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The Entrepreneurial Agenda by Robb Mandelbaum
April 3, 2009
Why Obama's Small Biz Rescue Plan Is Collapsing
Posted at 9:25 AM
You might recall that a couple weeks back, the Obama Administration convened a "small business summit" to trumpet its efforts to shore up small business lending. Most notably, President Obama and Treasury Secretary Geithner determined that the Treasury Department would spend up to $15 billion to buy SBA-guaranteed loans. The idea was to loosen up SBA credit by unfreezing the secondary market for those loans; banks or middlemen who sell their loans to the government could then use the proceeds to make or buy new loans.
So what's happened with that initiative? Nothing, according to the Washington Post. "Every major provider of these kinds of loans," the newspaper reported on Wednesday, "says the plan will not work as designed."
The problem seems to be that the money for the program is to come from the Troubled Asset Relief Program, to which Congress has attached some strict ("onerous" is the adjective du jour) conditions. Institutions that sold SBA loans to the government would have to surrender an ownership share, too. And they'd face limits on the salaries and bonuses they could pay key employees. "Why would you participate?" Signature Bank CEO Joseph J. DePaolo asked the Post rhetorically. "How can you do business if the government at any time can change the rules of the game to protect its investment?" According to the article, Signature Bank is one of six broker institutions that together control 80 percent of pooling market, none of which plan to sell to the Treasury.
We should have expected this. Too many financiers, on Wall Street and Main Street alike, are eager for a helping hand from Washington, provided they don't have to give anything up in return. Not the indulgent compensation schemes that reward short-term results at the expense of long-term success. Not a share of the profits, even though taxpayers would eat the losses. "You need us," they are saying, "so you will fork over your money on our terms." And why not? They're certainly not obligated to sell their loans to the government.
The Obama Administration seems ready to capitulate. The Post says it's trying to work out a structure that evades the mandates from Congress -- for instance, chartering a special "vehicle" that would technically not be a government entity. This is a mistake. Why reward intransigence? Moreover, as Agenda reader "Frank" points out, a secondary market is not unconditionally a good thing. "If a lender knows that it can sell a loan as soon as the loan is made, do you think that loan will be underwritten with the same diligence as a non-SBA guaranteed loan held on that lender's books?" he's asked elsewhere. It was, after all, the secondary market that facilitated the residential mortgage meltdown. Now, "Frank" is an implacable SBA critic, and I've never seen evidence that pooled loans perform worse than portfolio loans. Still, it stands to reason that an unconditional market maker (particularly the government) could change a banker's risk calculations.
The Post story doesn't make clear why the Treasury couldn't simply elbow the poolers aside and buy the loans from the banks themselves, though presumably the banks, too, would chafe under the "onerous" rules. As an alternative, Slate BizBox columnist Marc Tracy wants the federal government to compel TARP recipients to lend to small firms. The Agenda is a big fan of BizBox, but finds this idea problematic: if the point of TARP is to replenish capital lost to risky loans and stabilize fragile banks, it hardly makes sense to demand risky new loans from those banks. (And in this economy, any small business loan is a risky loan.) Moreover, as Tracy notes, some banks, including Signature, are already returning TARP money to free themselves of government accountability. This new stricture would certainly drive more of those banks that could to reject TARP. That in turn would heap further stigma on the institutions that couldn't reject federal help while simultaneously (and perversely) forcing this lending on the banks least able to absorb the risk.
A better idea -- and one that Tracy finds his way to eventually -- is that if even a generous government guarantee won't induce small business lending, the SBA should, for the next several months, make those loans itself. The House of Representatives actually contemplated direct lending by the agency in its version of the stimulus bill. At the time, the Agenda was leery of expanding the SBA's mission when the agency can barely meet its obligations now. But we've come to prefer that to indulging the financiers' taste for structuring transactions on heads-I-win-tails-you-lose terms.
And in fact, there are a lot of out-of-work bankers right now who could help the SBA ramp up a provisional direct lending operation quickly and easily. Many of them are in fact already expert in the ways of the SBA, having until lately worked in the SBA loan divisions of commercial banks large and small. As of last November, SBA lending had lost more than a third of its jobs, according to an industry recruiter.
The most recent casualty is Community West Bank. In 2008, this little California-based bank wrote 62 SBA loans for $25 million, while expanding its reach to 20 states across the U.S. Earlier this week, industry analyst Coleman reported that Community West had changed its mind. By Wednesday, it had reduced its lending footprint to the Rockies and west, and halved its staff.
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"chartering a special "vehicle" that would technically not be a government entity."
As Yogi Berra once said, "It's like déjà vu all over again." Perhaps they could keep with tradition and call it Fonda Mao. Any thought of setting up an SBA version of Fannie or Freddie is a clear sign of government not learning from its mistakes as well as being the definition of insanity.
Perhaps a better use of resources might be a program for blending unemployment with entrepreneurship. Given the current rate of unemployment, there should be at least a few who would like to strike out on their own but don't because they fear the lack of a safety net. Find a way to bridge that gap. It could be as simple as a temporary waiver that gives people a set time to get on their feet and doesn't disqualify them from their original unemployment benefits if they fail. Maybe it's six months, maybe a year. The waiver could be contingent on having a sound business plan and maybe some other _simple_ requirements.
Having a fall back might give them the confidence they need to take those first steps before they feel they have run out of options. If they fail, they go back to where they were, no harm, no foul. If they succeed, they might pull a few other people off unemployment as well.
If Banks wont redistribute the TARP money they have been given by the U.S. Taxpayer, then the Banks need to be Nationalized.
