How Has Today's Economy and Housing Market Affected Small Business Owners and Entreprenuers - Research Proposal Example

Research Proposal Columbia Southern How has todays economy and housing market affected small business’ owners and entrepreneurs? 2009 David Southworth: Abstract Title: How has todays economy and housing market affected small business owners and entrepreneurs? Author: David Southworth Purpose: To determine how todays economy and housing market affected small business Questions: The main questions are what effect housing market decline has had on the US economy and how these changes influenced small business’ activity Methodology: The methodology has two main parts. In the first different literature and necessary data are analyzed to find out how the current housing market crisis affects credit availability. In the second, the indirect influence of housing market decline is explained by means of the research of the corresponding literature. We will apply the works of different authors to find an answer to our question. Our applied research will be based on the basic research implemented by Randall Kroszne (2008) and Donovan Wadholm (2008) Conclusions: The main conclusion is that housing market decline influences small business activity both directly and indirectly. The direct influence is connected with decreased availability of loans, while indirect influence represents more serious threat as it is related to low purchasing power and demand for goods. How has todays economy and housing market affected small business’ owners and entrepreneurs? 1. Introduction 1.1 Background Small business represents very important sector in the United States’ economy.  It makes about 50% of GDP, and provides work for a great number of people significantly decreasing the level of unemployment. Furthermore, large and thriving companies usually start as small offices.  In order to provide small businesses with the opportunity to work for the country’s benefit, it is necessary to make credit available for them. The aim of this paper is to analyze the current situation in the housing market and explain how the declining economy affects small business. Also it will discuss the governmental actions recently taken to improve the general performance of housing market and weakening economy, and how these actions can help small businesses (Shostak, 2008) From the beginning of the 21st century the housing market in the US underwent rapid changes. First, the prices on the market were rapidly growing. However, in 2007 prices started decreasing and resulted in high interest rates and credit crisis. Credit crisis represents very factual and pressing threat influencing people’s everyday work and private affairs. It influenced small business directly, because it became very difficult for them to get a loan to start or expand business. But the most serious threat is the decrease of people’s purchasing power because of devaluation of their immovable property. The interrelation between housing market decline, credit crisis and consequential problems for small businesses is worth-discussing. However, while problems with loans are really factual, the destabilized economic situation and the decreased demand for goods and services represent a much more serious threat for small enterprises’ activity. The given paper will prove that housing market decline affects small business negatively. This will be done by means of analyzing data of surveys implemented in banks and different small companies. 1.2. Problem discussion The prices in the housing market represent a very important issue because they determine the value of people’s property. If a person borrows money to buy a house and the house’s price drops, he suffers serious losses because he still has to pay the loan with fixed sum and interest rate. The only way out is to stop paying off the loan, that means mortgage default. However, it only seems to be a simple solution. In reality this step meets a lot of serious obstacles. First, a person loses his property and in addition his reputation can be tarnished. But that is not the end. The trouble is that such behavior is illegal. The laws of the United States do not allow one to make the decision to stop paying the mortgage and just walk away: As home prices have declined following the housing boom that we experienced for some time. and as re-financing standards have tightened or disappeared altogether, a number of homes have been foreclosed and sit vacant. These vacant homes are often poorly maintained and sometimes attract squatters and/or criminal activity with the result that increasing foreclosures in a neighborhood often serve to further accelerate home price declines in the area. Rents have not fallen as much as home prices with the result that in some affluent neighborhoods homes that were formerly owner occupied are now occupied by renters. In select areas, falling home prices along with a decline in the U.S. dollar have encouraged foreigners to buy homes for either occasional use and/or long term investments (Morgenson 2008). Many investigations showed that immovable property value alteration and the financial characteristic of the borrower influence credit default possibility. Mortgage default affects small businesses’ access to loans because of consequential rising credit cost and less credit availability. The difficulty with paying off the loan the borrower faces makes his purchasing power decrease (Hopkins, 2008). 