During the darkest days of the credit crisis last October, Congress granted President Bush’s urgent request to address growing problems in the credit and financial markets by passing the Emergency Economic Stabilization Act of 2008 (EESA).
Since then, the government has spent more than $1.6 trillion dollars bailing out big businesses, such as troubled insurer American International Group and mortgage purchasers Fannie Mae and Freddie Mac. But almost none of the money has trickled down to small community banks or, by extension, small businesses.
“The federal government missed a real opportunity to help small firms when it chose to limit this provision to big businesses,” says House Small Business Committee Chairwoman Nydia Velazquez, D-N.Y. “Small business credit markets are as frozen today as they were when the crisis began.”
Velazquez and the House committee have held a series of hearings in recent weeks to examine how small businesses have fared so far under the government’s economic relief efforts. They found that community banks and small businesses have not only been bypassed by relief efforts, but also that lending through the Small Business Administration (SBA) is down sharply.
“Small business lending is in a freefall that will require very strong action to stop,” said Margot Dorfman, chief executive of the U.S. Women’s Chamber of Commerce, who testified at one of the hearings. “Loan volume has dropped dramatically, thanks in large part to the collapse of the secondary market for small business loans.”
A centerpiece of EESA is the $700 billion Troubled Assets Relief Program, also known as TARP. The government is supposed to use the money to purchase failing bank assets. The goal is to free up reserves so banks can start lending money again. To date, nearly all of the TARP’s initial $250 billion appropriation has been distributed. So where has the money gone?
More than half quickly went to just nine of the nation’s largest banks through the government’s Capital Purchase Program. Even large, non-bank companies like credit card firm American Express, auto lender GMAC, and Wall Street’s two surviving investment banks, Morgan Stanley and Goldman Sachs, have been allowed by the government to convert to bank-holding companies and step to the front of the line for TARP funds.
Yet, despite getting government handouts, many of the nation’s largest banks have yet to increase lending. Instead, they are using the money to rebuild reserves in the face of huge write-downs, gobble up other banks, or they are simply hoarding it, says Paul Merski, chief economist for the Independent Community Bankers of America, a trade group representing small banks.
Meanwhile, most of the nation’s 8,000 community banks, which provide loans to 48 percent of all small businesses, have yet to receive any TARP money. Of those, 3,000 community banks have been declared ineligible for the program simply because they are Subchapter S corporations or mutual institutions, Merski says.
“The Treasury and the Federal Reserve have created so many new programs, you would think that at least one would directly benefit small firms — but unfortunately this is not the case,” says Velazquez. “The Treasury and Fed must stop giving small business lip service and actually provide them with the resources they need to survive in this very challenging time.”
In times past, community banks, a traditional conduit for SBA lending programs, could serve as a counterbalance to tight credit for small firms. But just the opposite is happening. In the first quarter of the government’s 2009 fiscal year, which ended Dec. 31, the number of flagship SBA 7(a) loans dropped by 57 percent compared with the first quarter of FY2008 and by 62 percent compared with the first quarter of FY2007.
Lending through the SBA’s Community Express program, which targets low- and middle-income areas and firms owned by minorities, women, and veterans, has been hit even harder. Loans are down 76 percent from a year ago.
Naturally, small business loan demand is down in the slowing economy, but misguided Bush administration policy decisions have hobbled the SBA at a time when it’s needed the most. Over the years, the administration has hiked SBA loan fees, slashed the agency’s budget by half, eliminated the SBA’s successful “Low-Doc” program, and increased red tape, says Merski.
As a result, hundreds of community banks have dropped out of the SBA programs. Today, just 10 large banks make nearly 60 percent of all SBA loans, while lenders that have made at least one SBA 7(a) loan have dropped by almost half, from 5,288 banks in 2001 to about 2,700 banks today.
“This gross imbalance in SBA lending was a recipe for disaster,” says Merski. “Many of the largest financial players have tripped up on toxic investments and subprime lending and have been forced to pull in their lending across the board, including small business and SBA lending.”
During the hearings, small business advocates warned the committee that urgent action is needed to avert even more dire consequences for the economy. “As we watch the falling business lending statistics and the climbing unemployment numbers, I can assure you that the next fatality will be marked by a declining number of small businesses and increased numbers of business and personal bankruptcies,” said Dorfman.
If the nation is ever to break this recessionary spiral, it must tap the power of small businesses to create jobs. There certainly is no lack of proposals, but the Bush administration so far has only focused on big corporations. That has to change in the incoming Obama administration.
Among just some of the proposals discussed, one calls for the Treasury to use its authority to purchase troubled small business loans from banks to free up capital so lenders can make more Main Street loans. Another would require the Fed to set up a facility to directly inject liquidity into the small business financing market. Most important, the committee urged the Federal Reserve to work directly with the SBA to jump-start its lending.
“There are options on the table to help small businesses, and we need to implement them now, before more enterprises go out of business altogether,” says Velazquez. “Our economic recovery depends on the contributions of small firms, and we are at risk of providing them with too little and too late.”