Today’s New York Times has an excellent article on the difficulty that small businesses are still having in getting loans. While the capital markets have freed up, and as a result larger firms are able to tap the capital markets for bonds and commercial paper, small businesses cannot do that.

For very small businesses, the main sources of credit — home equity loans and credit cards — are drying up. Now it looks like one of the biggest lenders to slightly larger firms, CIT Group (CIT) is on the brink of failure.

The length and depth of the recession has made many small businesses less credit worthy, and banks are being extremely cautious. This looks like it could be another reason that the labor market is going to stay weak for some time to come.

The graph below shows the change in employment levels by firm size for each quarter from 1992 through the end of 2008. In good times, small businesses (less than 50 employees) are responsible for about a third of all new jobs in the country. In the 2001 recesssion, small business employment held up well and was responsible for only 9% of the job losses.

Not so this time, with 45% of the jobs lost through the end of 2008 coming from small firms.  In the most recent employment report, the BLS gave a preview of its benchmark revisons that will be part of the January employment report. That preview indicated that the statistical “birth/death” adjustments had understated job losses in the year ending March 2009 by over 800,000.

Almost by deffinition these are all small business jobs. The birth/death adjustments have also consistently been adding jobs so far this year, so there will probably be an additional downward adjustment come Jannuary of 2011 for the year ending March 2010.

If small businesses cannot get credit, they are not going to be able to expand and hire people. Thus, one of the main forces for job creation is likely to be out of action for some time to come.  We have seen the rate of job losses decline, but the rate of job creation is at very low levels.

There is always both job creation and job distruction going on in the economy, and it is the difference between them that we see in the overall changes in employment levels. The evidence is mounting that the problem right now is not an extremely high rate of job destruction, but a very low level of job creation.

This is one of the reasons that so many people have been out of work for so long. On average, people who are now out of work have been out of work for over 6 months. That is a very different experience, financially and psychologically, than being out of work for a few weeks.

For millions of people it is going to result in a permament reduction their standard of living. Once they might have been middle class homeowners. Many will be foreclosed upon, leading to more losses for banks like Bank of America (BAC) and for the whole mortgage complex, including Fannie (FNM) and Freddie (FRE), and through them to the taxpayers.

Read the full analyst report on “CIT”
Read the full analyst report on “BAC”
Read the full analyst report on “FNM”
Read the full analyst report on “FRE”
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