1.3. Purpose The purpose of the research proposal is to evaluate how the change in housing market influences the small businesses. 1.4 Limitations The research is telling about the situation in the United States using the data of the given country. 1.5. Target group The target group is learners in the field of economics and finance, and entrepreneurs. Learners can find out more about the current economic situation, mortgage default and the problems of small business. Entrepreneurs can learn about their problems and find solutions. 2. Literature review It is essential to remember that scientists who participate in investigations in the sphere of small business differentiate between small and large businesses. Benoit, R., Morabito, L., & de Calan, R. (2008), Morlok, E. K., & Chang, D. J. (2007), Runyan, R. C. (2006) and Boin, A., & Mc Connell, A. (2007) - all emphasize the distinctiveness of small businesses and the fact that small businesses are not able to utilize administration and financial resources as actively as large companies do. Studies results show the connection between the housing market situation, mortgage default and small businesses’ performance. A review of twenty-six small enterprises made it possible for Benoit, R., Morabito, L., & de Calan, R (2008) to discover a serious relation between the situation on the housing market and small companies’ activity. Runyan, R. C. (2006) revealed a considerably high level of productivity in addition to good sales showings in the conditions of rising prices for immovable property. On the contrary, Boin, A., & Mc Connell, A. (2007) found a serious decrease of earnings and return per company in small business sector in the conditions of housing market decline. Important alterations connected with earnings and productivity in small enterprises and loans against home equity were revealed by Runyan, R. C. (2006). A very useful study was implemented by Boin, A., & Mc Connell, A. (2007). They found that small businesses who had written strategic planning appeared to be more prepared to deal with critical situations. Emphasized by all of the authors, was that, the United States’ welfare is highly dependent on small enterprises’ activity and their opportunity to get loans. All things considered, the credit requirements for small business have become stricter during the last few years. Benoit, R., Morabito, L., & de Calan, R (2008) stated that the amount of new small enterprises has significantly reduced. Notwithstanding that loans seem to be theoretically obtainable; their availability is often accompanied by the stricter requirements and high interest rates that prevent many entrepreneurs from taking loans. Boin, A., & Mc Connell, A. (2007) revealed not only the decreased credit availability, but also fewer applications of small businesses for loans. The data that will be analyzed in our paper in provided by Randall Kroszne (2008) and Donovan Wadholm (2008) in their works discussing the problems small businesses face in the conditions of crisis. However, all the authors point out that while problems with loans are really factual, the destabilized economic situation and the decreased demand for goods and services represent much more serious threat for small enterprises’ activity. 3. Effects of the housing market conditions on small business 3.1 Methodology As it was stated above, the given paper is to prove that housing market decline affects small business negatively. This will be done by means of analyzing data of surveys implemented in banks and different small companies. We will use the survey data provided by Randall Kroszne (2008) and Donovan Wadholm (2008). The data is taken from the investigation made in small companies and commercial banks in 2007-2008 years, when the housing market prices started changing rapidly. Different surveys will be analyzed in order to evaluate present economic situation and its effect on small businesses. It is obvious that loan requirements for small businesses became much stricter against a background of housing market decline. Moreover, the households suffer serious losses because of increasing level of unemployment and devaluation of their immovable property that results in low purchasing power (Benoit, R., Morabito, L., & de Calan, R., 2008). It is essential to analyze how credit supply and demand influences small enterprises. Speaking about supply, loan availability is influenced by unwillingness from the side of banks to give credit to small enterprises (Shostak, 2008). Moreover, small enterprises’ access to loans is decreased, because of their unavailability to present needed guarantees. On the other hand, low demand for goods and services against the background of declining economic situation and low purchasing power considerably reduces income and does not offer enterprises the opportunity to expand. This decreases their readiness to get credit and influences the supply. The information received from banks and small enterprises testifies that during the second half of 2008 it was becoming more and more difficult for small businesses to get loans, however the amount of their application for credit also dropped. The banks introduced more credit requirements for small businesses, at the same time as weakening economic positions of small enterprises resulting from low purchasing power and low demand for their goods and services make them unable to present necessary guarantees and take credit (Morlok, E. K., & Chang, D. J., 2007). Credit remains theoretically available for small enterprises; however, the survey data showed that while problems with loans are really factual, the destabilized economic situation and decreased demand for goods and services represent much more serious threat for small enterprises’ activity. 