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Wall Street Leads to Your Street

SOURCE: iStockphoto

The financial crisis on Wall Street spills over into the fortunes of Main Street, affecting credit markets, small businesses, and jobs.

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Congress and the Bush administration this week are continuing to debate the specifics of a financial rescue package for Wall Street. Many lawmakers are rightfully worried that taxpayer dollars will be used to atone for irresponsible conservative policies that got us all here in the first place and bail out greedy Wall Street bankers who profited the most from these misguided policies. Any recovery package will have to ensure that taxpayers and families will get most of the benefits of such a rescue effort.

But make no mistake: A rescue package is necessary to protect most Americans from the fallout of eight years of Bush administration economic and financial mismanagement. The data unmistakably show that Main Street—including the labor market, small businesses, farmers, students, and state and local governments—needs support from policymakers precisely because of the turmoil plaguing our financial markets.

In these tumultuous days, it is often overlooked that the fate of Wall Street is, in this particular case, especially intertwined with the fortunes of Main Street. The connecting link isn’t just a matter of stock market volatility, but rather underlying problems in the credit markets. Lenders on Wall Street, and those who provide lenders their capital, are unable or unwilling to lend or invest because of the mortgage crisis. If nothing is done, the already large and growing impact on the routine borrowing of businesses will become even more acute. Businesses will face problems meeting payroll, purchasing inventory, and making investments—consequences reaching far beyond Wall Street. Personal credit for auto loans, student loans, credit cards and, of course, mortgages will also become harder to come by.

The housing, mortgage, and financial mess have already ensnared the labor market. Jobs have declined for eight consecutive months in total non-farm employment. Not all job loss can be directly linked to the current financial mess, but it is safe to say that job losses have continued and the economy’s ability to mount a recovery is hampered by the turmoil. Since the start of 2008, the economy has lost a total of 605,000 jobs, while the unemployment rate hit 6.1 percent in August 2008, up from 5.0 percent at the end of 2007. The number of unemployed climbed to 9.4 million from 7.6 million over the same period.[1]

Much of this labor market pain is directly linked to the unfolding housing and mortgage crisis. For instance, the construction sector employed 7,168,000 workers in August 2008, after losing a total of 297,000 jobs since the start of the year. Almost half of all job losses this year were concentrated in construction.

And these losses are only part of the picture. Construction employment declined over the past 14 consecutive months, losing a total of 488,000 jobs, and declined for 17 of the last 19 months for a total of 558,000 jobs.[2] The pain during the financial crisis is making a bad situation worse.

Not surprisingly, banks are laying off people in the middle of a crisis. Financial services lost a total of 45,000 jobs from January 2008 to August 2008. The sector has lost or not added jobs for 18 of the last 20 months, which has amounted to a total loss of 149,000 jobs. Job losses in this sector have been concentrated in credit intermediation and related activities. These include loan officers, which have lost a total of 44,200 jobs since the beginning of 2008, and a total of 151,200 jobs in 21 of the past 22 months, when jobs dropped. Additionally, jobs in finance, which include investment brokers, dropped by 28,200 jobs since the start of 2008 and lost a total of 82,800 jobs over the past 13 months, when 11 months showed job declines.[3]

With the labor and credit markets tightening, consumers have less money to spend, resulting in falling retail employment numbers. The retail trade sector lost 201,600 jobs from January to August 2008.[4]

It’s not just job losses that show up on Main Street as fallout from Wall Street’s credit market troubles. The availability of loans has gone down and the costs of a loan have gone up. A good indicator of this is the difference between a traditional mortgage, which is now perceived as much riskier than in the past, and a risk-free, long-term treasury bond. The difference in the interest rates between these two loan products is now more than two percentage points—2.2 percentage points to be exact.[5] From March 2001, when the current business cycle started, through the end of 2007, the average difference between these two interest rates was 1.7 percentage points. For 2008, this difference averaged 2.3 percentage points. The risk premium that the market charged for giving out mortgages thus increased on average by over one-third (35.3 percent) in 2008.[6]

More specifically, small businesses are having trouble getting financing for worthwhile projects. Small businesses, of course, rely on credit to finance many of their investments today in order pave the way for an ever more profitable tomorrow. In addition, businesses routinely borrow money for operations that they must undertake in advance of receiving payment for the goods and services they produce. In the second quarter of 2008, total non-farm, non-corporate businesses had $3.7 trillion in debt.[7] The ratio of credit to net income, largely sales, fell to 17 percent in the second quarter of 2008—the lowest level since the fourth quarter of 2003. This ratio is well below the recent high of 49 percent in the third quarter of 2007, and roughly half of what it was a year ago (35 percent).[8]

Large corporations are hurting, too. In particular, they are having a harder time financing their investments. In the second quarter of 2008, credit market borrowing financed 35.2 percent of fixed investment by non-financial corporate businesses, down from 80.1 percent a year earlier.[9] The remainder of fixed investment needs to be financed out of companies’ reserves and profits, which are dwindling due to a weak economy. Thus, the credit market troubles could translate

into less investment in the future as corporations can no longer finance all of their expansion plans.

