President Obama with SBA administrator Karen Mills at a Winning the Future Forum on Small Business. (Official White House Photo by Chuck Kennedy)
"Small business is the backbone of our economy.”
It’s a phrase that is a standard part of the politician’s rhetorical arsenal, but one that has been whittled down to little significance. Politicians on both sides of the aisle give great lip service to the importance of our nation’s small firms, especially during campaign season. However, the idea that the fate of small business determines the fate of our nation as a whole hasn’t manifested itself in our economic policy.
The truth is that if all of small businesses combined to form a single entity, the nation would be in a panic over its health and D.C. would be clamoring daily to fix the crisis. If it were a single corporation that created 64% of new jobs over the last 15 years, that paid over half of the private sector payroll, and that generated more than half of the country’s nonfarm private gross domestic product, it would be deemed “too big fail” and billions of dollars would be invested to rescue it.
But the nation’s 27 million businesses aren’t a single corporation, and thus they’ve been unable to stir the type of frenzied urgency that the troubles Wells Fargo and others commanded in late 2008 when Congress approved an emergency $700 billion bailout.
For comparison purposes, the Small Business Administration’s budget in 2008 was $569 million. After Democrats took control of the Senate, funding for the SBA increased in 2009 and reached a high of $824 million in 2010 (with an additional $962 million in supplemental stimulus appropriations). The president’s FY2012 budget looks to slide back SBA funding to $985 million.
It’s been an uphill battle to have the SBA’s budget break even $1 billion, (near the all-time high set by President Clinton’s 2000 budget).
Part of the problem is ideological–Republicans have tried to eradicate the agency since the days of Reagan. Part of it is institutional–the SBA is a hamstringed agency in need of reform. A large part of it, however, is a bias for the notion that private sector big banks can and will come to the aid of small business in numbers large enough to turn the economy around.
The evidence disproves that notion. The nation’s biggest banks, who were all too willing to hand out the risky loans that jumpstarted the recession, now find themselves gun shy about lending to small businesses. We need to continue to urge the private sector to lend “the backbone” of America the capital it desperately needs, and President Obama has been making that goal a cornerstone of his economic plan. But that should be only half of the solution. If the post-bailout behavior of big banks proves anything, it’s that we need greater direct government investment in small business.
CREDIT REMAINS ESSENTIALLY FROZEN, SMALL BUSINESS SUFFERS
If a company is going to hire new workers, it needs capital and demand. Gallup’s chief economist, Dennis Jacobe, has reported that 40% of small businesses are hiring less people than they need. Cash flow is a major problem for existing businesses and potential start-ups alike. A recent Brookings report underscored the financial fragility of most Americans, finding that “half of Americans report that they would probably or certainly” be unable to raise $2,000 in 30 days.” Some 42% of Americans have $2,000 or less in their bank accounts. Whether it’s starting fresh or growing a business, third-party help is needed.
Yet far too many small businesses find themselves unable to secure that third-party help. According to a recent study released by Pepperdine University this month, over half of small businesses surveyed say that attempts to access additional capital failed. The Pepperdine survey found that banks have denied about 60% of loan applications this year. The biggest decline was seen in loans by the biggest banks.
Yes, those same banks that were bailed out and that were provided incentive after incentive over the last several years to increase lending have actually decreased their lending to the critical small business sector.
According to government reports, in the first quarter of 2011, “total loan and lease balances continued to fall, declining $126.6 billion (1.7 percent).” In the 28 years of data available, that decrease represented the fifth largest quarterly percentage decline.
“WE'RE NOT AS EXCITED ABOUT DOING IT”
In late May, the FDIC announced that the banking industry earned $29 billion in the first quarter, an $11.6 billion increase from a year before. In the wake of taking bailout money and in the face of claims that big banks aren’t doing enough to help small business, big banks have been on a PR spree. In May, after being named the Small Business Administration’s 2001 Large 7(a) Lender of the Year, Wells Fargo granted interviews to the New York Times and Reuters. The bank has lent some $3.7 billion to small businesses this year, and expects to loan a total of $16 billion to small businesses (in 2009, it pledged to loan $16 million and lent $14.5 billion).
But as the New York Times points out, Wells Fargo uses the same definition for “small business” that most banks use: any company with less than $20 million in annual revenue. So that $3.7 billion number for “small business” looks a lot less impressive when you see that it loaned just $677 million in SBA 7(a) loans (loans under $100,000).