3.2 Data analysis The information received from the banks showed that credit availability for small enterprises’ decreased in the second half of 2008.  75% of the domestic banks were investigated and the results showed that they made the requirements for small enterprises stricter. It is explained first of all by changing prices in the housing market as real estate is no longer a reliable mortgage and the low demand for goods and services resulting from devaluation of peoples’ immovable property. Notwithstanding that the requirements were increased also for big companies, banks are still more inclined to give credits to the larger companies with a long, established history. The information received from small enterprises showed that it became much more difficult for them to receive financing. However, investigations also showed that availability of credit does not represent the main concern for small businesses. In the conditions of crisis where the prices in the housing market are decreasing that is reflected on the people’s income and their demand for goods and services, weak demand conditions is the main concern for most of the small companies. The effect of the present economic situation on families’ income represents a very important factor that influenced the small enterprises’ revenue. The income of small enterprises and the income of families are interdependent. Information received from consumers’ financial position analysis showed that more than 10% of families have small enterprises and some of them use their real estate to finance their business. As their property devaluates, they risk loosing their business. Moreover, the poor financial position of the consumers, who loose their jobs, because their companies loose the opportunity to get proper financing, can’t allow them to use the services and buy goods offered by small enterprises. Randall Kroszne (2008) explains: Another indicator of the stress that current conditions have placed on small business credit access is the recent experience of the Small Business Administrations (SBA) 7(a) guaranteed loan program. This program is generally used to provide loans to small businesses when they cannot get conventional loans.  Although SBA-guaranteed loans are only a small portion of total small business loans, in recent months the dollar volume of these loans has dropped significantly, and in October 2008 the volume was less than 50 percent of its level 12 months earlier.  These declines are the result of a number of factors--lower demand overall for loans due to the weaker economic outlook, tightened credit standards by lenders, and declining creditworthiness among applicants because of their deteriorating financial condition.  In addition, market reports indicate that in recent weeks, banks and other lenders that make SBA loans have not been able to securitize and sell SBA-backed loans to other institutions in the secondary market (Kroszne, 2008). Speaking about demand for credit, the results received from small companies’ investigation appear to be even more upsetting. During the year 2008 many small enterprises reviewed their plans for the future and now they see them as not so optimistic as it was at the beginning of the year 2007. Instead of applying for the new loans, which still seem to be available in order to expand their business, they try to save what they have in the conditions of crisis and are not going to make new debts. Survey data proved that customer’s demand represents the most serious concern for small businesses (Bernanke, 2008). 3.3 The effect on small business activity: The analysis of the data showed that the crisis has the following effects on small businesses’ activity: No opportunity to get additional funds when it is necessary. Almost all of the companies are likely to have one of three possible situations that force them to look for extra funds to finance their activities . It usually happens during their slow seasons, when the earnings naturally drop, but the activity should not be stopped and the preparation for the hot season should continue.    Some companies have cyclic activity. That means that they have high profit during several years and then their profit decreases due to different reasons. The decrease lasts also for several years and in this situation it is necessary to use additional capital in order not to go bankrupt. It is important to note that depending on the business, this cyclic system can not only run in years, but also months, seasons, or around holidays.    A lot of companies use “standing” credits that represents the foundation of their business.  They just use the funds during an exact period, at the end of which they are to return the funds to renew their credit line for the next period. Strict Long-Term Credit Requirements - Commonly there are two kinds of business mortgages provided: a) mortgage for development with fixed interest and b) “standing” working funds mortgage.  