Professor Cole's Finance Blog

Passage of the $42 billion small-business bill is virtually assured after two lame-duck Republicans joined 59 Democrat Senators voting in favor for the bill on Thursday, but don’t expect this new stimulus bill to help the economy avoid a double-dip recession. Why? Look no farther than the two key components of the bill: $30 billion to boost lending to small businesses and $12 billion in targeted tax cuts for qualifying small businesses.

First and most importantly, the $30 billion won’t actually go to small businesses in the form of loans, it will go to small banks in the form of capital. At it’s heart, this  plan is nothing more than a Son-of-Paulson TARP bank bail-out, except, of course, that it is much smaller and is focused on community banks rather than Wall Street banks. But won’t this new capital lead the recipients to make more loans to small businesses? To answer this question, we need only look at what happened to bank lending after the original Paulson TARP. From June 2008 to June 2010, commercial & industrial lending by commercial banks declined by  $222 billion or 18%, from $1,204 billion to $982 billion. Over the same period,  small-business lending by commercial banks declined by $57 billion or 8%, from $661 billion to only $604 billion. The lesson is clear: investing taxpayer dollars in commercial banks leads not to more lending, but to less lending by the banks.

Why this perverse outcome? The answer is that the TARP, and this new mini-TARP, are bleak examples of crony capitalism at its worst—an unholy alliance of big government and big business. Taxpayer money goes to bankers who made hundreds of billions in bad loans, which depleted their capital. The taxpayers’ investments recapitalizes these failing banks, but does nothing to remove the bad loans from the bank balance sheets. The troubled assets remain in the system, which could lead to a lost decade, just as a similar strategy did in Japan during the 1990s.

Instead of going to small business loans, look for the $30 billion investment in bank capital to morph into a political slush fund for Democrats to use to bail out politically connected banks. Think Shorebank in Illinois and OneUnited in California. The FDIC’s most recent problem-bank list includes more than 800 banks, more than one in ten, even though it has already closed 126 banks year-to-date. Look for these problem banks to line up at the public trough in yet-another Obama bank bailout.

Second, the $12 billion in targeted small-business tax credits won’t result in new investment or hiring. Remember Cash-for-Clunkers and First-Time-Home-Buyers tax credits? These costly programs simply time-shifted sales of cars and houses from after to before the programs expired. In both cases, sales of cars and houses fell off of a cliff when the programs expired. These tax policies are tantamount to handing out winning lottery tickets to those lucky enough to qualify for them at the time they are offered.

What are the real problems for small businesses? According to a recent survey by the National Federation of Independent Businesses, the biggest problem is slow or declining revenues (cited by 51% of respondents, followed by uncertainty (cited by 22%) and then by falling real estate values and access to credit (each cited by 8%). Even among those reporting they can’t get credit, twice as many firms pointed to poor sales as pointed to credit access. Moreover, these small firms responded that both their reported, and planned, capital spending are at 35 year lows. Most of those looking to borrow are doing so for cash flow, not for investment or hiring. Firms need sales, not the loans and tax credits that are promised by this bill.

Why is uncertainty the number two concern of small businesses? Look no farther than the two massive bills passed by this Congress: health-care and financial reform. Each of these bills exceed 2,000 pages. For comparison, the much maligned 2002 Sarbanes-Oxley Act needed only 66 pages to do untold damage to our economy. What is in these bills? Well, as Speaker Pelosi so eloquently said about the 2,074-page health care bill that not a single Congress Critter read before voting on it, “we need to pass this bill so that you can find out what is in it.” What we are now finding, we don’t like.

For example, a business now will have to file an IRS Form 1099 for each and every vendor from which it buys more than $600 of goods and/or services. I personally will have to file forms more than two dozen forms for companies like United Airlines, Hyatt Hotels and Dell computers. Where am I supposed to find the required Taxpayer Identification Numbers and mailing addresses for these firms? How much time must I waste on this task? More importantly, what does this have to do with health care? Nothing. Yet just this past week, Democrats blocked Republican efforts to repeal this Obama abomination.

Rational adults (outside of the Beltway) know that the health-care bill is going to cause health-care costs for small businesses to skyrocket, but we won’t how far until provisions of the legislation are fully phased in--in 2014. Why would any employer want to hire a new worker when he or she doesn’t know how much that employee will cost in benefits?

