Deficit reduction is on nearly everybody’s mind in Washington. With a soaring national debt and a third-straight year of trillion-dollar deficits, policymakers in Washington are keeping their eyes and ears open for spending cuts any way they can get them. One proposal came in mid-March from Senator Orrin Hatch (R-Utah): rescind $10 billion of currently unused funds from the Small Business Lending Fund (SBLF). The $30 billion fund is still sitting idle despite being signed into law last fall, so why not return some of those taxpayer dollars to the Treasury to reduce the debt? At a time of severe budgetary stress, that would be a smart and quick way to shrink the deficit. But with the SBLF’s continued implementation delays and, more importantly, the program’s significant design flaws, perhaps the full $30 billion ought to be on the chopping block.
The SBLF is a $30 billion fund set aside by the Treasury Department with the purpose of stimulating small business lending. Taxpayer dollars from the fund will be used to inject capital directly into community banks (traditionally the biggest source of financing for small businesses). In return, banks will pay a dividend to Treasury at a rate tied to their small business lending levels. The more a bank increases its lending to small businesses, the lower the rate on its funds. Treasury believes this sliding-scale rate will provide strong incentives to increase lending.
The problem with this approach is twofold.
First, it addresses the wrong problem at the wrong time. The president first proposed the SBLF in his State of the Union address in January 2010. Nearly a year and a half later, Treasury has yet to use a single dollar to actually help banks make loans. In the meantime, the approach became all but obsolete to an ever-changing, dynamic economy. The financial crisis has now largely passed and the SBLF fails to address the current challenges facing small businesses and the banks that lend to them.
Let’s look at the specifics. Treasury’s approach is to inject capital into the banks, but it doesn’t appear that lack of capital is the banks’ problem. Banks are sitting on one of the largest stockpiles of cash and excess reserves in history, but bankers have repeatedly reported that lackluster demand for loans leaves them with few opportunities to employ this capital profitably. Here we see the ripple effects of the recent recession: with continued economic uncertainty and depressed consumer spending, businesses remain reluctant to take on the credit risk of financing for new investments. In fact, surveys of small business owners confirm that only 31 percent of owners have reported regularly seeking credit to finance their businesses in recent months, near a record low. Until demand returns, loan growth will remain stagnant. As one community banker explained to a congressional panel over a year ago, “[Our bank] certainly has room to expand lending, given that we have [excellent capital ratios]…We would do more, but it is difficult to find anyone who has not been impacted and remains creditworthy.”
Small banks are just as likely to complain that over-zealous regulators — tightening their standards and ramping up oversight because they were embarrassed by their failure to prevent the last financial crisis — are getting in the way, consuming bankers’ time and resources, and preventing them from making what they believe are sound loans to creditworthy borrowers. At a recent hearing, a community banker from Ohio told a panel of senators that this increased oversight is a “huge disruption to business” and that it continues to “crush our ability to respond effectively, efficiently, and quickly” to customers’ needs.
Likewise, the program does little to help small businesses because it fails to tackle the most pressing problems they face in today’s economic environment. It is true that many small businesses continue to report difficulty obtaining credit, and lending certainly has not returned to its pre-crisis strength. But a litany of data suggest that credit conditions for small businesses have already begun easing over the last year, prior to a single SBLF dollar being spent.
Access to credit is not even among the most pressing problems facing small businesses today. In survey data from national small business associations, owners overwhelmingly cite poor sales, tax burdens, health care costs, and the red tape of government regulations as the top problems facing their businesses, not lack of access to credit. One survey is most telling in this regard. When small business owners were asked directly what issues they wanted Congress and the president to address first, improving small business access to capital came in fifth among the priorities, behind reducing the national debt, reducing tax burdens, reining in skyrocketing health-care costs, and reducing regulatory burdens on small businesses.
Second, the SBLF carries with it the undeniable risk of distorting healthy market operations by encouraging reckless lending. Treasury hopes that the SBLF will encourage banks to work harder to dig up and approve loans for worthy small business projects. But despite already having more-than-sufficient resources (capital sitting idle) and incentives (good loans are profitable) to do so, right now banks cannot find enough quality loan projects to profitably employ those resources. Why should we assume they will suddenly discover thousands of creditworthy projects when there is a little extra payout from Uncle Sam thrown in the mix?
Instead, it seems more likely that banks will chase the lower dividend rates on their SBLF funds by artificially inflating the book values of their portfolios or by lowering their underwriting standards — approving more risky projects that they ordinarily would have rejected. This will stretch and distort their loan portfolios beyond what is prudent under normal market conditions. Perhaps the administration has failed to learn a lesson from the past three years: the last financial crisis was precipitated by high nationwide default rates on mortgage loans due to poor-quality underwriting and risky products. Incentivizing poor-quality small business lending would seem likely to lead to similar disastrous results.
To summarize, the SBLF wastes today’s resources on addressing yesterday’s problems. Banks have the resources and are ready to make good loans when demand returns, but first they need regulators to get out of their hair. Small businesses continue to struggle not because of the cost, terms, or access to financing, but because of tax and regulatory burdens and continued worries about the economy. Unless it is repealed now, the SBLF may create another dangerous bubble of reckless loans. At best, the program will become yet another example of Washington’s slow, bureaucratic response to pressing issues that, while well-intentioned, end up falling wildly short of expectations.
The administration should listen to the very people they are trying to help. Repeal the SBLF and use its $30 billion in funding to reduce the national debt and ease tax burdens on our nation’s job creators.
Adam Berkland is a Legislative Assistant at Americans for Prosperity.