The first is taken to expand an already functioning company, while the second is usually needed to start a business. The second type is still provided in the new economic conditions, however, in many cases, not easy to obtain. Banks require more guarantees from the side of the borrower and give such credits for much shorter terms. Moreover, in the changing housing market conditions, banks offer smaller sums against home equity. In other words, the conditions offered by banks become not advantageous for the borrowers. The situation with credits for the functioning business is better; however, they also suffer from current economic conditions. Security requirements also became stricter and the offered sums became smaller.    - The decrease of people’s purchasing power. In the conditions of crisis potential customers have a lot of worries about their salaries, employment, and the prices for their immovable property, credits and deposits. The crisis creates poor conditions for companies, which are directly dependent on the people’s purchasing power. Wadholm (2008) states: Interestingly, one of the only positive stocks on the day of the big 700+ point crash recently was…Campbell’s Soup.  Apparently all the anxiety over the above issues is translating into stellar comfort food sales.  Overall though, sales are suffering and small businesses are suffering along with it (Wadholm, 2008). 4. Policy actions and their implication for small business Having analyzed the negative effect the current housing market situation has on small businesses, it is essential to discuss the policy actions recently taken in order to improve the situation on the market and help small enterprises overcome crisis. The main task of the government is to restore people’s trust in the banking system. In September 2008, the US government took a number of different actions directed at market activity improvement. The Federal Reserve kept trying to resolve current problems providing banks with the financial support (Justin, 2007). The government tries to convince people that banks still represent the financial intermediates and perfectly fulfill their main function: The Emergency Economic Stabilization Act (EESA), enacted by Congress provides critically important new tools to address financial market problems.  The Troubled Asset Relief Program (TARP), authorized by the legislation, allows the Treasury to provide capital to financial institutions across a wide spectrum of sizes and to purchase or guarantee troubled mortgage-related and possibly other assets held by banks and other financial institutions. The EESA also temporarily raises the limit on the deposit insurance coverage provided by the Federal Deposit Insurance Corporation (FDIC) from $100,000 to $250,000 per depositor and temporarily fully covers non-interest-bearing transactions accounts, such as payroll accounts. As you know, this latter action was aimed particularly at helping small businesses. Additionally, the federal banking agencies released an interagency statement aimed at ensuring that all banking organizations fulfill their fundamental role in the economy as intermediaries of credit to businesses, consumers, and other creditworthy borrowers (Kroszne, 2008). Such measures must improve the whole economic situation and affect small enterprises’ activity positively.  Government’ efforts should restore market activity and people’s trust in the banking system. Only the common effort of people, government and enterprises can help overcome the difficulties and adjust to the new economic conditions. The financial backing of the banking system will restore bank’s ability to give credits with satisfactory requirements. The stable activity of the banking system will help to strengthen the national currency and stabilize the situation on the housing market. This in its turn will generate more trust in the economic system, stabilize the activity of enterprises and decrease the level of unemployment, in theory. 5. Summary and Conclusion Small business represents a very important sector in the United States’ economy. It makes about 50% of GDP, and provides work for a great number of people significantly decreasing the level of unemployment. Large and prosperous organizations usually start as small businesses.  In order to provide small businesses with the opportunity to work and prosper, it is necessary to make credit available for them. After the current situation in the housing market and its effects on small business was analyzed the following main effects were defined: - No opportunity to get additional funds when it is necessary. Almost all of the companies need extra funds to be used during definite periods of their activity. Impossibility of getting extra finances can lead to bankruptcy of many small enterprises (Runyan,. 2006). Strict Long-Term Credit Requirements “Standing” working funds mortgage is still provided in the new economic conditions, however, in many cases theoretically. Banks require more guarantees from the side of the borrower and give such credits for much shorter terms. Moreover, in the changing housing market conditions banks offer smaller sums against home equity. In other words, the conditions offered by banks become not advantageous for the borrowers. The situation with mortgages for development with fixed interest is better, however, they also suffer from current economic conditions. Security requirements also became stricter and the offered sums became smaller. The decrease of people’s purchasing power. In the conditions of crisis potential customers have a lot of worries about their revenue, jobs, and the prices for their immovable property. The crisis