Government Small Business Loan Program Becoming A Shambles

By Marc Tracy

A couple months ago, when last we checked in on Small Business Administration-backed loans, things were looking bad: a combination of the slumping economy (lowering demand for credit), the credit crunch (lowering the supply of credit), and an utter lack of any sort of regulation or govermental directive requiring banks to maintain some lending to small businesses had led to these loans' having declined 30%, in total loans, and 13%, in loaned dollars, from fiscal year 2007 to 2008. (It is important to remember that banks, not the SBA, initiate and actually make all SBA-backed loans, the most common type of which is the 7(a) loan; the agency guarantees anywhere from 50%-90% of each one.)

Since then, the SBA changed two rules (allowing banks to use the Libor rate in addition to the prime one and to bundle loans with differing rates into the same security for sale on the secondary market) in an effort to grease the small-business-lending wheels. Even the Federal Reserve has gotten in on the act, pledging to buy up to $200 billion in now-crappy securities backed by now-crappy types of loans, including small business ones, in an effort to encourage banks to make loans with those past ones off of their hands.

So things are improving right?

Well, the Fiscal Year 2009 first quarter (which was October to December 2008) numbers have come in. The results? A little under 9,000 SBA-backed 7(a) loans were made--a 57% drop from the previous fiscal year's first quarter. These loans totaled $1.94 billion--a 40% yearly drop.

In other words: no, things are not improving.

First: what's causing the drop?

Dropping demand for credit is certainly part of the problem. We're in a recession, investment and plans for growth are way, way down, and so most small business owners are trying to borrow as little as they can; which means they are turning less to SBA-backed loans; which means the loans are going down. "Owners tell us that their primary concern is terrible sales," a National Federation of Independent Business spokesperson told CNNMoney.com. "Under those circumstances, why would they want to expand? They just aren't doing that right now."

Another problem is the general, extreme cutbacks at banks. They are tightening lending like nothing else right now.

Moroever, as we've pointed out before, there's a particularly insidious dynamic regarding the now-$350 billion in government capital that has been invested in banks. No, it's not the fact that banks are largely hoarding this new cash rather than lending it out, though that's bad, too. Rather, it's the fact that the bigger a bank you are, the more likely you are to take the money (and more of it); and the bigger you are, the less likely you are to be lending right now to small businesses, because you are looking at impersonal metrics rather than broader characteristics of an applicant's situation.

Robb Mandelbaum points to a couple of other things that may have caused this latest plummet. For one thing, sales staffs at banks have been decimated by layoffs, inevitably decreasing lending (and in particular, local lending, and therefore small business lending). The terrible resale market for these loans is another reason, although the Fed's $200 billion program is designed to resolve exactly that issue.

And so what can be done?

We say that at some point regulators and legislators are going to have to admit that the typical types of steps--which involve using government intervention to condition and encourage the private sector and the otherwise-free market to increase small-business lending; stuff like the Fed's purchasing of loan-backed securities and the government's investment of capital--simply are not working, and so a completely different approach is necessary. The government must do more than just coax the market to lend to small businesses. The government may soon need to step in and do it itself.

Revolutionary? Tell that to all the banks to whom the government has lent. Or American Insurance Group and Bear Stearns (indirectly via JPMorgan) or Citigroup, all of whom were saved because of favorable government loans. Or the Big Three automakers. We're not trying to lord this over the government--in fact, we were in favor of most if not all of those loans. We're trying to point that in this context any sort of free-market objection is really quite, quite silly.

Where have you gone, Chuck Schumer? Why aren't you clamoring for your plan of direct lending to small businesses? For now, we guess we'll have to do the clamoring.

Comments (4)

January 9, 2009 9:05 AM