What does tighter credit really mean to the economy?
I thought I might take a moment to share some perspective you may or may not have realized about the impacts of a credit crunch could have on you, directly or indirectly.
While we know about the "big bank" failures like WaMu coming about because of lots of loans that seemed to be good at the time (yes, I wrote that - even stated income liar loans and adjustables worked as long as the perceived value of real estate continued on rapid growth) later turned into default as the market crashed.
And those folks who are facing ruined credit and/or bankruptcies while losing their homes are having no picnic either. But hopefully, unless they are in a real estate related field they probably still have their jobs.
But now let's fast forward. To give this perspective, let yourself imagine that you are the owner of a small business, of which there are 50,000 or so in the US.
And as a small business owner, you often times need short term loans to meet the fluctuations in business cycles. A firm with 20 employees may be generally healthy, maybe even profitable, but a couple of bad months in sales can result in a cash flow crunch.
So what do they do when they get crunched? They only have a few choices. They can not pay their bills, but that causes problems as suppliers may cut them off and/or interest charges make the problem worse. They can not make payroll, but that won't go over very well. They could avoid paying taxes and/or funding things like 401Ks, but that is filled with risk including potential jail time.
No, the viable solution is to either;
A) Get a loan for the business or
B) Loan the business money from their own pocket.
If they go with A, frequently the lender will expect a personal guarantee from the business owner.
If they go with B, they better have deep pockets.
So...
If there is a credit crunch, and the banks stop lending money, then even being willing to sign a personal guarantee might not be enough, or there may be VERY high fees for the loan (up front money paid to the bank to reduce risk on default) which could be extremely problematic because at the time the business needs the loan, they don't have money for the fees.
So if they decide they have to self-fund a short term cash flow crunch, how do they do it? A payroll check for 20 employees, taxes, rent and operational costs for a month is typically many tens to even hundreds of thousands in a month. Few, even successful small business owners have that kind of jack just laying around.
Maybe they have a home-equity line they can borrow against. On a decent stock portfolio they can borrow against.
Oh, but wait...
What if the lenders start calling home equity lines because of excessive risks of default and/or banking regulations say they have to based on the amount of already outstanding bad debt? Yes, these banking regulations indeed exist. And the stock market? Borrowing power on it just dropped dramatically like everyone's 401Ks, and nobody really wants to sell low, right?
Suddenly, the business owner has very hard decisions to make.
Layoff good employees you would give your right arm for?
Ask them NOT to take payroll?
And now, what of those employees that are either laid off or not paid? What happens to their obligations? What happens to unemployment costs (back on the small businesses that do survive)? What of those other suppliers not getting paid, and what happens to their businesses? The businesses they do business with? And if there are small business failures in droves, what happens even to big businesses, who are also facing these problems?
This is why the government wants to prop up the banking system. It is a HUGE house of cards.
Got soup?
Hope we don't need it...
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