Small Biz Is Still Sucking Wind

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President Obama had a shinning moment on Thursday when the Senate pulled together (in barley bipartisan fashion) and passed the assistance package for small business. Now there will be a quickie conference with the House, which passed its own version in June. The bill basically puts billions of dollars into the hands of community banks in the hope they in turn will be encouraged to make more loans to local businesses.

What’s not to like about a $30 billion boost to small biz, which has been taking it on the chin on this lethargic recovery? Perhaps only that it will be insufficient to counter the  strong headwinds that small companies are facing.  True, they have been denied access to credit for too long, but neither have they been clamoring for loans–the latest report from the National Federation of Independent Businesses which shows  small business capital spending plans continue heading down, confirms this. Why expand when business is so poor?

We know that this has been a particularly harsh recession for small business. As colleague Barbara Kiviat observed in a recent post the brunt of the job losses in the recession came from small business. To counter the pain and give business owners the ability to expand and rehire,  the Senate bill establishes the Small Business Lending Fund and fuels it with money from the U.S. Treasury. The infusion to banks will be made in the form of preferred stock and will require participating institutions  to pay a 5% interest rate on the  federal money. As part of the plan’s incentives banks will pay an even higher interest rate if they don’t step up their lending, and a lesser rate if they do lend more. It all sounds like plan with oomph, but it won’t get banks to do what they don’t feel like doing.  Sam Sherraden of the New America Foundation put his finger on the plan’s weak spot:

After a two-year period, if banks have not increased small-business lending, the dividend payment increases to 7 percent. The program also has a pricey incentive built in to encourage banks to repay the Treasury and get out of the program: After four and a half years, dividend payments on all participants in the program leap to 9 percent.

The program is structured, however, in a way that leaves the Treasury with few teeth to ensure that community banks are using Treasury funds to increase small-business lending. While banks that increase lending to small businesses pay the Treasury a smaller dividend payment, there is no financial penalty for failing to increase lending during the first two years. This does little more than encourage banks to participate in the program.

True, there are additional small business boosters in this package, including a smattering of tax breaks such as the one that lets small biz owners deduct their cost of health insurance as well as an extension of accelerated depreciation deductions beyond 2010. But these breaks are not the bulk of the plan–Sherraden puts the value of these breaks at just over $4 billion.

The plan will surely help small business, but it won’t deliver what small business owners need most. The bigger issue facing small companies–and that includes small companies that are bigger than the ones addressed in this bill– is that the U.S. economy is not creating enough domestic demand.  That’s a far more serious problem for small companies than it is for large.  Don’t take my word for it. Here are the  numbers,  from Steven DeSanctis, head of small-cap strategy at BofA Merrill Lynch:

Given the fact that small caps derive 80% of their revenue from the U.S., earnings growth is more tied to US GDP. The correlation between profit growth and GDP stands at 0.72 for the small caps versus 0.48 for the large caps. Despite the fact that small caps have increased their overseas exposure over the last few years, this correlation has actually risen more recently.

It’s a simple and costly truth: If you want to increase hiring among small companies, yes, keep their health costs and related taxes affordable, but most importantly stimulate economic growth–with more federal spending if necessary. Small business will hire when there is rising demand for their products and services.