For many years, Republicans, in particular, have espoused the virtues of "trickle-down economics." This theory holds that "increases in the wealth of the rich are good for the poor because some of such additional wealth will eventually trickle down to the middle class and to the poor." (Wikipedia)
Since the credit bubble began to burst, however, we've seen a malignant variation of this phenomenon. Instead of wealth, red ink has been trickling down from the orifices of badly-run financial companies, undermining the economic wellbeing of a wide range of individuals and firms.
Among the victims, according to a CNNMoney.com report, "Credit Crunch Freezes Hiring, Expansion," are small businesses.
When small businesses can't get loans, job growth and economic expansion stall.
After 41 years in business, Hull Printing shut down its printing presses for good in March, laying off 19 workers and closing one of the oldest family-run businesses in Barre, Vt. The catalyst: Hull Printing's bank slashed its line of credit, kicking off a death spiral that led to the company's collapse.
"All of the equipment's gone and been liquidated," said Jon Hull, 32, whose grandparents started the commercial printing business in 1967. "The bank got all of their money back, but it left a lot of unsecured creditors that will never be paid back, including many other small businesses in town."
Hull's story is a familiar one to millions of small business owners across the U.S. who rely on credit lines and loans to fund expansion or help them recover from setbacks. In a National Small Business Association (NSBA) survey released this week, 67% of business owners polled reported being affected by the credit crunch in August, up from 55% in February. Additionally, 32% reported a deterioration in the terms of available bank loans, up from 27% six months earlier.
"If there is a squeeze on banks, even if only large investment banks, the repercussions can easily flow over into commercial bank loans," says NSBA President Todd McCracken. "Based on what history suggests, if banks have to pull back, they'll pull from small business loans first."
A small business cutback will have ripple effects on the larger economy - and on the jobs pool. Small businesses employ about half of all non-government employees in the U.S., according to Small Business Administration estimates. This year, small companies have been crucial in keeping the job-loss numbers from turning even grimmer: While bigger businesses shed workers, companies with fewer than 50 employees have reported a net increase in positions every month this year, according to ADP, which compiles a monthly employment report. In August, when overall employment fell by 33,000 jobs, small companies added 20,000 net new hires, according to ADP's estimates.
A credit crunch can force companies to make hard choices. "Sometimes there may not be enough work for key staff, so they'll face the choice of losing good people or hanging on to them until they catch the next wave," McCracken said.
In D'Iberville, Miss., Fayard's Grocery owner Rusty Quave is waiting to find out if he'll receive a deferral on loan payments that will mean the difference between staying in business and going under for his general store. For now, Quave has shortened the store's operating hours and temporarily stopped selling gas and diesel as he tries to cut his daily operating costs enough to stay afloat.
Stalled growth
Quave is also the mayor of D'Iberville, a town of 6,000. All around, he sees signs of economic development at a standstill. Shattered three years ago by Hurricane Katrina, D'Iberville responded with a comprehensive urban-development plan for rebuilding. The 60-page document is a blueprint for sustainable retail, residential and industrial development, but little ground has been broken because of the credit-market freeze.
"All the major developers can't come up with the financing," Quave said. "We're a district that has legal gaming. We have groups that have bought property and haven't been able to start."
The NSBA's president says Quave's situation is in line with others he's seen. "For a company that has a growth opportunity, you can still get funding, if you take a lot of energy and time and pull from different places. But companies not in a position to expand may lose money," he said.
While officials in Washington hash out the details of a proposed $700 billion bailout to address the financial-system crisis that began unfolding on Wall Street last week, business owners far from the financial markets' epicenter are already feeling the effects of banks' reluctance to risk new loans.
When entrepreneur Tim Trzepacz and his partner sought funding last year to expand their fledgling product-development company, Sprout Creation in Wayland, Mass., they had the benefit of sterling personal credit and years of experience and networking in their industry: Trzepacz is the former merchandising director at consumer-electronics retail giant Brookstone, where his partner, David Laituri, headed up design and engineering. They also had one product already on the market and generating sales, the Vers iPod dock, available at Target.com (TGT, Fortune 500) and other retailers.
