Why hasn't Washington noticed that there is another crisis - this one in business lending? What's the difference between the subprime mortgage crisis and business lending crisis?

Both leaders and followers alike in Washington are so focused on the mortgage crisis that they're oblivious at times to the truth about business lending and the impact of tight business credit on the American public. Media coverage of the subprime mortgage crisis is so overpowering that staff and management in offices throughout the Federal Government are focused solely on those stories.

In truth, there is a separate crisis in business lending that few in the nation's Capitol have recognized.  Business lending is in trouble.

The difference between the two should be obvious. People do not lose their jobs at the local plant because mortgages fail. They do, however, when the businesses the plant sells to fail because they couldn't get a loan to buy the plant's products. That makes the plant fail in turn - raising unemployment figures.

When conventional media covers business failures, it is never the small businesses on Main Street, or the little machine shop making parts for bigger businesses. Rather, media coverage is invariably about large layoffs like airlines or auto manufacturers. They deal with press releases announcing big reductions in employment or closures of large plants because this is what the public pays attention to - or so they think.

In truth, the public is equally concerned when a small plant or the local convenience store closes because it takes away from the core community.

With May's reported 49,000 job loss, about half of those jobs lost were from large closures or layoffs. The rest were from small businesses - offices, retailers and manufacturers who could not sustain their business.

As we progress with this business lending crisis, unemployment will continue to rise, though the percentage of unemployed from small to mid-sized businesses is going to rise against larger layoffs.

The business lending crisis is affecting the entire economy and will continue getting worse unless addressed at its core.

Part of that core is the manner in which banks lend today. One process - a key part that for decades kept bank lending in check - analysis of business plans - is now largely a thing of the past. Banks removed their analysts for cost savings, and in doing so, rely upon credit scoring and collateral valuation.

This makes almost every micro loan - loans of $100,000 and less - a personal loan. Because these loans are usually collateralized with a home, banks have made the loans on the basis of equity.

However, there's some major flaws here. First, is that business loans are not listed on the individual's credit score so banks may not be aware of other debt outstanding against that collateral. Second, the banks are not considering the ability of the borrower to execute his or her plans for the use of funds.

This results in the approval of risky loans by underwriters who are pressured routinely by branch officers. With no analyis, the underwriter cannot make a qualified determination of the ability of the borrower to reach loan maturity. As such, those who should not borrow, either because they're ill prepared presently or because their business concept has serious flaws are able to borrow. 

With recent reports of double-digit declines in property values spanning multiple years, we may expect that business lending will see further tightening of credit. That will mean increased unemployment and empty offices and storefronts throughout the nation.

The decline of property value means that when an entrepreneur or business owner seeks a small to mid-sized loan, whereever the value of personal property is considered as collateral that value will be far less than before. Banks will now be compelled to consider the value of real property moving forward in negative terms, rather than as it was in the housing bubble, in positive terms.

So if you have a $1 Million home, with 50% equity when you walk into the bank, even if their appraisal shows the same information, the bank will probably decline the loan or may only approve $60,000. The underwriter will deduct nearly 30% off the top for the decline moving into the next year - so they start with a value of $700,000. Next, they'll look at $500,000 in debt against that value, leaving only $200,000 in equity. They'll then only loan at a maximum of 80% of value in total - so, you could only get $60,000 which is the difference between current debt and 80% value ($560,000). Most business owners would need much more, and would have to either give up or find alternative sources of funding.

Now what's the solution, you ask?  We think it's a return to core principles in the evaluation and analysis of business plans. If businesses are better prepared to borrow before seeking a loan, then they will be better borrowers. If the entrepreneur is properly educated in financial management and the aspects of what the business is going to do, or how it will handle financial difficulties, then the business will be a more secure entity into which the bank may lend depositor's funds. If the business has a solid plan that has considered every aspect of the operation and built a solid business model, then it has a considerably higher chance of success which means it will be able to reach loan maturity securely.