The Fourteenth Banker Blog

September 25, 2010

Misdiagnosing the Small Business Jobs and Credit Act

Filed under: Running Commentary — thefourteenthbanker @ 5:40 PM

The AP did a reductionist story on the Small Business Legislation just passed by the Congress. This has circulated widely and the I will reference a version included in a post by Mish Shedlock, who I follow and generally find informative. On this one he has missed the boat. The Act does have something meaningful to offer, but only to bold and creative financiers and their clients.

There is a refrain taken up by bankers immediately in the wake of the financial crash of 2007-2008. The refrain is this, “It is not our fault that small business lending plunged, there was no loan demand.”

That refrain is basically repeated in Mish’s piece. Only now, we are two years later and in fact there is reduced loan demand. But contrary to his point, that does not make such a program irrelevant and wasteful, it makes it all the more necessary.

You tell me, does this look like insightful economic analysis or political reactivity?

When government passes out the money normally people are lined up, in advance, with both hands out. When that does not happen, it’s because the offer smells like a rotten fish.

Please check out Obama’s latest rotten fish offering as described in Small businesses, community bankers may snub Obama’s $30 billion loan program.

So here we have the tone of the piece. Note the comment, “latest rotten fish offering”. I guess this follows on many previous rotten fish offerings.

From the AP:

President Barack Obama’s $30 billion small community business lending program faces one big challenge: many of the community banks and businesses it’s supposed to help don’t want it.

The lending program is part of a bill that passed the House of Representatives on Thursday and now awaits the president’s signature. The legislation contains a mix of tax cuts and credits aimed at helping small businesses. The centerpiece of the bill is an effort to make billions of dollars available to community banks for loans to small businesses.

Bank executives say their customers don’t want loans, even at low interest rates, because the sluggish economy has chilled expansion plans.

Yes, the sluggish economy has chilled expansion plans. For historical context, we should be aware the the sluggish economy is the result of mal-investment by our largest financial institutions, hedge funds, private equity, pension funds, government sponsored enterprises, and individuals. Everyone wanted a quick profit. Banks chose to change their product mix to feed assets into securitized pools from which derivatives, CDOs, CDSs, etc could be created. Generally, this meant pushing standardized consumer loan products. The focus of credit activity shifted massively towards centrally underwritten, scored, mathematically modeled mortgages, home equity loans, and credit card products. These could be made sufficiently uniform to lump them together and sell off the risk to suckers at a quick profit. Customized personal credit and small business lending were de-emphasized. Why? they just did not generate the quick profit and the risk could not be offloaded to an investor or government sponsored enterprise. The result? Massive over-investment in residential real estate and debt fueled personal consumption. And, massive under-investment in the productive capacity of our industries. The busting of the bubble then had the follow on effect of putting most of our financial institutions on the brink of insolvency. The largest banks were saved by the bailout. Some will deny that they were saved by the bailout, saying they did not need the TARP. But the truth is, without the bailout all their counter-parties, including AIG and many foreign banks, would have wiped out even the strongest of our domestic financial institutions. Everyone was bailed out. Today however, despite what you will read below, many banks are constrained for capital and must limit lending and reduce their overall risk weighted assets. Do not let political posturing or propaganda fool you. Recent unofficial problem bank lists indicate that there are well over 800 problem banks in this country. These banks cannot freely lend. Many other banks are suffering the same conditions even if they have not moved to the point of being “problem banks”. Lending is constrained. I have seen it in the market.

The AP characterizes the situation as unproblematic, relying on the testimony of one banker. (there are others, but the AP article does no serious analysis)

Bank executives say their customers don’t want loans, even at low interest rates, because the sluggish economy has chilled expansion plans. Some say the federal money isn’t worth it because they fear it will come with too much regulatory oversight.

“We have taken a strategic decision not to have our primary regulator, the government, also be a partner in our bank,” said William Chase Jr., CEO of Triumph Bank in Memphis.

Chase said the bank already has enough capital to meet the paltry demand for loans. “Our business customers are mired in uncertainty and are reluctant to invest in their businesses,” Chase said.

This particular banker’s politics are also easily discerned. He does not want government money. Perhaps his little bank does not need it or does not have the creativity to know what to do with it.

The crux of the lending program is this. The balance sheets of banks will be improved by increasing their capital positions with government purchases of preferred stock in banks with under $10 Billion in assets. Depending on their size, the banks can obtain this capital in amounts up to 5% of their assets. That is a huge amount of capital. In some cases it could increase capital ratios by up to 70% and fully support both the increase in loan portfolios and risk. The ask in return is moderate. The cost of capital is 5% at the baseline and can drop to as little as 1% if a bank increases its business loans by 10% or more from today’s lows. That is not hard for a bank with the ability to take on risk and a plan to do so. It is hard for a bank with no plan. But why would we want such to participate anyway?

The loans may be used for these purposes:


(A)   IN GENERAL The term ‘‘small business lending’’ means small business lending, as defined by and reported in an eligible institution’s quarterly call report, of the following types:

(i)   Commercial and industrial loans

(ii)  Owner-occupied nonfarm, nonresidential real estate loans

(iii) Loans to finance agricultural production and other loans to farmers.

(iv) Loans secured by farmland.

So these loans are for job creating activity and agriculture. A bank with a plan could seek to develop expertise in businesses related to clean efficient energy. No, a small bank cannot do massive wind farms. But they can support the myriad of small businesses, engineering firms, etc that support clean energy production. They could be used for businesses that promote the use of new technologies that provide for energy conservation. What would be required is actual expertise, not the mechanized mass-production, judgement free methods that have come to pervade the industry. A bank could also support the development of more healthy local fresh food production and the logistical apparatus to bring it to market. This would serve multi purposes of job creation, improving diet and health, reducing health care expenditures, and increasing quality of life. Such is the role finance used to play.

There may not be massive demand for small business loans now. But should we be ready when the demand comes back? We cannot depend solely on the community banks that remain robust. We cannot depend on the mega-banks with their mechanized processes and lack of local knowledge or support for the subjective analytical processes that allow innovation. We cannot depend on bubble money providers from hedge funds and custodians for the uber rich. So we should have a program to support the development of more capacity for financial innovators in the banking sector, those that can develop a plan, build the expertise, act with purpose and integrity to do what is necessary to support our communities and the job and income growth that is necessary for a return to economic security.

To quote Amar Bhidé: “The measure of a financial system ought to be the service it provides the economy as a whole, not the employment or bounties it bestows upon financiers.”

So do not be discouraged by the words of Mish and others like him, works like these:

So what does Congress do?

Why it sets up a convoluted $30 billion program, onerous on small banks, so those small banks (who don’t want the money) can offer loans to small businesses that do not want the money either!

That is simply defeatism and is neither forward looking or backwards aware. This is a nice simple program that will provide benefits if even 5% of financial institutions choose to participate. But do you know what? When they figure out how easy it is, plenty of financial institutions will draw this capital down and then employ it in ways that help get us out of this economic funk.


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