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The Great Recession, Conventional and Non-conventional Federal Government Responses

and their Impact on U.S. Small Businesses.

October 20-21, 2010 Urbino Italy

Giuseppe GramignaChief Economist

U.S. Small Business Administrationgiuseppe.gramigna@sba.gov

The Origins of the Financial Crisis: Housing

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•Housing prices outpaced income.

•During the 2000- 2006 period, Housing Prices increased 13%, while Disposable Income grew 4.5%.

Source: Standard & Poor’s , U.S. bureau of Economic Analysis and SBA calculations.

The Origins of the Financial Crisis: Housing

3Source: Standard & Poor’s , U.S. bureau of Economic Analysis and SBA calculations

Housing took a bigger portion of disposable income.The Housing Price to Disposable Income ratio nearly doubled, from the 3.6 at the end of 1996 to 6.9 during the first half of 2006.

3.6

6.9

The Origins of the Financial Crisis: The Financial Sector Assets

4Source: Board of Governors of the Federal Reserve System, Flow of Funds and SBA Calculations

•Mortgages became a bigger portion of Financial institutions’ assets.•During the 1990’s mortgages accounted for 25% of commercial banks’ total assets. This ratio peaked at 32% during the first quarter of 2007.

The Development of the Financial Crisis: The Short-Term Credit Market

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•Lack of confidence led to a contraction in interbank lending. •Asset-backed securities increased rapidly during the 2005-2007 period.

•Product complexity and opacity increased the perceived risk of these assets.

•By the latter part of 2007 the market lost confidence in these assets.

Source: Board of Governors of the Federal Reserve System

July 08, 2007

January 07, 2009

Lehman Bros. bankruptcy 9-15-2008

The Development of the Financial Crisis: Risk Premiums

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LIBOR: interest on interbank lending.3-Month Treasury: Interest for safe investments.

Lehman Brothers collapse

Source: Board of Governors of the Federal Reserve and Moody’s Economy.com.

The Development of the Financial Crisis: The TED Spread

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Source: Board of Governors of the Federal Reserve, Moody’s Economy.com, and SBA calculations.

Financial sectors’ risk premiums rose sharply.

The Development of the Financial Crisis: Credit Supply

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Large Banks reduced credit (tightened standards) to large and small firms.

Source: Board of Governors of the Federal Reserve. Senior Loan Officer Opinion Survey on Bank Lending Practices

Less C

redit

Mo

re Cred

it

Large firm focus

Small firm focus

The Financial Crisis and the Economy: Real GDP

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Real GDP declined sharply.

Source: U.S. Bureau of Economic Analysis

The Financial Crisis and the Economy: Utilization Rates

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Utilization rates in the labor market and industrial sector dropped dramatically.

Source: Board of Governors of the Federal Reserve System, and U.S. Bureau of Labor

The Financial Crisis and Conventional Government Intervention: Monetary Policy

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Source: Board of Governors of the Federal Reserve System,

The Financial Crisis and Non-Conventional Government Intervention

12Source: Alan S. Blinder and Mark Zendi, "How the Great Recession Was Brought to an End", July 27, 2010

•38 actions in total.•32 actions for financial liquidity and asset price stability.

•6 actions to stimulate the economy.•Extending $12 Trillion in support, about 86% of GDP. Expected to cost $1.6 Trillion dollar, about 11% of GDP.

The Financial Crisis and Non-Conventional Government Intervention: The Fed

• The Fed intervenes to ensure liquidity and price stability.

• Intervenes in Fixed Income and Equity Markets.• (1) Extends direct-lending to Primary Dealers in Equity Markets.• (2) Directly purchases equities of trouble financial institutions.• Guarantees assets of large financial institutions.• (3) Provides funding for the guarantees of large financial institutions

(BofA and Citi).• Enhances liquidity in Asset Baked Markets.• (4) Swaps (sells) "safe" treasuries for less liquid assets.• (5) purchases ABS of recent vintage.• Enhances liquidity in the currency markets.• (5) Swaps U.S. dollars for other currencies with other central banks

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The Financial Crisis and Non-Conventional Government Intervention: Treasury, FDIC, FHA.

Treasury:• Allocates newly approved Congressional funding to the various Federal

Agencies (Fed, FDIC and FHA, SBA, etc.).

Federal Housing Administration (FHA):• Deploys additional funding for mortgage guarantees.• Initiates mortgage foreclosure prevention programs.

Federal Deposit Insurance Corporation (FDIC):• Increases individual account guarantee limit from $100,00 to 250,000.• Guarantees bank debts.

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The Financial Crisis and Non-Conventional Government Intervention: Congress.

