Three weeks have past since my last conflicting signals post.  Since that time, positive signs continue to appear, indicating that the economy is continuing to inch its way back into positive growth.  At the same time, other signals seem to be saying, “Not so fast.  We’re not out of this yet.”  And we’re not, but at least we are on the way.  Economic activity is beginning to pick up, but as each one occurs and gets trumpeted in the press, it is well to remember that we are coming from so far behind that we have a very long way to go to just get back even close to where we were two years ago.  Meanwhile, many small businesses are going to continue to have to run on thin profit margins and tight cash flow before beginning to reap the benefits of the improving economy.

So let’s look at some of the latest signals. 

On the positive side:

  • The Conference Board confidence index rose more than expected.
  • The pace of homebuilding is beginning to pick up.
  • Manufacturing is beginning to add jobs.
  • Consumer spending is beginning to increase, helped particularly by the major reduction in household debt that has been accomplished as the recession dragged on.
  • Retail sales and durable goods sales were up in March.
  • In the first quarter 2010 National Association of Business Economists survey the share of companies increasing payrolls rose to 22% from 13% in January – a substantial improvement. 

On the negative side:

  • The S&P Case-Shiller index of home prices fell slightly
  • Based on the rate at which banks have been selling already-foreclosed homes, according to LPS Applied Analytics, it has been estimated that it will take 103 months to unload the existing inventory not to mention the 4.6 million mortgage holders at least 60 days behind on their payments or already in the foreclosure process.
  • Preliminary results from the Reuters/University of Michigan survey of consumer confidence had declined.
  • Tight credit is still a major rein on the economy. 

So the beat goes on.  The important thing to remember is that more and more are we moving into the recovery phase of the recession.  Inflation is still low as well as interest rates.  But it is equally as important for small businesses to operate on the assumption that as long as there is high unemployment, it is going to take time for the benefits to begin to filter down to profits and cash flow – probably two years.

This is the headline (exactly as you see it) on the April 24th Reuters business blog.  As so often happens on the internet, it was picked up by another site, Slate Biz Box, and given a new headline – “SBA Loans Have Serious Problems.”  The power of the internet to find information is wonderful because information is available to everyone.  But that power can also lead to dangers.  It’s like the party game where some people sit around and start with a piece of information and whisper it to the person sitting next to them, who then whispers to the next person, etc.  Usually by the time it comes back around, it has been altered inadvertently, but nevertheless, it is not what it started out to be.  The same is true here.  Sometimes, as is the case with the Reuters story, the writers don’t really know or understand the facts.  They create an attention-grabbing headline, which is what most people remember, and then move on.  Meanwhile, it is picked up by another site, which may create a more attention-grabbing headline, making the story seem more negative.

The facts are that SBA’s inspector general in a lender audit (which SBA regularly does, just like bank examiners do with banks), found that some $255 million in loans made mostly by three lenders in the SBA 504 program were made to “borrowers who might not be eligible or might not be able to repay them.”  Note the use of the word “might.”  To begin with, it is talking about three lenders out of 24 audited on that specific audit.  There are 504 lenders in every state in the country, but the 504 program is dwarfed by the SBA’s flagship program, the 7(a) program.  Notice that none of those lenders were commercial banks, any of which can make SBA loans, and there are thousands of banks.  And in regards to the borrowers mentioned in the article, as of the date of the inspector general’s report (June, 2009), 80% of the loans made to borrowers who “might not be able to pay” were still current. 

The internet is an incredible resource.  But because of the interconnectedness with everything, sometimes it pays to really check the facts, because by the time the information gets back to the chair where it started, it may have created some unintended negative consequences.

Austerity.  Now there’s a word that hasn’t been thrown around much.  But that is what is facing school districts all over the country.  Because of what the recession has done in almost every state to state revenues, Arne Duncan, Secretary of Education, estimated that there are anywhere between 100,000 and 300,000 public school jobs in jeopardy.

As I mentioned in my February 18 post, state governments are facing a crisis.  Richard Sheppach, an economist who has headed the National Governors Association for 26 years said “… states are heading into a permanent retrenchment.”  High unemployment is going to keep a lid on consumer spending.  Schools are funded by state money and local property taxes.  There is much less state tax money available because of the drop in consumer spending, leading to substantially lower sales taxes among others, and a return to formerly higher levels will take time because of the slow recovery and constrained consumer spending.  Property taxes also provide a substantial amount of revenue, and since property values have dropped so dramatically in most states, property tax revenue has taken a huge hit.  And there is no question that it will probably take three years or more before property values return to anything near previous levels.  Maybe.  So revenue from property taxes is going to provide considerably less funds for an extended period.

