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May 20, 2014
Where Do Young Firms Get Financing? Evidence from the Atlanta Fed Small Business Survey
During last week's "National Small Business Week," Janet Yellen delivered a speech titled "Small Business and the Recovery," in which she outlined how the Fed's low-interest-rate policies have helped small businesses.
By putting downward pressure on interest rates, the Fed is trying to make financial conditions more accommodative—supporting asset values and lower borrowing costs for households and businesses and thus encouraging the spending that spurs job creation and a stronger recovery.
In general, I think most small businesses in search of financing would agree with the "rising tide lifts all boats" hypothesis. When times are good, strong demand for goods and services helps provide a solid cash flow, which makes small businesses more attractive to lenders. At the same time, rising equity and housing prices support collateral used to secure financing.
Reduced economic uncertainty and strong income growth can help those in search of equity financing, as investors become more willing and able to open their pocketbooks. But even when the economy is strong, there is a business segment that's had an especially difficult time getting financing. And as we've highlighted in the past, this is also the segment that has had the highest potential to contribute to job growth—namely, young businesses.
Why is it hard for young firms to find credit or financing more generally? At least two reasons come to mind: First, lenders tend to have a rearview-mirror approach for assessing commercial creditworthiness. But a young business has little track record to speak of. Moreover, lenders have good reason to be cautious about a very young firm: half of all young firms don't make it past the fifth year. The second reason is that young businesses typically ask for relatively small amounts of money. (See the survey results in the Credit Demand section under Financing Conditions.) But the fixed cost of the detailed credit analysis (underwriting) of a loan can make lenders decide that it is not worth their while to engage with these young firms.
While difficult, obtaining financing is not impossible. Over the past two years, half of small firms under six years old that participated in our survey (latest results available) were able to obtain at least some of the financing requested over all their applications. This 50-percent figure for young firms strongly contrasts with the 78 percent of more mature small firms that found at least some credit. Nonetheless, some young firms manage to find some credit.
This leads to two questions:
- What types of financing sources are young firms using?
- How are the available financing options changing?
To answer the first question, we pooled all of the financing applications submitted by small firms in our semiannual survey over the past two years and examined how likely they were to apply for financing and be approved across a variety of financing products.
Applications and approvals
While most mature firms (more than five years old) seek—and receive—financing from banks, young firms have about as many approved applications for credit cards, vendor or trade credit, or financing from friends or family as they do for bank credit.
The chart below shows that about two-thirds of applications on behalf of mature firms were for commercial loans and lines of credit at banks and about 60 percent of those applications were at least partially approved. In comparison, fewer than half of applications by young firms were for a commercial bank loan or line of credit, fewer than a third of which were approved. Further, about half of the applications by mature firms were met in full compared to less than one-fifth of applications by young firms.
In the survey, we also ask what type of bank the firm applied to (large national bank, regional bank, or community bank). It turns out this distinction matters little for the young firms in our sample—the vast majority are denied regardless of the size of the bank. However, after the five-year mark, approval is highest for firms applying at the smallest banks and lowest for large national banks. For example, firms that are 10 years or older that applied at a community bank, on average, received most of the amount requested, and those applying at large national banks received only some of the amount requested.
Half of young firms and about one-fifth of mature firms in the survey reported receiving none of the credit requested over all their applications. How are firms that don't receive credit affected? According to a 2013 New York Fed small business credit survey, 42 percent of firms that were unsuccessful at obtaining credit said it limited their business expansion, 16 percent said they were unable to complete an existing order, and 16 percent indicated that it prevented hiring.
This leads to the next couple of questions: How are the available options for young firms changing? Is the market evolving in ways that can better facilitate lending to young firms?
When thinking about the places where young firms seem to be the most successful in obtaining credit, equity investments or loans from friends and family ranked the highest according to the Atlanta Fed survey, but this source is not highly used (see the first chart). Is the low usage rate a function of having only so many "friends and family" to ask? If it is, then perhaps alternative approaches such as crowdfunding could be a viable way for young businesses seeking small amounts of funds to broaden their financing options. Interestingly, crowdfunding serves not just as a means to raise funds, but also as a way to reach more customers and potential business partners.
A variety of types of new lending sources, including crowdfunding, were featured at the New York Fed's Small Business Summit ("Filling the Gaps") last week. One major theme of the summit was that credit providers are increasingly using technology to decrease the credit search costs for the borrower and lower the underwriting costs of the lender. And when it comes to matching borrowers with lenders, there does appear to be room for improvement. The New York Fed's small business credit survey, for example, showed that small firms looking for credit spent an average of 26 hours searching during the first half of 2013. Some of the financial services presented at the summit used electronic financial records and relevant business data, including business characteristics and credit scores to better match lenders and borrowers. Another theme to come out of the summit was the importance of transparency and education about the lending process. This was considered to be especially important at a time when the small business lending landscape is changing rapidly.
