The Sunshine Report

Tag Archive: TARP

1. Small Business Lending Programs Aren’t Working and Need To Change

   July 18, 2009 6:12 am 3 Comments

   Pro­grams to get small busi­ness lend­ing mov­ing aren’t work­ing. Instead of a resur­gence of small busi­ness lend­ing the sit­u­a­tion is get­ting worse.

   Last week the Wall Street Jour­nal reported that the White House was search­ing for ways to help small busi­ness by unlock­ing frozen credit. This week CIT, the largest small busi­ness lender in the U.S., fought for sur­vival. Funds just aren’t get­ting to small business.

   I believe that the Obama Admin­is­tra­tion has good inten­tions and is try­ing hard to do the right thing but is trag­i­cally out of touch with the real world. Obama, Sum­mers and Gei­th­ner lack of actual busi­ness expe­ri­ence and haven’t fig­ured out that no mat­ter how smart they are there is no sub­sti­tute for real life. Study­ing small busi­ness lenders and small busi­ness just isn’t the same thing as run­ning a busi­ness and until they get some­one to help them who has real world expe­ri­ence they are going to con­tinue to flounder.

   In Feb­ru­ary and March I warned that pro­grams to get small busi­ness lend­ing going weren’t going to work. I thought that they were DOA and I was correct.

   Soon after becom­ing Trea­sury Sec­re­tary Gei­th­ner observed that most small busi­ness lend­ing was funded through the “shadow bank­ing sys­tem”, i.e., non-bank lenders. Yet, Obama’s recov­ery plans ignored non-bank lenders and instead focused upon push­ing banks to lend even though they weren’t the pri­mary source of lend­ing before the cri­sis began. Recov­ery plans also relied upon the SBA to get liq­uid­ity into the hands of busi­ness­men. Unfor­tu­nately the SBA hasn’t been rel­e­vant or effec­tive since the Rea­gan Administration.

   Back in Feb­ru­ary I thought that Gei­th­ner was a quick learner and that he would ditch pol­icy alter­na­tives that didn’t work. I was wrong. The Admin­is­tra­tion con­tin­ues to oper­ate in their “com­fort zone” which is bank­ing even thought the small busi­ness lend­ing cri­sis is play­ing itself out in the non-bank finan­cial com­pany arena.

   Below are the four sug­ges­tions that I made in Feb­ru­ary to help small busi­ness lend­ing. These appeared in an arti­cle I wrote in Feb­ru­ary and was the first in a small busi­ness lend­ing series writ­ten by myself and Rob Blum. Each of the arti­cles can be read by hit­ting this link, this link and this link. Also, I wrote an arti­cle for Forbes.com which can be read by hit­ting this link.

   • Form new gov­ern­ment spon­sored finan­cial guar­anty and bond insur­ance com­pa­nies. The fail­ure of the finan­cial guar­anty and bond insur­ance indus­try led the U.S. into the finan­cial cri­sis and the restart­ing of this indus­try will help lead Amer­ica out. These insur­ance com­pa­nies work because they cre­ate oper­at­ing effi­ciency for investors and back up their work by assum­ing risk. The bond insur­ers serve a func­tion sim­i­lar to rat­ing agen­cies but unlike rat­ing agen­cies, the bond insur­ers align their inter­ests with investors by putting “skin” in the game. Bond insur­ers were essen­tial to the cap­i­tal mar­kets for decades. Newly formed and well cap­i­tal­ized bond insur­ance com­pa­nies can be started by Trea­sury in a mat­ter of weeks and, if formed, will help restart­ing lending.

    

   • Amend the mutual fund and tax laws to pro­mote the for­ma­tion of tax effi­cient pools of invest­ment money for lend­ing. The inter­play of the laws gov­ern­ing mutual funds and taxes make it dif­fi­cult, if not impos­si­ble, for investors to form tax effi­cient invest­ment pools that orig­i­nate and own high qual­ity com­mer­cial and con­sumer loans. The laws are anti­quated, restrict cap­i­tal for­ma­tion, inad­ver­tently encour­age risky behav­ior and make lit­tle com­mon sense. A pas­sive invest­ment in a non-mutual fund direct lend­ing pool can have dis­as­trous tax con­se­quences for for­eign­ers, not for prof­its, pen­sion funds and indi­vid­u­als (because of state tax­a­tion issues in the case of indi­vid­u­als). And, the laws reg­u­lat­ing mutual funds have the unin­tended side effect of encour­ag­ing risky behav­ior instead of pru­dent lend­ing. Gei­th­ner can fix these laws and encour­age the for­ma­tion of invest­ment cap­i­tal to restart lend­ing. And, there will be no impact on Fed­eral spending.