The Dodd-Frank Bill is even worse, coming in at  2,319 pages that include mandates for 74 studies that will take a cumulative 79 years of studying by various bodies. Only after these studies are completed will scores of new regulations be written. Also remember the 800-pound gorillas that were left out of the financial reform bill—Freddie and Fannie. What is going to happen to them and the housing market? Is there any wonder why three times as many small businesses cited uncertainty rather than access to credit as their biggest problem?

Tough times call for new thinking. If we really want to incentivize small businesses to hire new workers, we need to make long-term changes to the tax code, not short-term gimmicks. What about replacing the combined 15% employer and employee levy of the payroll tax with a 15% national sales tax? This would provide a huge new incentive to hire, as well as a huge cost saving on existing employees that could be diverted to investment. At the same time, it would provide workers with incentive to boost savings. While both taxes are regressive, they essentially would cancel each other out and could be structured as revenue neutral.
 

(This blog appeared as an Op-Ed in the print edition of the Washington Times on Wednesday, Sep. 22, 2010.)

Posted by m1rac01 at 01:39 PM | Permalink

The majority of these second liens are held in the loan portfolios of just four banks—Bank of America, Citibank, J.P. Morgan Chase and Wells Fargo. These same four banks service most of the first mortgages owned by bondholders or other banks. When Joe Homeowner defaults on his first mortgage, but continues to pay his second mortgage and then seeks relief from the Home Affordable Modification Program (HAMP) or his first lender, he often is unable to obtain relief because the holder of the second lien refuses to take a loss on the second lien. This upsets the whole priority of claimants in the event of default. The second-lien holder is supposed to get wiped out before the first lien-holder suffers a dollar of damage, but that isn’t happening in this bizarre world. 

On Friday, the Bureau of Labor Statistics released the jobs report (more formally known as the Employment Situation) for August 2010. The headline numbers were a loss of 54,000 nonfarm payroll jobs and an upward tick in the unemployment rate from 9.5% to 9.6%, which, according to the BLS were “changed little” and “about unchanged,” respectively. Tell that to one of those 54,000 nonfarm payroll workers who lost their jobs or one of the 261,000 workers who reported that they became unemployed during August. Yet, in the very next sentence, the BLS reports that private-sector payroll employment “continued to trend upward” by 67,000. Clearly, there is biased reporting going on at the BLS, but that is not surprising in this administration that has been so hard hit by the jobs issue.

The unemployment rate has been at or above 9.5% for more than a year now, in spite of the administration’s promise that the $787 billion (later revised by the CBO upwards to $852 billion) stimulus plan, would keep unemployment below 8.0%, a target unseen in this labor market since Obama took office. And yet the President boldly claimed “The key point I’m making right now is that the economy is moving in a positive direction.” So we have a President who thinks that falling employment and rising unemployment is “a positive direction.” Heaven help those who are out of work, because is sure sounds like Washington isn’t going to.

Perhaps the most troubling number in the August jobs report is one that largely went unreported. U6, the broadest measure of unemployment reported by the BLS, which includes discouraged workers and part-time workers who would have preferred to work full-time, rose from 16.5% to 16.7%. This translates into 25.7 million workers out of a labor force of 154 million who are unemployed or underemployed. In August, there were 8.86 million workers who reported working part-time for economic reasons, up from 8.53 million in July.

This job market continues to discriminate against men and minorities. From July to August, the unemployment rate among men rose from 10.4% to 10.6% and among Blacks rose from 15.6% to 16.3%. In contrast, the August unemployment rate among women was only 8.6% and among Whites was only 8.7%. Among teenagers age 16-19, a group that is usually the first to lose their jobs during a recession, the unemployment rate rose from 26.1% to 26.3%.

Clearly, education plays a major role in those who do and those who do not have jobs. The August unemployment rate for those with a college degree was only 4.6%; for those with some college or an associate degree was 8.7%; for those with a high school diploma but no college was 10.3%; and for those with less than a high school diploma was 14.0%.

There were a few bright spots in the employment report. The average duration of unemployment declined from 34.2 weeks to 33.6 weeks and the median duration declined from 22.2 to 19.9 weeks. Also, the chronic unemployed—those out of work more than 26 weeks, declined from 6.57 million to 6.25 million. However, it may simply be that these workers gave up hope and exited the labor force.

Don’t worry, though. Our President and his economic team assure us that we are moving in a “positive direction.” Come November, the voters will let the President know how they view his economic stewardship.

Posted by m1rac01 at 12:13 PM | Permalink