Other lenders also claim to have picked up the pace of their small business lending, but fall far short of any seismic change in their lending practices. Bank of America made just 308 SBA-backed loans in 2009, a 90% drop that reflected across-the-board slashing of small business lending, even in non-SBA sectors. In December 2009, at a meeting with President Obama, then-CEO Kenneth Lewis announced plans to increase lending to small and mid-size companies by $5 billion in 2010. Big banks did indeed increase small business lending in 2010, but at levels far short of small business demands–just enough to save face, yet not enough to save jobs.
The arguments put forth by big banks as to why small business lending isn’t on the rise is two-fold. First, the banks claim that there is “little demand” for such loans. That argument is absurd on its face in light of the empirical data.
Next, the banks claim that small businesses aren’t worthy of the investment:
“We are trying to do everything we can to get people who apply for a loan approved, but the fact of the matter is that there are a lot of small businesses that unfortunately have been hit very badly by the downturn and are struggling and it’s hard to see how they’re going to handle more debt.”
This appears to be the view of most big banks, who insist they are ready to lend, so long as the business owner can show they are capable of repaying the loan. […]
“We love collateral, but we are first and foremost cash-flow lenders,” said Bank of America small business executive Robb Hilson, adding a company’s current and future sales are a better indicator of its ability to handle more debt. “We could have bullet-proof collateral, but if the business owner has a hard time demonstrating that they can repay the loan vis-a-vis cash flow then we’re not as excited about doing it.”
SBA loans are guaranteed by the federal government from 50% to 85%, with certain loans having carried a 100% guarantee. Part of the recovery package included temporarily increasing the guarantee to 90% to encourage banks to lend. Yet banks are still maintaining that it is too risky to loan out to small businesses (despite the fact that the federal government assumes most, if not all, of the risk).
The argument that small businesses may not have enough collateral or are not creditworthy enough to merit a loan is particularly insulting given that it was big banks that caused the environment of uncreditworthiness. The mortgage crisis caused by reckless lending on Wall Street caused home values to plummet. When small business owners go to the same banks that caused the crisis with low home values as collateral, they’re told it’s not enough. Many businesses have indeed been hit hard by the recession and of course they have cash flow issues (that’s why they’re asking for a loan). But in circular argument, banks are asking that small businesses prove first that they have sustained cash flow to repay the loan that they are seeking because they have low cash flow.
It’s a hamster wheel situation for America’s small business owners. The federal government has provided every incentive for big banks to lend, yet credit markets for small business are unfreezing at a glacial pace. Now more than ever, America’s entrepreneurs need an advocate. Can the Small Business Administration step up to the plate?
THE SBA: AN AGENCY IN DIRE NEED OF REFORM
In the late 1980s, Ronald Reagan made it one of the goals of his administration to completely eliminate the SBA. With Congress failing to act to that end, he appointed Charles Heatherly to head up the administration (he actually appointed him as deputy to avoid the need for Senate confirmation). Heatherly’s goal was explicit: destroy the agency from within. Heatherly became acting director and, on his first day on the job, fired half of the SBA’s regional administrations. The “April Fool’s Day Massacre” as it was called was just the beginning: “If that was controversial,” Heatherly said at the time, “I can’t wait for the reaction to some other things I have planned down the road.”
George H.W. Bush declined to adopt Reagan’s approach, choosing instead to expand the SBA by creating microloans and other programs. In 1994, Bill Clinton elevated the SBA to a cabinet-level post. Like any government agency, the SBA has had its share of scandals, fraud, waste or abuse. But throughout, it has continued to serve a vital role in streamlining access to capital for America’s entrepreneurs.
During the George W. Bush years, the agency was once again in the crosshairs. Bush sought to greatly increase SBA lending fees and he decimated SBA funding. Between 2001 and 2005, the SBA budget was slashed by nearly 50 percent, limiting access to much-needed capital. The Center for American Progress reports:
Not surprisingly, staff morale also fell sharply as employment was reduced 26 percent, to 2,095 employees in 2008, from 2,860 in 2001 […] In addition, SBA’s microloan program, which serves very small businesses with a $35,000 lending cap and which is widely utilized by minority business owners and entrepreneurs, was flat-funded in the Bush years. One result: the share of SBA loans to minorities stagnated, compared to the almost four-fold jump in loans to minorities between 1993 and 2000 under the Clinton administration.”
Despite the slash-and-burn approach of Republicans during the Bush administration, the SBA played a vital role during the financial crisis. In 2008, the SBA facilitated loans to nearly 70,000 businesses.
