Budgets in almost every state in the country are facing deficits – some of them very large.  As a result of the current recession which has caused serious shortfalls in state tax collections, some states are beginning to consider radical permanent changes in the way they operate.  Most states currently operate on models that have been in place since the 50′s and 60′s, and which have generally worked fine up to now.  But the current recession has caused some serious soul searching in many states because they are beginning to realize that they cannot operate in the same way any more.  It is too expensive.  The current recession has turned everything upside down, and old ways of doing business are getting a very serious look, and some changes are already happening.  One thing that is common to many of the changes being considered is going to be loss of jobs.  And in an economy that is struggling to create more jobs, more people are going to be put out of work with little likelihood that they will ever regain those jobs.

Michigan, for example, has gradually dropped certain state departments and eliminated 11,000 jobs.  Some of the ideas currently being bandied about in some states are fairly radical and would have been unthinkable in the past or politically impossible.  But the fact that they are even getting serious consideration shows how serious the crisis is.  For example, in one state a lawmaker proposed cutting in half the number of counties in the states.  Another lawmaker in another state proposed eliminating the system of more than 1,000 township boards in the state.  It is probably a fairly safe bet that neither of these proposals will get very far.  But other less radical ideas are already happening that will change many state governments for decades to come.  States are combining departments and services, merging school districts, and in some cases moving to four-day workweeks.  Cutting costs is the new imperative, and one of the largest costs is people.

Some of the changes being contemplated in different states are not going to just have a negative impact in lost jobs.  For example, suppose a state goes to a four-day workweek in a department.  That will mean that fewer supplies of certain types will be required, so will not have be purchased.  Think of just one example – a cleaning service.  Say the office is going to be closed on Friday.  It probably won’t have to be cleaned on Friday night.  Many cleaning services are small locally-owned businesses.  All of a sudden they see their sales drop by 20% overnight which will mean that any type of financing that might have been considered will be either much more difficult, or impossible.  So the budget crises in many states are going to have a much farther reach than just the jobs lost.

From 1991 to 2000 Japan endured a period of almost stagnant growth.  Read Wikipedia’s discussion of the Lost Decade and think about how many similarities we have to that Lost Decade, and are seeing in America today.  The parallels are remarkably similar.  One of the major trigger points in Japan was exceptionally high land values facilitated by easily available and cheap credit.  Substitute America in 2010.  Exceptionally high house prices coupled with plentiful and cheap (or so a lot of people thought without actually thinking about it) credit – subprime loans.  Then the party stopped and things started blowing up.  But one thing that Japan had which America does not, and which eased the effect on Japan’s households, was the Japanese tradition of high personal savings.  Americans’ savings rates until recently had been very close to zero overall, so there was no cushion.

Many American companies were burdened with massive debt going into the recession due to overzealous expansion.  Banks that had accumulated massive amounts of real estate debt on their balance sheets started seeing more and more of that debt go bad, many failed, and are still failing.  Some of the largest banks in the country had to be propped up with massive amounts of Federal money through TARP.  Some of the country’ largest financial institutions – Bank of America and Merrill Lynch, for example – were forced to merge.  And we know what happened to the car companies and the effects that had on the communities around them.  The Federal Reserve has lowered interest rates for banks to nearly zero but credit is still locked up.  Many large Japanese companies during the Lost Decade rid themselves of thousands of permanent employees and replaced them with part-time workers with no benefits.  We see a similar trend in America.

Now look at where we are in 2010.  Just look at two facts.  Growth is beginning to happen, but it is very slow.  Unemployment is still high and is only expected to decline very slowly.  None of this is good for small business especially if credit remains tight.  The economy will improve and will eventually get back to full employment (historically considered to be around 5%).  But it is going to take several years, and a lot of what used to be one of the mainstays of the economy – manufacturing – will be much changed.  More production has been moved offshore and technology continues to improve manufacturing capabilities without adding employees.  Jobs are gone that will never return, and these are usually some of the higher paying jobs.  Most small businesses will grow at a pace with the economy, but because it is likely to be slow, they may have to stay lean much longer than many larger businesses that have a larger cushion and margin of error financially.

Japan’s Lost Decade offers a mirror for America today.  Small businesses should take a look into the mirror and see what might be in store for them.

The economic news so far this week has not been very good, and every week that there is little or no improvement is one more week that postpones any meaningful recovery, which also means one more week that banks probably aren’t going to loosen the strings on small business lending.  On the economic front, the Conference Board’s index of leading economic indicators unexpectedly declined 0.1% for the first time in more than a year.  Unemployment claims rose slightly last week indicating that labor markets are still weak.  That was also not expected.  Because of severe decline in state revenues across the country, possibly up to 150,000 teaching jobs are likely to be lost because of state budget cuts.  On the housing front, there are now 4.3 million home loans either 90 days behind or heading to foreclosure.  Overall, 14.6% of the home mortgages in the country are in some stage of delinquency or heading to or already in foreclosure.  One positive note is that in many areas in the country, the housing market has stabilized, and in some areas prices are actually rising. 