creates poor conditions for organizations which are directly dependent on the people’s purchasing power. United States’ welfare is highly dependent on small enterprises’ activity and their opportunity to get loans. All things considered, the credit requirements for small business have become stricter during the last few years. The data received from banks and small enterprises testify that during the second half of 2008 it was becoming more and more difficult for small businesses to get loan, however the amount of their application for credit also dropped. The banks introduced more credit requirements for small businesses, at the same time as weakening economic positions of small enterprises resulting from low purchasing power and low demand for their goods and services make them unable to present necessary guarantees and take credit. Credit remains theoretically available for small enterprises; however, the survey data showed that while problems with loans are really factual, the destabilized economic situation and the decreased demand for goods and services represent much more serious threat for small enterprises’ activity. Speaking about demand for credit, the results received from small companies’ investigation appear to be even more upsetting. During the year 2008 many small enterprises reviewed their plans for the future and not as optimistic as they were at the beginning of the year 2007. Instead of applying for new loans, which still seem to be available in order to expand their business, they try to save and use funds in hand vs. creating new debt. Survey data, proved that customer’s demand represents the most serious concern for small businesses. While problems with loans are really factual, the destabilized economic situation and the decreased demand for goods and services represent much more serious threat for small enterprises’ activity. The measures taken by the government must improve the whole economic situation and affect small enterprises’ activity positively. Governmental efforts should restore market activity and people’s trust in the banking system. Only common effort of people, government and enterprises can help overcome the difficulties and adjust to new economic conditions. The financing of the banking system will restore bank’s ability to give credits with satisfactory requirements. The stable activity of the banking system will help to strengthen the national currency and stabilize the situation on the housing market. This in its turn will generate more trust in the economic system, stabilize the activity of enterprises and decrease the level of unemployment (Boin, A., & Mc Connell, A., 2007). Now the possibility of small businesses to get credit and the demand of their services is really affected by the governmental actions directed on the situation’s improvement. These actions are directed at restoring the normal activity of the markets and the people’s trust in the banking system. However, the results of this influence are really uncertain. That is why the government should continue implementing proper actions aimed at supervision of the market activity and banks’ financing in order to restore the financial system and the economy of the United States. So, what exactly may the current changes mean for people who would like to start new business? They may require them stop and wait for further changes or start looking for new assets to support their ability to pay off credit. Luckily, many banks again start offering credit with normal conditions, so the capital is again, albeit slowly, flowing back to the small business sector. Thus, people should continue to try and realize their dream of being an entrepreneur. Bibliography Benoit, R., Morabito, L., & de Calan, R. (2008). Modeling interdependencies among critical infrastructures.International Journal of Critical Infrastructures, 4(4) Morlok, E. K., & Chang, D. J. (2007). Disaster and degradation management: relevance of the concept of flexibility. International Journal of Critical Infrastructures, 3(3/4 Runyan, R. C. (2006). Small Business in the Face of Crisis: Identifying Barriers to Recovery from a Natural Disaster. Journal of Contingencies and Crisis Management, 14(1) Boin, A., & Mc Connell, A. (2007). Preparing for Critical Infrastructure Breakdowns: The Limits of Crisis Management and the Need for Resilience. Journal of Contingencies and Crisis Management, 15(1), 50-59. Boin, A., & Mc Connell, A. (2007). Preparing for Critical Infrastructure Breakdowns: The Limits of Crisis Management and the Need for Resilience. Journal of Contingencies and Crisis Management, 15(1), 50-59. Morgenson, Gretchen. (2008). The Reckoning: How the Thundering Herd Faltered and Fell. New York Times Bernanke Ben S. (2008). The Subprime Mortgage Market. Chicago, Illinois Shostak, Frank. (2008). Does the Current Financial Crisis Vindicate the Economics of Hyman Minsky?. Mises Institute Justin Lahart. (2007). Egg Cracks Differ In Housing, Finance Shells. WSJ.com, Wall Street Journal Hopkins, Jamie Smith. (2008) Out without warning. The Baltimore Sun, Kroszne, Randall S. (2008)Effects of the financial crisis on small business Before the Committee on Small Business, U.S. House of Representatives Available at http://www.federalreserve.gov/newsevents/testimony/kroszner20081120a.htm Wadholm, Donovan. (2008). How credit crisis affects small business available at http://www.mrbizplan.com/archives/how-the-credit-crisis-affects-small-business Read More