The Fourteenth Banker Blog

May 13, 2010

Warren Commission Report on the Assassination of Small Business Lending

Filed under: Running Commentary — thefourteenthbanker @ 11:15 PM

The Federal Oversight Panel on TARP makes a valiant effort to determine factors causing the downturn in Small Business lending in their report issued today. For a Huffington article read here. Other data was uncovered by James Kwak in this post in regard to one TARP bank.  This indicates a much more drastic reduction in the origination of credit than the Panel report cites. In my review of annual reports, most banks are not reporting good detailed data and the way each defines Small Business is different.  I would be very curious about what data was presented to the Panel by banks.  In my quick review, it appears the Panel attempted to rely on data from government sources.

In other words, there is a lack of transparency.  Sigh.

Despite these criticisms, there is a lot of quality work in this report.   Some areas that deserve more attention are:

What are the business deposits the banks are taking from the communities they serve and how much is provided back in Small Business Lending? The ratio of Small Business Loans to Small Business Deposits would be a good measure.  This information should be easily obtainable from the banks.

The report identifies the shift towards Quantitative Scoring models as resulting in greater variation of Credit Supply.  To follow up on this line of thought, the questions should be asked about whether the banks have the skills to engage in relationship banking with a credit focus.  A scoring environment would result in the diminishment of skills at the level facing the customers.  Therefore at the time the Small Businesses need it most, the skilled bankers needed could be in very short supply.  Note I highlight skilled bankers, not skilled salesmen.

Additionally, the questions should be asked about what changes were made in bank policies through the recession.   If there was not a reduction in credit supply (versus demand), then there should have been no major tightening of credit standards and policies.

Were any groups that previously had access to credit excluded from obtaining credit?  This would mean outright prohibitions on certain types of loans or industries.  These days there are many banks that are restricting commercial real estate loans because of industry conditions, risk concentrations, and capital constraints.   Over the last two years, was there other rationing of credit and was it justified by safety and soundness concerns or was it based on other management factors?

How were bankers incentivized? Did their incentives shift away from credit to other products?

What was done with excess business deposits?  Were Small Business Deposits effectively diverted to activities deemed more profitable?  In light of the current legislative matters, was there a shift to activities and products that could more easily be securitized or otherwise repackaged into derivatives, CDOs or other investments?

How much additional concentration of Small Business Deposits has there been as a result of bank failures and acquisitions? Are the comparisons apples to apples?  For example, if Bank A made X dollars in Small Business Loans in 2007, but Bank A is now the combination of Bank B and Bank A, should not the change in the flow of credit reflect that combination?

Finally, what should be done about this issue?  This country’s economy is still operating far below potential.  Most economists believe it will take several if not many years to get economic activity up to a level consistent with full employment and general prosperity.   There must be a “Marshall Plan” in regards to entrepreneurship and Small Business Lending.  Is any bank implementing a Marshall Plan?    Not that I can see.



  1. We have bank regulations that say that if a bank relends our deposits to a sovereign rated AAA, then it needs no capital at all, meaning unlimited leverage; if it lends to a sovereign that has been rated A+ to A, or to a private client rated AAA, then it needs only 1.6 percent capital, implying a leverage of 62.5 to 1; but when lending to small businesses and entrepreneurs, those on whom we depend so much for our jobs, those who cannot afford being rated by the raters, those who the banks are supposed to help while they make it to the capital markets, then the banks are required to have 8 percent in capital and need to limit their leverage to 12.5 to 1.

    So it is more than clear that the game has been further stacked against the small and new and in favor of the big and established.

    What to do? While the banks are rebuilding the equity that was impaired by the fake triple-As we should decrease, significantly, the capital requirements when lending to small businesses and entrepreneurs.

    Comment by Per Kurowski — May 14, 2010 @ 6:15 AM | Reply

    • Yes, there need to be changes. I don’t think capital requirements should be reduced for lending, which is an inherently risky activity. I think the favorable treatment of other investments should be modified. We have seen that AAA does not mean much anymore. Sovereigns are becoming as risky as business loans. Likewise, making huge loans is not as hard work as making many smaller loans. So these balances need to change. There are many ways to change them.

      Comment by thefourteenthbanker — May 14, 2010 @ 7:11 PM | Reply

      • I prefer the banks to get out the money to the small businesses or entrepreneurs that having government bureaucrats deciding what stimulus to do. And I also think it is less risky for the public purse.

