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October 06, 2009

Prospects for a small business-fueled employment recovery

In a speech yesterday, William Dudley, the president of the Federal Reserve Bank of New York, identified financial constraints for small businesses as a restraint on the pace of economic recovery. Specifically, he said:

"For small business borrowers, there are three problems. First, the fundamentals of their businesses have often deteriorated because of the length and severity of the recession—making many less creditworthy. Second, some sources of funding for small businesses—credit card borrowing and home equity loans—have dried up as banks have responded to rising credit losses in these areas by tightening credit standards. Third, small businesses have few alternative sources of funds. They are too small to borrow in the capital markets and the Small Business Administration programs are not large enough to accommodate more than a small fraction of the demand from this sector."

President Dudley's comments are even more relevant in the current recession if one considers the disproportionate effect the recession has had on very small businesses. In general, the Small Business Administration defines a small business as a firm with less than 500 employees. However, for my analysis here I focus on the very small firms (those with less than 50 employees) as the data indicate these firms have been the most affected by the current recession. (Look here for another take on how to define a small business).

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During periods when national employment levels were expanding since 1992 (when this data series began), firms with less than 50 employees have made up approximately one-third of the nation's employment growth. During the employment declines associated with the 2001 recession, these firms made up only 9 percent of job losses. In the current recession, though, these very small firms have made up 45 percent of the nation's job losses.

Looking ahead, it's not clear whether small businesses will continue to play their traditional role in hiring staff and helping to fuel an employment recovery. However, if the above-mentioned financial constraints are a major contributor to the disproportionately large employment contractions for very small firms, then the post-recession employment boost these firms typically provide may be less robust than in previous recoveries.

By Melinda Pitts, research economist and associate policy adviser

October 6, 2009 in Labor Markets | Permalink

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In my browsing this morning, I came across this article from the Federal Reserve Bank of Atlanta - Prospects for a small business-fueled employment recovery. Here is a quote from a speech given by William Dudley of the Federal Reserve... [Read More]

Tracked on Oct 7, 2009 11:02:17 PM

Comments

This is absolutely the problem. One thing that has hurt is the fact that if you are self employed you have to show 2 years of income at a certain rate before obtaining a mortgage. By the time these owners can prove that business has grown....we could be in another recession.

In addition, the credit card companies are pounding these people....sometimes just profiling their line of business. Add this to the fact that health insurance costs 40% more and rapidly rising and you can see why these people would not or could not hire!

Posted by: Annie | October 07, 2009 at 02:55 PM

"Third, small businesses have few alternative sources of funds. They are too small to borrow in the capital markets..."

Why "too small"? Are capital markets simply wary of lending to small businesses or are sb's denied access to these markets via regulation? If the latter, it can be changed and I don't see a reason it shouldn't and if the former, it seems an excellent opportunity for capital marketeers to open a new market. If impoverished Africans and SE Asians are proving a good market for micro-loans, I don't see why American small businesses shouldn't be a good bet so long as the lender does his due diligence. The loans might come with more risk, but you should be able to hedge that in some way.

Posted by: The Apologist | October 07, 2009 at 03:16 PM

It is not just credit. We live in a new environment where you need political connections to succeed in business. Friends in congress, etc. Things just not available to the little guy who just wants to make a living charging a fair price for a good or service.

Posted by: JQT | October 07, 2009 at 03:27 PM

The Apologist - The cost of doing due diligence does not scale at a 1:1 ratio. A firm 1/10th the size does not cost 1/10th as much to investigate to see whether a loan is worth it. Below a certain size the cost of due diligence exceeds the expected profit of loans so... no loans.

At some point somebody's going to make a killing by bringing that due diligence cost radically down but nobody's figured it out yet so the small business capital access problem persists.

Posted by: TM Lutas | October 07, 2009 at 03:41 PM

The specters of higher taxes and less credit are also accompanied by the expectation of more onerous regulation in the coming years. Small business only pays taxes on profits but regulatory costs are incurred before any profits are had. Why invest in such a climate? Hunker down and hope to survive is what we are all doing. Except for those with government connections that is.

Posted by: Steve Plunk | October 07, 2009 at 05:18 PM

What TM Lutas said. Now, extend that point to securitization. While even larger loans now mostly have to be carried on bank books, the hope is that securitization will pick up. Banks will want to have the most readily (cheaply) securitizable loans on their books. That means rated firms with publicly available books - publicly listed firms come before mom and pop firms. Now, compound the cost problem by the fact that banks are cutting costs and loan risk in just about any way they can. They have an incentive to simply stop processing applications from small firms until their risk-adjusted capital is ready for more risk.

It's a pretty bad situation.

Posted by: kharris | October 08, 2009 at 08:24 AM

Though Dudley is certainly another bank-centric, he is correct in putting deterioration of fundamentals at the top. From that, the rest follows.

Posted by: wally | October 09, 2009 at 05:42 PM

I'm not hiring. My small business customers, home owners needing roofs, almost always need financing to get it done. They can't get it easily. I hope it changes soon..

Posted by: Atlanta roofer | October 18, 2009 at 10:48 AM

Health insurance, or the lack thereof is the reason for hiring problems for small businesses. Insurance costs much more to purchase through a small business, than a large corporation that it is hard to compete for good employees.

I know, I was an HR Manager for a small company and the premiums charged to small businesses is much more than large corporations.

Posted by: Flan | November 07, 2009 at 01:40 PM

Being on the middle of this kind of crisis isn't really good. There was a report before that the economy is back to normal status but then a latest report comes out that it's not doing fine again.

Hmmm... I just hope it will recover as soon as possible so that small business operators will earn what they should've earn last year. In that way, opportunities will come out again.

Posted by: Sam@ home business | September 21, 2010 at 11:55 PM

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