Entrepreneurs and the Lending Squeeze

If you haven’t seen the outstanding front page article in today’s Wall Street Journal by Mark Whitehouse, Loan Squeeze Thwarts Small-Business Revival, you should get a cup of coffee and be sure to read it.

Some points that I thought were particularly interesting:

A year and a half after the financial crisis hit, the U.S. credit machine is still malfunctioning. During the boom, credit was too abundant. Now the pendulum has swung. With an eye toward limiting such swings, Sen. Christopher Dodd is expected to unveil a bill Monday that would be especially tough on big banks while preserving the Fed's regulatory role, but the bill's prospects remain uncertain.

For a recovery to take hold, hundreds of thousands of small businesses must find the confidence to expand and create jobs. But when they get to that point, the local banks they depend on—worried about borrowers' financial strength, scrutinized by regulators and slammed by souring real-estate loans—might not be willing or able to provide the credit they need.

While big companies have been able to borrow in bond markets, smaller companies rely mainly on bank credit, which has been shrinking. In 2009, total lending by U.S. banks fell 7.4%, the steepest drop since 1942. In all, the credit pulled out of the economy by banks since the downfall of Lehman Brothers in September 2008 amounts to about $700 billion, more than double the amount so far distributed under President Barack Obama's $787 billion stimulus program.

The dearth of credit for small businesses could have a big effect on prospects for restoring the 8.4 million jobs lost since the recession began. From 1992 through the beginning of the latest recession, companies with fewer than 100 employees accounted for about 45% of net job growth, according to Labor Department data.

Policy makers have been looking for ways to reopen the spigot. President Obama has proposed creating a $30 billion fund to support small-business lending. Last month, in an unusual show of solidarity, the Federal Reserve, the Federal Deposit Insurance Corp. and other state and federal regulators issued a joint statement urging banks to continue lending to credit-worthy small enterprises.

Making sure small firms get access to credit "is crucial to avoiding a Japan-type scenario of persistent stagnation," says Mark Gertler, a New York University economist who has done seminal research with Fed Chairman Ben Bernanke, then a Princeton University professor, on how troubles with bank lending can aggravate economic downturns.

Getting banks to lend more won't be easy, given the rising tide of defaults on loans made to finance housing developments, office buildings, shopping malls and other commercial real estate. Deutsche Bank expects banks to suffer at least $250 billion in losses on such loans, with about half coming in the next few years. Together with an estimated $250 billion in further charge-offs on home mortgages, that's more than double banks' current reserves against losses on all types of loans.