The biggest negative of the week as it relates to bank lending of all kinds is that commercial real estate prices declined 0.5% in March.  Commercial real estate prices are down 42% since they peaked in August 2007!  The commercial real estate foreclosure rate has been steadily climbing and is not expected to peak until sometime later this year.  And if the economy stays in the doldrums for some time, it isn’t going to peak this year, and the longer retail sales take to start any significant increase, the more likely it will be that more tenants in shopping centers will close, pushing the shopping center owner closer to default.  Since commercial real estate loans are much larger loans, when a loan goes into default and the asset is sold at a loss, or carried on a bank’s books at a value lower than the mortgage amount, it is a big hit against the bank’s capital.  And thinking in terms of $1 in capital being able to generate $5 in loans, any substantial loss immediately takes a much larger chunk out of a bank’s funds available to lend.  Unfortunately, this problem is more acute in smaller community banks where a lot of small business owners are more likely to find financing.

Tepid  growth; modest growth; jobs lost in the recession that won’t come back; skill sets that no longer match what employers want; these are just a few of the words and phrases that are being used to describe the current recovery and its outlook.  As much business and economic news as I look at every day, I have seen almost no one who is expecting a strong recovery.  This very slow growth could have a sizeable impact on the future of a lot of small businesses, and some of it will not be positive.  Slow economic growth means slow improvements in business growth and profits which then means less likelihood of obtaining bank financing.  On the other side of the lending desk, slow growth means slow growth in bank assets, putting restraints on what they are able to lend whether they want to or not.  So while banks may be becoming more confident that many small business borrowers are becoming better credit risks because of their improving businesses, the banks may not be able to help right away.

For small businesses doing well today and who may be thinking about a need for financing at some time in the future, what should they be looking at today?  I might suggest one word – debt.  Small business credit is going to remain tight no matter what anybody says.  So if a small business owner goes to a bank looking for expansion financing of some kind, the first thing a bank will probably look at, after whether or not the business is profitable, is how much debt is on the business balance sheet.  In many cases where a business is an LLC or partnership, the bank is going to look at the combined debt of the business owner and the business. 

There was a situation recently where a small business owner wanted to refinance his business real estate to free up additional funds to hire two new employees.  His business was growing again, and he could not take on any more until he hired two new people.  His business had never lost money, although his sales and profits had declined in the last two years because of the recession, but he was still making money and his credit was excellent.  The bank turned him down because he had four separate lines of credit – business and personal – that he had used to keep his business afloat.  He had succeeded, but it didn’t matter to the bank.  Some of his competitors are gone, so there is more work available than before.  His industry is beginning to grow again.  He is a survivor – someone you might think that a bank would want to bet on as a future customer because he has proven himself under adverse conditions.

But it was not to be.  What that may say to successful small business owners is that in this kind of credit climate, anything that can be done to either pay down debts or increase assets in the business by reinvesting more profits in the business may mean the difference between growth and just hanging on.  Banks are looking much harder at balance sheets now than they have at a long time, and debt may be their number one concern.



More and more signs continue to appear that the economy has turned and is improving.  For example, rail traffic was up 15.8% in April over April 2009.  I’ll bet that one really makes your skin tingle.  There has been a recent surge of refinancing applications from homeowners because mortgage rates are so low.  That is significant because wherever a homeowner is able to do that means that household cash flow is improved.  U.S. hiring was at the highest rate in 15 months in March.  Because this has been such a severe recession, every piece of good news gets trumpeted all over the press, and it should.  Psychology is very important to consumer behavior.  If it begins to look like the shoe is not going to fall, people might feel a little more confident about opening their wallets a little more.

These same headlines are read by bankers.  Even though they know that the recovery is going to be very slow, and because of that the financial performance of a lot of borrowers isn’t going to show much strength for a while, at least the bleeding may be stopped and the prospects for growth are looking a little brighter.  So maybe a small business borrower who might have been considered a borderline no when the outlook was still bleak may be a borderline yes now.  And here is particularly where the SBA guarantee can help a bank strengthen that borderline yes to a yes.  The availability of the SBA guarantee has led to a tremendous increase in small business loans, many of which may have been borderline no’s.  We can never know, but what we can know is that a large number of small businesses are still in business and growing because of SBA.

Other than the wild day last week when electronic trading systems briefly took over the market and led to the almost 1000-point drop, the stock market has had a very good year.  To look at the Dow-Jones or the S&P 500, one might get the feeling that the economy was rebounding strongly.  But the major indexes are made up of the biggest American companies that have millions of shares of stock.  Stock prices are driven by earnings, and earnings at many of America’s major corporations are beginning to show good growth.  But, much of that increasing profit is the result of increased productivity which has allowed companies to grow without adding a lot of new workers.

This fact highlights the continuing problem that job growth is slow and is going to be slow for the foreseeable future.  Every month that someone has no job or only part-time work means slow growth in consumer spending, and that is not good for a lot of small businesses.  The current number of unemployed and underemployed (people who have been searching for over six months, have quit looking for jobs, or people in part-time jobs who want to be working full-time) is 29.4 million, of which 14.6 million are simply unemployed.  That is an absolutely staggering number.

