Today, a discussion on where our problems came from in the current economic crisis.  Next week, a little more detail on the Emergency Economic Stabilization Act of 2008, and it’s specific provisions. 

“When credit markets freeze, the economy starts to seize.”  That’s what was happening.  A freezure in the credit markets shuts the flow of available credit to businesses for expansion, and the economy reacts in panic.  An immediate shortage of free flowing credit in our economy, brings quick results to slow our economy to a crawl.  Our economy is dependent on the availability of credit.  It greases the system.

The problem: we thought house values would continue rising, thus, the loans on those houses would always be secure.  As builders glutted the market with new construction, house values didn’t keep up with the influx of new homes.  And the subprime loans handed out to people who couldn’t even afford them didn’t stand up to the slagging house market.  And there were a lot of subprime loans.

The banks that handed out these subprime loans (some being adjustable rate mortgages, or ARMs, where you could get in at a small payment and interest rate only to have it rise after year 3, 4 or 5), and the Federal-backed entities that bought those subprime loans from the market (Fannie Mae and Freddie Mac), got into real trouble when the owners of these loans started defaulting.  And they defaulted in a big way…  mortgage default rates were up over 10%, when they stood around 4 to 5% in the mid-2000s.

So people default on their loans, banks don’t get paid back and the credit markets are shot.  Then the economy starts tanking and banks stop lending.  And that really affects the small business.  Growth grinds to a halt.  And the market has only responded to what was headed our way from our past sins.  Credit is still available, but only for the well-funded, those with excellent credit and for seriously solid business models.  Emerging expansion is going to be slow for a while.

What have we learned?  There are fundamentals in life and business to follow.  When rejected, we all hurt:

1.  Even if you can doesn’t mean you should.  Some who could get loans, didn’t need to take on those loans.  Be your own regulator… is your business solid enough to ENSURE future cash flow to pay back your loans?  Be honest with yourself… you’ll be stepping into deep waters with a large loan you can’t pay back.

2.  Cash is king.  Operating on cash is never unsafe.  Your cash flow and cash availability speak to your abilities to service your debt.  Listen to and get to know your cash flow (hey, I’m a poet).

3.  Know your industry’s margins.  Can your business make enough money to provide good cash flow for future growth, while also servicing debt that allowed for the last expansion?  Make sure your industry is a safe one to loan in.

Let’s not let this downturn happen to our businesses, even though it is happening to our economy.

Thanks, Jason M. Blumer