    

   • Expand the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund. Every year the IRS grants sev­eral bil­lion of tax cred­its to lenders through the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund (“CDIF”). This pro­gram is sup­posed to encour­age eco­nomic devel­op­ment through tax cred­its that are earned by lend­ing in low income and blighted areas. Unfor­tu­nately, over the years the CDIF has favored real estate related lend­ing rather than core busi­ness lend­ing. If CDIF was reori­ented to encour­age busi­ness lend­ing, an exist­ing pro­gram that is annu­ally cost­ing tax­pay­ers bil­lions could be con­verted into an impor­tant tool to restart com­mer­cial finance.

   
    

   • Encour­age the SBA to license non-bank lenders and update and mod­ern­ize the pro­gram. The last non-bank lender to receive a new “Sec­tion 7A” license was dur­ing the Rea­gan Admin­is­tra­tion. Under pres­sure from crit­ics, SBA pro­grams have been cut back year after year and are almost totally depen­dent upon banks. The SBA lend­ing indus­try is almost vir­tu­ally irrel­e­vant.
     

   30 years ago the SBA had a ter­ri­ble rep­u­ta­tion because its pro­grams were badly admin­is­tered. Since then the SBA has shrunk as a pro­por­tion of the econ­omy. But, the SBA’s poor his­tory doesn’t mean that the SBA can’t restart itself and con­tribute to Amer­i­can busi­ness health. A top down review of SBA pro­grams with an eye towards mod­ern­iza­tion and inclu­sive lender eli­gi­bil­ity, includ­ing non-bank par­tic­i­pants, could fix the SBA.
   

   Geithner’s cur­rent pro­pos­als won’t get bank lend­ing going again and cer­tainly aren’t going to get non-bank lenders excited. The Trea­sury Sec­re­tary needs to get out of his com­fort zone and start to look at sup­port­ing non-bank lenders and investors. They make up most of the mar­ket for con­sumer and busi­ness loans and ignor­ing non-bank lenders won’t get the econ­omy going again.  4mse9b6vyu

2. Create Jobs Quickly By Capitalizing Small Business Lenders By Robert Blum

   February 26, 2009 9:06 pm Leave a Comment

   In my post­ing last Fri­day with Mark Sun­shine, TARP Isn’t Work­ing For Small Busi­nesses; Two Sim­ple Solu­tions For Small Busi­ness Lend­ing, we dis­cussed the severe fund­ing stresses being faced by small and medium sized busi­ness enter­prises (“SMEs”). Unfor­tu­nately, most of the gov­ern­ment aid announced to date does not help in deploy­ing cap­i­tal to SMEs any faster. In par­tic­u­lar, the non-bank lend­ing sec­tor is shrink­ing dra­mat­i­cally as their lever­age lines get pulled and other cap­i­tal dries up, which is bad because these pri­vate finance com­pa­nies and other lend­ing sources have tra­di­tion­ally been the source of a sig­nif­i­cant por­tion of SME fund­ing. SME’s, of course, are the well­spring for north­ward of 75% of the jobs that are cre­ated in this coun­try, so help­ing SMEs is crit­i­cal to national recov­ery.
   

   In our post­ing last week, we sug­gested mod­i­fy­ing tax rules and amend­ing the mutual fund rules to attract and free up cap­i­tal for senior secured SME loans. A third idea, dis­cussed below, involves the government’s mak­ing direct equity or pre­ferred equity invest­ments in pri­vately man­aged loan funds, which would use this money to make new senior, junior and mez­za­nine loans to SMEs. This would not be gov­ern­ment aid, down the sink­hole, but gov­ern­ment invest­ment, achiev­ing mar­ket returns on cap­i­tal to the ben­e­fit of all Amer­i­cans, while also cre­at­ing long term jobs, help­ing sta­bi­lize the econ­omy and encour­ag­ing more pri­vate invest­ment. Addi­tion­ally, the invest­ment of Fed­eral monies as equity in smaller, SME-oriented loan funds would bet­ter enable those funds to attract cur­rently frozen pri­vate cap­i­tal, through the reas­sur­ance of gov­ern­ment reg­u­la­tion, decreased risk of fraud and com­mu­nity of inter­ests due to the invest­ment of Fed­eral funds along­side pri­vate cap­i­tal, not above it.
   

