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Source link: http://archive.mises.org/11186/productive-debt-versus-unproductive-debt/

Productive Debt versus Unproductive Debt

December 8, 2009 by

Low interest rates don’t especially make lending to small businesses worth the heightened risk. Moreover, if a bank can afford to, it will likely take all the bad-debt charge-offs possible in the fourth quarter. FULL ARTICLE by Doug French


Richard Robinson December 8, 2009 at 9:29 am

A point that may have been missed in this piece is that a significant amount of lending to small businesses is that it is classified as consumer not comercial lending.
Small businesses such as mine are financed via the good old fashioned plastic money of the credit card issuers on personal accounts. This I believe is quite hard to quantify.
In addition, for other small and medium size enterprises, the bank has taken a back seat to private sources of capital, both debt and equity.

Briggs December 8, 2009 at 10:27 am

Mr. French made the point: “But commercial and industrial loans outstanding barely budged, only growing from $947 billion a decade ago to $1.27 trillion by September 30 this year.”

This is even more disturbing when one plugs $947 billion into the government’s official CPI calculator. This number is $1.23 trillion once adjusted for official inflation. So over the last decade, it seems as if commercial and industrial loans actually shrank!

Though I could be overlooking something.

Ohhh Henry December 8, 2009 at 10:29 am

“Washington should be lowering taxes and the costs of hiring employees, especially in industries that produce capital and wealth.”

I don’t think that DC should be doing anything other than what it is doing right now. It, or rather the people who live there, are parasites. For them to do the things that you prescribe would be to act against their own interests. Less tax revenues and a strong economy mean fewer jobs for state nannies and less power and patronage for legislators, executives and cabinet members. You might as well say, “Mosquitoes should stop sucking blood and spreading malaria and encephalitis.” You cannot appeal to mosquitoes’ better sides because they have none. It is not in their nature.

I think that the first step toward fixing the problem is to identify the harmful effects of public policy, which you have done. The second step is to relate these bad policies to the fundamentally parasitical and incorrigible nature of coercive monopolies, i.e. of government. Only when these lessons have been sufficiently absorbed by the public can there be a peaceful rejection and repudiation of state control.

fundamentalist December 8, 2009 at 10:58 am

Does bank lending to business include GE Capital and the big firm that just went bankrupt, the name of which I can’t remember, but they did primarily business loans?

Argosy Jones December 8, 2009 at 11:57 am

This is very interesting. I’ve recently been attracted to a lot of the Austrian Economics lectures and articles on mises.org and I’m partial to the Austrian theory of the business cycle, but I was always puzzled by the fact that real estate speculation and building construction seemed to have been the proximate cause of this bust– I understood ATBC to hold that low interest rates gave false signals to businessmen that led them to divert unsaved resources into long-term capital goods that facilitate a more roundabout production process. It’s true that builders spent a lot on earthmoving equipment and the like, but this really an extension of the same production process, rather than, for example building a factory to build houses in.

So I was always puzzled that so much of the bad lending going on was to consumers of houses and condominiums. I know that construction loans etc. were made, but these are only possible because of the ready availabilty of home loans, which must necessarily exceed construction loans in volume, during the boom, at least.

Thanks for the article. Thought provoking.

greg December 8, 2009 at 1:09 pm

It is not the availability of financing that keeps a small business from growing, it is the nature of the evolution of the small business.

When a small business starts out, they usually operate on very low overhead. As the business grows, demand requires the business to expand their overhead. The problem is the two person operation needs to hire one person that increases their labor overhead by 33%. To cover this expense the business needs funds to carry them until product sales increase.

This is easy to forecast as long as the economy is expanding. But throw in a downturn and the overhead begins to eat into their reserves. The small business can layoff the employee, but the fixed cost of the expansion and the financing they received still exist.

In my business, home construction, I can build up to 5 houses a year with just my wife and I working. However, if I took on a 6th house, I would need to hire one person and the equipment required to perform their work. I would need to build 8 houses a year in order to cover these expenses.