The Obama administration greatly increased SBA funding as part of its recovery packages. The Small Business Jobs Act, which the president signed in 2010, represented a huge shift in policy from the Bush years. It was a large investment in small business lending, but as explained below, the investment had mixed results. President Obama's FY2012 budget cuts back SBA funding to about $100 million more than pre-recovery levels.
President Obama signs the Small Business Jobs Act
One program that fell short of expectations was “America’s Recovery Capital" (ARC). The goal of the program was to provide quick access to up to $35,000 of capital to struggling businesses to help them get out of debt. “Quick” is a relative term.
The program itself was attractive for banks and small businesses alike: a 100% loan guarantee, no interest and no repayments for a limited time to help businesses get their heads above water. But the program, whose goal was meant to provide a rapid injection of capital into America’s struggling business, struggled itself to get off the ground. Where many expected applications to be open within 14 days of the authorization, it would take the SBA over four months to kick the program into full gear. And when small businesses did finally apply, many waited months more for a response.
Part of the problem was finding a lender participating in the program. Despite the 100% loan guarantee, banks were “reluctant” to participate in the program. When they did, “they [were] very choosy about to whom they’re willing to make a loan, and for what purpose.” As the program drew to a close, the number of ARC loans was pitiful in relation to what many expected–JP Morgan Chase loaned to 850 businesses, “the most of any lender.”
Moreover, borrowers “had to prove that they were both suffering a financial hardship and sound enough to survive in the long term.” In short, they had to walk a delicate tightrope of proof to demonstrate that yes, they were in critical condition but that they could make it out of the ICU.
Small business experienced a similar tale of frustration with the Obama administration’s “Small Business lending Fund” (SBLF). In 2009 and 2010, community banks were failing at an alarming rate. The idea behind the $30 billion fund was simple: use the fund to rapidly inject much-needed capital to these small institutions so that they would in turn lend to smaller, community businesses that may be turned down by larger institutions.
Yet almost eight months after President Obama signed the fund into law, the program was not fully implemented. Applications for community development financial institutions weren’t even open until three months before the program was set to expire.
The SBA did the most it could with the limited resources it had, especially given that it's been neglected for about the last decade. But imagine how successful ARC and SBLF could have been with a robust, vibrant SBA.
The best conceived policies to help small business mean little if the vehicle meant to implement them is broken. It's time for a big investment in small business. It's time to revolutionize the SBA.
A PATH FORWARD:
REVITALIZE THE SBA IN ORDER TO REVITALIZE SMALL BUSINESS
The strategy of entrusting America’s biggest banks to come to the aid of struggling small business is not working. Despite record profits, banks are not lending at a pace necessary to put our nation on a firm path of recovery. Big banks aren’t biting at massive lending incentives, and community banks lack the massive capital required to lend at job-creating levels. The government needs to take bolder action.
As it proved with increased lending during the recession, the SBA can be a vehicle for rejuvenating lending and reigniting the fire of American entrepreneurship. But the agency needs to be modernized. It needs help before it can successfully help small businesses.
If the Obama administration wants to “win the future,” it must treat the task of revitalizing small business like a campaign. And it has to campaign to win.
GIVE THE SBA CABINET-LEVEL STATUS
The notion that small business owners should have a seat at the president’s cabinet table has been advocated for quite a while. President Clinton elevated the agency to cabinet-level status during his first term. The Center for American Progress explained in 2008 why the SBA needs to be restored to cabinet-level status (PDF):
In order for SBA to be a more effective tool for the vitality and growth of our economy, it should be restored to cabinet status by executive order. SBA participation in cabinet proceedings allow for input on a broad range of economic policy and budget decisions. Being a part of the cabinet also means inclusion in policy formation by the National Economic Council. SBA will bring its much-needed experience and perspective to the table through cabinet proceedings and at the NEC. In the 1990s (when the head of SBA was a member of the cabinet) much of the economic growth came from the small business sector, aided by innovative financing tools.
In a 2003 interview with Inc. magazine, Fred Hochberg, who served as deputy SBA administrator under Clinton, said “it was not simply titular; it helped enormously.” Inc. Magazine explained:
Former President Bill Clinton elevated the SBA administrator position to Cabinet-level rank during his administration. That meant Erskine Bowles or Aida Alvarez would meet regularly with the heads of Treasury, Defense, Agriculture, and the other departments in the President's inner circle. It also meant that small business was given the same clout as big business, which is represented in the Cabinet by the Secretary of Commerce. […]
Entrepreneurs need a cop on the beat to protect against policies and regulations that have a disproportionate impact on small companies […] Formally adding the SBA administrator to the Cabinet sends an important message: a formal acknowledgement that entrepreneurs are a potent source of economic growth and new jobs. And it can yield real results, says Hochberg, who was Clinton's deputy SBA administrator. While SBA Administrator Alvarez was a member of the Cabinet, Hochberg sat on the President's Management Council, where the deputies of all of the Cabinet agencies met monthly.”