   Mod­els for this type of pro­gram have existed in gov­ern­ment for decades, at the SBA, OPIC and a host of com­mu­nity rede­vel­op­ment invest­ment pro­grams. The prob­lem has been that they take years to obtain approval – time that we do not have – and these pro­grams typ­i­cally involve the gov­ern­ment inject­ing debt or debt guar­an­tees rather than equity into these invest­ment funds (e.g., SBICs). Market-appropriate struc­tur­ing of the government’s equity par­tic­i­pa­tion would enable stream­lined approval processes for Fed­eral invest­ment. Cus­tom­ary fund struc­tural fea­tures, that have worked for decades at pro­tect­ing pri­vate investor cap­i­tal, would do the same for the government’s money, and incen­tivize a prof­itable out­come (some­thing we prob­a­bly will not see from most of the TARP invest­ments).
   

   Fund man­agers, who would be required to have some of their own cap­i­tal at risk (as is almost uni­ver­sal with pri­vate funds of this sort), would charge a man­age­ment fee, but most of their expected com­pen­sa­tion would be based on the suc­cess of their invest­ments, i.e., for every dol­lar of real­ized profit on the government’s equity invest­ment (and of other pri­vate investors par­tic­i­pat­ing in the vehi­cle), the man­ager would earn a twenty per­cent per­for­mance fee, per­haps above a pre­ferred return hur­dle rate. In order to min­i­mize expo­sure to inex­pe­ri­enced man­agers, this pro­gram would only be open to man­agers for their sec­ond (or later) fund­ing pool, with at least three years’ expe­ri­ence run­ning invest­ment vehi­cles of sim­i­lar invest­ment objec­tives, and their prior fund(s) would have to have been audited by a major audit­ing firm and received clean opin­ions. The government’s equity con­tri­bu­tion, together with privately-sourced equity con­tributed to that fund, would be capped at an amount equal to twice the equity level of the largest of their pre­vi­ous funds, capped at $200 Mil­lion per fund man­ager, to ensure that they can effi­ciently and quickly deploy the cap­i­tal to SMEs for growth (after all, the whole pur­pose of this pro­gram is to effi­ciently deploy cap­i­tal as quickly as pos­si­ble, to obtain fis­cal stim­u­lus NOW, within the next 6–12 months). Fur­ther to that point, the government’s equity would only be draw­able for twelve months from com­mit­ment, renew­able at the government’s option (pri­vate funds typ­i­cally allow an invest­ment period that is any­where from two to three years – the point here is that, within rea­son, we need the cap­i­tal deployed quickly).
   

   This pro­gram could either be admin­is­tered out of the SBA, which has rel­e­vant expe­ri­ence in these mat­ters but is hope­lessly under­manned to move quickly, or by the Trea­sury Depart­ment, in either case employ­ing third party invest­ment con­sult­ing firms with rel­e­vant domain exper­tise,
   work­ing off an expe­dited set of approval cri­te­ria. With this pro­gram, applied with urgency and using pri­vate indus­try deci­sion processes, money could be flow­ing to SMEs within three months of final­iza­tion of the plan.
   

   No sin­gle magic bul­let will solve our finan­cial cri­sis. This SME pro­posal, though, would more than carry its weight in cre­at­ing long term jobs quickly.
   

   Click here for Rob Blum’s bio.

3. 7 Faint Signs That The Economy’s Bottom Is In Sight

   February 25, 2009 12:32 pm 1 Comment

   There are opaque and early signs that the U.S. econ­omy has started the begin­ning of a bot­tom­ing process. Just like a div­ing sub­ma­rine needs to stop its down­ward motion and reach its low­est depth before it can resur­face, the econ­omy needs to go through the steps of slow­ing its decline and sta­bi­liz­ing before it can start ris­ing again. Some recent eco­nomic data seems to sug­gest that the rate of eco­nomic decline has started to slow and that some­time in the sec­ond or third quar­ter the bot­tom maybe found.

   Of course, exter­nal events such as a large nat­ural dis­as­ter, war or a regional eco­nomic col­lapse (like of China, Japan, the EU or East­ern Europe) will push the U.S. into a renewed freefall. But, assum­ing the rest of the world isn’t dead weight on the U.S. econ­omy, we are head­ing into a period of crummy eco­nomic per­for­mance with a dra­mat­i­cally dimin­ished base of recur­ring eco­nomic activ­ity. The eco­nomic bot­tom­ing won’t feel like recov­ery because it won’t be; it will merely be an arrested freefall of a dam­aged economy.

