How the Housing Bubble Explains the Small Business Mess

One of the places where some economists see bright spots for the US economy next year is the return of small business investment. For the last two years, small businesses have been starved for credit for a few reasons. The weak economy has hurt demand for their goods and services, so businesses see no reason to expand. The recession's impact on profit means small business have worse credit and qualify for fewer loans. And the economic climate, combined with tighter regulations, have made banks reluctant to lend to riskier small firms.

Some economists think the credit freeze might be coming to an end. But a new report from the Cleveland Federal Reserve says small business lending, like so much of the Aughts' economy, was propped up by inflated housing prices and home equity loans. The housing bubble pop continues to weigh on small business expansion:

The decline in home values has constrained the ability of small business owners to obtain the credit they need to finance their businesses.

Those more likely to [use residential real estate to finance businesses] include companies in the real estate and construction industries, those located in the states with the largest increases in home prices during the boom, younger and smaller businesses, companies with lesser financial prospects, and those not planning to borrow from banks. These patterns are also evident in the data sources we examined.

The link between home prices and small business credit poses important challenges for policy makers seeking to improve small business owners' access to credit. The solution is far more complicated than telling bankers to lend more or reducing the regulatory constraints that may have caused them to cut back on their lending to small companies. Returning small business owners to pre-recession levels of credit access will require an increase in home prices or a weaning of small business owners from the use of home equity as a source of financing. Neither of those alternatives falls into the category of easy and quick solutions.

Once again, even if most indicators are turning up outside of the housing market, ongoing weakness in real estate continues to reach into all sectors of the economy.

Read the full story at Cleveland Fed.

Presented by

Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

Why Is Google Making Human Skin?

Hidden away on Google’s campus, doctors at a world-class life sciences lab are trying to change the way people think about their health.

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register with Disqus.

Please note that The Atlantic's account system is separate from our commenting system. To log in or register with The Atlantic, use the Sign In button at the top of every page.

blog comments powered by Disqus

Videos

Why Is Google Making Skin?

Hidden away on Google’s campus, doctors are changing the way people think about health.

Video

How to Build a Tornado

A Canadian inventor believes his tornado machine could solve the world's energy crisis.

Video

A New York City Minute, Frozen in Time

This short film takes you on a whirling tour of the Big Apple

Video

What Happened to the Milky Way?

Light pollution has taken away our ability to see the stars. Can we save the night sky?

Video

The Pentagon's $1.5 Trillion Mistake

The F-35 fighter jet was supposed to do everything. Instead, it can barely do anything.

More in Business

Just In