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Treasury Moves to Get Credit Flowing;Will It Come in Time to Help?

The U.S. Treasury’s bold and uncharacteristic decision on Tuesday, Oct. 14, to put itself in the banking business is designed to assure bankers that they can safely lend funds to one another and, in turn, eventually reopen the spigots of credit that are the lifeline for the nation’s small-business owners.

But getting the pumps turned on again may not come soon enough for business owners such as Patricia Schulte, whose gelato and confectionery business in Apple Valley, Minn., may not survive because so far no one will lend her the $50,000 she needs to purchase new equipment.

“No, no, no. All we’ve heard from the bankers is no,” said Schulte, 44, who with her husband, Douglas, 45, has already put some $350,000 into Luxury Sweets, their two-year-old business in the south suburbs of Minneapolis. “We couldn’t find anybody who believed in what we’re doing in terms of funding.”

To help get credit flowing to people like Schulte, Washington intends to deposit $250 billion of taxpayer money into many of the nation’s banks in exchange for an ownership stake. By buying preferred stock in nine major banks, including such notables as Wells Fargo, JPMorgan Chase, and Citigroup, plus a number of smaller banks, the Treasury Department is effectively signaling the market that it will not allow those institutions to fail since the government now holds a stake in the bank and will expect its ownership value to be protected. This implicit guarantee is expected to jump-start lending among banks, a necessary step to get credit markets unfrozen and more normal lending patterns to resume.

Once the financial system stabilizes and the market improves, the Treasury could then sell its stock holdings back to the banks at a higher price, and pocket the proceeds, thus reducing the ultimate cost to taxpayers.

In addition, the Federal Reserve announced that on Oct. 27 it will begin buying vast amounts of short-term debt to help break the credit clog. The Fed is invoking Depression-era emergency powers to buy commercial paper—the short-term funding many companies rely upon to pay workers and buy supplies—while waiting for the companies’ own customers to pay their bills. This move should also ease the credit squeeze by giving banks greater assurance that any short-term loans will be repaid.  

Tuesday’s dramatic action, in effect a partial nationalization of the banking system, violates a central tenet of free-market orthodoxy, which made President Bush and Treasury Secretary Henry Paulson reluctant to take such a drastic step, originally proposed by the British government.

“Today’s actions are not what we ever wanted to do—but today’s actions are what we must do to restore confidence to our financial system,” Paulson told reporters in announcing the plan.

But the rescue plan may prove too little, too late for small-business owners on Main Street. Even though the rescue plan may unfreeze loans, small business will still face plenty of hurdles. “You still will need impeccable credit to get a Small Business Administration loan and you won’t have been able to use up any of the equity in your house—which we already have exhausted,” said confectioner Schulte. “I’m afraid Washington is coming too late to the party.”

Robert Reich, a professor of public policy at the University of California, Berkeley, and former labor secretary in the Clinton administration, told ABC News the plan is a necessary first step because “right now a lot of small businesses and individuals and even some big businesses can’t get any money. They can’t get the credit they need simply to keep operating.”

Schulte and her husband, a former landscaper, started the business in 2006 in hopes it would fund their retirement. Slow sales—and a threatened rent increase—forced them to close their gelato and chocolate shop in a local shopping center last month, but at almost the same time a large supermarket chain offered to put their homemade gelato in their refrigerator cases. Without additional financing to ramp up production, however, Schulte doesn’t know how the couple can stay in business.

Christine Pigsley, director of the South Metro Small Business Development Center and an associate dean at the Dakota County Technical College in Apple Valley, Minn., says hundreds of her clients are in situations just like the Schultes. “What started on Wall Street is ending at strip malls in Apple Valley,” she said.

Pigsley notes that the sudden collapse of home values, 401(k) retirement accounts and stock investments—the three pillars of finance normally used by middle-aged entrepreneurs to fund their new pre-retirement businesses—are no longer worth what they were even a year ago. Moreover, banks, which once saw stocks and homes as collateral that would only appreciate in value, now tend to see them as deteriorating assets.

“So the banks may be right when they say they haven’t changed their criteria,” Pigsley said, but their view of the underlying collateral used to secure any loan has radically changed. “Your house is no longer being viewed as an appreciating asset. The bank is asking, where’s the collateral?”

Pigsley says many of the small-business owners who seek her counsel were hard-working and savvy but could not anticipate that such a severe downturn would crash into a stable and relatively prosperous suburb.

“Usually the suburbs are shielded from all this, but this credit crisis is now coming to the quintessential suburban community” of middle incomes, a wide variety of jobs and conservative, Republican leanings, she said. “In an established community full of large homes, we have empty storefronts. Not just one, but storefronts that have sat empty for a year. Now we’re starting to feel like some struggling urban center.”

If banks refuse to offer new loans, a wide variety of industries are under siege. Movie producers such as Steven Spielberg can’t easily get financing for new films. Hotel owners are canceling construction of new buildings because construction loans are hard to secure. Even shipping lines are being stung because those shipping goods can’t get letters of credit, which assure a shipper of payment for a cargo after it is loaded onto a vessel but before the buyer receives it, from banks.

“Banks right now are basically having a problem trusting each other,” said Dorothy King, owner of a chain of barbecue restaurants in Oakland, Calif., on ABC7 News in San Francisco. She says she may have to put an expansion plan on hold because of the credit squeeze, and has already laid off some employees. “I will be looking to make more cuts.”

Schulte wonders how the American economy can recover unless business owners like her can get new loans.

“It’s the small businesses that drive the economy,” she said, now that she has laid off her three employees. “There are a lot of little people getting hurt in this economy.”

Pigsley hopes the Small Business Administration, which has reduced its number of loans in Minnesota by 20 percent in fiscal 2008, will jump into the breach by guaranteeing more small-business loans to operators like the Schultes and offer a higher level of guarantee to existing note holders.

“They should help loosen the bank from the other end,” she said. “If the Fed can do it from the top end, why can’t the SBA people do it from the bottom?”

Michael Zielenziger, author of Shutting Out the Sun, covered Japan’s banking crisis as a foreign correspondent for Knight Ridder Newspapers.

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