Fed May Keep Rates Low as Tight Credit Impedes Businesses

Michael Chapman, the owner of a building company with 20 employees in Santa Fe, New Mexico, has had trouble getting a bank loan and this month he let Kansas City Federal Reserve Bank President Thomas Hoenig know it.

Tight credit in commercial real estate “has really made it impossible for banks to lend to people like me,” the president of Chapman Homes said during a question period after an April 7 speech by Hoenig. Chapman said his company, unable to get a loan to hire 15 workers while big Wall Street firms get record bailouts, is “too small to succeed.”

Owners of small businesses across the country are telling Fed officials that they would expand and hire more workers if only they could get financing. Policy makers at the end of a two-day meeting starting tomorrow may cite scant lending as a drag on demand as they affirm a pledge to keep interest rates low for an “extended period.”

“It’s going to be a slow recovery to the extent it depends on banks opening up their lending,” said William Ford, a former Atlanta Fed president now at Middle Tennessee State University in Murfreesboro. “Lenders have gone to the extreme of being very tight, very cautious, as they recover from serious earnings problems.”

The Federal Open Market Committee is scheduled to issue a statement on April 28.

Confidence among U.S. small businesses fell in March to the lowest level since July 2009 as executives grew more concerned about earnings and sales, the National Federation of Independent Business reported April 13. More borrowers reported credit hard to get and good borrowers saw little reason to expand borrowing, said William Dunkelberg, the group’s chief economist.

Out of Woods

Fed Chairman Ben S. Bernanke said in an April 7 speech that while a U.S. economic recovery is under way, “we are far from being out of the woods,” in part because of tight credit.

“Bank lending remains very weak, threatening the ability of small businesses to finance expansion and new hiring,” Bernanke told the Dallas Regional Chamber.

Commercial and industrial loans at U.S. commercial banks declined by $900 million during the week ended April 14 to $1.27 trillion, according to Fed data released on April 23. In March, such loans hit the lowest point in more than two years.

Revolving debt, such as credit cards, which are often used to finance small businesses, fell by $9.4 billion in February, the biggest decline in three months, according to Fed statistics.

‘Extremely Weak’

“Currently, there is little evidence that financial institutions are significantly expanding the provision of credit and liquidity,” Janet Yellen, president of the San Francisco Fed said in an April 15 speech in San Francisco. “Quite the contrary, even with very low interest rates, credit flows remain extremely weak.”

The shortage of credit for small businesses will probably slow a decline in the U.S. unemployment rate, which fell to 9.7 percent in March from 10.1 percent in October.

Small companies generated about two thirds of the new jobs over the past 15 years, Cleveland Fed President Sandra Pianalto said in February. During recoveries from the 1990 and 2001 recessions, firms with fewer than 20 employees expanded their payrolls more than any other firms, she said.

The FOMC this week will probably affirm its view that the recovery may not be strong enough to reduce unemployment rapidly, said former Fed Governor Lyle Gramley, a senior economic adviser at Potomac Research Group in Washington.

Gotten an Earful

While speaking to executives across the U.S., Fed officials have gotten an earful from small business owners hungry for financing.

In Dayton, Ohio, Bernard Jergens, general manager of Breckenridge Financial Supplies, which sells automated teller machine supplies, told Pianalto in February his firm was forced to scramble for funding after its lender declined a refinancing application. Businesses “have to work harder to find a solution” to meager credit, he said to Pianalto.

In Santa Fe, Richard Czoski, 57, Santa Fe Railyard Community Corp’s executive director and a developer for 25 years, told Hoenig that “conservative” real estate projects can’t obtain financing.

“There is an unwillingness on the part of local banks to lend,” he said in an interview. “Even reasonable projects can’t get financing.”

In Alexandria, Virginia, Diane Palmintera, president of Innovation Associates, told Fed Governor Elizabeth Duke on April 19 that start-up firms -- hurt by “contracting venture capital” and declining home equity -- are pressed for loans. “They are increasingly challenged even more than existing small businesses,” she said.

Never Defaulted

Chapman, 57, who’s never defaulted on a loan, says that with financing he’d add 15 or more jobs and build five or six more houses. “Anything called a commercial real estate loan is virtually unavailable,” he said in an interview.

His concern was echoed last week by New Mexico Governor Bill Richardson, who wrote Bernanke and other banking regulators that the “overzealous” application of rules may be choking off lending. Community banks didn’t cause the financial crisis but they “are feeling increased pressure to restrict lending by federal financial regulators in the field,” he said.

Some banks may be reluctant to lend because of the large numbers of problem loans, Hoenig said in response to Chapman. “The banks are going to be more cautious,” he said.

‘Problem’ Banks

U.S. banks reported profits of $914 million in the fourth quarter, compared with a $38 billion loss in the year-earlier period, the Federal Deposit Insurance Corp. reported. Still, the number of “problem” banks climbed to 702 with $402.8 billion in assets, the highest level in 17 years.

The policy makers’ statement will probably affirm their March 16 description of inflation as “subdued,” Fed watchers said. The central bank’s preferred gauge of inflation rose at a 1.3 percent annual rate in February, below the Fed’s longer-run goal of 1.7 percent to 2 percent.

In assessing the economy, the FOMC may be “heartened” by strength in the housing market and a firming in financial markets, said Gregory Hess, a former Fed economist who’s now dean of the faculty at Claremont McKenna College in Claremont, California. He is a member of the Shadow Open Market Committee, a group that critiques Fed policy.

Gross domestic product grew at a 3.4 percent annual pace in the first quarter after increasing at a 5.6 percent rate in the last three months of 2009, according to the median estimate of 67 economists surveyed by Bloomberg News.

“Credit demand has been pretty soft and that means the economy is not going to grow rapidly or very much,” said Sung Won Sohn, former chief economist at Wells Fargo & Co. and now an economics professor at California State University-Channel Islands in Camarillo, California.

“Sluggish growth, low inflation and weak credit demand all translate into what Bernanke has talked about: low interest rates for an extended period,” he said.

To contact the reporter on this story: Steve Matthews in St. Louis at smatthews@bloomberg.net

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