Unexpectedly Intriguing!
08 September 2011

Small businesses drive the growth of the U.S. job market.

BLS-Seasonally-Adjusted Number of Employed Americans, January 2001 through August 2011

So with today's unemployment rate over nine percent, which the White House anticipates will be the case well into 2012, it would only be natural for President Obama to focus on initiatives to support small businesses in his address this evening to a joint session of the U.S. Congress.

Because President Obama would really rather not be held accountable for the low rate of employment that has come to characterize the U.S. economy under his presidency (see the chart above for the period since 01/09), it is likely that he will point to two of his favorite union-approved economic bogeymen in another attempt to avoid having the focus of blame fall upon himself: banks "that won't lend" and businesses "that hoard cash."

We thought we'd take a closer look at why those things might be and found our answer in the U.S. Federal Reserve's Z.1 Flow of Funds statements for nonfarm, noncorporate businesses (aka "small businesses"). We looked at the assets and liabilities of U.S. small business since 1951 and calculated their collective debt-to-equity ratio (the ratio of total liabilities to net worth, the difference between total assets and total liabilities). The chart below reveals what we found:

Debt-to-Equity Ratio for U.S. Small Businesses, 1951-2011

Here, we observe that the debt-to-equity ratio for U.S. small businesses soared above 100% in 2008, where it has persisted to the present. That level is significant in that it indicates that external lenders (banks) currently have a greater financial interest in the small businesses to which they've lent money than do the actual owners of the small businesses.

Consequently, lending institutions are carrying over half the financial risk associated with the operation of U.S. small businesses.

This is why "banks won't lend". While bankers might be skilled at running banks, like government bureaucrats, they're not qualified to run any other kind of business operation. So they don't, because doing so would guarantee the failure of the businesses to which they're carrying a majority of the financial risk. Too many of those kinds of failures and the lenders themselves would be facing the risk of going under.

We can see this logic at work in the economy today as it applies to banks that hold large numbers of mortgages undergoing foreclosure proceedings. Rather than become landlords by trying to make money by renting out the houses they've foreclosed upon, the banks seek to unload these properties from their books as quickly as possible because they are smart enough to know they cannot succeed in that business.

That smartness is a key difference between bankers and government bureaucrats.

Accounting

Meanwhile, businesses have built up their cash reserves in response, because they can no longer rely upon their lines of credit with their banks as they might have before 2008, thanks to restrictions their lending institutions have placed upon them to protect themselves from their increased exposure to financial risk.

In that kind of operating environment, businesses also seek to operate as leanly as possible, forgoing investments or new hiring unless they have can count on generating sufficient revenue to both cover the costs and provide enough financial cushion to make it through lean periods, because that's the only way they can survive.

It could have been different. If President Obama had acted to support the little guy instead of big corporations, unions and government bureaucrats in his $787 billion "stimulus" back in 2009, the U.S. economy would be much healthier today.

If only. Just think - we could all be enjoying the start of the NFL's season rather than another presidential tantrum or even more uninspiring rhetoric seeking to convince the American people that the same corporations, unions and government bureaucrats who burned through all the $787 billion from the first Obama stimulus in 2009 could really use $300 billion more taxpayer dollars.

References

Board of Governors of the Federal Reserve System. Z.1 Flow of Funds Accounts of the United States. B.103 Balance Sheet of Nonfarm Noncorporate Business. Accessed 5 September 2011.

Elsewhere on the Web

David Tufte looked at whether big corporations (or rather, nonfarm, nonfinancial corporations) were hoarding cash in, well, Are Corporations Hoarding Cash? back on 3 April 2011!

The WSJ's Emily Maltby specifically looked at why small businesses are "hoarding cash" in Another Season of Hoarders: Recession-scarred companies are holding back from spending—even if they have the cash, back on 16 May 2011.

The Entrepreneurial Mind's Jeff Cornwall speaks on behalf of the people who actually create brand new jobs.

And for our part, we've built tools that estimate both what it costs to employ you and also how to tell if a government program to "stimulate" the economy, or job creation, actually works.

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