Small Business Lending: Why the Programs Need to Change

Programs to get small business lending moving aren’t working. Instead of a resurgence of small business lending, the situation is getting worse.

Last week the Wall Street Journal reported that the White House was searching for ways to help small business by unlocking frozen credit. This week CIT (CIT), the largest small business lender in the U.S., fought for survival. Funds just aren’t getting to small business.

I believe that the Obama Administration has good intentions and is trying hard to do the right thing but is tragically out of touch with the real world. Obama, Summers and Geithner lack actual business experience and haven’t figured out that no matter how smart they are, there is no substitute for real life. Studying small business lenders and small business just isn’t the same thing as running a business, and until they get someone to help them who has real world experience they are going to continue to flounder.

In February and March I warned that programs to get small business lending going weren’t going to work. I thought that they were DOA, and I was correct.

Soon after becoming Treasury Secretary, Geithner observed that most small business lending was funded through the “shadow banking system”, i.e., non-bank lenders. Yet Obama’s recovery plans ignored non-bank lenders and instead focused upon pushing banks to lend even though they weren’t the primary source of lending before the crisis began. Recovery plans also relied upon the SBA to get liquidity into the hands of businesspeople. Unfortunately the SBA hasn’t been relevant or effective since the Reagan Administration.

Back in February I thought that Geithner was a quick learner and that he would ditch policy alternatives that didn’t work. I was wrong. The Administration continues to operate in their “comfort zone,” which is banking, even though the small business lending crisis is playing itself out in the non-bank financial company arena.

Below are the four suggestions that I made in February to help small business lending. These appeared in an article I wrote in February and was the first in a small business lending series written by myself and Rob Blum. Each of the articles can be read by hitting this link, this link and this link. Also, I wrote an article for Forbes.com which can be read by hitting this link.

• Form new government sponsored financial guaranty and bond insurance companies. The failure of the financial guaranty and bond insurance industry led the U.S. into the financial crisis and the restarting of this industry will help lead America out. These insurance companies work because they create operating efficiency for investors and back up their work by assuming risk. The bond insurers serve a function similar to rating agencies but unlike rating agencies, the bond insurers align their interests with investors by putting “skin” in the game. Bond insurers were essential to the capital markets for decades. Newly formed and well capitalized bond insurance companies can be started by Treasury in a matter of weeks and, if formed, will help restarting lending.

• Amend the mutual fund and tax laws to promote the formation of tax efficient pools of investment money for lending. The interplay of the laws governing mutual funds and taxes make it difficult, if not impossible, for investors to form tax efficient investment pools that originate and own high quality commercial and consumer loans. The laws are antiquated, restrict capital formation, inadvertently encourage risky behavior and make little common sense. A passive investment in a non-mutual fund direct lending pool can have disastrous tax consequences for foreigners, not for profits, pension funds and individuals (because of state taxation issues in the case of individuals). And, the laws regulating mutual funds have the unintended side effect of encouraging risky behavior instead of prudent lending. Geithner can fix these laws and encourage the formation of investment capital to restart lending. And, there will be no impact on Federal spending.

• Expand the Community Development Financial Institutions Fund. Every year the IRS grants several billion of tax credits to lenders through the Community Development Financial Institutions Fund (”CDIF”). This program is supposed to encourage economic development through tax credits that are earned by lending in low income and blighted areas. Unfortunately, over the years the CDIF has favored real estate related lending rather than core business lending. If CDIF was reoriented to encourage business lending, an existing program that is annually costing taxpayers billions could be converted into an important tool to restart commercial finance.

• Encourage the SBA to license non-bank lenders and update and modernize the program. The last non-bank lender to receive a new “Section 7A” license was during the Reagan Administration. Under pressure from critics, SBA programs have been cut back year after year and are almost totally dependent upon banks. The SBA lending industry is almost virtually irrelevant.

30 years ago the SBA had a terrible reputation because its programs were badly administered. Since then the SBA has shrunk as a proportion of the economy. But, the SBA’s poor history doesn’t mean that the SBA can’t restart itself and contribute to American business health. A top down review of SBA programs with an eye towards modernization and inclusive lender eligibility, including non-bank participants, could fix the SBA.

Geithner’s current proposals won’t get bank lending going again and certainly aren’t going to get non-bank lenders excited. The Treasury Secretary needs to get out of his comfort zone and start to look at supporting non-bank lenders and investors. They make up most of the market for consumer and business loans and ignoring non-bank lenders won’t get the economy going again.

Comments

[Ted Hurlbut:]

Lack of access to financing has caused many small and independent retailers to retrench more than the sales declines warrant. A CIT failure would only worsen the situation. Small and independent retailers are already behind the 8 ball because they trade primarily in discretionary goods.