So even if the lower end of Secretary Duncan’s projections do take place, say 100,000 jobs, suddenly dumping another 100,000 people into the ranks of the unemployed, most of whom will have to make substantial cuts in their spending, is a big hit.  And of course, some of that spending makes its way to small businesses.  More and more people are talking about the economy improving, and overall it is – very slowly.  But small business owners need to look past that.  They need to be doing ground-level-intelligence in the area that they draw business from.  They need to be looking at and deciphering a broad range of information to see what, if any, effect it could have on their businesses.  And they need to realize that because the economic recovery is going to be slow, the effect on their business could be lower sales and profits, which mean that future financing will be that much more difficult.

After almost three decades of slowly declining interest rates, the direction is beginning to reverse and we are about to begin a sustained period of rising interest rates.  How high they will go is impossible to predict, but it is not going to be a short-term event.  It will probably go on for several years because the Fed must keep inflation in check, although inflation is close to non-existent right now.  But as the economy begins to improve, prices are going to start rising slowly but surely, so inflation will begin to increase.  One certainty is that any increase in interest rates is going to be slow so as not to hinder the economic recovery in any way.  But it is coming, and soon.  Consider a few of the results of rising rates.

One of the first places it could be felt is in housing.  Mortgage rates are already starting to rise, having risen a half a point since December.  As mortgage rates continue to rise, and with the Federal Reserve having ended its mortgage buying program, there is a risk that the gains that have begun to appear may be reversed.  Mortgage delinquency rates are still increasing, and mortgages with adjustable interest rates will have higher payments, possibly pushing more borrowers into default.

Car loans will become more expensive, creating some resistance to increasing car sales.  Consumer spending, which has recently shown signs of life, could be negatively impacted because of increasing rates on credit cards, which is already happening now.  There has already been a substantial amount of deleveraging on the part of consumers over the last year, often with emphasis on paying down credit card debt because it carries the highest interest rates.  Since credit cards are used so often to make purchases, and if the unemployment picture does not improve more rapidly than expected, more motivation may exist to keep paying down the credit card debt, especially as the interest rates on the cards go up, continuing the restraints on consumer spending. 

Now flip to the other side of the ledger.  Almost as important as the consumer’s use of credit cards is the fact that approximately 50% of small businesses in the United States use a credit card for financing.  Most of the time is because bank financing is not available.  So the cost of financing is going to increase for many of these businesses putting yet more pressure on profits because raising prices to cover increases in costs has become extremely difficult in the current economic environment.

So rising interest rates, even though very slow, are going to be another drag on the economic recovery, both for small businesses and the consumer.

There is no question that the economy is beginning to improve.  But real questions remain – how much; how fast; is it sustainable?  It is beginning to feel like we are moving into a recovery that is similar to a backroll at the base of a low-headed dam where the water going over the dam creates a strong recirculating current at the base of the dam which can pull a swimmer or a boat under.  Think of the water as the economy, and the direction of the water as the economic recovery.  There are still a lot of backrolls in the economy that will impede the flow of the recovery.

Here are a few examples of the churning currents.

Good currents:

  • Of the members of the Business Roundtable three out of four see sales rising in the next six months.
  • Consumer spending is up.
  • Retail sales were up last month.
  • Wholesale inventories are up which means factory output (and therefore manufacturing jobs) is up.
  • More jobs were added last month than lost.

Bad currents:

  • Of the members of the Business Roundtable, few expect to see much new hiring.
  • Sales of distressed homes are increasing, adding a drag to the recovery of prices.
  • Housing foreclosure rates are expected to increase in the coming months.
  • Commercial loan default rates at banks are not expected to peak until late this year or early next year, putting more strain on bank balance sheets thus further impeding lending.
  • Consumer credit declined in February the most in three months giving a strong signal that consumer purchases will be limited until the employment picture becomes clearer.

So what we are seeing is an economic backroll.  There is a lot of churning ahead before the flow toward a steady recovery returns.

As I mentioned Tuesday, Dr. Christina Romer, head of the White House Council of Economic Advisors appeared on Meet the Press last Sunday and predicted that the consumer was not likely to be leading the way out of the recession, which caught my attention.  But as I thought more about it, I am beginning to think that to a large extent, she is right because the overarching fact dictating an increase in consumer spending is lack of jobs.  Jobs create consumers and consumers create spending, so until consumers begin to again become employed or feel more secure that their jobs are safe, they are likely to restrain their spending.  And small businesses that rely heavily on consumer spending could be facing difficulties for the next two years.

Because the recession has been such a jolt to so many people, even when jobs are again plentiful there could be a more frugal mindset for a long time; witness the sudden increase in the consumer savings rate from near zero three years ago to over 3 percent now and projected to go higher.  That is very positive for long-term growth in the economy, but negative in the short term.  Many people probably know someone’s parents or maybe their own parents that came through the last great recession in the late twenties and thirties.  That dictated many peoples’ spending and savings habits for the rest of their lives.

