Unusual Uncertainty

A defining phrase, to be sure.  Almost as good as “irrational exuberance.” Also just as likely to result in effective policy action by the Fed.

In response to Egor’s question (no relation to Eeyore, except perhaps in a shared opinion of the other animals in the woods), I was thinking again about the virtual hiring freeze we’ve seen since the financial crisis took hold.

Nearly everyone says that private businesses aren’t hiring because of uncertainty.

That’s true, but the commentators then contort the facts to support a political explanation of what drives that uncertainty.  The real reason is much simpler, and much more powerful than marginal tax rates, or even the cost of health insurance.

The single factor that prevents long term planning is lack of financing, especially for businesses with fewer than 500 employees.

I know the pundits would have us believe that the potential of returning to 1990’s tax rates are keeping small businesses from hiring, but this chart from the Wall Street Journal (Tax Foundation data) shows us that a business owner with no children taking out $500,000 per year in income after every business tax break and deduction will be facing a whopping $6,442 increase in taxes.

That difference in after-tax income just can’t be the kind of disincentive to hiring that the corporate and business press make it out to be.  And let’s face it, there are far more small businesses whose owners take out $150K in profit than ones with $500K in personal income passed on to the business owner.  For them, renewing the Bush tax rates raises their taxes by several percent.

Even sillier is the argument that health insurance reform mandates that apply in 2014 somehow keep people from hiring today, since small businesses get a benefit from the reform that actually lowers their cost per covered employee.

The elephant in the small business room is lack of financing for every aspect of their business.

The ABCP (Asset-Backed Commercial Paper) market used to provide very affordable financing for everything from receivables to raw materials, inventory and equipment.  The CMBS market provided the financing for small commercial buildings.

The ABCP market has shrunk to less than a third of what it was, removing more than a trillion dollars of five to seven year financing capacity that banks could originate and sell into securitizations.  The market for small commercial building loans is basically nonexistent.

Since banks fund themselves through deposits and CDs, they can’t take the risk of holding longer-dated debt issued to companies that don’t (and can’t support) investment-grade public ratings.  Until the securitization market offered an affordable alternative, small business owners could apply for SBA loans (giving the banks a government guarantee), pledge their homes or other real estate, or simply wait until they had enough savings to make new commitments to plant, equipment, inventory, or employees.

Planning for a small business today consists of staffing and buying raw materials sufficient to handle the orders that are in hand.  Unfortunately, the capital market crisis destroyed the source of funding for longer term investments and planning.

It’s beyond silly to think that minor changes in future taxes or health insurance costs can outweigh the reality that a business owner simply can’t get multi-year credit to expand or maintain their business.

We need to see the return of non-government securitization before the economy can return to a growth path robust enough to absorb the unemployed and the new workers coming into the market.

That applies to commercial property financing, and to new equipment, inventory and receivables.  Without knowing you can depend on five years or more to make new investments pay, no one will be making new investments, including hiring.



5 Responses to Unusual Uncertainty

  1. cyn says:

    I thought that the big banks had decided they could make more money playing in the fields that you know so well and selling real estate that they acquired by not following any of the making loan affordable criteria. I think they will make enough on selling the good real estate that the loosing ones will seem insignificant. Lending is a loosing proposition, so why bother. These are not our father’s banks anymore.
    Oh Lloyd Blankfeld gave a party for 20 somethings with servant holding torches to lead to the tent, dessert was over $50,000. Everything was so over the top my friend’s children that have been to many over the top thought this one vulgar. Long live the banks!

    • hhill51 says:

      No doubt about it, especially with the capital requirements for loans to private borrowers sop much higher than what gets reserved for “loans” to the government (eg MBS investments).
      My point is that the private label ABS, MBS and CMBS market provided a means of long-term matched funding, and the banks that originated those loans, leases, mortgages, or whatever sold them to the securitizations.
      Definitely an important baby thrown out with the bathwater. As I explained in my summary of how to fix the problem, “first level” securitizations that have direct exposure to a large pool of borrowers were an excellent innovation, at least as important to the world of finance as the integrated circuit was to communication. They went off the rails with CDO’s and other “second level” securitizations.
      PS the Fed should definitely stop paying interest on bank overnight deposits.

  2. HR says:

    You seem to focus exclusively on the federal tax rate. All taxes and fees have gone up and are going higher at the local, state, and federal levels. Taxes are my biggest expense by far over food, clothing, housing, transportation combined. I pay a far higher percentage of my income in taxes now with the Bush tax cuts in place than I did under the higher federal rates in the 1990s.

    Also, for my business, a lack of financing is not an issue. I refuse to hire any employees because of all of the onerous rules and regulations that come with them.

    • hhill51 says:

      At first I thought you might be exaggerating a little to make a point, but then I looked at what you said as a “word problem,” like in grade school. In other words, I asked myself what sources/changes in your income stream could make what you say all true?
      First, let me congratulate you on how successful you are. Second, let me guess that a significant portion of your taxes are property taxes on income property, at least some of which has been added since the 1990’s. I suppose you “pay” those taxes, but I’ll bet your tenants actually earn the money that pays those taxes, giving it to you in rent. I liken it to the claim by vertically integrated oil companies that they pay more taxes than anyone on the planet, when the bulk of the taxes they pay never come out of their equity “pocket” but are paid by us when we buy gas at the filling station. If the truth be told, the oil company turns a handy profit on all that cash by extracting the float until they forward it to the gubmint.
      Finally, your business must be a service business where you can be a one-man shop where you never had any employees. Again, congratulations on choosing a profession where you could do that and succeed so well.
      Am I close?

      • HR says:

        You are very close.

        I’m self-employed with a service business (Consulting Engineer) and own two SFR rental properties (with mortgages) in addition to the property I live in (also mortgaged). I’ve made it into the highest tax bracket by working 60+ hours/week and with no retirement benefits (other than SS) while well off, I’m hardly rich. I drive a $25k used car and vacations are used to work on the rental properties that are located in another state.

        The real estate taxes, while large (to me) are only about 20% of my total tax burden. I must say I find your comparison of me to BIG OIL interesting, LOL. Isn’t investing in rental real estate providing a service to my tenants and society in general? Politicians always talk about providing affordable housing, yet property taxes are the biggest expense at 39% and 50% or the total rent. Property taxes have also increased faster than inflation and my ability to raise the rent. I’ve learned my lesson and will never buy another rental property because even with low interest rates there is no payback and as a property owner you are a hostage to property taxes.

        You are good with numbers. One house is worth about $300k and rents for $1300/month. Taxes are $650/month and insurance about $125. Not considering maintenance and other costs if you paid cash you’d net $6900 on a $300K investment or about 2.3%. Depreciation is deductible and improves your net, but as a “rich” taxpayer, deductions are also limited. You also have the problem of a lack of access to your funds and the fees associated with RE transactions and capital gains taxes if you sell. Is this an investment you’d make?

        With a Wall St career and friends that can buy 100k shares of DX, you travel in a different circle than I do. I’d be willing to share more tax info privately, but I think you are going to have a very hard time convincing me I need to be happy about paying more taxes!

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