Jul 19 11:10 AM

[Gem Hudson:]

Well because you are going into business for me, going from my rags to your riches is you making it happen for me but do they know the buisness? What they are selling is what you have to buy into but what is sold isn't selling if you just produce it. Selling the sold does not buy buy much.

What the customers are buying into. Produce, for them, the very best that their money can buy and you are selling their money worth but as for selling his Obama-mobile, is it the world owe him more than a good living or not to sub prime this deal?

Jul 19 11:48 AM

[jtareen:]

Where is the private sector now and why is it not lending?


On Jul 19 01:11 AM PastTense wrote:

> I see no reason the federal government should be involved in lending
> money to small business (or big business for that matter). This is
> a function of the private sector.

Jul 19 12:10 PM

[rrbatch:]

I volunteer with our local chapter of SCORE, a private foundation and "resource partner" of the SBA. We see budding entrepreneurs each week looking for startup capital and advice on how to develop business plans and organize new operations. We have access to the SBA web site, publications, and financial resources, but over the past years I have yet to see any of these "services" be useful to a new - or existing - business.

There are other federal and state agencies with paid employees offering services similar to those we offer as volunteers - except that our staff of eight volunteers has more than 200 years of collective business experience, whereas few of the government employees we see have ever held responsible positions outside of government. One recent client with a highly credible business plan was denied an opportunity to even meet with a bureaucrat responsible for disbursing state Small Business Financing Authority funds because she was "extremely busy preparing for an upcoming Board meeting".

I doubt that the SBA or corresponding (and duplicative) state agencies can be reformed to be more responsive or useful. Better to save the taxpayers the expense of maintaining these costly and useless agencies, and let small businesses make their case to the wide variety of established private funding sources. And support community-based volunteer advisors like SCORE to help guide new businesspeople through the hoops.

Jul 19 12:10 PM

[Robert Gary:]

In April of 2009 I wrote to the SBA and to Larry Summers suggesting that stimulus money be put into direct SBA micro-loans.

For this to work, the money would have to go out in increments of $25,000, and go directly (not through a bank) from the SBA to individual entrepreneurs stating new small businesses. These would have to be talent-based loans in which the risk is kept low by lending to persons with strong academic degrees in Accounting, Marketing, Product Design, Manufacturing Operations, Cost Management, or Export/Import. The idea is not to make the program more elitist by only lending the money to qualified people, but ratther the idea is to lower the risk of default by loaning the money to people with business-relevant talent that has been established by study and documented by transcript.

A mere $25 Billion would create One Million of these micro loans. I tried to explain that a million micro loans to talented qualified people would actually be more stimulative than stuffing another $25 Billion down the throat of the next NYC bank that said they did not want the money, and would just use it to re-capitalize their balance sheet (provide money for executive pay and retirement).

The SBA wouldn't hear of it. They said they had a Temporary Administrator so their hands were tied, not a thing they could do to get any of that stimulus money or develop and program to loan it out. I said that the money would be re-cycled about four times, assuming 25% defaults, and that the stimulative impact would be immediate and dramatic -- imagine 20,000 new small businesses in each state. New employees, new equipment, new advertising, the velocity of that money would be very high.

Defaulting at the rate of 25% per cycle, you would get a hundred billion dollars worth of stimulus out of a mere $25 billion (one Wall Street Bank Bite).

White House was too disorganized to respond to my plan. SBA was appreciative but their hands were tied (probably by G.W. Bush), they simply had no ability to respond -- they were like the Katrina responders -- not ready for prime time.

Jul 19 12:17 PM

[Robert Gary:]

My B.A. involved four years of math study and is from St. John's College (Annapolis). My M.B.A. in Management Science is from G.W. My J.D. is from Southwestern University (Los Angeles). I have 25 years experience as a trial lawyer and policy analyst. I currrently write books and file patents. I was an applicant for an SBA Patriot Express Loan (decorated vet with service oversaes) in May of 2009. I finally did get a very small loan $5,000 from an SBA affiliated non-bank lender. The Obama could have done so much better, had they been awake, and had they seen the SBA as a part of the solution. The SBA could have been really rising to the occasion if the imagination had been there, and the courage. It was in sleepy world, sort of like FEMA.

Jul 19 12:25 PM

[badScooter:]

Re SCORE: Rribatch, it is disturbing for me to hear your disillusionment...not surprising, particularly, but disturbing. I've run a small business about 8 years now. Always kind of looked up to you SCORE people. Never had a need for an SBA loan though. Now it would be nice to take a look into this "35k special loan program", but after talking to the 'crat, sounds like we'll just do what we've always done (make it work on our own resources) until we recover or we fail. I KNOW, however, I could make better use of money than say New Hamshire, which has apparently spent 400M+ in stimulus to create a net 50 jobs...35 of which are full time! Think about what has already been pissed away, formed instead into microloans for the productive. On the other hand, who wants government screwing up small businesses, too...I'd prefer a "tax holiday" instead of other peoples' money.

