Tuesday, October 20, 2009

Economic Recovery?

Yesterday we said, "It's not hard to see that if we don’t get a dramatic recovery in the economy, Canada is going to be in deep trouble." And on the weekend 'economic recovery' was the main topic of discussion at our Rainforest Roundtable.

Despite the belief in the mainstream media that the economy is starting to turn around, we just don't see it happening.


Because access to credit in the United States, our largest trading partner, is being denied at an accelerating pace.

Large, well-capitalized companies have no problem finding credit. But small businesses, on the other hand, have never had a harder time getting a loan.

According to prominent banking analyst Meredith Whitney, available credit to small businesses and consumers has contracted by trillions of dollars since the onset of the credit crisis over two years ago.

Small-business credit has contracted at one of the fastest paces of any lending category. Small business loans are hard to find, and credit-card lines (a critical funding source to small businesses) have been cut by 25% since last year.

Unfortunately for small businesses, credit-line cuts are only about half way through. Home equity loans, also historically a key funding source for start-up small businesses, are not a source of liquidity anymore because more than 32% of U.S. homes are worth less than their mortgages.

Why do small businesses matter so much?

In the US, small businesses employ 50% of the country's workforce and contribute 38% of GDP. Without access to credit, small businesses can't grow, can't hire, and too often end up going out of business.

What's more, small businesses are often the primary source of this country's innovation. Apple, Dell, McDonald's, Starbucks were all started as small businesses.

Whitney notes that, as is true in most recessions, banks' commercial lending portfolios shrink as creditworthy customers pay down their debts and the less-worthy borrowers are simply denied loans. Banks, in other words, want to lend only to those that don't want to borrow. Challenging as that may be, in the last cycle small businesses at least had access to their credit cards.

Small businesses primarily fund themselves through credit cards and loans from local lenders.

But in the past two years, credit-card lines have been cut by over $1.25 trillion. During the same time, 10% of all credit-card accounts have been cancelled. According to the most recent US Federal Reserve data, small business lending is down 3%, or $113 billion, from fourth-quarter 2008 peak levels — the first contraction since 1993.

Credit cards are the most common source of liquidity to small businesses, used by 82% as a vital portion of their overall funding. 79% of small businesses surveyed tell the Small Business Association that credit-card lending standards have tightened drastically and their access to credit lines has decreased materially.

Whitney believes that the US is only in the early stages of the second half of this credit cycle. She expects another $1.5 trillion of credit-card lines to be removed from the system by the end of 2010. This includes not only the large lenders reducing exposure but also the shuttering of several major subprime credit-card lenders. Beginning in the fourth quarter of 2007, lenders began reducing available credit by zip code. During the past four quarters, lenders have cut "inactive" accounts (whether or not the customer viewed the account as a liquidity vehicle).

The next phase will likely be credit-line cuts as lenders race to pre-emptively protect themselves from regulatory changes associated with the Credit Card Accountability, Responsibility and Disclosure Act, passed in May of this year, and the 2008 Unfair and Deceptive Acts and Practices Act.

The relationship between the United States and Canada is the closest and most extensive in the world. It is reflected in the staggering volume of bilateral trade - the equivalent of $1.5 billion a day in goods.

But when your biggest customer can't buy your goods, it doesn't bode well for your 'economic recovery'.


Email: village_whisperer@live.ca
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  1. MBNA cut my Mastercard's available credit by 60% in May 2009. It's not much of a problem for me, because I always pay my balance off, but it came as a surprise.

    The biggest change for me, though, is that I have to watch my card balance over the course of the month-- my card's total credit is such that if I have a few expensive purchases straddling my card's month-end, I could go over the credit limit, which would result in over-limit fees.

  2. I am aware of 30-45% cuts, but this is the first I have heard of a 60% cut.

    Thanks for the comment and welcome to the blog.