One of the great American dreams has always been to own a home.  Homes were bought to live in, generally for a lifetime.  Peoples’ investments outside the home tended to be stocks or bonds or savings accounts.  America is a capitalist society, and making money (honestly) is a characteristic of capitalism.  As computer technology continued to advance, more and more smart people began to find ways to create different types of investments, and assets that had seldom been anything other than illiquid began to be monetized – such as home mortgages – and turned into liquid assets in the form of mortgage pools.

As this was happening, the economy set off on one of its periods of strong growth.  Strong growth created jobs, higher wages, more optimism, and along with them, higher home values.  People, who had bought their houses simply to live in, often using down payments nearly unheard of for the last several years, began to realize that their houses had increased in value, creating significant amounts of excess equity.  Banks, always looking for ways to generate profits, began to promote lines of credit secured by this additional equity.  Now people who had never thought of their houses as anything other than a place to live and hopefully provide for their retirement, began looking at them as free money to buy a new car or big screen TV or take a big trip, etc.  So they borrowed against their equity and started spending, fueling more growth, which created more jobs.

Smart financial minds, with the help of ever more powerful computers, created new mortgage instruments with less stringent initial terms to induce more people to buy houses.  These mortgages were then assembled into pools and sold to investors, marketed as a low-risk  investment secured by one of America’s safest assets – owner-occupied housing.  Then many of the new mortgages that had been created started defaulting because of built-in changes in the terms that had made them so attractive in the beginning, people couldn’t make the new higher payments, and started defaulting on their loans.  They stopped buying as many cars, TV’s and many of the things that they had wanted and bought.  Companies making products that had been in big demand started seeing their sales fall and started eliminating employees.  So here we are in the worst recession since the Great Depression, and at the center of it is the American dream – the home.

The nightmare isn’t even close to being over and until the economy starts to show strong enough improvement to create enough jobs to begin to bring down unemployment, foreclosures will continue, housing prices will stay far below what they were just a few short years ago, and the recession will continue.  At the same time this is happening, there is collateral damage being created in the banking system, mostly out of sight.  These foreclosed homes are on bank balance sheets, and banks in general have been unwilling to start to liquidate them because they will take losses on most of them, which will mean even less money to lend, both to individuals and businesses.  So the collapse of the American dream for so many people is affecting both individuals and businesses as well; and until something happens to start bringing the economy out of the recession and housing prices start to rise, credit is going to remain tight for small businesses.

The next meeting of Federal Reserve policy makers occurs in two weeks.  There is widespread and growing sentiment that the Fed will take further, and perhaps more aggressive steps to get more money into the economy, with the idea that long-term rates would be pushed still lower and encourage borrowing.

Companies might then start  buying new machinery or equipment, and consumers might be encouraged to  make some purchases because of the rock-bottom rates.  But as far as a lot of small businesses are concerned, the NFIB’s September business survey pretty accurately assesses why more money into the economy – that has to be borrowed in order to use it – is going to have practically no effect on short-term job creation. Almost all signs are pointing to very difficult times for the economy in the near future.  No one can say how near, but more and more indications are that hardly any improvement is going to happen at least through 2011.  And unless something really serious happens to the economy, it is almost guaranteed that absolutely nothing is going to come out of Congress to improve anything before the next presidential election.  Gridlock is going to be even worse than it is now, if that’s possible.

In the Federal Reserve’s latest beige book, two particular things stand out.  First, companies are reluctant to hire because of the uncertain outlook for future sales and orders.  Where they do need increased production, they are still increasing staff hours and using part-time and temporary workers where they can.  The second is that in many cases, continuing productivity gains (often related to technology) and cost efficiencies will continue to hold down demand for full-time workers.

Now translate that into more money available in the market to borrow.  If a company is not seeing some indication of stronger growth ahead, why would they want to borrow?  Going back to the NFIB survey, 91 percent of the respondents reported that all their credit needs were met or that they were not interested in borrowing.  If companies are willing to borrow, it might be to add new technology or machinery that will make them more efficient, meaning that they can grow with less new hires.  More money going into the economy and lower interest rates is not going to go very far in creating new jobs.

Much has been written about Japan’s “lost decade” in the 1990’s, and their problems with deflation.  There is currently substantial debate on both sides of the question as to whether America could be entering such a period.  Sometimes American opinion tends toward “Oh, that’s Japan.  It can’t happen here.”  But in the immortal words of George Santayana, “Those who don’t read history are doomed to repeat it.”  How many people remember the term “Japan Inc.” in the late 1980’s?  Japan was in the midst of a major economic boom.  Japanese companies were making so much money that many of them were looking for places to spend it, and a lot of it was spent in America, buying trophy properties like the Pebble Beach golf courses and Rockerfeller Center.