Henry Buttal, you're right, very few people who know what the hell they're doing business-wise in government...that old saying about "those who can...DO, those who can't...GOVERN (or whatever)". And every smallbusinessperson I've ever talked to places a premium value on time and clarity. As such, unlikely to make enough bullshit mouth noises for the adoring public to elect them.

Jul 19 01:01 PM

[rollini:]

FYI, the new Administrator of the SBA, confirmed April 6, 2009, Karen Gordon Mills, is an experienced business person and venture capitalist by background. Now what is needed is more clarity regarding its mandate, streamlining of its processes, and stimulus funding to be made available in 2009, or else the SBA will have no ability to contribute to an economic recovery.

Jul 19 01:54 PM

[Buckoux:]

Two facts so profoundly true that they bear repetition.


On Jul 18 03:50 PM Henry Buttal wrote:

> "...access to funding SMB's have is constantally overrated and >undervalued by this and previous administrations, and b) the SBA has >become a tool of large banks to reduce risk from the few SMB loans >they actually give out...

And:

> ValleyBoy - experienced business people are hard to vote into office
> because they often are brutally candid about the world, and espouse
> self-reliance. This may play well with the Tea-Party movement types,
> but not in comparison to the pandering, sugar-coating and lies used
> by most politicians to get into office.

Jul 19 02:12 PM

[Buckoux:]

"Obama, Summers and Geithner lack actual business experience and haven’t figured out that no matter how smart they are, there is no substitute for real life."

Another grain of truth that needs planting, watering, fertilizing, and, someday harvesting (maybe).

Jul 19 02:15 PM

[KAIMU BIZ:]

ALOHA !!

Please-e-e ... according to Karen Gordon Mills she "honed her expertise as a former managing director and COO for E.S. Jacobs & Co., a leveraged buyout firm. "

Those are more MADE IN WALL STREET skills ...

As I said I would prefer a "real' Venture Capitalist, non CFO type heading the SBA.

Obama has chosen WALL STREET once again ...


On Jul 19 01:54 PM rollini wrote:

> FYI, the new Administrator of the SBA, confirmed April 6, 2009, Karen
> Gordon Mills, is an experienced business person and venture capitalist
> by background. Now what is needed is more clarity regarding its
> mandate, streamlining of its processes, and stimulus funding to be
> made available in 2009, or else the SBA will have no ability to contribute
> to an economic recovery.

Jul 19 02:18 PM

[Buckoux:]

FYI, rollini, no matter how experienced this person is she will be beaten down to conform to the theoretical academic model of small business that is within the government, then to achieve the practical needs of small business in the actual world. The SBA should be gotten rid of to end its cynical charade of false hope.


On Jul 19 01:54 PM rollini wrote:

> FYI, the new Administrator of the SBA, confirmed April 6, 2009, Karen
> Gordon Mills, is an experienced business person and venture capitalist
> by background. Now what is needed is more clarity regarding its
> mandate, streamlining of its processes, and stimulus funding to be
> made available in 2009, or else the SBA will have no ability to contribute
> to an economic recovery.

Jul 19 02:23 PM

[sethmcs:]

The SBA does not lend money to no one. The SBA guarantees the bank who lends the money. SBA loan programs just like Federal student loan programs are welfare for banks. Do they help small business? Yes they do. Does SBA program increase availability of loans to small business? Yes it does.

Jul 19 02:44 PM

[58robbo:]

the govt had the perfect opportunity to lend a hand to small business. the problem is they went and bailed out the 'too big to fail' crowd. in my opinion, when companies become overweight, their failure provides an opportunity for the smaller guys to grab some market share be it through price, service, cost control, etc. that's how the free market works.
it's one thing having to compete against your opponent it's another story to try and beat the umpire

Jul 19 03:12 PM

[Robert Gary:]

OK Here's my Modest Proposal: Give Ms Mills some Action Attainment Deputies. Make them two Marine colonels, fleeted up to Brigadiers for their SBA TAD assignments. Make them Plum Book Level 1 Appointees. Back them up with Letters of Instruction from the West Wing to Ms Mills so that anything that gets between the Generals and the attainment of their mission can be quickly and cheaply neutralized. The problem, is about DOING. Doing is not the same as talking.


On Jul 19 01:54 PM rollini wrote:

> FYI, the new Administrator of the SBA, confirmed April 6, 2009, Karen
> Gordon Mills, is an experienced business person and venture capitalist
> by background. Now what is needed is more clarity regarding its mandate,
> streamlining of its processes, and stimulus funding to be made available
> in 2009, or else the SBA will have no ability to contribute to an
> economic recovery.

