Why Small Businesses Aren’t Hiring …

This is the first time I’ve seen somebody make the direct connection between the decline in housing prices and the high unemployment rate. 

Common knowledge: consumers are spending less because of the “wealth effect” .

Insightful twist: most small businesses serve the real estate market and many of them use their owners’ homes as collateral for their loans.

For my answer to the residential housing mess, see last week’s post:
https://kenhoma.wordpress.com/2010/08/18/instead-of-an-august-surprise-answer-for-getting-housing-on-track/

* * * * *

According to AEI …

In the recoveries from the previous two recessions, small businesses led job creation. This time, however, small businesses aren’t hiring.

Here’s why.

The collapse in home prices is holding back small-business hiring. And unless we fix the residential real estate mess, we won’t see small business hiring anytime soon.

The weak residential real estate market is keeping small businesses from hiring in five ways:

1. Declining house prices have softened demand for small businesses’ products and services.

The 29.5 percent drop in home values from the first quarter of 2006 until the end of the first quarter of 2010 has led to a huge drop in household wealth, which has led to reduced consumer spending.

Studies show that consumption falls by about 8 cents for every dollar of decline in wealth.

2. Small businesses are overrepresented in the real estate-related industries that have been decimated by the residential housing market collapse.

Falling home prices have devastated employment in construction and real estate businesses, virtually all of which are small companies.

Prior to the recession, 10.4% of all people employed in small businesses worked in construction. Add another 2.5% who work in real estate and rental and leasing businesses, and we had more than one in eight U.S. small business workers in construction and real estate.

3. Small business owners use their homes to obtain business credit.

Business borrowing of almost one in four small business owners is tied to the value of their homes.

As home prices have fallen, small-business-owning homes have seen their personal balance sheets weaken.

As home values have fallen, small business owners whose business debt is linked to residential real estate have faced demand for more collateral by lenders.

The weakened balance sheets and demand for additional collateral has meant that fewer small business owners have been able to expand.

4. Banks have tightened lending standards in response to a rising share of non-performing real estate loans.

The banks with real-estate problems are among the biggest small business lenders.

These banks have tightened up their lending standards.

Tighter loan standards mean fewer small businesses can get capital for expansion that leads to hiring.

5. Small business owners were major customers of residential real estate loans during the boom, making them among the consumers hardest hit from the collapse in home prices.

Small business owners took on a lot of mortgage debt during the real estate bubble and are now suffering from the fall in residential real estate prices.

Tighter loan standards mean fewer small businesses can get capital for expansion that leads to hiring.

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We should acknowledge why small businesses aren’t leading job creation this time around and come up with solutions to the residential real estate problems that are holding them back.

If the residential real estate mess keeps the small business sector from hiring, it will be awfully difficult to reduce our unemployment rate to a reasonable level.

Excerpted from AEI: Why Small Businesses Aren’t Hiring, August 24, 2010
http://www.american.com/archive/2010/august/why-small-businesses-arent-hiring

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