Ask any small business owner to sum up their experience with banks, and they are likely to reply with the old adage: “Banks only want to lend you money when you don’t need it.”
If the saying was true in good times, why does President Obama think it will be any different in the depths of the worst recession since the Great Depression?
The president this week renewed the administration’s effort to jump-start the economy by unveiling a series of initiatives to spur lending to small businesses. He targeted programs that will aid community banks and bolster lending through the federal Small Business Administration.
Certainly the initiatives will help, but whether they will get desperately needed capital to small businesses in a meaningful way is problematic at best.
The president’s plan is two-pronged. First, he intends to redirect the remaining $173 billion in the Troubled Asset Relief Program, known as TARP, to lower the cost of capital for smaller banks. Then, he’s proposing to boost lending through the SBA’s flagship 504 and 7(a) loan programs by increasing loan limits and raising the amount the government will guarantee.
But the money won’t come without strings attached, and that’s troubling right off the bat for many small banks. According to some reports, senior administration officials have let it be known that tapping the TARP program will likely require executive compensation limits and warrants allowing the government to purchase common stock at a set price, if necessary. The administration thinks compensation rules won’t be a deterrent for the smaller banks.
But many small bankers disagree, according to the Independent Community Bankers Association, a Washington trade group that represents community banks. If the program means additional red tape, many small banks, especially healthy ones, may decide to forego the programs.
When the government extended TARP funds to big banks, there was an understanding, at least on the government’s part, that the money would be used to unfreeze credit markets. But most banks used the money for other purposes — from acquisitions to bolstering balance sheets — and small business lending actually declined overall among those banks.
The administration is proposing to juice lending by allowing banks with less than $1 billion in assets to borrow from the U.S. Treasury at a lower interest rate. The going rate is currently around 5 percent, but could fall as low as 2 percent if the bank is lending in low-income areas.
The initiative will reportedly include incentives to make sure the money goes toward small business loans and will impose such things as quarterly reporting requirements to keep tabs on bankers. In short, more red tape.
Even with the incentives, there is no guarantee that banks will expand lending beyond their top-tier clients. Throughout the recession, financial institutions have continued to tighten standards and terms on all major types of business loans, and expect them to remain in effect at least through 2010, according to the Federal Reserve’s July 2009 Senior Loan Officer Opinion Survey.
SBA loans are an alternative, and the administration will open the tap to federally backed loans. The administration’s plan would raise the limit on the most popular loan, the 7(a) loan, to $5 million from $2 million. Micro-loans targeted at startups and smaller firms would be raised to $50,000 from $35,000.
The administration would also presumably continue the temporary reduction, and in some cases the elimination, of SBA loan fees to reduce the cost of capital. But whether SBA programs will have a significant impact is also open to debate.
A study released in July by the National Federation of Independent Business (NFIB) concluded that such efforts, “while well intentioned” would be only “marginally positive.” The study found that less than 1 percent of small businesses have a government-sponsored loan of any kind. And, because of the complexity and securitization requirements of most SBA loan programs, the study noted, only very large banks participate in them.
In fact, until the housing market collapsed, many small business owners relied on loans against property, including personal homes, to finance their businesses.
More than three-quarters (76 percent) of small business owners had at least one mortgage on real estate they own, according to a 2008 NFIB survey. Twenty-two percent of owners with a mortgage took out at least one other mortgage to finance business activities. Sixteen percent used real estate to collateralize other business assets, and for 10 percent of those it was their homes.
With real estate prices in decline in most markets, that source of funding no longer exists.
Ironically, the NFIB blames the financial crisis on lax lending standards and supports limiting programs to only “creditworthy” companies. “Making more bad loans may help save some firms in the near term, but [i]ncreasing lending for lending’s sake, without regard to the creditworthiness of borrowers, is not the solution to current problems,” the study said.
That may be prudent, but in today’s economy, when many previously healthy firms have seen revenues fall by 30 percent to 50 percent, how do you define “creditworthy?”
Given the government’s recent experience with large banks, it’s hard to see how the latest proposals will provide significant assistance to small businesses, which don’t need to pile on more debt in any case. What they need is capital, and the best way to provide it may be through the tax code.
Republicans have been pushing for a two-year, 50 percent cut in payroll taxes, elimination of the capital gains tax, a cut in the corporate tax rate, and accelerated depreciation and greater expensing of equipment purchases. At least these proposals put money directly into the pockets of small firms. It might also encourage investment to boot.
The president seems to have an aversion to anything that smacks of Republican tax cuts for the wealthy, but these breaks can be targeted directly to small business owners. If Obama truly intends to remain open to all suggestions to solve the economic crisis, as he often says, it’s time to give these proposals serious consideration.