For decades, credit cards have provided (for good or bad) a source of working capital for households and entrepreneurs. Those easy to obtain credit line increases proved a lifeline for small businesses and were much easier than dealing with a bank, if a bank approved the loan at all. When the credit market crisis began in 2007, the behavior of the card companies began to change, and with those changes small business began to feel the pinch.
The problem is access to credit. Angel investors and venture capitalists used to provide small, innovative businesses with capital to expand before going public. But that market has slowed recently, with venture capitalists wary for two reasons: there are a limited number of new ideas in which to invest and even if an idea has promise and works, where will the additional financing come from when the VC investors are ready to cash out?
The credit market crisis is now two years old and showing signs of easing. The stock market also shows some positive momentum, but these early signs of market improvement only apply to the largest, most credit worthy businesses. Small business owners and entrepreneurs still suffer under-funding as the markets strain under the past indulgences of the easy money boom.
A resurgent secondary stock market does not necessarily mean that IPOs will be successful even if they make it to the starting gate. Banks have tightened their grip on small businesses, with no real end in sight. Under these conditions, investing money in the next new thing is risky and may have to wait for another day.
We're not talking the next software or information technology companies here, but rather the average local business--the retail store, service provider, or small manufacturer. Over the years their second line of financing was a loan from a bank or the Small Business Administration. But their first round of financing came from an equally familiar place--the entrepreneur's personal credit card. No card company ever asked what those sundry charges were for as long as they were paid for on time--until now.
Credit card terms were mostly favorable for entrepreneurs with one exception--the interest rates. Minimum payments, constantly increasing lines of credit and the side benefits of reward points took some of the sting out of the high rates of interest. That is, until the credit crisis prompted the card companies to increase their interest charges and tighten up their billing practices.
The loudest complaints about the new wave of credit card company practices centered on the arbitrary raising of interest for no apparent reason. The Federal Reserve, aware of the practice, tried to stem things last December by announcing that the card companies couldn't raise rates without giving card holders adequate notice. The Fed later backpedalled, stating that the new guidelines would not go into effect until July 2010, time enough for all card companies to act in their own best interests.
Even the new Credit Card Act does not obviate these practices. Cardholders have seen their rates rise, credit lines scaled back and major penalties added for minor infractions such as a rare late payment.
At the same time, no public discussion about the ridiculous interest rates card companies charge consumers has been heard. The only discussion is about the timing of the rate hikes, not the levels to which they are rising.
When the old state usury laws were dismantled one-by-one during the 1980s, consumer interest was free to rise without restriction. The Fed's authority didn't extend to the levels of interest charged, only whether the rate was stated clearly following the Truth in Lending Act.
It will be some time before anyone knows the effect of these card company practices on small businesses. It is not quite analogous to say that entrepreneurs with a bright idea are just ordinary card holders who suffer like anyone else. The role the personal credit card has played in the early financing of small businesses is being neglected. In the early millennial boom, it was assumed that many were using that extra credit provided to purchase frivolous items. No one gave much thought to the entrepreneur who was desperately trying to get a venture off the ground.
More stringent credit card reform is needed to protect consumers against predatory practices by the card companies. Those controls won't just help the typical consumer, they would also make the small business owner smile again. Then the angel investors and the venture capitalists will be flying high again in the not-too-distant future.
Charles R. Geisst has written eighteen books on finance and economics, which have been translated into eight languages. The latest is Collateral Damaged (Bloomberg Press). He holds the Ambassador Charles A. Gargano Chair in Global Economics at Manhattan College.