A View From the Trenches
Posted on May 13, 2010
My golf game is terrible. I would like to blame my 4 year old son for the fact that my game has deteriorated so rapidly over the past five years, but as Jimmy Buffett might say, “Some people say that there’s a little boy to blame, but I know, it’s my own damn fault.”I had a chance to play golf with a guy earlier this week whose golf game is just as bad as mine. I had never seen more shanks in my life than I saw from Brendan Quinn, a friend of mine, whose game is in pretty lousy shape. But he has an even better excuse than I do. He has five kids, one who was just born a couple months ago.
Brendan has a lot on his mind, his fivesome being just part of the story. He is the successful owner of a concrete block company (they make concrete blocks), and as he said during the game, he is lucky to live in our nation’s capital, where business is still pretty good.
Brendan is a Notre Dame business school grad, and he is a pretty sharp observer of the current business climate. He sent me an email giving his view of the next big crisis to hit our national economy, the problem with small business lending. I asked if I could share his thoughts with you, and he said sure, so here they are.
“Small business lending will become the next bubble albeit a small one. The government is trying to assign blame on banks and create new programs for banks to provide government-guaranteed loans to small businesses (sounds eerily familier to Fannie/Freddie). Here are the facts as I see them:
1. Demand. There is not enough demand to create as many jobs. Small businesses create 2 of 3 jobs but some may never come back. Look at, as I have, construction-related employment from 2002 to 2009. There are at a minimum 2 million jobs that will never return (construction and related services - restaurants, equipment suppliers, building material dealers). That is 1.333% of the unemployment rate. Start at zero and add up and you will find that credit-induced job creation may equal 2.5% between construction and other boom-related services. If normal unemployment is 5 to 5.5, you remain at 7.5 to 8.0 unemployment permanently.
2. REAL ESTATE. People think that banks should lend to small businesses because they are job creators. Strangely enough, banks employ some credit analysis when lending to a business or commercial real estate because it is hard or impossible to securitize. What everyone does not understand is that real estate underpins most small business lending. The bank asks for a personal financial statement because a personal guarantee is required. Most small businesses either used personal home equity loans or personally guaranteed financing. Most small business owners "bought up" in housing. Their chief "financeable" asset was their real estate. That asset is most likely underwater. The other assets available on a personal level are retirement plans and personal savings which have also depreciated. No assets to lend against on a personal level rejects many loans. The commercial real estate either held personally or in the business has declined as well.
3. Current Assets. If a company does not have a receivables aging issue or inventory aging issue, they are a statistical outlier. I happen to be an outlier. Companies may have made money from 2000 to 2007 but now much of their profits lies are tied up in their receivables and old inventory. You use cash to pay the payroll while you wait for the customers to pay receivables. Many of which have "aged" over the last year. The same goes for inventory, which is essentially embedded cash in an object. If it goes out of style, which happens in many small businesses or becomes defective, it is unsellable. It will never return to its origin - cash. Banks are seeing both of these phenomena and are rightfully scared to lend.
4. Human nature has changed. We don't have any savers any more at the top of businesses. They buy houses, boats, and other material objects. Like the homeowner, they chose not to pay debt and paid themselves moving much of it into things that cannot return to its origin - cash. Banks now see that this move to an illiquid personal balance sheet has made it impossible to trust their judgment.”
One of my son’s favorite programs is “Wonder Pets". Like most programs aimed at little kids, it is a fairly silly little program, but one of the characters, a little duckling, likes to say with a bit of a lisp, “This is sewious.”
To quote the little duckling, “This is sewious.”
The nature of the workforce has changed, and nobody is talking about it, especially the President. Larry Summer, the President’s chief economist, recently said that 1 in 6 men are going to be out of work for the foreseeable future.
Brendan seems to agree with that assessment. It sure would be nice if the President and the Congress would start taking this seriously.