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The Real Threat to the U.S. Economy

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So far, all eyes have focused on the big companies hit by the credit crunch. But for most people, the worst effects on the U.S. economy will come from further down the economic chain -- as small businesses increasingly have trouble keeping their day-to-day operations going.

Large companies have plenty of options to raise capital. Publicly traded companies can do secondary public stock offerings, as Bank of America (NYSE: BAC  ) did to raise $10 billion in capital. They can negotiate private deals, as Goldman Sachs (NYSE: GS  ) did to get $5 billion from Warren Buffett. They can issue bonds to get long-term debt financing. Tapping the short-term commercial paper market to get direct debt financing at a lower cost also usually works, although recent high rates have led companies such as General Electric (NYSE: GE  ) , Deere (NYSE: DE  ) , and Caterpillar (NYSE: CAT  ) to reduce their reliance on commercial paper to raise cash. And going directly to a bank for loans and lines of credit is a common practice as well.

Nightmare on Main Street
Small businesses, though, lack the financial flexibility that larger companies have. Issuing stocks or debt directly isn't typically an option, leaving small business owners at the whim of bank decisions. And since Small Business Administration statistics estimate that about half of all non-government jobs come from small businesses, it's just as important for the overall economy to keep small business healthy as it is to keep large companies afloat.

One thing small businesses can do to get financing is to apply for special loans guaranteed by the SBA. Although the SBA doesn't lend money directly, small businesses can go to a bank and apply for an SBA-guaranteed loan. One SBA program, for instance, guarantees up to 50% of a loan up to $350,000 for borrowers that meet certain requirements. Because the lending bank is still responsible for half or more of the loan if the borrower defaults, getting a loan isn't as easy as getting a mortgage loan was several years ago. But the SBA guarantee can make a big difference.

Unfortunately, banks seem to be tightening the strings on SBA-program loans. The SBA reported a 30% drop in the number of guaranteed loans in the year that ended Sept. 30. Although banks cite declining credit quality among applicants, borrowers claim the process of obtaining loans has become more difficult.

Putting it on the card
Alternatives to traditional bank financing for small businesses aren't attractive. Some businesses have used online loan services like Prosper and LendingClub to get financing directly from individuals. Although some owners successfully find financing at fair rates, concerns about how diligently these services pursue borrowers who default on their debt have led some prospective lenders to bow out of the service. In turn, that's made it more difficult for responsible borrowers to find money.

Other business owners increasingly rely on business credit cards to cover expenses and make ends meet. But with extremely high interest rates even for borrowers with good credit histories, it's easy for a small business to find its entire profit margin going to cover just interest payments. In addition, with many lenders decreasing credit limits on cards, the timing couldn't be worse for those who've turned to cards as a last resort.

No easy solution
In the end, what happens to small businesses on Main Street will depend largely on the health of the banks they use to obtain credit. Although big national banks like Citigroup (NYSE: C  ) and JPMorgan Chase (NYSE: JPM  ) may capture the headlines about the impacts of the bailout on the banking system, the primary question for small businesses is whether benefits from the bailout trickle down to small community and regional banks. It's the health of those banks that will eventually determine the fate of small-business owners across the country.

For more on responses to the economic crisis, read about:

JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. Now more than ever, stocks that have cash to pay dividends give investors a competitive advantage over those that require constant financing. To learn more and get our other recommendations, take a look at our income investing newsletter -- it's absolutely free with a 30-day trial.

Fool contributor Dan Caplinger sees small businesses suffering firsthand. He owns shares of GE. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is never threatening.

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  • Report this Comment On October 10, 2008, at 1:49 PM, UncleSkell wrote:

    There's something about this that I don't understand, and before I ask about it, I'd like to emphasize that this is a serious question and one that I hope merits a serious answer.

    It seems to me that a business that has to rely on credit to fund continuing operations rather than income from its regular business activity is in a bad position to begin with.

    In other words, should a company's business model rely on borrowing money rather than generating profits to stay in business? At some point all that borrowed money is going to have to be paid back, and if there isn't enough income to keep the doors open, there isn't likely to be enough income to keep the doors open and pay interest on loans. Eventually, the whole thing will collapse.

    What am I missing here?

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