        Comment by Per Kurowski — May 14, 2010 @ 7:31 PM

  2. First, I’d love to see Mr, Fourteenth’s questions asked at the senate hearings I wonder who could put them in the agenda?
    Secondly, I have a question for this astute forum, and excuse my ignorance in asking. I was reading an article about the dollar today, and how the Bush administrations (both 41 and 43) had kept the dollar low, benefiting the multi-nationals over the American consumer (and, in my mind) the American small businessman. If I am right in reading it thus, and if, as we are constantly told, 70%+ of our jobs are created by small businesses, wouldn’t a dollar policy that works for the big boys and against the small entrepreneur, be another stake in the heart of the American middle class?
    I doubt we can return to the days when a small businessman like my dad could go to his local bank at the beginning of the slack season and get a loan or line of credit that would tide him over until his flush season rolled around again, but it seems to me we’re strangling real productivity and innovation in the cradle when we choke off funds to the emerging businesses.
    Thanks to any and all who will enlighten me.

    Comment by Sandi — May 14, 2010 @ 8:03 AM | Reply

    • That’s a complicated question. Generally a weak dollar is good for any exporter and bad for any importer. A weak dollar would be expected to be bad for consumers because it should cause price levels to rise, all else being equal. Except, when you have countries that subsidize their exports then you can have both a weak dollar and little inflation. This was the case with China. It contributed though to the imbalances in the system because they generated huge dollars which they reinvested in US securities, keeping interest rates low and contributing to the bubble in asset prices including real estate. Now we have a mess on our hands. Probably the best thing is a stable dollar. The traders don’t want that because they make money on movements and on other folks being forced to hedge. So if the traders don’t like it, a stable dollar must be a good thing.

      i believe we have strangled both funds and talent from the real economy and this is having a hangover effect on our inability to create a new wave of innovation to power small business and our economy higher. Nothing has changed about this and I am not sure anything in the reform fundamentally changes that either. So, people are going to need to come up with other solutions.

      Comment by thefourteenthbanker — May 14, 2010 @ 7:21 PM | Reply

      • Thank ou, Mr. Fourteenth.

        A few weeks ago, I heard the owner of a small manufacturing company in Michigan, who is holding on by her fingernails, tell the interviewer that she can’t buy the steel to make her product for what the same product can be imported from China to Michigan for. One of the bones of contention, as I understand it, is China’s unfair trade practices, which, apparently, our government has no stomach for challenging. How many more American jobs and companies must disappear before someone in Washington gives a hoot? This is not merely a rhetorical question -I seriously believe that, just as on Wall St., there are a large number of our “leaders” who have sold us down the river and don’t really care – or haven’t thought through – the end result of the “me first, last and always” attitude from the top. As Arrianna quoted someone recently, in a most excellent HuffPost column she did on jobs, “it appears the only way we can compete with Third World nations is to become one.”

        Comment by Sandi — May 15, 2010 @ 6:53 AM

      • This is a long post but you might enjoy.

        Comment by thefourteenthbanker — May 15, 2010 @ 1:36 PM

  3. Arresting.

    Comment by Steve — May 15, 2010 @ 1:04 PM | Reply

  4. Is there supposed to be a link to the long but interesting?

    Comment by Sandi — May 15, 2010 @ 2:37 PM | Reply

  5. I followed a link on Naked Capitalism to this re: Joseph Stiglitz letter on why swaps should not be included in FDIC coverage –

    So long as those financial institutions that have access to federal assistance (or are likely to have access in the event of a crisis) can write such contracts, the government is effectively underwriting these con-tracts. The market gets distorted in two ways: first, these institutions have a competitive advantage, not based on greater efficiency, but based on more likely access to government assistance. Second, the insurance is underpriced, because it is effectively subsidized (or, when these instruments are effectively used as gambling instrument, gambling though these instruments is encouraged). Subsidies, whether explicit or implicit, distort resource allocations and contribute to a less efficient economy. There are certain instances where the government might want to encourage certain economic activities, but those should be clearly articulated and narrowly circumscribed. I see no compelling reason why the U.S. gov-ernment should be engaged in subsidizing credit default swaps or derivatives, <sniP

    This is such a no-brainer that even I, a mere peon, get it. So I can only assume that Washington doesn't WANT to get it. If a march down Pennsylvania Ave. would be effective, I'd be on the train right now. But I am fast losing hope that anyone is listening, or gives a rat's rear end what anyone except the lobbyists and the other plutocrats think. Present forum excluded, of coure.