How did Japan become such a powerhouse?  One of the reasons was that it rode a great speculative rise in stock prices and real estate prices – especially real estate.  There is a popular children’s’ game called musical chairs.  The chairs are placed in a circle, and when the music starts everybody jumps up and starts running around inside the circle.  Someone outside the circle pulls out one of the chairs.  The music stops, everyone dashes for a seat, and someone gets left out.  The music stopped in Japan in the late 1980’s, and suddenly the bubble of overinflated prices burst and as a result, in the 1990’s Japan started to shrink as a world economic power, and was caught in a slow downward cycle of declining prices and asset values – deflation.  Consumers started to decrease their spending; companies started cutting back on investments and curtailing expansion plans.  More and more people started to see the value of their assets decline, which further curtailed spending.  A feeling of pessimism began to creep into the population.  Does any of this sound familiar?  An exploding real estate bubble; declining asset values – both homes and investment and retirement portfolios; consumers cutting back dramatically on spending.

In a normal economy – one not in a major recession – if a product is offered at a price that people are not willing to pay, the price gets lowered.  That’s fine in the normal economy, but when people stop spending, hoarding cash and paying down debt rather than spending it, the more prices have to be lowered to entice buyers to buy, the more deflation starts to appear, and the more people postpone purchases waiting for prices to drop further.  The Federal Reserve is seeing these small signs of deflation, and is becoming more and more concerned about it.  It is probably going to start very soon a strategy to inject more money into the economy to further lower long-term interest rates to entice more people and companies to begin to borrow and spend.  That looks really good on paper.  But another problem lurking just below the surface is the growing pessimism that things aren’t going to be getting better any time soon and the unemployment rate is going to stay high for at least the next two years, and only begin any meaningful decline thereafter.  If there are no jobs and not a lot of confidence in where the economy is going, people may not be inclined to spend, even some of the 9 out of 10 people who still have jobs.  Some of them may be waiting for prices to decrease, especially on big-ticket items such as cars.

If George Santayana was here with us today, he might suggest that we read the history of Japan’s “lost decade.”  The similarities are startling.  It could happen here.

One of the sometimes-overlooked issues facing the economic recovery is jobs that existed before the recession that won’t be back in anywhere near the numbers that existed before.  In the past, the “normal” progression from recession to economic recovery was that companies that had lain off workers began to hire them back as the economy improved.  But some of those old normals are not going to happen in this recovery.  There are now companies in industries that have shrunk dramatically, and because their “product” has either taken a new form (newspapers being replaced by the internet, for example) or demand for it does not exist as it did before the recession, that will never return to their previous levels of employment.  Here are a few more industries and jobs that have changed.

How often do people interact with a bank teller any more?  The advent of ATM machines, which are being improved all the time (creative destruction caused by technology), has dramatically reduced the need for bank tellers.  Not only that, but because the recession has caused so many bank failures – over 283 being closed since 2008, and also caused a large number of large bank mergers, less and less tellers are needed as merged banks cut costs.

Newspapers, as mentioned above, can now be produced without pressmen.  More and more news consumption is moving to the internet where it is free (for now), so reporters and editors are losing jobs.  Some major papers have shut down completely, causing everyone’s’ jobs to be lost, and they won’t be back.  Well over 100,000 jobs have been lost in the last ten years, and the US Department of Labor predicts that another 120,000 layoffs will occur over the next ten years.

Everyone knows what has happened to the housing market.  When the bull market in housing was in full swing, a real estate agent could “make some real money,” so lots of people became real estate agents and did earn a lot of money.  But not as many Realtors are needed in a major bear market that we are in now, and a lot of those jobs will not be back for probably ten or fifteen years, or longer. 

And one final industry that is now gone completely from the radar – the manufacture of incandescent light bulbs.  Congress has essentially  banned the use of incandescent light bulbs by 2014, so in September, the last GE plant making incandescent bulbs closed in Winchester, Virginia, putting 200 people out of work permanently in that industry that will now no longer exist.  Most of what will become the replacement bulbs for incandescent are now made in China.

What types of jobs are going to replace these lost jobs?  Good question

One of the major components of structural unemployment is jobs that are available in the economy but not enough workers with the necessary skills to fill them.  There are those who say that any emphasis on structural unemployment as a major obstacle to economic recovery is misplaced.  In some cases it may be.  But the mismatch of jobs and skills is very real, and is growing.

