Bring Back Bankers: Get Gov’t Out of Commercial Lending
We all have images of commercial bankers — gray-suited men with an accountant’s charm and the conscience of an undertaker. Bankers used to be common; with their limited work hours, they were first at the Friday afternoon martini bar and to tee-off on Saturday morning. However, it is unlikely that you’ve seen a banker for some time. They’re an endangered species, replaced by cheery, underpaid branch managers who could just as easily be the manager of a McDonald’s. Banks don’t need bankers anymore.
Sure, when you buy a car you get a loan, but it is likely from a finance company affiliated with your car maker. There are no bankers involved. Need a school loan? The federal government is your direct source for loans. Buying a house? The loan will be arranged through a mortgage broker who will come to your house to do paperwork. There may be a bank involved but only as a collector; there is a 95% chance that the U.S. government, through Fannie or Freddie, will fund your loan. If a farmer needs a loan for equipment, material, or expansion, the Department of Agriculture has a program. Need a small business loan? The branch manager will arrange a visit with an SBA specialist to help you fill out forms. Any loan you receive will be largely guaranteed by Uncle Sam.
Per the Small Business Administration, loans of $62.6 billion were made to small businesses under SBA programs in fiscal 2011. This is up 41% from the $44.5 billion loaned in 2010 and a whopping 135% from the $26.6 billion lent in 2009. These loans were made while overall small business lending was falling dramatically.
The SBA’s share of overall small business lending likely exceeds 10% of overall small business credit currently outstanding, up from under 4% in 2009, and this share is still growing. At this pace, SBA lending could exceed $140 billion by 2013, perhaps as much as 25% of total small business credit outstanding. This may seem implausible, but one need only look to Fannie Mae and Freddie Mac to see just how government programs can quickly supplant private lending. In addition, it is highly likely that banks are steering customers with higher risk profiles into the government guarantee program, while keeping the “better” customers for their own portfolios. So not only is the federal government taking on a larger proportion of lending, it is also taking on a disproportionate level of risk.
The majority of small business loans are still made outside of federal programs, but traditional credit line options are fast becoming obsolete. Awkward, inflexible, and expensive asset based loans, once considered the funding source of last resort, are becoming the norm in the private small business lending market. And the movement of credit risk from private banks to the federal government has been in large part a circular migration, a direct reflection of regulatory oversight and misguided directives. A bank’s loan portfolio is the primary subject of regulatory scrutiny. But not only are bank regulators concerned with the financial health of underlying borrowers, they are also concerned with race, address, national origin, gender, etc., factors that have nothing to do with financial qualification. Banks are penalized for lending to poor credit risks while at the same time criticized for not lending to the economically disadvantaged. Left with a Hobson’s choice, it is not surprising to see that banks have retrenched and that the federal government has filled the void.
Good post, all this political interference spun off the SBA loan program as well as the Community Reinvestment act of the Carter years, and like a cancer it expanded, with the usual and expected results. A sensible idea, to get government with it’s ludicrous incompetence and built in corruption out of a field neither understood or apart from politics, cared about. Some rebuilding is in order, and government slugs will not give up their power gladly.
Thanks Doug Kimball. This is a very good start on my request to Pajamas to educate us in this area. Going back into the thirties I have known that the government financing schemes were politically motivated and anti-Constitutional.
They were all designed to put private financing in second place. They require tax revenue and gain capital at the expense of those who create capital.
Our current unemployment, excessive pricing and many other problems are directly traceable to this attitude.
The whole concept was integral to the New Deal. One of the first manifestations was in the launch of the REA or Rural Electrification Act which put a government entity in competition with private initiative. The REA was a so-called Co-op and still is but is always run by a clique. This was a Socialist ploy attacking profit making as the path to wealth as well as a proven method of spreading the wealth. A detailed understanding of this history is needed but this is not the place to begin.
Fannie Mae and Freddie Mac are designed on the REA template and were designed to produce the same effect on finance as the REA was on Power distribution.
The government,under our Constitution, would have had no funds for the REA or any of the others subversions. This was the result of deliberately overruling our Constitution with sugar coated pills.
The underlying philosophy as seen in non-profits and co-ops is the Marxist and Bolshevik aversion to a profit which our federal government has bought, lock, stock and barrel. It has been pushed by the Labor Union, which are, in a sense, also unconstitutional since they have been adversarial to business where the wage earner is symbiotic. For business to prosper the wage earner also needs to prosper and they cannot fight each other and grow. We have massive evidence of that error.
There is a lot more to write about in this area so sharpen you pencils.
