02/ 11/ 2008
by Bill Dunkelberg
Credit problems seem to be the top concern of the Federal Reserve and the talking heads these days. Although the GDP grew at a phenomenal 4.9 percent in the third quarter and job growth has been strong (more than 100,000 new jobs monthly), the Fed embarked on a rate-cutting path that most observers think will extend into 2008. If consumers didn't spend enough during the 2007 holiday season, the Fed will likely cut rates to make it better.
Credit markets "froze," we are told, and to restore the flow we need to cut the cost of credit. It is true that bad assets look better with lower interest rates (because valuation models have interest rates in the denominator), so firms that were taking risks can write down smaller losses. But for most banks with variable priced loans, it was a revenue loser. Savers, of course, get hurt when the interest rates on their savings plunge.
The Small-Business Perspective
Small-business owners don't see it the way Fed Chairman Ben Bernanke is painting the picture. The story is that the "crisis" started last August (according to observers and the variance in the daily Federal Funds rate) and is not improving. But, according to NFIB's Small-Business Economic Trends report, the percentage of business owners citing credit costs and availability as their No. 1 business problem has not changed for 20 years (see chart, line 1). There has been no change in the percentage of owners reporting "all borrowing needs met" (line 2), regular borrowing activity has not spiked but has remained in the same range for the past 15 years (line 4), and the net percentage of owners reporting that loans are harder to get was basically unchanged (line 3), a good proxy for the tightness of monetary policy. And despite all the negative news, there has been no change in owners' expectations about the difficulty in getting the financing they need to run their businesses. Bottom line: There is no "credit crunch" on Main Street.
So it doesn't appear that spending and hiring is being adversely affected by a lack of credit availability. Credit gets cheaper for some business owners (with variable priced loans or new loans), but that takes time to translate into new spending. That's the idea: Lower rates stimulate borrowing to finance new spending and create more jobs.
The Reverse Effect
But the impact of all this "credit crunch" talk was not positive. With third-quarter GDP growing 4.9 percent, the economy wasn't showing signs of tanking. Indeed, before the Fed rate cut on Sept. 18, owner optimism was on the rise. Job creation plans were up, there were more job openings and capital spending plans were up sharply. Fewer owners thought the economy would weaken (line 10) and more thought it was a good time to expand their businesses (line 9).
But those positive outlooks ended with the Fed announcement. Following the rate cut, small-business job creation plans fell (line 6), job openings evaporated (line 7), capital spending plans halted (line 8), and more owners expected the economy to worsen.
The "bad news" conveyed by the Fed action produced a logical result among business owners: If things are going to get bad, then it is smart to pull back and be more cautious. As a result, spending and employment growth fell—the reverse of what lowering interest rates is supposed to produce.
