Tag: SBA

CBO Perpetuates Small Business Administration Myth

A new brief from the Congressional Budget Office discusses the role of small businesses in the economy and how they’re affected by federal policy. The CBO cites the Small Business Administration as one example of how federal policy favors small businesses over larger businesses:

Assistance from the Small Business Administration (SBA), through loan guarantees that enable small firms to borrow at more attractive terms (for example, lower interest rates and fees) than they might otherwise obtain.

That’s the popular perception of the SBA’s loan guarantee programs, but I would argue that it’s inaccurate for two reasons:

  1. The Government Accountability Office has calculated that SBA 7(a) loans only account for a little more than one percent of total small business loans outstanding. Veronique de Rugy and I looked at the top 15 industries that received SBA-backed loans from 2001-2010 and found that only 0.5 percent of the small businesses that comprise these industries received loans backed by the SBA. Thus, rather than helping small businesses compete against big businesses, SBA loan guarantees mainly help a tiny share of small businesses compete against other small businesses.
  2. The real winner from the SBA’s loan guarantees is the banking industry—particularly large banks. In 2009, the top 10 lenders (out of 2,600 total lenders) accounted for close to one-quarter of the SBA’s flagship 7(a) loan guarantee program’s volume. Wells Fargo & Co. alone accounted for 7.3 percent of the total 7(a) loan volume. Other large banks in the top ten include J.P. Morgan Chase, U.S. Bancorp, and PNC Financial Services Group. Although lawmakers portray the SBA’s loan programs as a boost for small businesses, the programs are actually a form of corporate welfare for some of America’s largest banks.

See this Cato essay for more on why the Small Business Administration should be abolished.

Banks Are Lending, but to Whom?

A recurring concern we have heard since the financial crisis erupted is that banks are simply not lending, and that this is holding back economic activity.  If only banks would lend, the economy would grow.  As usual, the truth is a little more complex. 

Unlike in the Great Depression, and despite about 300 bank failures, the balance sheets and deposits of insured commercial banks and thrifts has been steady, if slowly, expanding throughout the financial crisis and recess.  Banks have continued lending during this time; however, they have changed who they are lending to.  Over the last two years we have witnessed a massive shift from lending to the private sector to lending to the public.

The chart below shows banking business lending and bank holdings of U.S. government securities.   The chart suggests that the approximately $500 billion increase in bank lending to Uncle Sam came at the expense of a $400 billion decline in lending to private business.  If one assumes that bank balance sheets have either been stable or increased slightly, then a loan to the government must off-set a loan otherwise made somewhere else.

While its hard to exactly measure the job impact of this reduced business lending, some estimates have been made on the impact of SBA lending.  According to one study, every $41,600 in new small business loans is associated with 1 new job created.   While this number should be taken with a grain of salt, it implies that the $400 billion reduction in business lending has cost over 9 million jobs.  Of course, one might argue that the half-trillion in lending to the govt has created or “saved” some jobs.  Accepting the difficulty of coming up with a reliable estimate, I think its fair to say that on net a few million jobs have been lost due to this shift of lending from the private to the public sector.

Also of interest is that since the financial crisis, and despite the failures of Fannie and Freddie, commercial banks and thrifts have increased their holdings of Fannie/Freddie/Ginnie securities by over $300 billion.

Textbook economics usually teaches that government crowding out of private investment only really occurs when we are near full-employment.  Yet looking at the balance sheets of our commercial banks and thrifts, would suggest that U.S. Treasuries and Agency securities have crowded out significant lending that would otherwise go to the private sector.   But this should come as no surprise, since banks can borrow for close to zero and invest risk-free in government debt, earning a nice spread of 3 to 4 percentage points.

Spending Our Way Into More Debt

Huge deficit spending, a supposed stimulus bill, and financial bailouts by the Bush administration failed to stave off a deep recession. President Obama continued his predecessor’s policies with an even bigger stimulus, which helped push the deficit over the unimaginable trillion dollar mark. Prosperity hasn’t returned, but the president is persistent in his interventionist beliefs. In his speech yesterday, he told the country that we must “spend our way out of this recession.”

While a dedicated segment of the intelligentsia continues to believe in simplistic Kindergarten Keynesianism, average Americans are increasingly leery. Businesses and entrepreneurs are hesitant to invest and hire because of the uncertainty surrounding the President’s agenda for higher taxes, higher energy costs, health care mandates, and greater regulation. The economy will eventually recover despite the government’s intervention, but as the debt mounts, today’s profligacy will more likely do long-term damage to the nation’s prosperity.

Some leaders in Congress want a new round of stimulus spending of $150 billion or more. The following are some of the ways that money might be spent from the president’s speech:

  • Extend unemployment insurance. When you subsidize something you get more it, so increasing unemployment benefits will push up the unemployment rate, as Alan Reynolds notes.”
  • “Cash for Caulkers.” This would be like Cash for Clunkers except people would get tax credits to make their homes more energy efficient. Any program modeled off “the dumbest government program ever” should be put back on the shelf. 

  • More Small Business Administration lending. A little noticed SBA program created by the stimulus bill offered banks an “unprecedented” 100 percent guarantee on loans to small businesses. The program has an anticipated default rate of 60 percent. Small businesses need lower taxes and fewer regulations, not a government program that perpetuates more moral hazard.

