Here's Why Small Business Isn't Hiring, Part II   (July 12, 2011)

Here are four more structural reasons why small business isn't expanding/hiring.

Continuing our exploration of why small business isn't expanding and hiring: here are four more deeply pernicious structural dynamics crushing small business. Yesterday I addressed this issue in Here's Why Small Business Isn't Hiring, and Won't be Hiring; Part II covers four other systemic issues:

1. The real estate bubble completely mispriced/overvalued commercial real estate. The Federal Reserve's policies of maintaining super-low interest rates and flooding the markets with easy-money leverage has distorted and poisoned the U.S. economy in multiple ways, one of which is the elevation of commercial real estate valuations to absurd heights.

Here's how the dynamic works. Landlord A bought his building back in the dog days of the early 1990s for $1 million; his tenants were struggling in the lingering recession and so he kept rent increases modest, or even cut them to keep tenants in a low-demand market.

Along comes the Fed-fueled credit and housing bubble, and suddenly his building is worth $2 million. Based on standard multiples of income to value, Landlord A calculates his building's rents are now grossly underpriced. With the economy bubbling along, demand is rising for premium commercial space; hey, isn't his restaurant tenant doing gangbusters business every night?

So he raises rents, and the small business tenants eat the increase. Business is getting better, and so they pony up the increased rent with a sigh.

As the bubble inflates, Landlord A gets an offer of $4 million for his building. Landlord A has no trouble accepting the offer from Landlord B, who raised the money for the purchase by leveraging another building of his to maximum debt levels and taking out a short-term loan on his new acquisition.

At the $4 million purchase price, the rents don't even cover the debt and expenses, as property taxes shot up along with the building's value. Landlord B nearly doubles the rent, and a few of the marginal small-biz tenants bail out for cheaper space elsewhere or just close shop.

Then the recession hits. The restaurant's traffic plummets to a shadow of its pre-recession level, and the other tenants are suddenly running negative cash flow, too. Meanwhile, Landlord B's other property--the one he maxed out to finance the purchase of this building--just lost its anchor tenant and he's deep in the red every month.

When the restaurant closes, that's the end of Landlord B's mini-empire. He turns both buildings over to the bank, who hires a realtor to find a new buyer.

The problem here is that the inflated $4 million price tag has become the "real value" and the inflated rents are the new benchmark. Thus the building is listed at the "bargain" price of $2.5 million, and rents are notched down a bit, but not to where they should be, i.e. 2/3 lower.

Adjusted for inflation, the building is "worth" no more at $1.3 million, and rents should be about 35% higher than the 1995 rent, which was a mere 1/3 of the top pre-recession rent.

All of this increase in value and rent is the result of super-low interest rates, which enabled speculation and leverage that drove up valuations, which then drove up rents as landlords raised rents to pay their bloated mortgages and property taxes.

The net result is commercial space is completely overvalued and thus rents are sky-high. Thanks to the Fed's misguided policies, small business has little left after paying rent, and overindebted landlords struggle to pay the gigantic bubble-era mortgage and property taxes: most of the income from small business flows to the "too big to fail" lender.

2. Financing is cheap to global Corporate America and costly to nonexistent to startups and expanding small businesses. If you're the CEO of a global Corporate America firm, borrowing $1 billion to acquire a smaller competitor is cheap, no problem: Corporate America has floated hundreds of billions of low-yielding bonds in the past year to fund buyouts and whatever else they want to do with cash.

If you're a startup or new firm seeking $10 million to expand--forget it. Your only chance is to give most of your company to a vulture capital firm and hope you end up with a slice at the end, after they window-dress it for sale or IPO.

The eventual buyer: global Corporate America, of course.

3. Crony capitalism doesn't like competition; it seeks monopoly or a shadow cartel, imposed and maintained by the regulatory agencies of the Central State. The naive and sentimental view of Capitalism is that it thrives on competition; this is incorrect. Capitalism actually thrives on monopoly, as that's what it takes to skim fat, low-risk profits. Competition mucks everything up, which is why Corporate America arranges for regulatory strangulation of small-business competitors via its partner, the Central State (Federal regulatory agencies).

Since government bureaucracies are a priori delighted to extend their reach, power and budget, it doesn't take much persuasion for them to tighten the screws on potential competitiors with absurdities like "food safety" regulations, which require hit-teams of government agents to descend on criminal conspiracies such as organic dairies.

Meanwhile, back in the real world, food-borne epidemics only spring from Corporate America's own agribusiness "factories," not from the small producers which the Federal government has tagged as "enemies of the State." It would be comical if it wasn't so tragic.

This game is transparent: cartels and monopolies lobby politicos and agencies to crush small business (potential competition) with overlapping regulations so onerous and costly that compliance alone will drive the small businesses under.

Take a look at the sickcare "insurance industry" for an example. Ours is supposedly a "free market" system, yet there are never more than two providers in any market. That's the definition of a shadow cartel.

4. Overlapping regulation designed to suppress competition, benign neglect/hostility from government bureaucracies obsessed with self-preservation and lack of financing make it impossible to scale up a success business in the real world. No wonder young entrepreneurs crowd into social media; it's the only space where startup costs are low, office space is a luxury (your living room will do just fine), regulation is light to nonexistent and you can scale up ideas and enterprises without jumping through dozens of costly regulatory filings and hoops where your Corporate America Overlords are sharpening their regulatory knives to eliminate any competitors before they get a chance to scale up.

Where are the real-world Facebooks and Googles? It's not that there are no opportunities; it's that there is a near-zero chance of raising enough money and political muscle to escape the regulatory and financial black holes imposed by cartels and their yes-men in regulatory agencies at every level of government.

Concentrated financial and political power stagnates the economy by suppressing new enterprise in favor of the Status Quo. That's one key reason why there are so few new small businesses that scale up; the forces of Cartel America and the government are arrayed against such threats. Protect the Status Quo at all costs and you've made lobbyists and their agency lackeys happy ("we did our job, the dangerous miscreants at the organic dairy were punished"), but you've fatally undermined the real economy.

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