The corrupt Bank CEO's need to be jailed for Economic terrorism, and tried in a U.S. Court of law, and if found guilty they should be jailed for life.
China's government execute's their corrupt business executives, Maybe its time for the
US government to follow China's example.
After that you will see lots of money being loaned out to the small businessmen.
I don't think I would call for anything as drastic as Joe B, but I do sometimes wonder why, if the President can impel the CEO of a major global corporation to step aside, why he can't do more to trigger SBA lending.
I do think that it's high time for the SBA to stand up and start lending on its own if these government guarantees are not bringing about a sea change.
On one hand you have the Administration, very publicly, pushing the banks to make more loans to small businesses, on the other hand you have the same government, through the regulatory agencies, pressuring the banks to NOT make any bad loans. This is a huge disconnect, one that needs to be taken into consideration when looking at the current situation, and one, quite frankly, that the majority of the public is either unaware of or is completely ignoring.
That, combined with an ever changing approach to combat the current economic downturn, are the biggest obstacles to correcting the current malaise facing our economy.
"If a lender knows that it can sell a loan as soon as the loan is made, do you think that loan will be underwritten with the same diligence as a non-SBA guaranteed loan held on that lender's books?"
The issue here is the the SBA does not hold banks accountable for their lack of proper due diligence. Historically, the SBA has found issues with how large SBA lenders are making SBA loans when performing their regular ongoing audits. The problem is that they don't do anything about it because they don't want the big players to stop making loans. Remember BLX! Half of the blame belongs squarely in the lap of the SBA for not holding the banks accountable to the rules they are supposed to enforce.
It does not make any sense to impose TARP restrictions including warrents to sellers of SBA loans. These loans are not toxic assets. They are 100% full faith and credit of the US Treasury so it is absurd to impose any restrictions. The bank that originates the loan has to keep the unguaranteed portion so they have skin in the game. More lending would take place if the 0.55% on-going guarantee fee that banks have to pay was temporarily waived just like the borrowers guarantee fee, in fact if only one of the fees was waived it should be the banks fee, lets face it borrowers want to borrow, but banks still cannot make money at these yields (maximum rate the bank gets is 5.45% if it cannot sell the loan).
Mike hits the nail on the head. The secondary market program was substantially weakened when default and prepayment ratios didn't meet investor's models.
That is to say, SBA's own statistics indicate that there were an extremely high number of defaults and there were an extremely high number of prepayments in both the 7(a) and 504 programs in the two years leading up to the collapse of the private secondary market. Those two issues are indicative of the fact that the market for SBA loans recently has been for those who are less than credit worthy or those who can exit the rather quickly for a more affordable product.
Lending more to those who aren't credit worthy is the bedrock of our present economic situation. Why can't this adminsitration understand that neither it, nort individuals nor businesses can borrower their way out of financial problems?
The Obama Administration wants banks to take more risk while penalizing the leadership of those banks for past risk taking with restrictions on income. At the same time, the administration has proven that its not above changing the rules of the programs midstream to meet their populist political agenda. Frankly, I'm surprised that Bankers are even giving the administration the time of day today.
If the administration wants the SBA to lend more, it should revert to the former model of SBA where it made most of its loans directly to borrowers and it shouldered all of the risk of those loans.
One of the biggest problems right now in SBA lending is the we cannot price these loans commensurately with the associated risk. If the SBA would lift the interest rate limitations, we might be able to make more loans, however, we still need to make good loans. We cannot afford to lend money to businesses that are already failing or have little prospect of success. And lastly, the SBA got out of the direct lending business because they could not keep up with demand. Their infrastructure has been gutted and it would take months to re-build the system, even then, it would not be sufficiently efficient to handle the volume of requests.
You made reference to the comment by "Frank", who made a fundamental and incorrect assumption about the SBA secondary market in assuming a double standard in loan underwriting. The lender's risk is not gone when the loan is sold on the secondary market, as it often is with residential mortgages. The originating lender retains some interest in the loan, and usually services the loan. The lender is required to buy it back from the secondary market and liquidate it if and when it goes bad.
If the lender has not used proper due diligence to underwrite and document the loan for both creditworthiness and eligibility, the SBA can and does deny or repair (reduce) the guaranty. There is no free ride from the SBA secondary market, it simply creates liquidity for the lenders to allow them to make more loans.
Good comments all; one point to keep in mind: The SBA still has direct loan-making capability and still uses it to process and make all manner of direct disaster loans to individuals and businesses. This capability was significantly reengineered in the aftermath of the Rita-Katrina-Wilma debacle and is now designed to effectively handle a much larger volume and with quicker turnaround than before.
Because of this restructuring, the major systems and processing components of a commercial direct-lending model are already in place if SBA is directed by the Administration to move in that direction. There would need to be some integration with the SBA's current loan guarantee processing center in Sacramento, but such integration could likely be accomplished fairly quickly if the necessary fiscal and staffing resources were made available.
Having the SBA make direct loans again would be a disaster for two reasons: 1) It would take months,if not years to develop an organization large enough to meet demand. Disaster loans do not approach the complexity of commercial loans, especially during a major recession and 2) Profit. What drives a sucessful program is profit for the lender. A government employee has no stake in making good loans. That is why the default rate on direct SBA loans was over 20%, when they left direct lending in the early 1980s. Don't get me wrong. Government employees do their best. However, there is no better incentive to make as many good loans and as few bad loans than saying "if you make good loans, you will make more money and if you make bad loans you will loss your job". The SBA needs to eliminate lender fees and the industry will provide all the loans the creditworthy borrowers need.
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