The reduction in credit is also showing up in business surveys. A Discover Small Business Watch survey released earlier this week found that 72 percent of small business owners say that it has become harder to get loans.[10] In fact, already in February 2008, the tightening of credit was becoming apparent to small business owners. A National Small Business Association survey of 500 owners of small- and medium-sized business found that a record low of 28 percent had used bank loans over the previous year.[11] This survey also found that 44 percent had used credit cards to meet their capital needs over the previous six months, and that 57 percent indicated that their credit card terms had worsened over the past year.[12]

For small businesses, the most important source of financing are mortgages, as mortgages amount to more than half of all loans of non-farm, non-corporate businesses. These businesses, though, have had less access to mortgages than in the past.[13] In the second quarter of 2008, new mortgages amounted to 1.9 percent of all outstanding loans of these businesses—the smallest contribution from mortgages to small business financing since March 1997.[14]

Another group vulnerable to the vagaries of credit markets is farmers. Farmers, like small businesses, rely on loans to finance many of their farms’ activities. Farmers are now being asked to make commitments for their 2009 fertilizer needs and to pay a considerable portion of it up front, sometimes 100 percent, because fertilizer producers cannot secure credit from other sources. As farmers effectively turn into lenders for fertilizer producers their costs are increasing.[15]

Further, farmers rely heavily on commodity markets, especially the commodities futures markets, to secure prices in the future for their products. In essence, these markets function as insurance for farmers by guaranteeing a future price and thus a certain level of income, which allows farmers to plan, invest, and pay for their working capital, such as fertilizer and fuel. Commodity markets, though, are heavily disrupted right now with a lot less trading going on than usual. This is because futures investors don’t know if the person they are striking a deal with will be around to deliver on that deal in the future. Because of less capital in this market, farmers have to pay more than they had to in the past to secure the same level of future prices for their crops, which again reduces the income stream for farmers since their cost of doing business has gone up.[16]

The impact of the crisis has also spread to borrowing to pay for education, with private student loans becoming harder to come by. According to Sallie Mae, 8 percent of college students use private loans.[17] A recent consulting firm report found over two dozen lenders either cut back in their private lending to students this past summer or stopped it entirely. These included larger lenders such as Bank of America, Citigroup, JP Morgan Chase, Wachovia, and Wells Fargo, along with smaller lenders such as CIT Group, College Loan Corporation, Education Finance Partners, and Student Loan Corp.[18]

One of the report’s authors, Dimitri Michaud, stated that “not all of them pulled back entirely; the likelihood is that they probably just limited the number of loans they were originating. If they normally wrote 15,000 loans for the summer, they most probably limited it to 10,000.”[19] The drop-off in private student lending appears to have started in the first quarter of 2008. As Michaud noted, “spillover from the overall credit crisis caused many investors to become a little gun-shy to invest in private student loans, even though historically they are safe.”[20]

Finally, the public sector is not immune to the woes emanating from the credit crisis on Wall Street. State and local governments face lower revenues due in part to reduced property tax revenue following the bursting housing bubble as well as the effect on other taxes from the economic slowdown. This has happened while they are trying to continue and improve public services that are necessary to maintain and help out their communities—demands which have expanded during the downturn. Governments need to borrow to pay for services and investments, but it is now harder for state and local governments to do so.

Case in point: The share of new municipal bonds relative to outstanding municipal bonds was just 0.5 percent in the second quarter of 2008—the lowest rate since the first half of 2000, when good economic times allowed state and local governments to pay for services without borrowing.[21]

Because of these real implications, Congress and the Bush administration must resolve the situation at hand and pass legislation that will address the problems on Main Street along with those on Wall Street. The consequences of financial market turmoil are clearly evident in towns across the country. Failing to enact legislation that will generate a real change in the situation will only worsen the situation for America’s families, and not just those living on Wall Street.

Endnotes

[1] Calculations based on U.S. Department of Labor, Bureau of Labor Statistics, 2008, Current Population Survey, Washington, DC: DOL and U.S. Department of Labor, Bureau of Labor Statistics, 2008, Current Employment Statistics, Washington, DC: DOL.

[2] Calculations based on U.S. Department of Labor, Bureau of Labor Statistics, 2008, Current Employment Statistics, Washington, DC: DOL.

[3] Calculations based on U.S. Department of Labor, Bureau of Labor Statistics, 2008, Current Employment Statistics, Washington, DC: DOL.

[4] Calculations based on U.S. Department of Labor, Bureau of Labor Statistics, 2008, Current Employment Statistics, Washington, DC: DOL.

[5] Calculations based on Board of Governors, Federal Reserve System, 2008, Release H.15 Selected Interest Rates, Washington, DC: BOG.

[6] Calculations based on Board of Governors, Federal Reserve System, 2008, Release H.15 Selected Interest Rates, Washington, DC: BOG.

[7] Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

[8] Calculations based on Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

[9] Calculations based on Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

[10] N. Carey and C. Bishopric, “Economy worsening, small business survey says,” Reuters, September 29, 2008.

[11] Ibid.

[12] J. Birnbaum, “As Credit Lines Fade, Credit Cards Step In,” The New York Times, September 11, 2008.

[13] In the second quarter of 2008, mortgages were 50.8 percent of total loans of non-farm noncorporate businesses. Calculations based on Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

[14] Calculations based on Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

[15] T. Francl, “The Financial Crisis and U.S. Agriculture,” September 25, 2008, Market Update: Special Financial Analysis, Department of Economic Analysis, Washington, DC: American Farm Bureau Federation.

[16] Ibid.

[17] Jay MacDonald, “Lenders curtail college student loans,” creditcards.com, September 29, 2008.

[18] Kaulkin Ginsberg, “Kaulkin Ginsberg Executive Brief: The Student Market for Credit Cards: Issues and Trends,” September, 2008 (Rockville, MD: Kaulkin Ginsberg Company).

[19] MacDonald, “Lenders curtail college student loans.”

[20] Ibid.

[21] Calculations based on Board of Governors, Federal Reserve System, 2008, Release Z.1 Flow of Funds Accounts of the United States, Washington, DC: BOG.

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