Why Banks Won't Lend

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GREGORY O'DANIEL WAS READY TO play a role in getting the economy back on the road to recovery. The Pennsylvania businessman wanted to lease new machinery and hire a dozen more employees so that his two-year-old firm, Tempco USA, could boost its production of cosmetic cotton pads and facial tissues. But O'Daniel needed financing to do that, so he went to his local bank for a $300,000 line of credit. His company has an unblemished credit history and has been ringing up $600,000 in monthly sales to such customers as Wal-Mart and K Mart. Yet the bank turned him down on the grounds that Tempco's track record wasn't long enough. O'Daniel now has to scale back his plans and lay off four employees.

Susan Karlin suffered a similar fate. The graphic designer, who has managed a profitable studio in Manhattan for seven years, needed more computers and a larger staff to accommodate her growing clientele. When she applied for a $100,000 loan at a large bank, she even agreed to put up $200,000 worth of personal property as collateral. She had no previous history of credit problems. A week later, a lending officer called her with the bad news: "We don't feel comfortable with it." Karlin was upset. "I gave them all the documentation they asked for," she said. "Still they wouldn't give me an explanation for why I was rejected."

Frustrating experiences such as these help explain why the U.S. is having trouble pulling out of its doldrums. Small and medium-size businesses across the country are ready to hire more workers, buy new equipment and lease additional office space. But the financial fuel needed to generate this activity is locked up tight. America's commercial-banking industry, on whom these companies rely for financing, is shying away from its traditional role of taking on new risks. Business loans held by banks have plunged a record 8% since the beginning of 1991, to $594.2 billion. "What will create new jobs and new businesses? It certainly hasn't been lower interest rates," says Jay Goldinger, co-founder of Capital Insight, a securities firm in Beverly Hills, California. "Only one action can jump-start the economy. Banks must start lending again."

The persistent credit crunch has its roots in the go-go lending years of the 1980s, when banks and savings and loan associations issued an extravaganza of careless loans to real-estate sharks and corporate raiders, oil drillers and developing countries. "All you had to do to get a loan in the 1980s was have a pulse," says Jon Goodman, vice chairman of California United Bank. The resulting avalanche of bad loans forced the U.S. to allocate nearly $100 billion to bail out the S&Ls and set aside a $70 billion credit line for cleaning up the banks. To prevent such a disaster from happening again, Congress and the Bush Administration fired off a barrage of tough new banking standards. But when federal regulators began enforcing the new rules with an iron fist, many banks and borrowers started to howl. Last year the Bush Administration ordered regulators to ease up, but so far, most bankers remain fearful that any laxity on their part will bring regulatory punishment or even closure. "The weaker banks want to spend more time trying to clean up their balance sheets than making new loans," says Verne Istock, vice chairman of Detroit's NBD bank.