  • More aid to state and local governments. State and local government should be using the recession to implement reforms that will prevent them from going on another unsustainable spending spree when the economy recovers. Also, we need fewer state and local government employees – not more – as they’re becoming an increasing burden on taxpayers.

The president said his administration was “forced to take those steps largely without the help of an opposition party which, unfortunately, after having presided over the decision-making that led to the crisis, decided to hand it to others to solve.” Mr. President, nobody has forced you to do anything. You’ve chosen to embrace – and expand upon – the big spending policies that were a hallmark of your predecessor’s administration.

The Subway Business Administration

Yesterday, President Obama announced a government initiative to help small businesses, largely through the Small Business Administration (SBA). But more on that in a bit…

A February 24th Wall Street Journal article discussed the fact that defaults of SBA-backed loans to franchisees at 500 franchises went up 52% in fiscal year 2008. Loan losses went up 167%. Sure, the economy isn’t doing too hot right now. What grabs my attention is the fact that taxpayers are backing loans to business operations like Subway, Domino’s Pizza, and Planet Beach tanning salons. Is capitalism in this country so incapable, recession or not, that the government needs to ensure an adequate supply of credit to sandwich shops? Tanning salons? A recent headline on MSNBC.com reads, “In many cities, tanning salons exceed Starbucks.”

The Journal reported that in the last eight years 42% of SBA-backed loans to Cornwell Quality Tools Co. franchisees went into default. Yet, Cornwell’s CEO says that it opened 127 new franchisees last year and indicated that “relatively few used SBA lending to enter the business,” according to the article. Proponents of the SBA argue that the agency is needed to help businesses that are unable to obtain credit or financing through traditional channels. What this story shows is there’s obviously a very good reason why these businesses couldn’t obtain private financing. It also shows that, in the case of Cornwell, there’s no “need” to have taxpayers backing loans to its franchisees when so many are opening up without such help.

Is it even true that small businesses are generally so unable to obtain credit that the government must fill the void? According to a recent study by the Government Accountability Office (GAO), “Between October 2006 and March 2008, SBA determined that 31 of the 97 lenders reviewed had failed to consistently document that borrowers met the credit elsewhere requirement or personal resources test.” In other words, a third of the borrows didn’t prove they couldn’t obtain money elsewhere. Moreover, the GAO says, “we found that lenders evaluate a borrower’s ability to obtain credit elsewhere on reasonable terms against their own conventional lending policies.” That litmus test hardly provides proof that deserving small businesses are being left out in the cold. The reality is that the SBA-backs loans to small businesses that could have obtained credit through private means – or shouldn’t have been loaned money in the first place.

Cato adjunct scholar, Dr. Veronique de Rugy, has found that “no more than 1 percent of [all] small business loans each year are SBA loans. The private sector finances most loans without government guarantee and, hence, the SBA is largely irrelevant in the capital market.” Moreover, because SBA financed loans have below market rates, small businesses who aren’t subsidized by the government are placed at a competitive disadvantage. Table 3 of de Rugy’s study for Regulation magazine (download article here and go to pdf page 7), lays bare the SBA’s irrelevance, and the competitive disadvantage the vast majority of small businesses face because of the agency’s subsidies.

The table shows the top 25 industries receiving SBA 7(a) loans for fy2002. At the top of the list are full-service restaurants, with limited-service eating places in second, and automotive repair and maintenance in third. The SBA loan ratio (SBA loans divided by total number of small business establishments in the industry) for the top three, are 1.5%, 1.2%, and 0.6%. The ratio for the top 25 industries was 0.3%; the ratio for all industries was 0.2%. I’m not a math whiz, but less than 1% isn’t very much.

Let’s circle back to the President’s announcement…

First, the President said the U.S. Treasury “will begin making direct purchases of securities backed by [Small Business Administration] loans to get the credit market moving again, and it will stand ready to purchase new securities to ensure that community banks and credit unions feel confident in extending new loans to local businesses.” That idea sounds kind of familiar to me. Oh, right.

Second, the President said “These purchases, combined with higher loan guarantees and reduced fees, will help provide lenders with the confidence that they need to extend credit, knowing they both have a backstop against their risk and a source of liquidity.” According to the Wall Street Journal, “Mr. Obama’s plan, aimed at helping troubled small businesses, will increase that guarantee to as much as 90% of a loan. The plan also will temporarily eliminate many of the loan fees that help pay for the program and cover potential defaults.”

It’s this second part that should be particularly galling to regular taxpayers and the vast majority of small businesses dealing with subsidized competitors. The President mentions some temporary tax breaks, but as Raymond Keating, chief economist at the Small Business and Entrepreneurship Council, told the Journal, “the Obama administration would accomplish much more in terms of boosting confidence and getting the economy moving by, at the very least, moving away from imposing higher personal income, capital gains, dividend and estate taxes on investors and business owners.” Additionally, a small business owner writing in Slate, in a piece entitled “Why Small Business Hates the Taxman,” says that what rankles a lot of small businesses is “the sheer hassle of compliance with the tax laws and the complete loss of control you feel when dealing with the government.”

Instead, the administration’s idea of helping small businesses is perpetuating the same moral hazzards that has the government already bailing out reckless private interests to the tune of trillions of dollars in current and future taxpayer dollars. This is change we can believe in? Unbelievable.