Are Credit Constraints Important among Self Employed? Søren Leth-Petersen and Ramana Nanda Discussion by Kris Gerardi Federal Reserve Bank of Atlanta

IFS Housing Conference: Microdata, Macro Problems

These views expressed are mine and do not necessarily reflect those of the Federal Reserve Bank of Atlanta. Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

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Summary Goal of Paper: Did increased access to collaterized borrowing from 1992 Danish Credit Market Reform impact small business owners? Reform took effect on May 21, 1992 and made three important changes to the Danish mortgage market: 1

Allowed borrowers to extract up to 60% of their house value for non-housing purposes. Extended to 80% in December 1992.

2

Maximum maturity of mortgages expanded from 20 to 30 years.

3

Borrowers given free prepayment option.

Gerardi (Atlanta Fed)

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Preliminary Results Some evidence of increased equity withdrawal by business owners likely to be “constrained”. Liabilities (which includes mortgage debt) grew after 1992 Reform. All of the action comes from owners with at least 50% equity in 1991.

Very little evidence of impact on growth of firm sales, expenditures, profits, or number of employees. Possible explanations for (lack of) results: Business owners are very reluctant to use home equity as source for business financing. Poor identification of constrained business owners. Home equity financing more important for start-ups than existing firms. Gerardi (Atlanta Fed)

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Home Equity as Source of Small Business Financing? Not much evidence in literature. Huge housing bust in U.S. brought issue to forefront of policymakers’ attention. 2010 National Federation of Independent Businesses (NFIB) survey of small business owners: Designed to be representative of businesses with 500 employees or less. 16% reported borrowing against home equity for business purposes. 7% reported putting up their homes as collateral for business purposes. Numbers rise to 20% and 11% if real estate other than owner’s primary residence is included.

Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

May, 24 2013

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Home Equity as Source of Small Business Financing? 2007 Barlow Research Survey: Firms with sales between $100,000 and $10,000,000. 25.4% of owners reported using their home equity to finance their businesses.

2012 FRB Atlanta Small Business Survey: Representative of Southeast U.S., and focused on businesses with less than 250 employees. 22% of “mature” firms (older than 5 years) and 13% of “young” firms (5 years or younger) relied on home equity for start-up financing.

2010 FRB Atlanta Small Business Survey: 15% of firms cited lack of equity in business or personal real estate as an obstacle to accessing credit for their businesses. Gerardi (Atlanta Fed)

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Home Equity as Source of Small Business Financing? Robb and Robinson (2009) use Kauffman panel survey of small businesses. Approximately 4,000 firms from their birth in 2004 through 2006. Only 8% of firms had more than 5 employees in their first year. Category Owner Equity Insider Equity Insider Debt Outsider Debt

Funding Source

Personal bank loan Owner bus. CC balance Personal bank loan by other owners Bus. CC balance Other Bus. CC balance Bus. bank loan Credit line balance Non-bank bus. loan Govt. bus. loan Other bus. loan Other individual loan Other debt Total Gerardi (Atlanta Fed)

Mean $27,365 $1,695 $7,605 $31,255 $11,066 $1,358 $1,430 $856 $190 $9,357 $3,237 $2,033 $721 $163 $246 $597 $78,406

All firms Mean $34,509 $34,984 $51,221 $85,681 $65,154 $9,710 $62,251 $7,417 $11,929 $150,704 $62,156 $123,622 $80,333 $61,586 $52,529 $122,512

All > 0 firms Count 3,292 186 564 1,487 669 556 97 463 62 242 216 75 37 20 21 21 4,163

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Identification of Constrained Business Owners Current definition: Financial assets < 1% of house value. Wealth by itself may not be a great proxy for constraints. If I have low wealth but could borrow from my family (or some other source) at low cost, then I am not constrained. Could be that business owners have low personal wealth because they financed their (successful) business using their own savings (which might have been the lowest cost of financing at the time). Could be that owner has high wealth because business is very productive and profitable, but still may be constrained in the sense that he would invest more if borrowing were unlimited. Could be that business owners with high personal wealth are risk averse and worried about the possibility of future binding constraints.

Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

May, 24 2013

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Identification of Constrained Business Owners What does it mean to be a constrained business? Would like to expand (hire more labor, build more factories, etc.), but cannot due to lack of credit availability. ⇒ Productive, profitable businesses!

In past work, have tried to identify relaxation of credit constraints based on changing relationship between expenditure and future income growth. Households that have high expected income growth would like to spend more today, all else equal. Binding constraints attenuate that effect. ⇒ Relaxation of constraints should result in opposite effect. Could try something similar in firm context. Estimate whether correlation between future profit/sales growth and current input expenditures has changed before vs. after the reform. Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

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Existing Firms vs. Start-ups

Paper focuses on firms that existed before the 1992 law. Home equity as a source of financing may simply be more important for start-ups than for existing firms. Could do simple comparison of new firms before the reform and new firms after the reform. Try to determine whether reform had any impact on the likelihood of entry, or the probability of success for young firms. Would need a different identification strategy.

Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

May, 24 2013

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Other Comments

Like to see more detail about Danish mortgage market. Balance principle?

How high are moving/transactions costs in Denmark? Possible that individuals used equity to finance new businesses before the reform by simply moving to rental housing?

Are farmers highly subsidized like U.S.? One-third of sample is farmers, so may want to just throw out.

Why not use growth in variables relative to 1991 (year before reform)?

Gerardi (Atlanta Fed)

Are Credit Constraints Important among Self Employed?

May, 24 2013

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Are Credit Constraints Important among Self Employed?

May 24, 2013 - Page 2 .... If I have low wealth but could borrow from my family (or some other source) at low cost, ... own savings (which might have been the lowest cost of ... Would like to expand (hire more labor, build more factories, etc.) ...

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