06/ 03/ 2008
Owner optimism measured by the NFIB Small Business Optimism Index fell to 1991 recession levels at the start of 2008. The decline in optimism started in September with the Fed's first warning and rate cut.
The economy was hot in the third quarter, and there was no evidence on Main Street that it might be in trouble. A few hedge funds were having liquidity problems, and the housing market was in the process of realizing that builders produced far too many housing units and that new construction was on the slide. But did these events merit all the bad press delivered by the media and, more importantly, the Fed?
We'll never know the answer, of course. The Fed has finally figured out that the problem is on Wall Street among a handful of very large, over-leveraged institutions. Bear Stearns failed because of liquidity issues—and because no other big institutions would lend it money against its mortgage-based securities.
This scenario illustrates why lower rates won't help. No matter how cheap money was, no one would lend to Bear Stearns or buy its assets. That's why low rates won't get builders to construct more spec houses or get small business owners to buy new equipment to help increase the GDP. The Fed understands this principle now and has designed a set of policies that will keep other institutions from Bear Stearns' fate while the mortgage mess works itself out.
On Main Street, small business owners are reporting no problems getting the credit they need. Only 3 percent report credit issues as their No. 1 business problem, and only 5 percent report that loans are harder to get. Borrowing activity has not picked up, but virtually all owners who borrow regularly reported that all their credit needs are being met.
The low level of owner optimism is more of a “recession in expectations” than a reflection of real economic activity. In 1991, only 2 percent of the owners planned to increase employment compared to more than 10 percent in the first quarter this year. But as many owners expect real sales levels to fall as to rise now—the lowest reading since 2001. Why? Their negative outlook stems from being told that we are in a recession and facing a possible depression, which is the forecast from economists working on Wall Street where, indeed, things are bad.
Except for the possibility of bad policy mistakes in Washington, D.C. (it is an election year after all), a recession appears unlikely at this point. If GDP growth turns negative, it will be because consumers have decided to cut spending, which seems likely, as consumer optimism is in the tank as well. On the other hand, government spending and exports will rise significantly, and housing will not be as bad as the first quarter, which is a plus for GDP.
In the meantime, the percentage of owners raising prices remains at double-digit levels, and the percentage of owners citing inflation as their No. 1 business problem is at the highest level since 1983.
When the Fed finishes saving us from recession, it will have to save us from inflation. In other words, there are higher interest rates to come.
Dr. Bill Dunkelberg, a nationally known authority on small business and entrepreneurship, has served as NFIB's chief economist since 1971.