   Recent news on con­tin­ued home price defla­tion and sales, Bernanke’s tes­ti­mony that the econ­omy could be worse than expected and record low con­sumer con­fi­dence all mean the econ­omy is still shrink­ing. The econ­omy is, how­ever, start­ing to show signs of shrink­ing at a slow­ing rate which is the begin­ning of the bot­tom­ing process.

   The early signs of find­ing a bot­tom include:

   • Money sup­ply is essen­tially sta­ble and in the case of M1 slightly down (on a sea­son­ally adjusted basis) since the begin­ning of Jan­u­ary.
     

      

     Money sup­ply (as mea­sured by sea­son­ally adjusted M1 and M2) has sta­bi­lized and is no longer grow­ing at weekly dou­ble digit rates. Sea­son­ally adjusted M1 is actu­ally slightly down since the begin­ning of Jan­u­ary and sea­son­ally adjusted M2 has been essen­tially unchanged since the mid­dle of Jan­u­ary. Expo­nen­tial money sup­ply growth is a sign that the Fed­eral Reserve is try­ing to per­form eco­nomic resus­ci­ta­tion while slower money sup­ply growth indi­cates that the Fed­eral Reserve believes that the econ­omy is start­ing to sta­bi­lize. Hope­fully the Fed­eral Reserve knows more about the econ­omy than we know.

      

   • Excess reserves, while still at his­tor­i­cally unprece­dented lev­els, are drop­ping.
     

      

     Excess reserves at the Fed­eral Reserve are a barom­e­ter for the amount of cash hoard­ing that is tak­ing place by banks. When banks hoard cash they increase their deposits at the Fed­eral Reserve and “excess reserves” are cre­ated. On Jan­u­ary 13^th Ben Bernanke gave a speech where he said that when banks start lend­ing again excess reserves will decline. Excess reserves peaked in early Jan­u­ary at approx­i­mately $843 bil­lion and have been steadily declin­ing so that as of Feb­ru­ary 11^th excess reserves were down to $611 bil­lion. While the cur­rent level of excess reserves don’t mean that the econ­omy is healthy (prior to the cri­sis excess reserves were around $2 or $3 bil­lion), the direc­tion of excess reserves is down which is a good sign.

      

   • After 5 straight months of pro­ducer price defla­tion, PPI increased by 0.8% in Jan­u­ary.
     

      

     The econ­omy won’t slow its freefall as long as there is defla­tion. The PPI data for Jan­u­ary was very good news regard­ing pro­ducer prices. While one month of pro­ducer price increases doesn’t mean defla­tion is gone, the amount of the increase and that there were increases in fin­ished goods sug­gests sta­ble demand at cur­rent depressed inven­tory, price and pro­duc­tion levels.

      

   • Con­sumer prices increased in Jan­u­ary by 0.4%, before sea­sonal adjust­ments, which indi­cates that the risk of run­away con­sumer price defla­tion has got­ten lower.

      

     Just like the PPI num­bers were a good sign of restored supply/demand equi­lib­rium, the CPI num­bers also sig­naled that con­sumer prices maybe find­ing a floor. If the econ­omy is going to find a bot­tom con­sumer prices can­not be drop­ping. January’s CPI num­bers were a good sign for the economy.

      

   • Hous­ing con­struc­tion and auto­mo­bile man­u­fac­tur­ing are hit­ting bot­tom; after all $0 of sales is the absolute bot­tom and the U.S. is get­ting close to that boundary.

     These two sec­tors prob­a­bly can only go up from here. When pro­duc­tion and sales hit post WWII lows and approach “$0″ of sales, there isn’t much far­ther to fall which by def­i­n­i­tion puts them at a bot­tom. And, believe it or not auto­mo­bile sales are show­ing the signs of future strength. Used cars sales were rea­son­ably strong in Jan­u­ary with some price hard­en­ing tak­ing place. When used cars go up in price that is usu­ally a pretty good pre­dic­tor of new car sales rebounding.

    

   • A few weeks from now fis­cal stim­u­lus will start kick­ing in.
     

      

     Pay­roll tax cuts from the fis­cal stim­u­lus will begin in the next few weeks and will start to pro­vide some added dis­cre­tionary income to con­sumers. If the stim­u­lus works as planned this should pro­vide some addi­tional cash for con­sumer which will prop up demand. Also, con­struc­tion spend­ing from stim­u­lus bill will start to help the econ­omy in the next few months.

      

   • The newest ver­sion of TALF hasn’t started yet but when it does it will pro­vide addi­tional cash to prop up con­sumer demand.

