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TARP Isn’t Working For Small Business; Two Simple Solutions To Get Small Business Lending Going Again" rel="bookmark">TARP Isn’t Working For Small Business; Two Simple Solutions To Get Small Business Lending Going Again

A Joint Arti­cle By Mark Sun­shine and Robert Blum


Unfor­tu­nately, the Obama Admin­is­tra­tion isn’t propos­ing much to help restart lend­ing to small and medium sized enter­prises (“SMEs”). While SME’s make up the back­bone of the U.S. econ­omy and pro­vide most of its job cre­ation, the credit cri­sis is mak­ing them eco­nomic road kill. SME’s are small man­u­fac­tur­ing and ser­vice busi­nesses are inno­cent vic­tims; they pay their bills, employ work­ers and aren’t par­tic­u­larly over lever­aged. How­ever, the credit cri­sis doesn’t dis­crim­i­nate between the “guilty” and the “inno­cent”; it is an equal oppor­tu­nity busi­ness killer. Regret­tably, while Wash­ing­ton knows that that eco­nomic recov­ery requires a nor­mally func­tion­ing and sound small busi­ness lend­ing sec­tor, the Obama Admin­is­tra­tion hasn’t found the right pol­icy ini­tia­tives to restart SME lend­ing. Even worse, pump­ing tril­lions into zom­bie banks has the unin­tended side effect of enabling these banks to suck the eco­nomic life out of SMEs.


For­tu­nately, there are rel­a­tively inex­pen­sive mea­sures that can quickly restart SME lend­ing on a safe and sound basis. Tar­geted mod­i­fi­ca­tions in the tax code and mutual fund reg­u­la­tions can change the land­scape of SME lend­ing by dra­mat­i­cally enlarg­ing the cap­i­tal base and types of lenders that lend to SMEs.


TARP isn’t work­ing for healthy SMEs.


Healthy SMEs are get­ting squeezed by lenders and are actu­ally get­ting hit harder by the credit cri­sis than many trou­bled bor­row­ers. SMEs have three chal­lenges that are dra­mat­i­cally rais­ing their bor­row­ing costs and reduc­ing their options.


First, the pric­ing of new loans has been turned upside down. Instead of set­ting inter­est rates based upon risk (i.e., lower risk results in lower inter­est rates) many bank loans have a “zom­bie tax” that is charged to good bor­row­ers and cov­ers the cost of car­ry­ing bad cred­its. Banks are set­ting inter­est rates based upon the borrower’s abil­ity to pay which means that the best cred­its are pay­ing the most and sub­si­diz­ing bad cred­its that need help. And, it is the TARP banks that seem to be the biggest zom­bie tax­ers.


Sec­ond, SMEs lack nego­ti­at­ing lever­age to get the zom­bie tax reduced or elim­i­nated. By def­i­n­i­tion SMEs are small loan bor­row­ers and while as a group they are impor­tant to lenders, indi­vid­u­ally they aren’t impor­tant enough to lenders to make a mate­r­ial finan­cial dif­fer­ence.


And third, the non-bank lend­ing sec­tor, which makes up a sig­nif­i­cant por­tion of SME lend­ing, is get­ting ham­mered by the credit cri­sis and is dra­mat­i­cally shrink­ing. Non-bank alter­na­tives for SMEs to bor­row money are dis­ap­pear­ing at an increas­ing pace. Even worse, healthy non-bank lenders are them­selves being charged zom­bie taxes on their cap­i­tal which they are pass­ing on to SME bor­row­ers.


These fac­tors are com­bin­ing to dis­en­fran­chise SMEs from the finan­cial sys­tem at the very time that we need them invest­ing and cre­at­ing jobs and growth.


What can Obama do now?


There are two easy to imple­ment prin­ci­pal pol­icy ini­tia­tives that the Obama Admin­is­tra­tion can quickly do to restart healthy SME lend­ing. As con­trasted to the multi-trillion dol­lar TARP pro­gram, these pol­icy ini­tia­tives are sim­ple tech­ni­cal changes to reg­u­la­tions that will encour­age pri­vate cap­i­tal to invest in small busi­ness lend­ing. And, they are deficit neu­tral to tax pos­i­tive (i.e., if they work they will increase tax rev­enue with­out any cost).


