquire new plant and equipment and Main Street banks will be there to meet their needs.