The Comatose Job Market

It is a cliché to say there are many factors contributing to some phenomenon under consideration.  However, I find that in the economic and financial realm, key considerations are nearly always overlooked by the mainstream commentators.  The lack of bank lending and the comatose job market are cases in point.

It is an old saying that most job creation comes from small businesses.  That assertion, never well documented, was largely dispelled in a study completed around twenty years ago which showed that “gazelles” were responsible for the majority of job creation – small businesses that turn into very large businesses, Wal Mart being the poster child for this phenomenon.  Parenthetically, gazelles are a regular feature of the US economy but virtually nonexistent nearly everywhere else in the world, which explains much of why employment growth is more robust here.

As compelling the case is for gazelles, it is dwarfed by the far more powerful factor of startups.  Recent studies show that virtually all net new job creation every year can be attributed to new business formations.  Consider the following charts which track job creation relative to this metric using data up to 2006:

This makes intuitive sense.  A brand new business creates a minimum of one job (the owner).  Since most new businesses fail quickly, each failure destroying at least one job, it is reasonable to expect that existing firms would not experience net job creation economy wide.

Now we proceed to what it takes to start a business besides crazy optimism – money.  Home equity exceeds all other factors combined as the source of startup capital.  This goes far beyond merely extracting the net home equity because that equity is leveraged many times over when our prospective business person applies for a business loan.

In order to advance funds for something as dangerously speculative as a new business venture, the lender needs to have solid evidence of financial strength.  Skin in the game in the form of substantial home equity at risk by the borrower is just what the lender needs.  Without it there can be no loan.

Now we will see the biggest reason why housing is crucial to the economy, along with a key reason why banks are not lending despite massive excess reserves.  Home equity has been wiped out!  The following graph illustrates the point with some additional commentary:

Since about a third of all homes have no mortgage, the equity in homes with mortgages (using the above generally accepted data) is only about twelve percent!!!  As a general rule, only old people and rich people own their homes free and clear.  They are not likely to be creators of new businesses.  On top of that, our intrepid new business aspirant is not likely to have owned his or her home for a long enough time to have built up significant equity in today’s crippled market.  By my own, better reckoning, the average home with a mortgage is underwater.

The net is that the most important source of business startup capital has disappeared.  This largely accounts for anemic bank lending for all small businesses, not just startups.  Even existing small businesses will crash into a wall of rejection after their real estate equity is gone.  This becomes even more acute when factoring in the even worse situation for commercial real estate where values are down more than forty percent, more than wiping out any equity there as well.

Implications for our economy are dire indeed.  We have eliminated the major factor that makes our economy the most dynamic in the world.  For this reason alone, it will be at least a decade before our economy will have any chance at showing its usual vigor.  When combined with other factors I have dealt with before (and will revisit again) we must conclude that our economy is years from hitting bottom at levels much lower than today.

Read the original story at SedonaCyberLink