The Real Recovery Lies in Small Business Creation

LOS ANGELES—Since the Federal Reserve began easing monetary policy to combat the 2008-09 global financial crisis, most Fed forecasters have been predicting a normalization in the Fed Funds interest rate, or for the Fed to begin rate hikes. Since the beginning of the recession in 2008, surveys of America's top economists repeatedly predicted the Fed funds rate to rebound to 4.0% by the summer of 2010. As 2015 rolls on, the US recovery is apparently underway as evidenced by rising job figures, reaching nearly three million new jobs in 2014. 

Prices for commercial real estate of all types continue to escalate, cap rates are further compressed, interest rates remain low, and available product in all categories remains scarce. Yet it seems that while equities and real assets hit new highs, there is still a lack of real net job and wage growth in the economy. I have seen firsthand that bank credit is still scarce for those who are not fully liquid with tremendous assets.

In my opinion, the recovery will not be fully implemented until banks lend to middle America—to small businesses who are the true engine of job creation.  According to the Small Business Administration, 67% of all jobs created since 2008 have been by small businesses defined as firms with 20 to 499 employees.  However, there has been little regulation directing banks to lend to this cash-strapped segment of the economy.

On the federal balance sheet there is an entry for “Reserve balances with Federal Reserve Banks.” According to the St. Louis Fed, in October 2007 that number was below $7 billion. As of October 2014, that line item entry was above $2.7 trillion, or over a 38,000% increase. The bottom line is that the Fed has a direct policy of allowing banks to redeposit money at the Fed and paying the banks a positive spread for those same deposits. That payment is labeled as “Interest on Excess Reserves” but could also be called the “Bank Non-incentive to Loan to Small Business Plan.” 

Simply put, the banks are making money by borrowing from the Fed, then loaning that same money right back to the Fed at a profit. Why would a bank make a loan to a small business if the Fed will keep up this shell game to keep them profitable? No wonder earnings are up at all financial institutions, there is no need for risk, loan officers, underwriting fees or any other debt or increased overhead expenses.

The bottom line is that until the Fed weans the banks from this fully subsidized profitability charade, then there is no reason for lenders to take any chances on the real job-creating engine in America. As quantitative easing is tapered off, perhaps banks will again have to invest in the communities in which they are located and help fuel some real growth in this economy. Freeing up credit to small business will allow them to reinvest in their businesses and infrastructure. It will also allow businesses to expand and absorb existing commercial real estate and fuel demand for additional office and industrial space. 

This growth of middle America, this rebuilding of the American job engine and all the buildings, equipment, jobs and supplies, is what is really needed to achieve true employment and wage growth in the U.S. economy.

David A. Parker is senior managing director at Charles Dunn Co. He may be contacted at dparker@charlesdunn.com. The views expressed here are the author's own.