     TALF is a tril­lion dol­lar pro­gram that should almost imme­di­ately help con­sumers get financ­ing for pur­chases of auto­mo­biles, edu­ca­tion and other con­sumer related items. TALF will also pro­vide some relief for SBA lenders and small busi­nesses. As TALF kicks in it should pro­vide some addi­tional under­ly­ing sup­port for con­sumer demand and pro­vide sup­port to the economy.

   Let’s hope that what the U.S. econ­omy is look­ing at the bot­tom and not its own reflec­tion before being pulled down into a deeper abyss.

4. 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

   February 19, 2009 10:45 pm 3 Comments

   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.
   

5. TARP 1.0 Didn’t Get Lending Going and TARP 2.0 Won’t Be Much Better" rel="bookmark">TARP 1.0 Didn’t Get Lending Going and TARP 2.0 Won’t Be Much Better

   February 12, 2009 11:35 pm 7 Comments

   TARP 1.0 didn’t get lend­ing going and TARP 2.0 won’t be much bet­ter. The prob­lem is that TARP 2.0 con­tin­ues to focus on banks as the pri­mary lend­ing insti­tu­tions despite the fact that banks aren’t the pri­mary source of non-real estate credit for con­sumers or busi­nesses. Most non-real estate lend­ing takes place through the “shadow bank­ing” sys­tem which was bypassed by TARP 1.0; and, it doesn’t look like TARP 2.0 is going to help non-bank insti­tu­tions either. Until Gei­th­ner addresses the liq­uid­ity issues of non-bank lenders and investors, nor­mal lend­ing won’t restart.

   TARP 1.0 didn’t restore the nor­mal func­tion of the con­sumer and com­mer­cial credit mar­kets because it used flawed logic. Paul­son incor­rectly believed in a “cause and effect rela­tion­ship” that didn’t exist. He thought that increas­ing bank equity would result in increased lend­ing. Unfor­tu­nately, he was wrong because most non-real estate lend­ing takes place out­side of the bank­ing sys­tem and lenders and investors out­side the bank­ing sys­tem didn’t get helped by TARP 1.0. So, while banks ben­e­fited from TARP 1.0, it didn’t help the com­pa­nies that lend the most to con­sumers and businesses.

   Also, TARP 1.0 didn’t work because it was “back­ward lean­ing”, i.e., it didn’t pro­vide cap­i­tal for new loans but tried to fill in cap­i­tal holes cre­ated by old loans turned bad. To stim­u­late new lend­ing, TARP 2.0 needs to be “for­ward lean­ing pol­icy” and focus on new loans while hav­ing other pro­grams fix past prob­lems. Replac­ing lost cap­i­tal and a melt­down are great pol­icy objec­tives but they are dif­fer­ent from mak­ing new loans.

   While one sec­tion of TARP 2.0 is for­ward lean­ing, it doesn’t work because it almost entirely misses non-bank insti­tu­tions. Instead of look­ing for ways to restart non-conventional lenders and investors, Gei­th­ner reverted to what he is famil­iar with and focused on using the ulti­mate bank­ing insti­tu­tion, the Fed­eral Reserve, to restart lend­ing. But, non-bank lenders and investors don’t nor­mally inter­face with the Fed­eral Reserve, and, the AAA rat­ings require­ments to qual­ify for Fed­eral Reserve stim­u­lus puts even more dis­tance between non-bank lenders and Treasury’s pro­grams. Gei­th­ner made the rookie mis­take of retreat­ing into his “com­fort zone” to solve the prob­lem with­out exam­in­ing alter­na­tives. He is com­fort­able in the ster­ile world of Fed tech­nocrats and not expe­ri­enced in the down and dirty world of decen­tral­ized non-bank institutions.

   But, Gei­th­ner is a quick learner so there is hope that he will ditch pol­icy ini­tia­tives that don’t work.

   Set forth are four sug­ges­tions for ini­tia­tives that will get the non-bank sys­tem work­ing again.

   • Form new gov­ern­ment spon­sored finan­cial guar­anty and bond insur­ance com­pa­nies. The fail­ure of the finan­cial guar­anty and bond insur­ance indus­try led the U.S. into the finan­cial cri­sis and the restart­ing of this indus­try will help lead Amer­ica out. These insur­ance com­pa­nies work because they cre­ate oper­at­ing effi­ciency for investors and back up their work by assum­ing risk. The bond insur­ers serve a func­tion sim­i­lar to rat­ing agen­cies but unlike rat­ing agen­cies, the bond insur­ers align their inter­ests with investors by putting “skin” in the game. Bond insur­ers were essen­tial to the cap­i­tal mar­kets for decades. Newly formed and well cap­i­tal­ized bond insur­ance com­pa­nies can be started by Trea­sury in a mat­ter of weeks and, if formed, will help restart­ing lend­ing.
     