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Tangentially, the ubiquitous use of credit scores as the primary, and often only benchmark of creditworthiness, is about to bite us hard in the tush. Right now, my wife can refinance our house in 2 seconds. She has all the right things to give her a very high credit score, and she has a decent job, which she can probably rely on indefinitely. That’s great for us.
But what about all those other people who once had great scores, and now are screwed? How can they dig out, with a system tilted so far against them? It’s another case of unelected and unnaccountable bureaucrats (ratings agencies) making life easy for the banks, but impossible for the economy. There are indeed no bankers who are willing and able, for a little extra percentage, to give that important seed money to start things back up, and now that home equity has dissappeared, that choice of last resort doesn’t exist anymore, either.
My family has been in business since the 1860s, and we’ve seen many a drop and recovery, but all the usual things required for recovery to happen have been short-circited. We have now shot ourselves so often in the foot, that it is just a bloody stump, thus we limp along.
Meanwhile, thanks to PPT, Obama can point to the stock market and say all is well, and with guaranteed returns on their investments in stocks, why would the banks want to lend money, anyway? It is no longer hyperbole to describe the Market as anything but a huge gambling parlor, and remember, the House always wins.
Yet, we bail these scum out.
Doug, any thoughts on the role of Business Development Companies in filling the commercial lending gap left by the banks?
david:
I assume you are referring to a public BDC, which, like its RE cousin the REIT, is a regulated entity with investment limitations and income distribution requirements. Leaving aside the concerns with Sarbanes-Oxley, distribution requirements are very high for these kinds of entities. They are designed more as equity participants (leveraging unrealized gains) than as lenders – a sort of public venture capital company. There are also local development companies, organized by local municipal or state governments as conduits for Industrial Development Bond financing. Currently, IDB tax exempt financing is so limited (IRS regulations) it is all but extinct. Then again, lending rates are so low that the tax effects of conventional financing are probably lower than IDB underwriting costs.
Of course, the problem with investment in small business is a problem of valuation. This is not an easy question for a company issuing quarterly reports. Venture companies, private and funded by accredited investors, are not so concerned about the problem of investment value from an accounting perspective – just from an intrinsic value perspective. So I’m afraid that valuation and reporting kinda kills the public DC concept just as valuation was a major problem underlying mortgage derivatives impossible.
david:
I assume you are referring to a public BDC, which, like its RE cousin the REIT, is a regulated entity with investment limitations and income distribution requirements. Leaving aside the concerns with Sarbanes-Oxley, distribution requirements are very high for these kinds of entities. They are designed more as equity participants (leveraging unrealized gains) than as lenders – a sort of public venture capital company. There are also local development companies, organized by local municipal or state governments as conduits for Industrial Development Bond financing. Currently, IDB tax exempt financing is so limited (IRS regulations) it is all but extinct. Then again, lending rates are so low that the tax effects of conventional financing are probably lower than IDB underwriting costs.
Of course, the problem with investment in small business is a problem of valuation. This is not an easy question for a company issuing quarterly reports. Venture companies, private and funded by accredited investors, are not so concerned about the problem of investment value from an accounting perspective – just from an intrinsic value perspective. So I’m afraid that valuation and reporting kinda kills the public DC concept just as valuation was a major problem underlying mortgage derivatives.
As the author seems to be misinformed about the nature of SBA-backed loans, for your information:
Under the guaranty concept, commercial lenders make and administer the loans. The business applies to a lender for their financing. The lender decides if they will make the loan internally or if the application has some weaknesses which, in their opinion, will require an SBA guaranty if the loan is to be made. The guaranty which SBA provides is only available to the lender. It assures the lender that in the event the borrower does not repay their obligation and a payment default occurs, the Government will reimburse the lender for its loss, up to the percentage of SBA’s guaranty. Under this program, the borrower remains obligated for the full amount due.SBA acts like an insurance agency and provides a guarantee to the bank.
Since this is a bank loan, applications must be submitted to the bank and monthly loan payments are paid to the bank. The bank is also responsible for closing the loan and disbursing the loan proceeds. SBA’s involvement is limited to reviewing the loan application submitted by the bank to assure they meet eligibility and credit standards. SBA provides the bank with a written Authorization outlining the conditions of the SBA guarantee.
http://web.sba.gov/faqs/faqIndexAll.cfm?areaid=29
good article. As a commercial lender for 10 years, i’m exploring other opportunities and hope to get out of banking. What started as a blend of a sales/relationship job, has turned into an underwriting position to appease the ridiculous requirements of the FDIC which are hindering relationships and ultimately, business. My question to them, where were they 5 years ago?