There are many factors that mitigate against a strong and rapid increase in new job creation.  One obvious one is that many jobs that existed three years ago will never be back, such as in the auto industry, glass making, newspapers and magazines.  A recent Congressional Budget Office report commented, “Recessions often accelerate the demise or shrinkage of less efficient and less profitable firms, especially in declining industries or sectors.”  Add to that fact that there are millions of workers working either shorter hours or part-time at the companies they work for because of slowing sales or downsizing.  So as sales begin to increase and the companies begin to ramp back up, there is often a lot of slack that can be refilled by existing job holders, and until they have gotten back to full-time, very few new jobs will have to be created.  So in many cases it will require substantial growth in business before a lot of new jobs start to be created.  I think Dr. Romer has a very strong argument.

Whoa!!  The recovery needs to be fueled by exports?  On Sunday, April 4, 2010 Dr. Christina Romer, chair of the White House Council of Economic Advisors, was one of host David Gregory’s guests on Meet the Press.  She, as have many others, including now five separate Federal Reserve Bank presidents around the country, sent up another warning flag to small businesses not to get overconfident because the economy was beginning to show signs of improvement. 

In answer to a question by David Gregory about whether she thought as an economist that consumers could drive a sustained recovery, her answer was fairly surprising.  She said, “… I think it is going to be a different kind of recovery.  I think it’s not going to be one where consumers are going to come roaring back as the engine of growth.”  She went on to say, “It’s going to need to come from our exports.”  She also added to her answer in the same question business investment.  But not the consumer.  The entire transcript is available on the Meet the Press website.

Think about that for a minute.  Consumer spending generally accounts for 70 percent of economic output.  What she said may not be what a lot of people want to hear, but she is doing a real service to small business because a slow recovery means slow job growth and therefore, cautious increases in consumer spending.  That is not a formula for strong small business growth, and small business owners need to plan accordingly, especially as it may affect their chances for future financing.

More Friday.

I get a Google Alert every day on SBA, and almost every day for the last several months there is a story from somewhere about a dramatic increase in SBA lending.  One such example is Massachusetts.  Since the signing of the Recovery Act, there has been a 93% increase in the dollar volume of SBA loans over the comparable period prior to the Recovery Act.  Loans have been made to all kinds of businesses from restaurants to manufacturers and all types of “Main Street” businesses.  This kind of story is being repeated all over the country.  A total of 1,592 loans have been approved in Massachusetts totaling over $479 million since February of 2009.  Wouldn’t it be interesting if you could wave a magic wand and know how many jobs those 1,592 loans either saved or will create over the next two years, or, how many of those loans would never have been made without the guarantee?

One of the major complaints over the last two years about the bank bailouts is that the taxpayers are going to pick up huge amounts of losses, and they will.  But in contrast to those losses, SBA loans make taxpayers money.  Here’s why.  Over the years, a major criticism of SBA loans is that they have higher default rates which, to an extent, are true, but not that much higher than non-SBA commercial loans.  Today, that complaint has been turned upside down.  It is the non-SBA loans that are generating the big default rates.  SBA has a set of credit guidelines similar to a bank.  It is more lenient that banks, but not much.  So a bank writing a loan expecting to get an SBA guarantee cannot make an overly risky loan because SBA won’t guarantee it.

So that being said, assume a 20% default rate for SBA – and it is nowhere even close to that.  But we will use it.  So if two out of ten loans went bad, eight out of ten did not.  Those eight businesses paid taxes and the employees paid personal taxes.  Economic value was created.  So money paid in to the government (the taxpayers) far exceeded the money lost in the two defaults.  SBA makes money for taxpayers.

There could not be a better example of why Congress ought to get off it’s ______ and make the SBA terms in the Recovery Act permanent, or at least extend it for two or three years while the economy is recovering instead of staggering along and extending it a few months at a time.  How much more evidence does Congress need?  Banks that are hesitant to make loans to many small businesses – the smaller the business the more hesitant – are showing that they will use the SBA guarantee under the Recovery Act terms if it will enable them to make a small business loan that they might want to make but just aren’t quite comfortable with.  When that happens, the banks get good loans because of the guarantee and small businesses get credit they need.

So if anyone is going to raise hell against anyone, and banks deserve their share, raise it against Congress.  SBA is a creature of Congress because it is Congress that sets their budget and what they can and cannot do.  So with all the screaming from Washington about jobs, jobs, jobs, here is a proven tool to increase jobs by getting credit to small businesses that is in place, helping to create financing every day, and that does not require any new Federal or any other kind of agency to be set up.  It’s like wanting to know what time it is while you are standing there holding a watch and not realizing that you have the answer staring back at you.