      

   • Amend the mutual fund and tax laws to pro­mote the for­ma­tion of tax effi­cient pools of invest­ment money for lend­ing. The inter­play of the laws gov­ern­ing mutual funds and taxes make it dif­fi­cult, if not impos­si­ble, for investors to form tax effi­cient invest­ment pools that orig­i­nate and own high qual­ity com­mer­cial and con­sumer loans. The laws are anti­quated, restrict cap­i­tal for­ma­tion, inad­ver­tently encour­age risky behav­ior and make lit­tle com­mon sense. A pas­sive invest­ment in a non-mutual fund direct lend­ing pool can have dis­as­trous tax con­se­quences for for­eign­ers, not for prof­its, pen­sion funds and indi­vid­u­als (because of state tax­a­tion issues in the case of indi­vid­u­als). And, the laws reg­u­lat­ing mutual funds have the unin­tended side effect of encour­ag­ing risky behav­ior instead of pru­dent lend­ing. Gei­th­ner can fix these laws and encour­age the for­ma­tion of invest­ment cap­i­tal to restart lend­ing. And, there will be no impact on Fed­eral spending.

      

   • Expand the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund. Every year the IRS grants sev­eral bil­lion of tax cred­its to lenders through the Com­mu­nity Devel­op­ment Finan­cial Insti­tu­tions Fund (“CDIF”). This pro­gram is sup­posed to encour­age eco­nomic devel­op­ment through tax cred­its that are earned by lend­ing in low income and blighted areas. Unfor­tu­nately, over the years the CDIF has favored real estate related lend­ing rather than core busi­ness lend­ing. If CDIF was reori­ented to encour­age busi­ness lend­ing, an exist­ing pro­gram that is annu­ally cost­ing tax­pay­ers bil­lions could be con­verted into an impor­tant tool to restart com­mer­cial finance.
     

      

   • Encour­age the SBA to license non-bank lenders and update and mod­ern­ize the pro­gram. The last non-bank lender to receive a new “Sec­tion 7A” license was dur­ing the Rea­gan Admin­is­tra­tion. Under pres­sure from crit­ics, SBA pro­grams have been cut back year after year and are almost totally depen­dent upon banks. The SBA lend­ing indus­try is almost vir­tu­ally irrel­e­vant.
     

      

     30 years ago the SBA had a ter­ri­ble rep­u­ta­tion because its pro­grams were badly admin­is­tered. Since then the SBA has shrunk as a pro­por­tion of the econ­omy. But, the SBA’s poor his­tory doesn’t mean that the SBA can’t restart itself and con­tribute to Amer­i­can busi­ness health. A top down review of SBA pro­grams with an eye towards mod­ern­iza­tion and inclu­sive lender eli­gi­bil­ity, includ­ing non-bank par­tic­i­pants, could fix the SBA.
     

   Geithner’s cur­rent pro­pos­als won’t get bank lend­ing going again and cer­tainly aren’t going to get non-bank lenders excited. The Trea­sury Sec­re­tary needs to get out of his com­fort zone and start to look at sup­port­ing non-bank lenders and investors. They make up most of the mar­ket for con­sumer and busi­ness loans and ignor­ing non-bank lenders won’t get the econ­omy going again.

6. Money Supply and Economic Data Weekly Watch – It’s A Brave New World For Federal Funds

   November 10, 2008 6:35 am Leave a Comment

   It’s a brave new world for Fed­eral Funds. The actual rate that Fed­eral Funds were trad­ing at last week was 0.23% despite the Tar­get Fed­eral Funds Rate being 1.00%. This anom­aly could be sig­nal­ing the end of the era when Fed­eral Reserve pol­icy is expressed in a sin­gle num­ber, the Tar­get Fed­eral Funds Rate. Tech­ni­cal changes in Fed­eral Reserve deposit oper­a­tions included in the “Paul­son bailout bill” are the cat­a­lysts for the new “neg­a­tive utopia” of mon­e­tary pol­icy. These changes to the Fed­eral Funds rate are impor­tant because they change most of what econ­o­mists have learned and relied upon in con­nec­tion with mon­e­tary pol­icy for the last 30 years.

