Small bank business loans and the jobless recovery

Small bank business loans and the jobless recovery

October 4, 2014 0 Comments

Today’s +278K increase in non-farm payroll jobs is glass-half-full story. Employment (139.4M) has increased by almost 10M jobs from its February 2010 low at the bottom of the financial crisis but is barely above its December 2007 pre-crisis peak in spite of increases in population. Many workers have become discouraged and left the workforce; the employment-population ratio is more than 4% (10M jobs) below pre-crisis levels. And real incomes have barely budged. What’s going on?

One important factor in this story is the demise of small business loans. Total business loans actually look OK. They fell by $400B from their pre-crisis peak of $1600B in October 2008 to $1200B in July 2010 but are now climbed back to $1759B. But a careful look reveals the problem. As you can see in the chart, above, almost all of the increase in business loans came from big banks. Small bank business loans have barely increased from their lows and are still some 20% below pre-crisis levels.

The reason is simple. Dodd-Frank–so-called financial reform–has buried small banks under a mountain of new regulations. Compliance costs are enormous. Big banks can afford the compliance costs; small banks can’t. That’s why there are half as many banks today as there were in 2007.

I’m sure you catch the irony. Financial reform was supposed to end the risk-taking behavior of big banks. It ended up increasing big bank market share dramatically.

This is important because big and small banks serve different customers. Big banks loan to private equity sponsors, hedge funds, and big companies doing M&A. Small banks lend to local small businesses and local home owners. Small businesses are where all new jobs come from. Mystery solved.

The resulting non-price credit rationing for small firms has created a second irony. The Federal Reserve tells us that short-term interest rates are nearly zero. But that is the interest rate on the loans that small businesses can’t get. In reality, they are starved for working capital. This is a great opportunity for private equity investors, who are providing that capital at 15-25% rates of return. But it is not good for jobs, for growth, or for family incomes.


John Rutledge


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