Jul 19 03:13 PM

[whisperonth...:]

In several of his 'talks', Mr. Obama has mentioned small businesses and the great role they will play in helping the U.S. through this economic hardship. It sounded nice, like his promise of change.

It could work. IF small businesses could get the loans they need, they would hire more people. This would put more money into the income tax pools, at the same time it also put more money into the subsidiary businesses like restaurants, grocery stores, gas stations. That would give that level of business more money to hire more people, this starting another level of income revenue. As that level of income revenue starts working on the economy, the upper levels of businesses would grow, and even more people would be hired.

But the small businesses that Mr. Obama praised can't get loans because the banks won't give them, the government won't give them loans, no one can give them the money they need to enable them to do what Mr. Obama said they would do. With enough of this attitude, perhaps Mr. Obama will increase our unemployment benefits to 100 weeks instead of just 70.

Jul 19 05:40 PM

[rm:]

[My solution, which would be really radical, especially for Harvard and Wharton grads to swallow, would be to just eliminate the MIDDLE MAN, which are in this case "banks" or any entity that sets itself up in the middle skimming profits between government and entrepreneurs. ]

While it's popular to bash the evil middleman who "skims profits," most systems NEED middlemen in order to function effectively.

One of the fundamental flaws in government-run programs is that they try to eliminate middlemen, so decisions that would best be made in the field or on the ground are made by someone who's completely out of touch. The main criticism in this article more or less proves the point.

Like you, I used to be enamored by the idea of government "partnering" with business.

Now that I've seen how it works, a la Goldman Sachs and GE, I now realize that the only "partnering" that takes place is with the well-connected.

In addition, I have not one example of something that the federal government does well, other than obfuscate, confuse, major in minors, and expense magnification.

The less the federal government does, the better.

And yes, that includes small business lending.

Jul 19 06:36 PM

[W.E. Heasley:]

Excellent article. Good points.

SBA likely needs a boost and needs a new mission statement. The SBA is covered in dust and needs a coat of paint.

Private Capital Formation needs incentives. There is absolutely no incentive for Private Capital Formation. There however is a list of disincentives: rising Federal and State Taxes, Cap and Trade, Socialized Medicine, Increased Regulation.

Summers and the gang are stuck in a 1975 Keynesian Class Room, and if Keynes didn‘t write it in a textbook, then they have no clue. They are also stuck in the mud CYA’ing the Quasi Stimulus Plan based on Political-Political rather than Political-Economy.

Your points are very good, but the-powers-that-be are too busy with CYA and not business savvy enough to understand.

Jul 19 08:50 PM

[KAIMU BIZ:]

ALOHA !!

Here is my simple MONEY FLOW CHART ...

US TREASURY >>> US FED >>> WE THE PEOPLE

Who is that in the middle skimming profits and running insider trading scams night and day? It looks like a simple MAFIA MONEY FLOW CHART ...

CASINO >>> MAFIA >>> GAMBLERS

The CASINO creates the chips(DEBT) ... The MAFIA skims the take(interest/fees) and the GAMBLERS get hosed(TARP) ...

Not a whole lot of difference. The MAFIA skims Vegas casino profits and so does the US FED.

GET RID OF THE MIDDLE MAN ...

Is it not "our wealth" that is at stake in this high stakes fiat poker game? In my view we are allowing the US government and the US FED to play without even an ante! Why should we who hold the "real assets" of America ... we who are the only ones "AT RISK" have to pay interest at all?

Lose the US FED ... its a MONEY MONOPOLY ...

Then get rid of the REP and DEM Dog and Pony Show that resides at the US Congress which has brought ruination to these shores.

GOVERNMENT IS ONLY AS HONEST AS ITS MONEY ...

Jul 19 09:20 PM

[Between The...:]

I like the later of the proposals, but I disagree with your first bullet. A GSE for bond insurance would be a poor idea, basically taking the Fannie Mae and Freddie Mac business model and expanding it to an even more challenging arena. I consider fully securitized home mortgages to be a vanilla product, yet the GSEs completely mismanged their risk and used their implicit government backing (now explicit) to over leverage and profit in the good times and leave the taxpayer holding the pieces in the downturn. A bond insurance GSE would have similar incentives to under price tail risk, juice profits with taxpayer-backed leverage, and tunnel the money to the executives and the small equity slice before the whole thing blows up. Bond insurance is an incredibly complex business, and, as the CDS market has shown, can be easily mismanaged. This completely ignores that fact that a powerful GSE will be used as a political tool as well, making it unlikely that any meaningful regulation or oversight will prevent the scenario I outlined above.

Jul 20 06:10 PM