Small Business Credit

Reader Tim Allen writes:

I wanted you to consider that in a recent previous post you had
mentioned that people are filling up their gas tanks before they
previously would, and they are filling up all their other cars, and
spare gas tanks because of the fear of not having enough necessary gas.
This is a market reality and is completely rational considering the way
the game's rules are set up (no gouging, as per the govt).

I would like you to consider that I, as a small business man,
maxed out all my lines of credit and deposited the money in my bank
accounts. If fear is driving this market, and if it causes banks to dry
up credit, I want to be the first to be tanked up on money,
so-to-speak. The negotiated rate of interest is not high enough for me
to be disinclined to borrow, at least until this credit storm blows
over. I know I am not the first person to have this idea and I won't be
the last, and we (together) will create the situation that you think
can't happen. The tighter credit gets, the more people will borrow, if
just to have the cash on hand, to not need to borrow in the future.

I have done the same thing.  I am maxed on my line of credit, because the interest rate is low and I would rather have the money in hand and pay the interest rather than find out later my line is somehow revoked or frozen.  The money is not needed for near term expenses, but I want to have resources in hand if the recession creates a business opportunity that requires funding.  Does this worsen the near term crunch, the same way panic buying of gas worsens local gas shortages?  Probably.  And again, price is the key.  Like with gas, I would rather rationing by price rather than shortage.  In other words, I would rather my line of credit go up to a 15% interest rate, if that what it takes to put things in balance, than to be revoked entirely so a few businesses can still have 6% money.

I have never said that letting banks fail was without cost.  I just think the cost is going to be there, one way or another, and the cheapest and quickest solution is to let the whole mess sort itself out.

By the way, the notion that small business lives on short term credit is a hoot.  ExxonMobil may have access to the commercial paper market on short notice, but borrowing for our company, even in good times, generally takes a panzer division and a long war of attrition.  Even layup deals have taken me 6 months or more to finance.  Stephen Fairfax, via Mises, makes this point:

None of the small business owners I know depend upon easy credit to
make their payroll. When things get to the point where you need to
borrow to pay your employees, the end is near. Most small businesses
fail in the first few years, in large part because business is not
easy, it is hard. Not everyone is good at it. But it is an essential
part of free trade and the market economy that businesses fail, so that
new, better ones can arise in their place.

Few small businesses depend upon easy credit. Banks are generally
reluctant to lend to small businesses, with good reason. Most small
businesses are funded by owner's savings. Sometimes start-up money
comes from loans by parents or friends. While I can understand that
small businesses involved in building houses might profit from easy
credit, the market is sending unmistakable signals that there are too
many houses that are too expensive. Flooding the system with still more
easy credit can't be the cure, it is the problem.

  • Rolo Tomasi

    There is a huge difference between the gas scenario and the credit scenario. Price controls. As more and more people "stock up" with their credit lines, the interest they are charge will go up until some decide it isn't worth it. With gas, as is pointed out in the post, the price is not allowed to rise.

  • Brian

    While I can understand that small businesses involved in building houses might profit from easy credit, the market is sending unmistakable signals that there are too many houses that are too expensive.

    It didn't dawn on me until I read this, but thinking back to all of the various news outlets interviewing people that weren't going to be able to make payroll without a credit line, 9 out of 10 of them were construction companies.

  • Esox Lucius

    Rolo, I have a contract for my lines of credit, the rate won't move for the next 3 years or the bank will be in breach. Businesses contracts are usually either fixed, or tied to libor or tied to the fed funds rate. Right now, if you are tied to the Fed, you are making out like a bandit. If to LIBOR, not so much. If you are fixed and got your lines years ago like me, you are totally set. If credit dries up, they can't raise your rates, unless it is in your contract. So it is exactly like the gas scenario, only in the gas scenario, the government is limiting the price, in the credit scenario, the contract is limiting the price.

  • http://neubranderinc.com/blog Nobrainer

    From an article yesterday

    "...so a company trying to get a loan from [a bank] has about as much luck as a person trying to get a mortgage -- those with clean credit histories will likely get loans, but at high rates. And those with spottier credit histories might not get loans at all."

    It sounds to me like Congress wants to use the bailout to create easy credit for people with shaky credit histories as a solution to a problem of people with shaky credit histories having too much access to easy credit.

  • http://www.mutualinformation.org luispedro

    This might explain why we are seeing good credit growth even though some say we are in a credit crunch.

    (I wrote a post about it at http://www.mutualinformation.org/2008/10/credit-crunch-credit-growth/)

  • Dr. T

    You ought to talk with your local bankers before you believe Chicken Little Paulson's clucking about credit crunches. Most of the local banks, and quite a few of the national banks, have plenty of money and wish that more people and businesses were borrowing. Your actions are helping your bank, but probably are unnecessary for your business.

    I believe that we are hearing very one-sided presentations about the state of the economy. Paulson, his Treasury Department employees, financial industry CEOs who bet a bundle and lost, and a few pet economists are trying to make Paulson into Economic Czar of the country and are going along with the Chicken Little clucking. The media loves to report that "the sky is falling" and hates to report "things really aren't that bad," so all we hear is financial meltdown, domino-effect bank failures, credit crunch crisis, etc. The 100-plus noted economists who said the bailout plan would cause more problems than it would fix got little media attention.

    I believe we need local cooling: freeze Congress, the White House, and the Treasury Dept. until 2009. That will help prevent financial crises this year.

  • Rolo Tomasi

    Esox Lucius,

    You make a very good point, which I had not considered. To the extent that businesses have lines of credit with fixed rates this problem problem is similar to the gasoline shortages. However, if ones rate is tied to the LIBOR, then their rates will go up as more credit is demanded. If the rate is tied to the Fed funds rate, the Fed will have to give out more cash to keep the rate on target. So there is price signals with LIBOR tied credit, and Fed tied credit will have no shortage.

  • stan

    The fact that people are maxing out their lines is evidence of the error in Warren's previous post about govt statistics showing high loan volume. Warren tried to argue that loan volumes showed there was no problem in the credit markets. However, the maxing out of lines shows that these "loans" are not normal business. Accordingly, his argument fails.