Up until the financial crisis began, American consumers were on a debt binge, in many cases treating their homes like ATM machines for the cash they needed to pay for the things they needed. Now, of course, consumers are deleveraging and increasing their savings. But what few people realise is that the biggest borrowers during the debt binge were the self-employed. Therefore, consumer deleveraging could have substantial effects on the entrepreneurial sector of the economy.
According to data from the Federal Reserve’s Survey of Consumer Finances, entrepreneurs took on debt to a very large extent over the past 20 years, more so than people employed by others. The data indicate that there is some truth to the perception that entrepreneurs made excessive use of no document loans and other means of easy access to credit to borrow against their homes.
The Fed data show that much of the increase in borrowing by individuals over the 1990s and early 2000s was borrowing against the value of their homes, and that self-employed individuals increased their borrowing much more than people working for someone else. From 1989 to 2007, the share of the self-employed with home equity debt increased 82 per cent, as compared to only a 21 per cent increase in the share of people employed by others.
Fed Survey
The self-employed also substantially increased the value of that debt from 1989 to 2007. The data from the Fed Survey of Consumer Finances shows that the median value of home equity debt increased 48.4 per cent among the self-employed from 1989 to 2007. Among the wage employed, the value of this debt actually shrank by 28.9 per cent over the same period.
As the figure provided shows, real debt increased substantially for all consumers from 1989 to 2007, the debt reached higher levels for the self-employed. In 2007, the debt of households headed by the self-employed exceeded $120,000, about 50 per cent higher than the debt among households headed by the wage employed.
Dollar Value of Debt among Households Headed by Self and Waged Employed, 1989-2007 (in thousands of 2007 Dollars)
Source: Federal Reserve Survey of Consumer Finances
Now that the borrowing binge is over and consumers are deleveraging, the process is being reversed. Because self-employed households borrowed more than other households, they are probably cutting back more now that credit is less freely available.
Free credit era
But unlike households headed by people who work for someone else, self-employed households often engage in this type of personal borrowing to finance their businesses. The effort of self-employed households to correct excessive borrowing against their homes in the free credit era is likely causing cutbacks in their businesses as they deleverage.
This cutback in consumer borrowing among the self-employed is paralleled by a reduction in small business borrowing. According to the National Federation of Independent Businesses, during the period of easy credit, many owners of small businesses obtain loans by using real estate as collateral. Because the value of real estate increased to levels that should have not been reached during the real estate bubble, these business owners were able to borrow more than their credit, and perhaps their businesses, could support. As Michael Chow, William Dennis, and Jonathan Scott of the NFIB explain, “The recent sharp decline of real estate values has also hurt owners by reducing the value of properties owners normally post as collateral to secure loans for their businesses.”
The decrease in personal and business borrowing against real estate by business owners that has resulted by the reversal of the easy credit since the end of 2007 likely will result in a decline in spending in the entrepreneurial sector of the economy as businesses deleverage, and a spike in business failures, as businesses previously kept alive by borrowing need to be shuttered.
* The writer can be reached at
scottashane@gmail.com
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