frederic s mishkin : small business lending testimony of mr frederic s mishkin, member of the board of governors of the us federal reserve system, before the committee on small business and entrepreneurship, us senate, washington dc, 16 april 2008. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * chairman kerry, ranking member snowe, and members of the committee, i am pleased to appear before you on behalf of the board of governors of the federal reserve system to discuss the availability of credit to small businesses. small businesses are critical to the health of the u. s. economy. they employ more than half of private - sector workers, generated well over half of net new jobs annually over the past decade, and create more than half of nonfarm business gross domestic product. moreover, larger firms often begin as smaller firms that prosper and grow. if small businesses are to continue to provide major benefits to the economy, their access to credit is clearly a high priority. my testimony today will address the unusual stress imposed on credit markets in recent months and how that stress appears to be affecting small businesses. small business access to credit and the current financial market turmoil as we all know, financial market conditions began to deteriorate quite rapidly in the middle of last august. in response to these and subsequent events, and in recognition that growth of the u. s. economy was slowing, the federal reserve has, since last fall, taken a number of strong actions aimed at both restoring the normal functioning of financial markets and at stimulating the real economy. although our actions appear to have helped stabilize the situation, financial markets remain under considerable stress. for example, many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and have increased the amount of collateral they require to back short - term security financing agreements. credit availability has also been restricted because some large financial institutions, including some large commercial and investment banks, have reported substantial losses and asset write - downs, which reduced their available capital. the capacity and willingness of some large banks and other financial institutions to extend new credit has also been limited by the reduced availability of external funding from the capital markets for originated assets. the resulting unplanned increases in their balance sheets have strained their capital, thus reducing lending capacity. the good news is that several of these firms have been able to raise new capital, and others are in the

. the second is intermediate - term need for reserve expansion and contraction, arising, for example, from seasonal changes in the demand for currency and reserves. and the third driver is the day - to - day adjustment needed to keep the funds rate in line with the fomc's target. one way to think about the three drivers and their associated transactions is in terms of a multifaceted approach consisting of three portfolios. one portfolio might be focused on providing for the gradual long - term increase in the demand for currency and reserves. the second might provide for intermediate - term needs for reserve expansion or contraction. and the third portfolio might be designed specifically to provide for the day - to - day adjustments to keep the federal funds rate in line with the fomc's target. 1. the permanent portfolio long - term secular increases in the demand for currency or the demand for reserves could be met by outright purchases when the most important considerations would be neutrality and managing credit risk and when liquidity would be of less concern. i think that such demand could be well accommodated by a strategy of buying a slice of the same assets held by the private sector. we might think of this portfolio as one large index fund, with all private debt, equity, and other financial claims represented in proportion to their outstanding stocks. a major decision with regard to this portfolio would be whether or not to include equities as well as private debt. equities are fundamentally different from debt in that they confer ownership and a role in management of the firm to the equity owner. allowing the government to have, and perhaps exercise, wide - ranging ownership rights over private businesses would clearly be quite a significant move. with debt, however, the holder generally has no influence on management, especially if the debt is acquired in the secondary market ( so the holder does not negotiate any covenants associated with the debt ) and if the firm is not in bankruptcy. in the case of a firm in bankruptcy, the federal reserve would still need guidelines to govern its conduct as holder of private debt. on the other hand, including equities in the permanent portfolio would best respect the principle of neutrality. the government could hold a wider range of private - sector assets and possibly avoid altering the relative attractiveness of debt versus equity financing. also, given the large size of this market, including equities it would allow the government to hold a smaller share of all private debt, further minimizing potential distortions. the permanent