News Release: Faculty Experts, Finance and Economics, Politics

Feb. 17,  2009

Economic Experts: Will the 2009 Stimulus Act Fizzle?

From Knowledge@Emory

As a strangled credit market and record-breaking job cuts spur comparisons with the Great Depression of the 1930s, the Obama administration and Congress appear poised to agree on the American Recovery and Reinvestment Act of 2009, an $789 billion broad-based stimulus package designed to kick-start the economy.

But just as a predecessor initiative—the $700 billion Troubled Assets Relief Program (TARP) pumped money into banks by letting the U.S. Treasury buy equity stakes in financial institutions—appears to have done little to aid the larger economy, the latest taxpayer-funded program may stall out if it doesn’t pump more cash into businesses that can create jobs, say Emory University faculty and other experts.

Washington Tries to Thaw Credit Freeze

The big question, according to Charles F. Goetz, an adjunct professor of organization and management and a distinguished lecturer in entrepreneurship at Emory University's Goizueta Business School, is whether or not the new stimulus bill will truly thaw the capital freeze that is currently blocking business activity.

“Funding, not consumer spending, is the core issue for small businesses,” he says. “Right now lenders are hesitant to extend money to commercial borrowers even when they have a good track record, and in some cases are actually calling in loans that they have already funded.”

He acknowledges that a falloff in revenue is hurting small businesses and notes that the stimulus package could improve that, but says the bill will only fix a very small part of the problem.

“The freeze in funding is hurting small businesses much more than the shortfall in sales is hurting them,” Goetz says. “Without the necessary cash to grease the gears and keep the business going, companies have had no choice but to reduce costs. And that, unfortunately, results in a cutback on capital expenditures and a need to lay off workers. So cash, in the form of loans, is the mechanism that is most important, but the stimulus bill can do little to help in that regard."

So where will that help come from?

"It's going to have to come from the $350 billion still remaining in the TARP; or possibly even more from a future son-of-TARP,” Goetz says. “Whether the TARP is used for a Good Bank/Bad Bank strategy [similar to the Resolution Trust Corp. created after the Savings and Loan failures of the 1980s], or to put direct investment into troubled banks, the only vehicle that has any real chance of freeing up bank lending and truly helping small business is the TARP or some reincarnation of it.”

Treasury Secretary Timothy F. Geithner appeared to allude to a similar plan in his February 10 comments calling for a $500 billion, Public-Private Investment Fund “targeted to the legacy loans and assets that are now burdening many financial institutions.”

Meanwhile, says Goetz, “When consumers are worried about keeping their jobs, they spend less and save more, which results in lower sales for companies and exacerbates the whole cycle.”

Small businesses in particular are concerned that the stimulus package misses the boat. Small businesses are defined as companies with fewer than 10 employees, and they account for almost 80 percent of all U.S. companies, according to the National Federation of Independent Business (NFIB) lobbying group. Small businesses are credited with generating about 70 percent of all new jobs.

“By increasing the federally guaranteed portion of Small Business Administration (SBA) loans, and giving more power to the SBA to expedite loan approvals, we believe we can turn around the dramatic decline in SBA lending we have seen in recent months,” said Geithner.

But Goetz was not very impressed, since the package calls for only about $500 million for the Small Business Administration’s loan-guarantee programs, which he says "is a drop in the bucket" compared to the total drop-off in bank loans.

“Banks, particularly through the SBA guaranteed loan programs, have the potential to help both existing and new small businesses to expand and hire more employees,” he says.

In a February 6 message to the membership of NFIB, the organization’s chief executive officer Dan Danner asks, “Have you heard anything about what Congress is providing for small businesses in the current economic stimulus package being debated in Washington? Unfortunately, the answer is ‘No.’"

Did TARP Spring a Leak?

In fact, Goetz says, the remaining $350 billion in the federal TARP program could do a lot to spur business activity, if it is designed differently.

“Maybe TARP has not been used in the most effective way to date,” observes Goetz. “It was passed in a hurry, and apparently there were no direct requirements for banks to actually make more loans. Instead, many institutions have tightened lending standards and used the funds for things like purchasing other banks, instead of making more loans.”

Although the U.S. Treasury has invested about $350 billion into financial institutions under TARP, about 70 percent of U.S. banks reported they tightened standards on loans to small firms, according to the most recent Bank Lending Practices survey taken by the Federal Reserve Board.

“Perhaps the creation of a Good Bank/Bad Bank entity like the Resolution Trust Corp. (RTC) would have been a better use of the funds,” says Goetz, referring to a limited-life federal organization, created in the wake of the savings and loan crisis of the late 1980s, which managed and resolved financial institutions placed under conservatorship or receivership from January 1, 1989, through August 9, 1992.

“If my memory is correct, the government actually made money on the RTC and put money back into the banking system that got individuals and business to start spending again,” he says. “And contrary to what most people think, this is actually a good time to start a new business and to expand if you already have a small business. This is because in a recession, competition often shrinks at a pace even faster than demand does.”