Solu­tion #1 – Mod­ify tax rules to encour­age pas­sive invest­ment in lim­ited part­ner­ships that are in the busi­ness of SME lend­ing


Under the cur­rent tax rules there is sig­nif­i­cant tax risk if a per­son or entity makes a pas­sive invest­ment and becomes a lim­ited part­ner in a lim­ited part­ner­ship that lends to SMEs. The IRS says that these lim­ited part­ners are engaged in a “trade or busi­ness” by virtue of their pas­sive invest­ment. That tax rule basi­cally excludes for­eign­ers, not-for-profit orga­ni­za­tions, pen­sion funds and cer­tain other enti­ties from invest­ing in most unreg­u­lated funds that make loans to SMEs. This tax rule puts the tax exempt sta­tus of not-for-profits and pen­sion funds at risk and could sub­ject for­eign­ers to U.S. tax­a­tion on their global earn­ings and prof­its.


And, most U.S. cit­i­zens have a sim­i­lar state tax­a­tion issue. As an exam­ple, if a Florida res­i­dent (a state with no per­sonal income tax) makes a pas­sive invest­ment in a fund that makes loans in Cal­i­for­nia, the Florid­ian may be sub­ject to Cal­i­for­nia state income tax for part or all of his income (which could go well beyond the income earned in the lim­ited part­ner­ship). These tax rules basi­cally raise bar­ri­ers to invest­ment pools from form­ing to lend to SMEs. The Obama Admin­is­tra­tion should imme­di­ately amend the tax code to make it clear that investors who are pas­sive investors in lim­ited part­ner­ships are not deemed to be doing busi­ness as a result of SME lend­ing activ­ity. That sim­ple tax change could imme­di­ately result in bil­lions of new cap­i­tal for­ma­tion for SME lend­ing.


Solu­tion #2 – Amend the mutual fund rules to encour­age busi­ness devel­op­ment com­pa­nies to make senior secured SME loans


Cur­rently, the mutual fund rules limit the amount of lever­age that busi­ness devel­op­ment com­pa­nies (“BDC”) can incur. How­ever, these rules don’t work and actu­ally encour­age risky behav­ior. BDC’s are a type of mutual fund that is sup­posed to invest in SMEs. While the pur­pose of the lever­age lim­its is to make sure that mutual fund investors aren’t exposed to the risks of high lever­age, the prac­ti­cal effect is to make it eco­nom­i­cally unfea­si­ble for BDCs to make low risk, and there­fore lower yield, loans. Instead, BDCs have migrated to higher risk and high yield lend­ing and invest­ing and have per­formed mis­er­ably since the credit cri­sis began. The mutual fund rules should be imme­di­ately amended so that BDC’s are allowed to oper­ate at higher but pru­dent lever­age ratios (up to 4 to 1) but are restricted for that level of lever­age to high qual­ity senior secured lend­ing (which is the low­est risk form of busi­ness lend­ing), together with matched inter­est rate char­ac­ter­is­tics of assets and lia­bil­i­ties, i.e., float­ing rate assets and float­ing rate debt. That change will imme­di­ately result in new BDCs to be formed and push into SME lend­ing.


It is crit­i­cal to get the SME lend­ing mar­ket restarted now. Intel­li­gent gov­ern­ment tax and reg­u­la­tory pol­icy could go a long way to help­ing sta­bi­lize our econ­omy, and help us enter a new era of growth.

Posted in: BANKS, Credit Crisis, economy, Finance, Fiscal Policy, Obama, Politics, Public Policy, Robert Blum, Small Business Lending, TARP



    Indeed SMEs should be recov­ered fast for employ­ment to start show­ing pos­i­tive signs.

    They need less and give more.

    Mr Pres­i­dent would be doing some­thing, I hope.

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