Trzepacz pitched almost a dozen banks. One bank executive "told us we'd be approved unless they pulled our credit history and found out we'd committed mass murders," Trzepacz recalled. They were turned down. Over and over, the pattern repeated: Trzepacz and Laituri would meet with a bank and quickly win over their prospective loan officer. But when that advocate pitched the loan further up the bank hierarchy, it would be shot down. Banks wanted 18 to 24 months of cash flow and a demonstrated operating history before they would consider opening their coffers.
Bank of America (BAC, Fortune 500) agreed to extend the company a line of credit for around $80,000, but it was essentially a credit-card line, carrying interest rates of 15% and up. When Trzepacz sought a higher limit, Bank of America told him to look elsewhere.
In the end, Laituri found salvation literally on his doorstep. Laituri walked into a nearby branch of Middlesex Savings Bank, his local community bank, and asked if they'd be interested in talking about financing his business. Two weeks later, Trzepacz and Laituri had a $200,000 line of credit at interest rates less than half those they'd been paying to Bank of America - and they had a promise that as their business grew, their financing would grow with them.
Since getting that financing this spring, Vers Audio has added an employee, introduced new Vers models and created the next extension of its line, a combo iPod dock/alarm clock that will soon be on sale. None of that would have been possible without their line of credit.
"We came within 45 days of D-day," Trzepacz said. "We probably would have had to halt business operations, and our revenues would have been half what they'll be this year."
Other small businesses are stuck at a standstill. Take, for example, Jamaal Oldham of The Cheesecake Experience in Nashville. His four-person operation has been hand-delivering their specialty cheesecakes for years, and the business has been growing locally. The problem is that the team is still working out of Oldham's home kitchen. It needs funding to expand into a larger facility.
"Restaurants both in-state and out are interested in carrying our product, but we can't produce on a mass level because we don't have the facility," Oldham said.
He's confident he'll be able to pay back the $10,000 loan he's seeking. But banks are not budging, including the one that holds his company's accounts. "They told us to consider using credit cards, but with rates as high as 20%, I'm not really willing to go that route," Oldham said.
Oldham is now looking for cheesecake-loving investors, which may mean giving up partial ownership of the company: "I'd rather do that than deal with rates."
Weathering storms
Few entrepreneurs say they're looking for financing and loans to fund ordinary operations; business owners know that debt is expensive. What drives businesses to banks are growth plans or unexpected shocks.
For Hull Printing, the tipping point was an expansion gone wrong. About to outgrow a too-small building, the company owners began looking for new real estate. A sales manager pitched a broader expansion: Add new equipment and increase printing capacity, she said, and sales will jump.
That turned out to be inaccurate. Hull Printing added employees and bought advanced new printing presses, but sales stayed flat. Then the company's bank turned the vise tighter: It announced that by expanding without the bank's permission, Hull Printing had violated the terms of its existing loan. Although the company was making all its payments on time, Jon Hull says, the bank placed Hull Printing in default.
"Our banker knew, and chose not to tell us, 'you guys are risking a lot by making this expansion,'" Hull said. "Putting us in default instantly caused the interest rates on our credit lines to double, which only added fuel to the fire. Here we have a struggling company, and they're adding fees."
Hull worked with a business consultant to try to improve the business's cash flow, and he lined up a buyer interested in taking over the business. But as the company's credit dried up, so did its options and its daily operations. Eventually, closing down became inevitable.
Rusty Quave of Fayard's Grocery is trying to stave off that fate. Storms are his problem. Almost 30% of D'Iberville residents who left town after Katrina haven't come back. When Hurricane Gustav blew through last month, D'Iberville evacuated again, and Fayard's Grocery had no customers for several days.
Open every morning at 6 am, the store has temporarily pulled its closing time back from 9 pm to 3 pm. That's still enough time to feed the breakfast and lunch crowds, who gather at Fayard's for buffets of chicken, shrimp, crawfish, and other Gulf Coast specialties. Locked in negotiations this week with the Small Business Administration, which holds the note on the disaster-assistance loan Quave took out after Katrina, Quave is seeking a deferral. A one-year break on repaying his loans will give him the cash flow he needs to keep Fayard's Grocery open and his staff of 10 employed, he believes.
"We're not asking for free money, we're asking for loans and deferrals of payments to allow us to stay in business and keep being productive," Quave said. "My business is struggling but I'm hanging on. I'm not going to quit or file for bankruptcy, which would be the easy way out. You can't give up. We want to live here and keep our businesses going."
