Investigative Reporters Tackle the Small Business Administration

When it comes to reporting on the Small Business Administration, it seems to me that most journalists simply assume that if a government agency exists to “help” small businesses then it must be good. So I was pleased to read a weekend piece from two investigative journalists with the Dayton Daily News that challenges the conventional wisdom on the SBA. 

As the reporters explain, the SBA’s main job is to back loans issued by private lenders to small businesses that couldn’t get financing on market terms. The result is that taxpayers end up holding the bag when these naturally riskier loans go bad. 

And quite a few go bad as this Cato essay on the Small Business Administration explains. 

Lenders have little skin in the game so for them it’s heads they win, tails they win. Thus it was shocking – absolutely shocking – that a representative from the SBA and the head of the Ohio Bankers Association provided the reporters with the most favorable quotes.  

The entire piece is worth reading, but the authors did a particularly good job of turning the spotlight on the racket that exists between the SBA, lenders, and national franchisors: 

Franchises are major consumers of SBA loans, according to the Daily News analysis — and sub sandwich franchises top the list. Subway and Quiznos franchises dominated the list of businesses borrowing the government guaranteed loans. Subway franchises took out at least 4,649 of the 7(a) loans since the beginning of 1990, the data show, while Quiznos took out 2,586. 

But the battle of the sub shops went in drastically different directions, according to the loan data. While Subway borrowed more than 2,000 more loans than Quiznos, its loan failure rate was about one-fifth of Quiznos restaurants. Only 4.8 percent of Subway franchise SBA loans were charged off as of the end of February, while almost a quarter — 23.4 percent — of Quiznos franchise loans ended in failure and were discharged to the Treasury. 

Quiznos also led all franchises with $43.5 million in defaulted loan guarantees that SBA had to pay the lending banks. Cold Stone Creamery was second with $29.6 million, followed by Days Inn with $16.9 million and Ramada Inn with $14.3 million.

The sub shops also dominate the nine-county Dayton region in numbers of SBA loans, but the disparity is even more stark. While Subway franchises took out more than twice as many 7(a) loans as Quiznos (35 to 16), only one Subway loan (2.9 percent) failed and was charged off compared to six (37.5 percent) of the Quiznos loans. 

Nationwide, the 50 franchises that cost the SBA the most totaled more than $411 million in discharged loans. 

Corporate franchisors such as Quiznos and Subway contract with individual owners to operate the business, but some corporations take a bigger share of the profits than others.

Quiznos’ cut from its operators makes it harder for them to be profitable, said Robert Purvin, chief executive officer for the American Association of Franchises and Dealers. 

“My bet is lurking behind every failure there is price gouging to the franchisee,” said Purvin. “We’ve been after SBA for years to make no loans to franchisors that are bad players.” 

He said the SBA is essentially subsidizing these big corporate franchisors because the loan money is often used to pay the franchise fees, royalties and sometimes payments on leases controlled by the franchisor. 

What does it say about the state of American capitalism that federal policymakers think it is necessary and proper for the government to subsidize the creation of more Subway shops? 

The defaults and wasted capital aside, it is a quote from the Ohio chapter of the National Federation of Independent Business that gets to the fundamental problem with government-backed lending: 

“Many small business owners see this as an unnecessary program of government intrusion, of picking winners and losers,” said Roger Geiger, Ohio chapter executive director of the National Federation of Independent Business. “They most certainly wonder how equitable it is when it’s their tax dollars being used to fund what could potentially be a competing business.”

As former Sen. Scott Brown (R-MA) demonstrated a couple of years ago, the average policymaker doesn’t grasp that there are major problems with the federal government picking winners and losers in the market. 

Or else they just don’t care. 

The inconvenient truth is that from the SBA’s inception it has existed for politicians to show that they “care” about small businesses. For politicians who support economic policies that are destructive to businesses small and large, demonstrating support for the SBA allows them to pretend otherwise.