Amidst widespread speculation, the Federal Reserve's Open Market Committee (FOMC) decided to leave interest rates at its unprecedented near-zero rate in response to both a fear of deflation and economic uncertainty, and in response to fears of how China's own troubles may impact the global economy.
The theory is that a zero interest rate policy (ZIRP) will spur investment. But the Fed's extreme caution and conservatism has investors confused and frustrated, and big swings in the Dow shows that the great predictors on Wall Street really don't have a clue. ZIRP is a new phenomenon, and Wall Street in its youthful exuberance simply doesn't know how to respond. There is no precedence on which to act.
The downside of extremely low interest rates is that the Fed is attempting to fix the economy and stave off a Depression by robbing middle class savers and retirees of their modest interest incomes in order to provide cheap money to large banks and already well-funded corporations.
Union workers with pensions may feel the pinch as well, as most pensions operate on an expectation of eight percent return—and in today's environment will become seriously underfunded, or unbalanced with more funds shifting to higher risk equities. In the end, the Fed's gambit may well succeed, but it's a bitter pill for ordinary borrowers, savers and small businesses.
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Who's Getting the Money?
The Fed's theory is that low-interest rates will encourage banks to lend more money to businesses, and businesses will expand their capacity by taking advantage of low-cost loans. But when money is cheap, banks respond with stiffer underwriting requirements.
As a result, larger companies that already have resources get the lion's share of this Fed-enabled bounty, while small businesses and startups get denied. The short-sightedness there is in thinking that big businesses will save the day—but, in fact, it is small, entrepreneurial businesses that account for job growth.
We are seeing big business growth as a result of the Fed's policy, but it is coming at the expense of entrepreneurs, mom and pop businesses and start-ups.
Credit is indeed being stimulated, but it is disproportionately funneled to preferred borrowers such as mortgage-backed securities and large corporations. The dynamic entrepreneurial spirit that built the tech industry out of a handful of garage-based businesses would never have happened in a zero credit environment.
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How Your Small Business Can Survive ZIRP
Extremely low interest is enticing if you are a large corporation like Apple, who issued $40 billion in bonds despite having a significant cash hoard, simply because the rate at which it could issue those bonds is irresistible to any corporate giant.
Small businesses on the other hand, which often depend on short-term loans to cover irregular cash flows, may find themselves unable to get funding in this environment, either slowing growth or causing more small businesses to fail. Banks are more risk-averse than ever when it comes to small businesses and startups looking for smaller loans under $250,000, and this has created a major funding gap for smaller companies.
According to a recent report from the Federal Reserve Bank of Cleveland on alternative lending for small business, most small business owners do not see banks as a likely credit source. The report discovered that online alternative lenders are taking advantage of the bank's reluctance to do business with small businesses, and non-bank lenders are filling the gap.
Those alternatives though, must be carefully vetted, and some carry a disproportionately high price. Many state laws have responded to the lending crisis and growth of predatory lending companies with caps on interest and fees for loans, but unfortunately, these caps usually only apply to personal loans and not small business loans.
What the zero interest rate policy has wrought for small business is this: Low interest exists, but it is unavailable to small businesses, which turn instead to high-priced alternatives with price tags even steeper than pre-recession conventional business loans.
A new class of business loans have become popular with companies that offer quick money, with payback terms usually set for a year or less, with steep interest and fees. These loans are based on the small business's receipts and typically set up an automatic bank debit on a daily or weekly basis, and are similar to consumer payday loans.
They are easy to get, but wreak havoc on a small business that may have an irregular cash flow. Like payday loans, these short-term business loans should be used with caution. There are circumstances in which they can be useful, such as to fund a short-term need for equipment or expansion—but they are less advisable for funding day-to-day operating expenses.
And, like payday loans, the lenders make it remarkably easy to daisy-chain loans one right after another, quickly ramping up interest and fees beyond the amount of principal borrowed. These loans are tempting—but if you take advantage of them, take only one.
Another alternative may be found in the growth in popularity of crowdfunding, but this too, takes serious planning. The myth about crowdfunding is that there is a ready-made crowd ready to give money to worthwhile projects, but in fact, success hinges more on a "build your own crowd" model. Be prepared to put some significant time into marketing and public relations ahead of any crowdfunding offer.
Conventional bank lenders aren't going to fill the financing need for small businesses any time soon, but there are options with alternative lenders, crowdfunding or even use of personal loans and credit cards. Those options must be carefully examined and compared before proceeding, to make sure you have the best terms available.