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Small Business Lending Fund Bill Passes Senate – but will it Work?

The U.S. Senate passed H.R. 5927, a bill to create a Small Business Lending Fund, by a 61-38 vote.  The House of Representatives, which previously passed a similar bill, is expected to pass the Senate’s version next week.   A key component of the bill is to create a $30 billion fund that the government would invest in independent community banks to encourage lending to small firms.  The bill also contains a number of additional tax incentives to encourage capital formation, including elimination of capital gains taxes on the sale of qualified small business stock that is acquired after 3/15/10 and before 1/1/12.

Community banks are commonly defined as banks with less than $1 billion of assets, representing over 91% of all FDIC-insured institutions at the end of 2009. Community banks are generally believed to have closer relationships with small business owners, as a group they have had lower charge off rates than larger institutions (not having gotten as exposed to mortgage backed securities), and they have cut back less on lending than their larger competitors during the recession of 2007-2009.    To the economic strategists of the Obama administration, community banks are the good guys, and if injecting $30 billion of capital into the community banks would help pull the U.S. out of the current economic malaise, it would be doubly sweet.

I hope the Small Business Lending Fund works the way it is supposed to, but I am skeptical.  If Congress passed a bill to invest in independent bookstores, to sell greater numbers of books – despite competition from Amazon, Barnes & Noble superstores, and eBooks – with the hope that increased independent bookstore sales could stimulate the U.S. economy, it would be plain to all that it was bad policy, because the long term decline of independent bookstores is so widely understood.  Community banks are in long term competitive decline, suffering from lack of scale economies, higher cost of funds, and general lack of competitiveness.   While Citibank was “too big to fail”, community banks aren’t, and they recently have been failing in record numbers, even after a decade of industry consolidation.   The risk to the Small Business Lending Fund is that some community banks will choose not to participate in the program, while others may accept the government investment, and if business conditions stay bad, may hold onto the funds to strengthen their own balance sheets, rather than increase lending to small businesses.  Further, there’s nothing in the bill that improves credit worthiness of small businesses, nor the desire of small businesses to borrow, at a time when consumer spending and business conditions are so weak.

I also checked on this question with economist John Dunham, partner at John Dunham & Associates, who responded that “the recent recession came about as a result of too much borrowing, not to little.  While the TARP program was probably a good idea at the time because it provided confidence and stability to the banking system.  It was not designed as a way to increase the number of business loans nor did it. ”

Mr. Dunham went on to add:  “Businesses, like consumers are realizing that there is a cost to debt and have been deleveraging and looking for alternative means to fund expansion.  This is why loan traffic is down.  The $30 billion fund to community banks will not encourage businesses to demand more loans, and will do little to encourage banks to seek out risky projects to loan money to.  In fact, I don’t see any difference between this pot of money and the existing Small Business Administration Loan Guarantee Programs.  Some of the smaller tax incentives will increase small business profitability at the margin so could potentially encourage additional investment and hiring.  However, I personally doubt that small businesses will start borrowing until both the business and regulatory climates improve.”

How Long a Recession?

Thanks to economist John Dunham of John Dunham & Associates for putting the current U.S. economic situation in a historical context:

The last time the country experienced a serious recession was in 1980-81 when the economy contracted by 1.5 percent. This compares to our projection of a 1.2 percent decline for the current recession. This extended period of strong economic growth and very shallow and short recessions, has created an environment where many of those working in finance, the government and the media expect the same thing to continue indefinitely. During times like this it is good to remember what the pundits were saying in 1982, the last time the US experienced a true recession. Commentators during that period screamed that the US was entering an “economic Dunkirk,” and that we would be fighting economic stagnation for the next decade. The Dow Jones Industrial Average fell by 24% (to a low of 777), unemployment rose to a high of 10.8 percent, and states throughout the country experienced large deficits. Companies that were too big to fail like Bethlehem Steel shuttered plants throughout the country and there were more bank failures than any time since the great depression. In addition, the country was in the throes of the Savings & Loan Crisis which was also brought on by a fall in home prices. While Carl Sagan’s “Cosmos” topped the New York Times’ Bestseller List in 1981, other titles like “The Coming Currency Collapse” (Jerome F. Smith) and “Crisis Investing: Opportunities for investing in the coming Great Depression” (Douglas R. Casey) echoed the concern surrounding an economy in recession. As pundits and politicians decry the end of capitalism and suggest that today’s situation is some unique event unseen since the early 1930’s (when by the way, the economy shrank by 45 percent and unemployment approached 25 percent of the workforce) it is important to keep everything in context. Capitalism is not dead, markets continue to function, and new firms, and new industries will emerge from the creative destruction brought about by the recession of 2008.