Dan Smolnik

The trifecta of extended compulsory closing of businesses, the removal of trillions of dollars of cash from circulation, and a near-zero federal funds rate has rearranged the economic landscape of states, cities, and towns across America in a way that is likely to disrupt and slow recovery efforts after the social effects of the pandemic have passed.

Many businesses in many towns have closed and will not open their doors again. Many more will try, briefly, and fail because cash flows will be too slow, for too long, to sustain store rental, payroll, insurance and utility payments. Shops, shopping centers, and downtowns will stand partially empty, dragging down local property values and, in turn, property tax revenues. Banks will become awash in REO property as local markets find themselves unable to marshal the capital needed to restart their economies in any way other than piecemeal.

Large, well-capitalized businesses are more likely to have ready access to capital, whether through cash reserves or credit lines. The engine of the economy, which accounts for the vast majority of businesses in Connecticut and where most employees get their paychecks, are those firms employing fewer than 100 people. Indeed, $42.5 billion is delivered to Connecticut every year just through the payrolls of its businesses with fewer than 100 employees.  In addition to the benefit to the state income tax coffers, most of this income is spent by employees in their respective towns of residence, thereby delivering value, resiliency, and quality of life to those places.

It is these small businesses that are at greatest risk of becoming extinct. Surviving what is nearly certain to be an extended economic recovery period will present overwhelming risk to family entrepreneurs absent meaningful access to the capital need to survive the coming trough. This is where many cities and towns across America have already anticipated that their roles will include business stabilization and matching economic needs to capital.

Dozens of towns and cities across America have established business stabilization facilities. From Chattanooga to Detroit to Seattle, small and large towns have apprehended that their economic well-beings can be defended and even grown through anticipatory cultivation of their business constituencies. Most of these funds represent pools of $1 to $2 million and provide credit facilities such as bridge and micro loans for short terms.

Much of the funding for these facilities is provided by non-governmental sources which are also substantial stakeholders in their local communities. Some of the stakeholders include the Urban League, Community Investment Corporations, banks, and business trade associations.

The difficulties associated with credit risk underwriting, subordination, and due diligence often deter local governments from entering the business stabilization ecology. I suggest, however, that municipalities of all sizes can reduce their economic and administrative exposures and still provide support for these facilities through at least three approaches:

  • Reduce or eliminate collateralization requirements for smaller loans. This can be accomplished with a variety of techniques, including the municipal facility taking a subordinated security position, and piggy-backing on credit underwriting performed by commercial financial sources, such as banks. To this end, municipal facilities could reduce risk by lending in certain cases on a qualified matching basis, with a stated portion of the needed funding coming from satisfactory sources of credit risk underwriting.
  • Establishment of a reliable mechanism to differentiate needs for short-term liquidity from long term credit. Through effective intermediation of commercial underwriting or simple scoring (such as balance sheet volatility over time), municipalities can establish at least an initial yes-no test for various categories of risk which, when measured against the economic needs of the town, might prompt either further inquiry or the redirection of underwriting resources. For many businesses, a short term loan of even one or two thousand dollars can be a lifeline, and help return that employer to the town’s fiscal fabric.
  • Many businesses will reluctantly, and, without access to short term capital, file for bankruptcy protection. While governments have little taste for lending to a business in bankruptcy, in some cases local towns can serve themselves well by providing a super senior debt facility to a business that is executing a prepackaged bankruptcy under Chapter 11. While the administrative costs of this approach will vary greatly from case to case, town administrators should be willing to at least listen when debtor’s counsel calls

Finally, in response to the question of the moral hazard problem that inevitably arises when government at any level establishes what resembles a bailout package, I reply that this pandemic represents an external shock that neither invited nor encouraged reckless behaviors of the sorts that have precipitated some prior rescue efforts.

In fact, these strategies are aimed exclusively toward the business owners least likely to take unnecessary risk in the hope of some abstract economic solution later arising. These businesses are the most essential to our cities and towns, and to our economy as a whole.

Dan Smolnik is a tax attorney and a member of the Hamden Economic Development Commission. The views expressed here are exclusively his own.

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