A view from the trenches

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 e-mail 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 be come 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 loan 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 percent of the
unemployment rate. Start at zero and add up and you will find that
credit-induced job creation may equal 2.5 percent 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 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 Summers, the president’s chief economist,
recently said that one in six 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.

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