Congress:• Economic Stimulus Act of 2008: (Feb. 7): $152 billion to extend tax

rebates to low and middle-income individuals, and for accelerated capital depreciation for small businesses.

• Emergency Economic Stabilization Act of 2008: (Oct. 3): $700 billion to establish the Troubled Asset Relief Program (TARP).

• American Recovery and Reinvestment Act of 2009: (Feb. 17): $787 billion for tax incentives, social programs, infrastructure Investment, energy efficiencies and renewable energy investment, and small business related programs.

• Small Business Jobs and Credit Act of 2010 (June, 17) creates a $30 billion small business lending fund, provide $12 billion in tax breaks to help small businesses, and provides $504 millions to SBA.

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Small Businesses in the U.S. Economy

• Broadly classified as firms with 500 or less employees;

• Employ slightly over half of the private sector employees;

• Pay about 44% of total U.S. private payrolls;

• Generate 64% of net new private sector jobs;

• Create more than half of the nonfarm private Gross Domestic Product.

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The Financial Crisis and Small Businesses: Employment

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During the Great Recession of 2008-2009 employment contraction was heavily focused on small firms.

Small Firm Focus62% to 38%

Near Even Split:45% to 55%

The Financial Crisis and Small Businesses: Employment (BLS and ADP Data)

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The latest data from the private firm ADP indicates that employment by small firms is slowly rebounding.

Source: U.S. Bureau of Labor, ADP, and SBA calculations

The Financial Crisis and Small Businesses: Sales and Earnings

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Small firm sales and earnings dropped to historical lows

The Financial Crisis and Small Businesses: Capital Expenditure

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Small firm capital expenditure plans also plummeted.

Overview of SBA Programs

7(a) Loans

504 Loans

Microloans

SBICs (Investment Program)

The three Cs of SBA:

SBA supports small businesses through three major functions:

•Capital Access: credit & investment programs

•Contracting: increase access to federal procurement for small business

•Counseling: technical support through Small Business Development Centers, Women’s Business Centers, and SCORE chapters.)

Within Capital Access, SBA provides several core financing programs for small business

Product Type: Delivered through:

•Loan guarantee program for new & existing businesses•Used for general business expenses•Up to $2 Million

•Nearly 5,000 banks and credit union lenders across the country

•Long-term, fixed-rate financing (e.g. land, buildings, equipment)•Up to $2 Million

•+ 250 Community Development Corporations (CDCs)

•Smaller loans up to $35,000

•Over 170 non-profit intermediaries and CDFIs

•Debentures to support private equity capital, long-term, and debt-security investments

•Small Business Investment Co.’s•Privately owned and managed venture funds 21

The Development of the Financial Crisis: SBA

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SBA loan guarantee volume declined

Source: U.S SBA

$1.7 billion Average

$687 MillionJan. 2009

$1.4 Billion

Government Intervention: The SBA Component. Capital Access

• Increased funding• ARRA of 2009: increased SBA funding by $680 Million, which led to $30 billion

in additional loan support.

• Small Business Act of 2010: increased SBA funding by $505 million, which is expected to support $14 billion in additional lending.

• Program changes – Increased loan guarantees from 75% to 90%

– Reduced or eliminated fees

– Increased loan limits

• 7(a) and 504 loans from $ 2 million to $5 million ( 504 manufacturers loans $5.5 million)

• Smaller, more flexible Express loans from $ 350,000 to $ 1 million

• Microloans from $35,000 to $50,000

– Increased pricing flexibility : Prime, + or Libor +

– New programs

• Motor vehicle dealer floor plan financing

• Refinancing of 504 commercial real estate loans

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Government Intervention: The SBA Component. Capital Access

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In cooperation with the Department of Treasury, the SBA assisted in unfreezing the secondary market for SBA 7(a) loans.

Source: U.S SBA

Monthly Avg. to 9/2008, $328 M

FY 2010 Avg.$326 M

-

100

200

300

400

500

600

7(a) Secondary Market Settled Value$ Million

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Government Intervention: The SBA Component. Federal Contracts

•SBA is responsible for ensuring that 23% of all federal prime government contracts go to small businesses.

• As of August 31, 2010, 32.5% , $10 Billion, of federal stimulus contracting dollars have gone to small businesses.

Government Intervention and The Small Business Component. Tax Benefits

• Tax benefits to increase investment and employment:– Accelerated first year depreciation to 50% for 2008-20010 capital

purchases.

– Increased expensing limit from $133,000 to $250,000 (2008-2009) to $500,000 for 2010-2011.

– 100% exclusion on capital gains taxes for purchases of small businesses during 2009-2011.

– $1,000 new employee tax credit.

– Up to 35% tax credits toward employee healthcare premiums.

– Up to $10,000 start-up costs deductibility.

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