Take just one industry as an example – textile manufacturing in the south.  This used to be a big industry that employed a lot of people.  But gradually, manufacturers began to shift manufacturing overseas in order to take advantage of cheap labor.  The same thing happened in the mid-twentieth century in America as manufacturers began moving production to the south from the upper Midwest because of the cheaper labor costs.  And now most of the textile manufacturing jobs are gone to Asian countries where labor is much cheaper. 

But in the continuing cycle of economic growth and change, a new industry decides to move into the area because there is an ample supply of labor who had worked in the manufacturing industry.  But when the time comes to start hiring, it is discovered that although there are an ample number of workers, not many have the skills needed.  New production methods often require factory assembly workers who can program computers to run machinery, and not many of the workers formerly employed in the textile manufacturing plants have those skills.  So there you have good manufacturing jobs with good wages and not enough skilled people to fill them – classic structural unemployment.  This problem is not going to go away when the economy begins to recover, and is one of the major long-term obstacles in the way of decreasing the unemployment rate.

Another less visible example of structural unemployment related to job skills is jobs that are beginning to come back in fields and companies where workers had previously been laid off.  That should be good news.  On the surface, yes, but because of the severity of this recession many companies have pushed to become more efficient by getting more out of the same number of people, which meant that those people had to increase the number of functions that they had to be able to do.  This means that a person who was laid of from a company, who had only done one particular job, may not have the multiple skills necessary to perform the same job that they had when they were laid off.  Here is another example where new technologies have enabled people to perform more functions than they did before while still achieving the same end result.  So the person who had previously worked for that company can’t even qualify for their old position.  There is a growing need for retraining all over the country.  There could be opportunities for new businesses to meet that demand – an example of how creative destruction can lead to new industries.

In a recent post it was suggested that small business owners not get too excited about the new Small Business Jobs Act.  The main reason was that the increase in the SBA 7a loan limits to $5 million could lead to some banks becoming more interested in going for bigger loans because it would be easier than doing several smaller loans.  I still haven’t changed my mind on that, although there are not going to be that many big loans out there to start with, and companies that are looking for that amount of financing may be more likely to get it as non-SBA loans because it would be so much less paperwork for both parties.  But over the years we have seen plenty of loans that needed a guaranteed piece of $2.3 or 2.4 million that could not be done under the old limits.  So the new higher loan limits will matter. 

There are two other items in the bill dealing with SBA loans that first, may make it more attractive to some smaller community banks that are not averse to SBA lending, and the second, to microlenders.  For the banks it is an increase in the maximum amount of the SBA Express loans from $350,000 to $1 million.  Even though a bank gets only a 50% guarantee, they are mostly able to use their own loan documents, plus being able to reduce the risk on a loan by half which could make a big difference in whether or not they may be willing to make a loan.  This prevision expires 9/27/2011, so there is time for this to have some positive effect.  For the microlenders, the law permanently increases microloan limits from $35,000 to $50,000, helping larger entrepreneurs with start-up costs and small business owners in underserved communities.

For small business owners looking for financing of the size that might work with an SBA-guaranteed loan, opportunities may be better now.  Even though the lending climate is still awful, a few banks might be more inclined to take loan risks if they have the availability of expanded SBA terms.  There will probably be banks, especially smaller community banks that might not have had enough time to really dig into the new law, and that don’t realize what these changes could mean.  So my advice to any small business owner needing financing is to make sure that the bank really is aware of what they can do.  It might mean the difference between getting a loan and not.

We hear it again and again – one thing that the economy desperately needs is new businesses – startups.  As we are now in the third year of our great recession, there is a large pool of talented, experienced people who have lost their jobs.  But they have not lost their skills or knowledge.  Some of them may have ideas for a new business that could turn into something significant; even if not significant, a solid business creating some jobs and boosting economic activity.  There may be someone who knows how he could produce a product far more efficiently than it was being done by his previous employer.  All they need is some financing.

Peoples’ default source of financing has always been banks, because that’s where loans come from.  Financing startups has never been easy, and many banks have considered a startup to be any company less than two years old.  This does no good for the guy who has a legitimate business idea that is not just a “… I just know that there is a need out there for this product.”  But at a time when the economy desperately needs these companies that can grow and create jobs, the banks are on the sidelines, and probably will be for at least two or three years.  They still have too many of their own unresolved problems to deal with, particularly bad assets on their balance sheets, to make any serious lending efforts to even existing successful small businesses.  Forget startups.

So people who want to start businesses that need financing are going to have to be creative in putting together their financing packages.  There will be some new businesses that will get financed by banks, but they are going to be gold-plated.  There will be a lot of cash going in from the entrepreneur first, and the entrepreneur is going to have to have a successful track record in the business that he wants to start.  Bank financing is not impossible.  It is just safer to assume that it’s not going to be available.