   Fed­eral Funds are sim­i­lar to extra cash that banks have and deposit at the Fed­eral Reserve and at other banks. Overnight deposits of Fed­eral Funds are really overnight loans of cash between and among the Fed­eral Reserve and its mem­ber banks. The “actual Fed­eral Funds rate” is the annu­al­ized overnight rate that insti­tu­tions bor­row and lend their excess cash to each other and at the end of last week was 0.23%.

   The “Tar­get Fed­eral Funds Rate” is pub­lished by the Fed­eral Reserve and is widely referred to as the “inter­est rate” set by the Fed­eral Reserve. For decades Fed­eral Reserve announce­ments about the Tar­get Fed­eral Funds Rate have been the sin­gle most watched indi­ca­tor of global mon­e­tary pol­icy. And, until recently, there has been very lit­tle devi­a­tion between the actual Fed­eral Funds rate and the Tar­get Fed­eral Funds Rate.

   But the Fed­eral Reserve has changed the rules of the Fed­eral Funds game. On Wednes­day, the Fed­eral Reserve started pay­ing banks inter­est on Fed­eral Funds deposited at the Fed­eral Reserve at the same rate as their Tar­get Fed­eral Fund Rate (cur­rently 1%). Before TARP, the Fed­eral Reserve didn’t pay inter­est on deposits made by banks and Wednesday’s announce­ment was an adjust­ment to its new pro­gram of pay­ing inter­est that started a cou­ple of weeks ago. Since Wednesday’s announce­ment, the actual Fed­eral Funds rate has been approx­i­mately 0.23%, which is very dif­fer­ent than the Tar­get Fed­eral Fund Rate of 1.00% and is very close to 0.00%.

   On the sur­face, 0.23% seems like a typo. After all, why would any bank lend cash to another bank at 0.23% when they can lend it to the Fed at 1.00%? As it turns out, in this Brave New World of Fed Funds not all banks receive inter­est on their deposits at the Fed. Gov­ern­ment owned banks and other types of gov­ern­ment spon­sored enti­ties don’t earn inter­est on their Fed deposits. It appears that gov­ern­ment spon­sored enter­prises are try­ing to earn overnight inter­est on their funds by lend­ing their excess Fed­eral Funds to pri­vately owned banks. So, the actual rate for overnight bank lend­ing in the United States is 0.23% and it seems to be mostly made up of gov­ern­ment spon­sored enti­ties (other than the Fed­eral Reserve) lend­ing to pri­vately owned depositories.

   There are sev­eral impli­ca­tions to the actual Fed­eral Funds rate of 0.23% (espe­cially if it doesn’t move much in the next few weeks).

   First, the Tar­get Fed­eral Funds Rate has a new mean­ing which is very dif­fer­ent from its old mean­ing. Last month, the Tar­get Fed­eral Funds Rate was essen­tially the same as the actual Fed­eral Funds rate and both rep­re­sented the mar­ginal cost of overnight bor­row­ings for U.S. banks. This month, the Tar­get Fed­eral Funds Rate rep­re­sents the mar­ginal earn­ings that banks can get risk free from Fed­eral Reserve deposits while the actual Fed­eral Funds rate rep­re­sents the mar­ginal cost of bank fund­ing. If this rela­tion­ship con­tin­ues, the Tar­get Fed­eral Funds Rate won’t have a lot of use­ful­ness as an inter­est rate that can be used to inter­pret or estab­lish mon­e­tary policy.

   Sec­ond, 0.23% is very close to 0.00% and that means that the Fed doesn’t have a lot of mon­e­tary pol­icy options left relat­ing to inter­est rates. Instead of adjust­ing inter­est rates the Fed­eral Reserve’s options will be lim­ited to expan­sion of its bal­ance sheet and reg­u­la­tory changes in the cap­i­tal rules for bank hold­ing com­pa­nies. Bernanke has entered an era where his pol­icy options and con­straints are very sim­i­lar to those of his Japan­ese counterpart.

   Third, there isn’t a lot of demand for overnight cash bor­row­ings by banks which means that they must be pretty liq­uid (oth­er­wise the rate that banks would pay for Fed­eral Funds would be higher than 0.23%). But, given the rapid expan­sion in money sup­ply and the hoard­ing of cash by the banks, it isn’t sur­pris­ing that banks are very liquid.

   Fourth, the actual Fed­eral Funds rate once again high­lights that LIBOR is irrel­e­vant as a mea­sure of the mar­ginal cost of funds for banks. But, it con­tin­ues to mas­quer­ade as a “real inter­est rate” and under­mines the bank­ing system’s integrity.

