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Equity financing, not lending, is the cure for unemployment
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After spending most of its time on health care, the Obama administration was finally shocked into the reality that the economy needs more attention. A report issued Friday by the Labor Department said the jobless rate has risen above 10 percent, as predicted in this article last week.
President Obama stated that he “won’t let up until the Americans who want to find work can find work.” That is a noble but wholly unrealistic goal. With the current stimulus package costing $248,000 per job, the president would need to borrow close to $4 trillion each year to put more than 15 million Americans back to work.
Last month, President Obama announced new initiatives to spur lending to small businesses. The goal of those programs is to help banks get money into the hands of important and viable businesses, particularly those owned by minorities, women, immigrants and veterans.
However, the focus on lending makes a devastatingly incorrect assumption. It appears that the administration and its economic advisors believe there are countless “important and viable” small businesses just waiting for start-up cash that is being horded by ignorant bankers. Nothing could be further from the truth.
Most small businesses fail. Half of all businesses fail in the first year, and only one in five make it to year four. Those that do make it to the four-year mark often have too much debt to be future going concerns. Increasing loans to businesses that are not viable is no different than the previous policies that encouraged banks to give mortgages to those who could not afford them.
Failure is a natural part of the free market, and is the mechanism that is required to find stars like Microsoft, Google and others. However, lending to businesses that will eventually fail only consolidates the failure to the taxpayers, and will cause the enormous national debt to grow even more.
Equity financing, and not more lending, is the answer. Believe it or not, there are still plenty of individuals with cash available for investment. They are often willing to accept the risk of failure if the potential reward is high enough. Thus, the obvious goals should be to reduce the risks and increase the rewards.
Rather than encouraging banks to lend money to businesses that have already been declined, the administration should focus on increasing the probability that small businesses will succeed and find ways to improve the rewards to individuals willing to invest those companies.
Policy makers need to lower taxes and regulations for small businesses, lower taxes on capital gains resulting from direct investment in those businesses and increase annual tax deductions for losses from investments that did not work out.
Unless the U.S. finds a way to increase direct equity investments in new and growing domestic businesses, unemployment and the national debt will continue to rise.
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