DON’T CUT THE SBA BUDGET, REFINE IT
It's going to take a collective effort on the
part of the private and public sector
to turn the economy around.
In His FY2012 budget, President Obama
cut down the SBA budget from $1.8 billion to $985 million, mainly because recovery programs expired.
The investment shouldn’t be cut–it should be refocused.
First and foremost, the SBA needs to enter the 21st century. The vast majority of the “red tape” complained of by big banks can be remedied by modernized systems and more efficient access to information. The SBA is already working on some items, but with a bigger budget, it can adopt the newest technologies and do so at a much faster pace.
The administration should also take up the recommendation from Inc.com magazine that the SBA needs to be rebranded. The SBA “brand” is tarnished. Rebaptize it the “Department of Small Business” and declare that America is open for business again.
There's progress to be made on the digital front as well. Even a small advertising budget can go a long way online, and the same brilliance we saw in OFA’s online ad strategy should infuse the new department’s marketing. New programs require explanation and branding to attract the maximum number of candidates. An investment in a good online program will attract a new generation of new small business applicants.
CUT OUT THE MIDDLEMAN AND ISSUE DIRECT LOANS
It’s become readily apparent that no matter the incentive, banks will not invest in small business at the level and pace needed to dig our nation out of 9.1% unemployment. The government is already in the direct lending business–it invests in the economic stability of our nation by providing low-interest student loans. The SBA itself gives out its disaster recovery loans directly.
The administration has long rejected the idea:
SBA administrator Karen Mills has said that it could take a year before staffing, training and back-end computer systems are in place to manage any form of direct lending beyond what the agency already does in disaster scenarios. That would be too late for some struggling businesses.
An SBA representative speaks
to a couple at a Disaster Recovery
Center in Ohio. (John Ficara/FEMA).
The SBA already makes direct loans
to business owners who are
affected by disasters.
And from President Obama, responding to a small business owner in February 2010:
I just want you to know, it’s not like we haven’t thought of why don’t we use the S.B.A. We have. The challenge that we’ve got is that even S.B.A. loans are generally run not by the S.B.A.; the S.B.A. essentially works with local banks, community banks, neighborhood banks, to process the loan. And essentially the S.B.A. underwrites the loan.
And so the S.B.A. does not have the infrastructure to go all across the country in every region and process loans to small businesses directly because they don’t have enough people—somebody yelled, “Why not?” The S.B.A. doesn’t have the staff to do it.
Keep in mind, a small-business loan of any sort, or a large-business loan of any sort, requires some sense of, what’s the business plan? What are your projected earnings, etc., etc.? Somebody has got to do that. Now, if the S.B.A. were to suddenly take over that entire function, we’d have to stand up a massive bureaucracy—a huge one. And we’d have to train all those people, and it would take too long, and you’d be frustrated—why is it that this big government agency can’t seem to run anything? […] Ultimately, though, the vast majority of small businesses, their loans are going to come from the private sector. And we’ve got to get the private sector to think differently.
You can read the president’s full answer here. It should be noted that the SBA does engage in direct lending to provide immediate assistance to those affected by disasters. Why should an economic disaster be any different?
The $30 billion Small Lending Fund Program hasn’t helped as much as many hoped it would, and getting the private sector to “think differently” hasn’t either. The president is correct that it will take a long time to get the new SBA in fighting shape to engage in direct lending, but the frustration he cites as an excuse not to do it is already being felt by small business owners who are already waiting too long for loans that will never come.
The ARC and SBLF programs can serve as an example for the administration. A substantial investment in the SBA to hire more staff, increase morale, and modernize data systems is an investment worth making. If the ARC and SBLF programs were able to be better administered, and if small business did not have to rely on opt-in banks to find access to those loans, the programs could have been wildly successful.
Yes, it will take a long time to rebuild the SBA. But if small business truly is the "backbone" of our economy, it's time (and money) well spent.
The sad fact remains that high unemployment and underemployment will last much longer than the time it will take to revamp the SBA and institute a direct lending program. Small businesses are already waiting. It's time for the government to deliver.