As a result of the Covid pandemic last year and the mandated state and local shutdowns, local banks sprang into action and rescued small businesses through the Paycheck Protection Program (PPP) “loan program” that Congress and the executive branch forced on FDIC-charted financial institutions. For businesses struggling to stay open on Main Street, the PPP loans provided by financial institutions and backed by the Small Business Administration (SBA) played a crucial role in providing timely aid to small businesses, many of which would not have survived without the $800 billion program.
The genesis of providing PPP “loans” through the banks instead of through the SBA directly was the notion that banks know their customers better than the SBA and waste, fraud, and abuse would be mitigated if the $800 billion shoved out the door in a short period of time were done by the banks and reimbursed by the SBA. We put quotes around the term loans as really the PPP loans were actually grants as long the recipient followed some basic rules. In an odd twist after the success of PPP and the decades-long success of the SBA’s 7(a) loan program, the Biden administration is proposing an SBA direct lending program, which would bypass banks altogether. We suspect small businesses, local financial institutions, and the American taxpayer may all suffer if the government plays an expansive role in direct lending.
In November 2021, House Democrats voted to support the “Build Back Better” Act, which will cost billions of dollars. This bill includes a provision that gives the SBA approximately $2 billion to create a direct lending option that provides loans of $150,000 or less directly to borrowers through the existing 7(a) loan program operated by private lenders. Nevertheless, when the SBA engages in direct lending, history has shown waste, fraud, and abuse increases.
In 1998, the SBA found that its 7(a) direct lending subsidy rates – the amount of financial support given to businesses by taxpayers – were 10 to 15 times higher than the subsidy rate for its 7(a) loan guarantee program (which goes through the banks) . Despite this finding, the SBA has continued direct lending through its Economic Injury Disaster Loan (EIDL) program. More than $78.1 billion in suspected fraudulent loan activity was reported by the SBA Office of Inspector General (OIG) in an October 2020 report on widespread fraud in the Economic Injury Disaster Loan (EIDL) program. In October 2021, the IG reported $4.5 billion in potential fraud.
The SBA does provide various helpful programs to support small businesses, such as venture capital, technical assistance and training, SCORE, and contracting opportunities. What these successful programs have in common is these programs all utilize public-private partnerships to expand business opportunities and enhance access to capital.
SBA loans were never designed to be underwritten by the SBA. By guaranteeing loans issued by banks and other financial institutions that are experienced and have the regulatory safeguards necessary to detect and prevent fraud, the SBA is designed to “aid, counsel, assist, and protect the interests of small businesses.”
In order to help our country’s struggling small business owners, the Biden administration should reward them instead of excluding them from the lending process. These banks are the same ones helping small business owners navigate the lending process, develop relationships that often transcend business interests, draft a small business model, secure access to capital, and fight for borrowers when the process doesn’t work out.
By removing financial institutions from the lending process, the U.S. government exposes itself to criticism that small business owners’ and banks’ success are secondary to the growth of the federal government.
Members of Congress, especially Republicans, are advocating for legislation prohibiting the SBA from making direct loans under the 7(a) program. Congressional Republicans argue that the SBA 7(a) program works well as is, and borrowers receive the extra benefits of financial small business expertise guidance and experience from seasoned bankers.
Although the SBA has assured Congress it can spin up a new direct lending tool as soon as possible, it is unlikely to materialize within the current political climate. This author finds it implausible with Republicans taking over the House of Representatives and in January that an expansion of the SBA role in small business lending through a direct lending program as Republicans for decades have tightly embraced Ronald Regan’s quote from his inaugural in 1981 “In this present crisis, government is not the solution to our problem; government is the problem.”