The full results of the Atlanta Fed's Q1 2014 Small Business Survey are available on the website.
By Ellyn Terry, an economic policy analysis specialist in the Atlanta Fed's research department
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May 16, 2014
Which Flavor of QE?
Yesterday's report on consumer price inflation from the U.S. Bureau of Labor Statistics moved the needle a bit on inflation trends—but just a bit. Meanwhile, the European Central Bank appears to be locked and loaded to blast away at its own (low) inflation concerns. From the Wall Street Journal:
The European Central Bank is ready to loosen monetary policy further to prevent the euro zone from succumbing to an extended period of low inflation, its vice president said on Thursday.
"We are determined to act swiftly if required and don't rule out further monetary policy easing," ECB Vice President Vitor Constancio said in a speech in Berlin.
One of the favorite further measures is apparently charging financial institutions for funds deposited with the central bank:
On Wednesday, the ECB's top economist, Peter Praet, in an interview with German newspaper Die Zeit, said the central bank is preparing a number of measures to counter low inflation. He mentioned a negative rate on deposits as a possible option in combination with other measures.
I don't presume to know enough about financial institutions in Europe to weigh in on the likely effectiveness of such an approach. I do know that we have found reasons to believe that there are limits to such a tool in the U.S. context, as the New York Fed's Ken Garbade and Jamie McAndrews pointed out a couple of years back.
In part, the desire to think about an option such as negative interest rates on deposits appears to be driven by considerable skepticism about deploying more quantitative easing, or QE.
A drawback, in my view, of general discussions about the wisdom and effectiveness of large-scale asset purchase programs is that these policies come in many flavors. My belief, in fact, is that the Fed versions of QE1, QE2, and QE3 can be thought of as three quite different programs, useful to address three quite distinct challenges. You can flip through the slide deck of a presentation I gave last week at a conference sponsored by the Global Interdependence Center, but here is the essence of my argument:
- QE1, as emphasized by former Fed Chair Ben Bernanke, was first and foremost credit policy. It was implemented when credit markets were still in a state of relative disarray and, arguably, segmented to some significant degree. Unlike credit policy, the focus of traditional or pure QE "is the quantity of bank reserves" (to use the Bernanke language). Although QE1 per se involved asset purchases in excess of $1.7 trillion, the Fed's balance sheet rose by less than $300 billion during the program's span. The reason, of course, is that the open-market purchases associated with QE1 largely just replaced expiring lending from the emergency-based facilities in place through most of 2008. In effect, with QE1 the Fed replaced one type of credit policy with another.
- QE2, in contrast, looks to me like pure, traditional quantitative easing. It was a good old-fashioned Treasury-only asset purchase program, and the monetary base effectively increased in lockstep with the size of the program. Importantly, the salient concern of the moment was a clear deterioration of market-based inflation expectations and—particularly worrisome to us at the Atlanta Fed—rising beliefs that outright deflation might be in the cards. In retrospect, old-fashioned QE appears to have worked to address the old-fashioned problem of influencing inflation expectations. In fact, the turnaround in expectations can be clearly traced to the Bernanke comments at the August 2010 Kansas City Fed Economic Symposium, indicating that the Federal Open Market Committee (FOMC) was ready and willing pull the QE tool out of the kit. That was an early lesson in the power of forward guidance, which brings us to...
- ...QE3. I think it is a bit early to draw conclusions about the ultimate impact of QE3. I think you can contend that the Fed's latest large-scale asset purchase program has not had a large independent effect on interest rates or economic activity while still believing that QE3 has played an important role in supporting the economic recovery. These two, seemingly contradictory, opinions echo an argument suggested by Mike Woodford at the Kansas City Fed's Jackson Hole conference in 2012: QE3 was important as a signaling device in early stages of the deployment of the FOMC's primary tool, forward guidance regarding the period of exceptionally low interest rates. I would in fact argue that the winding down of QE3 makes all the more sense when seen through the lens of a forward guidance tool that has matured to the point of no longer requiring the credibility "booster shot" of words put to action via QE.
All of this is to argue that QE, as practiced, is not a single policy, effective in all variants in all circumstances, which means that the U.S. experience of the past might not apply to another time, let alone another place. But as I review the record of the past seven years, I see evidence that pure QE worked pretty well precisely when the central concern was managing inflation expectations (and, hence, I would say, inflation itself).
By Dave Altig, executive vice president and research director of the Atlanta Fed
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May 13, 2014
Today’s news brings another indication that low inflation rates in the euro area have the attention of the European Central Bank. From the Wall Street Journal (Update: via MarketWatch):
Germany's central bank is willing to back an array of stimulus measures from the European Central Bank next month, including a negative rate on bank deposits and purchases of packaged bank loans if needed to keep inflation from staying too low, a person familiar with the matter said...