For me, I prefer to stay with the 5 houses. But many builders in my area went with the expansion model. Most of them found that in order for them to maintain the 8 houses, they needed to spend more time marketing and needed to hire more people to cover the work he no longer had time for. Expenses and overhead continue to grow.

Then the downturn hit. I had no specs in inventory while the expanded builders had 3 or 4. Interest and overhead took them out while I maintained my capital to enter the market when no one else can.

It isn’t the availability of financing that is constraining small business, it is overhead!

Lysander December 8, 2009 at 2:50 pm

The article makes a good point that housing loans “stay on the banks’ books for long periods of time”. This is money coming into existence that might last for 25 years, while the deposits which originally funded it might be withdrawn almost overnight. This is money-creation on a scale 100 times larger than a 3-month commercial loan of the same value.

The housing bubble has been fueled directly by money-creation. Stock-market bubbles have been fueled by shorter-lived margin loans, and therefore the stock-market boom-bust cycle is shorter. We can look forward to a 25-year bust in the housing market if the correction is allowed to run its course, though more likely the housing junkie will be given new injections of cash long before then.

I disagree, however, that “houses are nonproductive assets”. We need somewhere to live and sleep if we are going out to work during the day. It is just as productive to build a house for someone as it is to grow food for him, clothe him, or cure him when he is sick. Buying a house for yourself saves you money that you would have needed for renting, while buying a house as an investment provides rental income. A house is nonproductive only to the extent that it contains unnecessary rooms, extravagant accessories (gold-plated taps?), or, as an investment, if bought for the purpose of capital gain rather than rental income.

billwald May 5, 2010 at 9:24 pm

At least two reasons why renting is cheaper than buying. First, routine maintenance and other costs are deductible to the landlord. Unless you can convince yourself that mowing the law is your hobby you need to pay yourself at your overtime rate to see what home ownership is costs.

Second, most people buy twice the house that would satisfy them if they were renting.

ABR December 8, 2009 at 3:14 pm

Greg’s story illustrates a truth of business: it’s often much easier (and more profitable) to remain tiny than it is to grow.

Once a company creeps up to around fifty, its internal structure starts to resemble socialism: central planning. The State exascerbates and encourages this tendency.

A company without much in reserve could withstand a downturn if the company could reduce the wages of its employees, but State regulations typically prevent that from happening.

In a family business, everyone can take a cut. The business survives.

Craig December 8, 2009 at 3:25 pm

I disagree, however, that “houses are nonproductive assets”.

That’s been a contentious point for hundreds of years. Of course, doctors and teachers would probably disagree that their professions are economically unproductive, too — but they are.

It’s true that, minus their valuable skills, we couldn’t go out and produce as much as we do, but the fact remains that they consume wealth to provide their services; they don’t create it. The same is true of houses, though your example of rental property is the exception.

Sebastian December 8, 2009 at 4:02 pm

I don’t understand why banks might have an incentive to issue longer-term debt (mortgages vs. short-term loans). Wouldn’t lending preferences depend on the interest strucure (which could change)?

Nelson December 8, 2009 at 5:00 pm

The distinction seems unimportant. Does it really matter if the builder gets funds directly from the bank or indirectly through purchasers?

Nelson December 8, 2009 at 5:33 pm

“It’s true that, minus their valuable skills, we couldn’t go out and produce as much as we do, but the fact remains that they consume wealth to provide their services; they don’t create it.”

This is false. Doctors and teachers do produce wealth. Doctors produce health. Teachers produce education. Both are “goods” and therefore wealth has increased.

Nelson December 9, 2009 at 11:40 am

“Teachers in the private sector do produce education. Public school teachers do not.”

What is the rational behind your statement? At most you can say that public school teachers have the possibility of not producing more education than they consume in resources. But the same can be said of private school teachers as well.

Dave December 12, 2009 at 12:25 am

Excellent article. Might this help explain why the U.S. doesn’t produce much of anything anymore and why jobs have “moved” overseas?

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