Fear is holding America back: Maley

US Fed boss Ben Bernanke knows that the US is stuck in the economic version of a chicken-and-egg situation. He knows that the economy won’t start picking up until banks start lending to small businesses. But, at the same time, banks won’t start lending – and small businesses will be reluctant to borrow – until the economy starts looking a whole lot better.

In a speech earlier this week, Bernanke tried to tackle one side of the problem – let’s call it the ‘chicken’ side – by urging banks to get a bit braver and to start supplying small businesses with the credit they need to create jobs. And with the US unemployment rate stuck at a stubbornly high 9.5%, this has to be a priority.

“The formation and growth of small businesses depends critically on access to credit,” he told a forum earlier this week. “Unfortunately, those businesses report that credit conditions remain very difficult.”

So weak, in fact, that lending to small businesses is actually contracting. Bernanke pointed to figures showing that outstanding loans to small businesses fell to less than $670 billion in the first three months of 2010 from about $710 billion in the second quarter of 2008.

The boss of the Federal Reserve recognised that banks faced a challenge in assessing the credit quality of small businesses in the current difficult economic environment. But he also said it was “clear” that some creditworthy borrowers were being denied credit.

There are a number of reasons why banks have cut back on lending to small businesses. Firstly, most banks significantly tightened their lending standards in the wake of the financial crisis. While banks have re-opened their doors to big business borrowers, they remain wary of small businesses. Small business borrowers have seen a collapse in the value of their collateral – typically the family home. As a result, they’re more dependent on borrowing based on their cash flow projections. What’s more, small businesses are much more heavily exposed to the troubled US domestic market, while large US companies find it easier to tap export markets.

In addition, many of the smaller regional banks that small businesses rely on for their loans are already struggling under a mass of distressed loans to the troubled US commercial real estate sector.

But there’s a flip-side – if you’ll excuse the bad pun – to Bernanke’s chicken-and-egg dilemma. Small businesses are so worried about the prospects for their future sales that they’re extremely wary about taking on new loans, even though the US Fed has reduced rates to close to zero.

The National Federation of Independent Business (NBIF) optimism index, released overnight, showed just how bleakly small businesses viewed their future.

The index dropped in June, reversing several months of small increases. Small businesses believed that the economic outlook – and their prospects for lifting sales and earnings – were deteriorating. They were scaling back their hiring intentions, and their plans for capital spending. They also reported that credit conditions had tightened in the month.

The NBIF’s chief economist, William Dunkelberg, warned that the dire state of the small business sector, and their lack of confidence in the Obama administration’s economic policies, meant there were “hurricane force headwinds” to the US economic recovery.

“The small business sector is not on a positive trajectory and with this half of the private sector missing-in-action, the economy’s poor growth performance is no surprise,” he said.

This article first appeared on Business Spectator.