Competitors that grew “fat and happy” in an easier time are falling by the wayside as they are unable to adjust in a more difficult environment, Goetz says. “In addition, you can pick up some very good employees that you would not have been able to in a better market. And even if you're not interested in starting a new business, the difficult economic environment means you can often purchase a company that is up and running at a fraction of what it would have cost just six months earlier.”

Some Goizueta faculty members are even more disenchanted with the stimulus proposal.

“In my judgment, this is a very poorly designed package,” says Ray Hill, an adjunct professor of finance. “I believe that only a small portion of the huge debt we will incur will produce any stimulus within any reasonable time frame.”

First, he says, “A big part of the [proposed] package is temporary tax relief directed to individuals. Economic theory and repeated experience—including the tax rebates of the 2008 stimulus package under the Bush administration—tell us that consumers save or pay down debt most of any change in income they perceive to be temporary, including the so-called tax ‘refunds’ to people who don't pay taxes.”

Both versions of the stimulus packages call for billions of dollars to be spent on infrastructure and other “shovel ready” projects that are projected to create jobs. “Although spending on infrastructure is commendable, this spending will take time, even for so-called ‘shovel ready’ projects,” says Hill.

“I believe that the Congressional Budget Office's own projections forecast that most of these funds will be spent in 2010 or later,” he says. By then the economy may already be recovering and the spending will either be inflationary or will take resources from private sector investment.”

Hill also faults proposed investments in alternative energy, noting that  “we already have a glut of solar panels so no one is going to start producing a lot more until whole projects are underway, which can take years. Of course, you hear venture capitalists supporting this part of the stimulus package, but that is pure self interest.”

The stimulus package being discussed by Congress may indeed help the economy in some ways, concedes Hill.

“It may provide funds to states and prompt them to maintain spending that would otherwise be cut,” he says. “But it may also have unintended consequences. I have in mind the extension and improvement in unemployment benefits.”

Extending benefits in the weak economy may be good policy, "but we have to recognize that the inevitable result will be a longer duration of high unemployment than would otherwise be the case,” Hill notes.

Some observers argue that permanent tax cuts will provide the most effective and immediate stimulus, Hill notes, adding that “I think experience shows that this probably is the case.”

Car Dealers Suffer as Sales Stall

Automobile dealers, which were hammered by high energy prices and the tight credit market, are one of the economic downturn’s latest casualties.

Based on falling sales, about 5,000 car dealers across the U.S., or nearly 25 percent of the estimated total, would have to close in 2009 to enable average sales per dealer to match 2007's results, according to a study released in January by the accounting firm Grant Thornton LLP.

At least one industry observer who attended a recent National Automobile Dealers Association convention is worried that the stimulus package won’t do much to help those at-risk dealers, many of which are family-owned businesses.

“Banks may be getting TARP financing, but they’re still skittish about providing floor financing [revolving loans that dealers use to finance their inventory],” says Richard Kotzen, a partner in the Dealership Services Group of Crowe Horwath LLP, a Florida-based CPA firm. “Further, some of the TARP money is being diverted to U.S. automobile manufacturers, which encourages them to build more cars and press dealers to take delivery and pay for even more units that may end up sitting on their lots.”

Kotzen says he believes the industry as a whole will eventually recover, but notes that so far, federal stimulus programs have not generated a “trickle down” effect.

“The ‘shovels in the dirt’ approach of the stimulus plan as it stands now will generate jobs down the road, but auto dealers and other retailers need money now,” he says. “Permanent tax relief for consumers and retailers might help. Tax rebates, the ability to depreciate assets faster, and the extension of loss carrybacks [offsetting prior-year profits with current year losses] to five years from the current two, could also help businesses to regain their footing.”

Increased SBA funding in the stimulus package could provide some rapid assistance to small businesses, says Andrea Hershatter, who teaches entrepreneurship and serves as associate dean and director of the BBA program at Goizueta.

“Typically, the propensity for risk taking goes down in a weak economy,” she says. “The typical rounds of early stage financing from friends and family and angel investors depends on excess capital. Reduced wealth means that these usual sources of early venture financing are unavailable to entrepreneurs. Additionally, in the current environment, many banks are not willing or able to provide loans or lines of credit, leaving very few options for entrepreneurs.”

Hershatter points out that the stimulus package must spur the economy on a wide scale basis in order to have a positive long-term impact for entrepreneurs. In the meantime, additional sources of credit for small businesses are needed to help them get off the ground, she adds.

But Hershatter cautions that federal assistance to new and fledgling businesses must employ the same criteria that the private sector would consider, funding only those businesses with the highest likelihood of success.

Additionally, it is crucial to consider the sectors most likely to thrive in the coming years, she says, noting that “funding that flows to businesses whose goals are consistent with the broader ambitions of the federal government have a higher probability of benefitting from the first wave of economic growth.”

The Obama administration “has committed itself to a number of segments, including improvements in healthcare, education and energy efficiency,” says Hershatter. “If economic stimulus funds help to set up or grow businesses that contribute to these agendas, there is good alignment. On the other hand, if the stimulus package simply provides a pool of funds that lend to businesses that are not viable in the long term, it could be a waste of taxpayer money.”

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