Up until the beginning of 2009, the unemployment rate had averaged less than six percent for the previous two decades.  It now stands at 9.9%.  Since the beginning of the current recession, over 7 million jobs have disappeared.  To lower the current rate by just one percentage point would take 1.3 to 1,5 million new jobs on top of the number of jobs to take up average new monthly entrants into the labor force.  Jan Hatzius, chief economist at Goldman Sachs said that even if we have a strong recovery, it could take at least five years to get the unemployment rate down to a more normal rate of 5%.  A good example might be the jobs figures from April.  The economy added 290,000 new jobs.  If that pace kept up, we might be getting back to the approximately 5% that is generally considered “normal.”  But most of the current signs are not pointing to a strong recovery yet, and it will be very unlikely that as many new jobs will be created every month for the next three years.  Nothing is impossible, and if we did that, the economy would be on a real roll and small businesses would begin to see the benefits much sooner.  But slower recovery means slow growth in sales and profits and slow growth for small business because of it. 

Growth is definitely good, and could be the difference between survival for a business or not making it.  But it will not immediately begin to show up on financial statements, and that is what banks look at.  So don’t expect a rapid increase in small business lending any time soon.

Every quarter the Federal Reserve issues a national summary of the Senior Loan Officer Opinion Survey on Bank Lending Practices.  Naturally, the data is skewed toward large banks.  But there is enough information in it specifically related to small banks that makes it worthwhile because the large banks are working in the same business and credit environment as small banks, and many big businesses served by the large banks are facing exactly the same problems as small businesses.

In questions in the survey on lending to business, the answers from all banks were very clear and very similar.  Here are just a few of the highlights. 

  • “… standards remain quite stringent following the prolonged and widespread tightening that took place over the two years.”
  • When asked about standards on C&I (commercial and industrial) loans to smaller firms, almost all domestic banks regardless of size reported little change.  However, net fractions of domestic institutions reported tightening terms on C&I loans extended to smaller firms.  The reported tightening of terms was more prevalent at smaller banks (italics mine).” 
  • On credit card loans to small firms, a majority of the respondents indicated that their standards for approving business credit card accounts are currently tighter than the longer-run averages that prevailed before the crisis.  Some also reported that their banks had tightened their terms on business credit card use to smaller firms.

What all this is saying is that credit availability for small businesses is not going to ease any time soon.  In a sense, bank lending to small businesses could be considered a lagging indicator.  The economy will begin to improve and start to grow.  But until the banks are convinced that the improvement is sustainable, they are not going to ease their credit policies.  So once it becomes apparent that banks are opening up, they become a perfect lagging indicator that the recovery really is real.  So no matter how much it is bemoaned in the press, and yelled about in Congress, no one can force banks to lend.  Lax credit standards were one of the things that got them into trouble in the first place, for which they are getting beaten over the head for by bank regulators, and they are not going to let it happen again.  So small business owners need to face the reality that credit is not going to suddenly open up, and manage their businesses accordingly.

Every month of gradual improvement in the economy is welcome news.  But the problem is gradually – slow.   Every month that business and the economy only slowly improves could mean one more month closer to not being able to hang on much longer, or another month of new sales opportunities that can’t be pursued for lack of funding to hire one or two employees.  There are several economic indicators out or coming out this week and the general consensus is for slight improvement.  The big one comes Friday – the employment report.  The consensus there at this time is for possibly a slight improvement to 9.5 or 9.6%, but so far the consensus is for no change from the current 9.7%.  Either way, it means another month of little increase in consumer spending, although consumer spending increased 0.6% in March.  The only problem with that number is that personal income only increased 0.3% which means that consumers were dipping into savings.  Even though the savings rate has increased in the last year, this kind of spending is unsustainable without an increase in jobs.

So a question to ask might be, is there any product or service that a business might offer in addition to what it is already selling or how it is being sold?  Here are two examples, one a manufacturer and one a retailer.  The manufacturer is a company that for 44 years had harvested and processed wood for the furniture industry.  It owned the land where the wood was harvested, so there were no questions of lack of supply.  But in the late 1990′s, more and more furniture manufacturing was moving to China where it was cheaper.  With sales declining and employees being laid off the company desperately needed another source of revenue.  So it decided to start making baseball bats.  It now makes 35,000 bats a year, and many major league players and minor league teams use them.

Next there is the retailer who sold used CDs and vinyl records.  The store had a first floor and a basement.  The CDs were on the first floor where people walked in off the street and saw what a selection the retailer had, and the vinyl was in the basement.  But the ability to download music from the internet to personal listening devices like iPods, has caused a steady decline in CD sales.  At the same time, interest in vinyl has begun to increase.  So the retailer rotated the stock.  The vinyl records were moved upstairs and the CDs downstairs.  So far this has benefited the business.

There are probably dozens of stories like this all over the country.  But it illustrates a point.  In the economy over the next two or three years, anything that a small business might be able to do that will help it grow or survive may be worth investigating.  There could be a Plan B out there somewhere.