From the Front Lines of Finance

In a post titled: would you give his small business a loan?

Once we dug deeper, however, we learned some things about the borrower that created problems. First of all, she was on payment plans with three government entities. This immediately knocked her out of the running for an S.B.A. loan — you have to be current on all of your taxes before you can benefit from an S.B.A. guarantee. We can sometimes solve this situation by paying off the back taxes with a six- or 12-month merchant cash advance loan before the borrower gets the S.B.A. loan. But in this case the back taxes were too large, more than she could borrow on this kind of loan.

The hairdresser’s second problem was that she had called her mortgage company a few months earlier and explained that she was having a tough time. She asked the company if she could make interest-only payments for a while. This was an honorable thing to do, but it is likely to give any potential new lender pause. And that was now an issue.

The hairdresser did have some options. For example, she might qualify for a “hard money” real estate loan — a bridge loan in which the lender takes five points upfront and then charges 12 to 14 percent interest for one year until the borrower can refinance through a more traditional source. While this might be her most appealing option, it would come with significant risk — the interest payments alone could destroy her business. As an alternative, she could sell the building, pay off the current note holder, and take the cash. If she took this approach, she would lose the tax advantages of owning her property, but at least she could focus on running her shop and generating cash flow.

Now consider the context of the Great Recession. If your bank is sitting on a stack of non-performing loans it simply cannot afford any more losses lest it need to realize the writedowns of its mortgage book.

Now imagine that because this hairdresser can’t get a loan her business closes. Those people are out of work. And now her suppliers are worse off. A bit a negative feedback loop develops and NGDP expectations are revised downward. Back to the banks and their new nancy-boy risk appetite who pull back even harder on the brake. And on it goes.

That’s a way a financial crisis might contribute to an overall economic downturn.

But remember that in order for a complex system to fail, many many underlying failures are necessary. This is not THE cause of the Great Recession, but it is A cause.

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