    Comment by Sandi — May 15, 2010 @ 2:56 PM | Reply

    • Good link. Taken to its extreme, the purpose of the corporate structure is to create externalities, keeping income for itself and pushing costs out to society. Cynical but thought provoking. If that is the case, BP has reached the ultimate. It produced the most it could while spending the minimum on safety, getting all the waivers it could, etc. Then, when an event that falls within random probability distributions occurs, several standard deviations out but in the “long tail” of possibility, those shareholders astute enough to get out at the right time do so and the public gets stuck with the costs. In a values free zone, that works.

      Comment by thefourteenthbanker — May 15, 2010 @ 6:09 PM | Reply

      • “A values-free zone” – yep, that is where we now live. Thanks for the link on the Spinoza material, too. Interesting stuff.

        What with corporations always whining about safety regs, and decent wages and such “costing too much”, I have decided to cynically propose that we bring back the old system of slavery. Feudalism seems to even be too costly for the poor dears in charge of the world, but slavery! Ah! That is nearly free! (I wonder if that would finally awaken the sleep-walking masses from their dreams of “American Idol” and so forth, to realize they have been screwed to the wall?)

        Comment by Sandi — May 16, 2010 @ 12:51 PM

  6. Do you think they should subsidize risk-adverseness… like they do by means of lower capital requirements?

    Comment by Per Kurowski — May 15, 2010 @ 4:50 PM | Reply

    • No. I’m not sure what the absolute level of capital requirements should be. But they should be adequate for the risks that are taken. Otherwise the FDIC becomes a subsidy for excessive risk taking and “go for broke” strategies often labeled moral hazard. The principle that higher capital should be held against a riskier balance sheet is one that there is an overwhelming consensus for. What we have found is that our ideas about what constitutes a risky balance sheet were incorrect. Ideally our system of regulation and international accords would support risk taking that promotes real economic activity, such as business lending, undertaken in a prudent way.

      Comment by thefourteenthbanker — May 15, 2010 @ 6:01 PM | Reply

      • Yes there is overwhelming consensus for it… but when has overwhelming consensus meant it has to be true?

        It has yet to be fully understood that when you allow lower capital requirements for those low risks that already are benefitting with lower interest rates… then you are arbitrarily subsidizing risk adverseness… and of course creating a stampede in search of AAAs and since the market is a market, it will provide those AAAs even if fake.

        The USA lost trillions in something that even if it had lived up perfectly to the AAAs would not have provided the USA with much jobs or other competitive advantages… as there are no new jobs or any new competitive advantages in never-risk-land.

        Comment by Per Kurowski — May 15, 2010 @ 6:19 PM

  7. “What are the business deposits the banks are taking from the communities they serve and how much is provided back in Small Business Lending? The ratio of Small Business Loans to Small Business Deposits would be a good measure.  This information should be easily obtainable from the banks.”

    Consumer loans are made because if consumers fall back on payments then banks make a lot of money if they don’t then banks make little money. Either way it’s beneficial. Business loans are a whole different story, to make a good small business loan in a down economy what’s needed is capable, meaning credit trained bankers, most banks only use credit trained bankers to make loans to middle market to large corporate sized companies. Small business is considered not ‘meaty’ enough to warrant such expertise. For them banks utilize automatic scoring models which compelety fail to take any individual situation into account.

    Next comes moratoriums on entire industries, in here as well the moratoriums mostly applied to retail and small businesses, not large established companies. This is not entirely wrong because retail has added risks, but a total refusal to not lend to a certain industy is wrong. A strong retailer who consistently managed risk should not have to struggle to get credit in tough times. Discouraged industries in my experience have been, retail, franchises, business aquisition loans with a slight shortfall in collateral, working capital lines of credit below $250,000. All of this is how this economy moves forward, when poor managers can be replaced by better managers with some help from cautious lenders. Not happening.

    Why? this brings us to incentive compensations. Lenders are not paid much at all for lines of credits, which are much harder to manage as a lender than a one off transactional real estate deal. Makes it doubly unattractive for them.

    Why do banks prefer real estate over working capital or business aquisition loans? Because real estate can be pooled and packaged and sold off, fees collected, risk offloaded requiring low capital requirements, executive compensation increases with short term stock gains, future generations will always be there to deal with it.

    Comment by Vocalbanker — May 16, 2010 @ 1:31 PM | Reply

  8. […] what they do and how they do it.  You cannot rely on public information. Elizabeth Warren’s report already showed you […]

    Pingback by Ben Bernanke (Confused Economist) Lessons from the Gulf « The Fourteenth Banker Blog — June 6, 2010 @ 12:11 PM | Reply

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