This marks the clearest signal yet that the Bundesbank, which has for years been defined by its conservative opposition to the ECB's emergency measures to combat the euro zone's debt crisis, is fully engaged in the fight against super-low inflation in the euro zone using monetary policy tools...
Notably, these tools apparently do not include Fed-style quantitative easing:
But the Bundesbank's backing has limits. It remains resistant to large-scale purchases of public and private debt, known as quantitative easing, the person said. The Bundesbank has discussed this option internally but has concluded that with government and corporate bond yields already quite low in Europe, the purchases wouldn't do much good and could instead create financial stability risks.
Should we conclude that there is now a global conclusion about the value and wisdom of large-scale asset purchases, a.k.a. QE? We certainly have quite a bit of experience with large-scale purchases now. But I think it is also fair to say that that experience has yet to yield firm consensus.
You probably don’t need much convincing that QE consensus remains elusive. But just in case, I invite you to consider the panel discussion we titled “Greasing the Skids: Was Quantitative Easing Needed to Unstick Markets? Or Has it Merely Sped Us toward the Next Crisis?” The discussion was organized for last month’s 2014 edition of the annual Atlanta Fed Financial Markets Conference.
Opinions among the panelists were, shall we say, diverse. You can view the entire session via this link. But if you don’t have an hour and 40 minutes to spare, here is the (less than) ten-minute highlight reel, wherein Carnegie Mellon Professor Allan Meltzer opines that Fed QE has become “a foolish program,” Jeffries LLC Chief Market Strategist David Zervos declares himself an unabashed “lover of QE,” and Federal Reserve Governor Jeremy Stein weighs in on some of the financial stability questions associated with very accommodative policy:
You probably detected some differences of opinion there. If that, however, didn’t satisfy your craving for unfiltered debate, click on through to this link to hear Professor Meltzer and Mr. Zervos consider some of Governor Stein’s comments on monitoring debt markets, regulatory approaches to pursuing financial stability objectives, and the efficacy of capital requirements for banks.
By Dave Altig, executive vice president and research director of the Atlanta Fed.
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May 09, 2014
How Has Disability Affected Labor Force Participation?
Editor's note: Since this post was written, we have developed new tools for examining labor market trends. For a more detailed examination of factors affecting labor force participation rates, please visit our Labor Force Participation Dynamics web page, where you can create your own charts and download data.
You might be unaware that May is Disability Insurance Awareness Month. We weren’t aware of it until recently, but the issue of disability—as a reason for nonparticipation in the labor market—has been very much on our minds as of late. As we noted in a previous macroblog post, from the fourth quarter of 2007 through the end of 2013, the number of people claiming to be out of the labor force for reasons of illness or disability increased almost 3 million (or 23 percent). The previous post also noted that the incidence of reported nonparticipation as a result of disability/illness is concentrated (unsurprisingly) in the age group from about 51 to 60.
In the past, we have examined the effects of the aging U.S. population on the labor force participation rate (LFPR). However, we have not yet specifically considered how much the aging of the population alone is responsible for the aforementioned increase in disability as a reason for dropping out of the labor force.
The following chart depicts over time the percent (by age group) reporting disability or illness as a reason for not participating in the labor force. Each line represents a different year, with the darkest line being 2013. The chart reveals a long-term trend of rising disability or illness as a reason for labor force nonparticipation for almost every age group.
The chart also shows that disability or illness is cited most often among people 51 to 65 years old—the current age of a large segment of the baby boomer cohort. In fact, the proportion of people in this age group increased from 20 percent in 2003 to 25 percent in 2013.
How much can the change in demographics during the past decade explain the rise in disability or illness as a reason for not participating in the labor market? The answer seems to be: Not a lot.
Following an approach you may have seen in this post, we break down into three components the change in the portion of people not participating in the labor force due to disability or illness. One component measures the change resulting from shifts within age groups (the within effect). Another component measures changes due to population shifts across age groups (the between effect). A third component allows for correlation across the two effects (a covariance term). Here’s what you get:
To recap, only about one fifth of the decline in labor force participation as a result of reported illness or disability can be attributed to the population aging per se. A full three quarters appears to be associated with some sort of behavioral change.
What is the source of this behavioral change? Our experiment can’t say. But given that those who drop out of the labor force for reasons of disability/illness tend not to return, it would be worth finding out. Here is one perspective on the issue.
You can find even more on this topic via the Human Capital Compendium.
By Dave Altig, research director and executive vice president at the Atlanta Fed, and
Ellyn Terry, a senior economic analyst in the Atlanta Fed's research department
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