   Oh yea…I almost for­got, this blog post is sup­posed to be about last week’s money sup­ply num­bers and eco­nomic data. Last week M2 went down a lit­tle. None of the other eco­nomic news was good. And, there is a new President-elect who one way or another will make history.

7. How the Credit Crisis Might Help American Manufacturers — A Reprint Of The New York Times Economix Blog

   November 6, 2008 6:05 pm Leave a Comment

   How the Credit Cri­sis Might Help Amer­i­can Manufacturers

   By Mark Sun­shine

   

   Mark Sun­shine is pres­i­dent of the com­mer­cial lend­ing insti­tu­tion First Capital.

   It’s hard to believe that the bank­ing cri­sis can be good for any­one, but the credit crunch is start­ing to help some Amer­i­can com­pa­nies at the expense of their for­eign competitors.

   Most peo­ple assume that man­u­fac­tur­ers in places like China always have an advan­tage over their coun­ter­parts in the United States because of cheap labor, cheap real estate and less reg­u­la­tion. But there are other fac­tors that influ­ence man­u­fac­tur­ing com­pet­i­tive­ness, includ­ing the avail­abil­ity of inex­pen­sive short-term bank loans.

   Abun­dant and cheap bank loans are needed for Asian man­u­fac­tur­ers to finance many of the goods con­sumed in the United States. Prod­ucts made in Asia have a long “sup­ply chain,” which means that man­u­fac­tured goods spend a long time being ware­housed, going through ports and cus­toms and being shipped from plants in Asia to buy­ers in the United States. Before imported goods are paid for, and while they are mak­ing their way to United States cus­tomers, Asian man­u­fac­tur­ers need cash to pay their bills. Bank financ­ing pro­vides the cash needed to pay bills and is crit­i­cal for Asian man­u­fac­tur­ers to export to the United States. If bank financ­ing either isn’t avail­able or is very expen­sive, then many prod­ucts in the Asian sup­ply chain can’t be shipped to the United States.

   On the other hand, goods pro­duced in the United States and shipped directly to buy­ers have short sup­ply chains. Prod­ucts man­u­fac­tured and con­sumed in the United States don’t spend a lot of time in tran­sit and can be deliv­ered quickly. As a result, many United States sup­pli­ers require a lot less bank financ­ing than their Asian com­peti­tors.Also, long sup­ply chains tend to require high lev­els of ware­housed inven­tory near the cus­tomer. The inabil­ity to pro­duce special-order goods for imme­di­ate deliv­ery cre­ates the need to ware­house extra inven­tory rather than man­u­fac­ture on an as-needed basis. Again, long sup­ply chains require higher inven­tory lev­els than short sup­ply chains and there­fore greater amounts of inven­tory financing.

   Over the last 18 months Chi­nese man­u­fac­tur­ers have suf­fered through high infla­tion, an appre­ci­at­ing cur­rency and new labor and envi­ron­men­tal laws. The credit crunch is their newest and tough­est chal­lenge. The dimen­sions of the prob­lem for Chi­nese and other Asian man­u­fac­tur­ers have become appar­ent only in the last 45 days, and the poten­tial for Amer­i­can sup­pli­ers to retake mar­ket share is only begin­ning to be realized.

   Last week’s eco­nomic sta­tis­tics don’t yet reflect shift­ing com­pet­i­tive­ness in favor of United States man­u­fac­tur­ers. In fact, both the Insti­tute for Sup­ply Chain Man­age­ment Report on Busi­ness (for Octo­ber 2008) and the Cen­sus Bureau report of new orders for man­u­fac­tured goods (for Sep­tem­ber 2008) showed mate­r­ial and grow­ing soft­ness in the United States man­u­fac­tur­ing sec­tor. But the full impact of the credit cri­sis hit the global econ­omy only in mid-September. The lack of bank financ­ing is begin­ning to depress Asian pro­duc­tion slated for deliv­ery in the United States in Decem­ber and beyond.

   It’s true that Amer­i­can man­u­fac­tur­ers may find their prod­ucts harder to sell in export mar­kets because of the recent appre­ci­a­tion of the dol­lar, also stem­ming from the credit cri­sis and flight to the dol­lar and yen. But pock­ets of increased demand for domes­tic man­u­fac­tur­ing, which is replac­ing Asian pro­duc­tion, are begin­ning to build and will have the effect of mut­ing an oth­er­wise bleak man­u­fac­tur­ing outlook.

   As the Obama admin­is­tra­tion takes office, it needs to closely exam­ine whether or not bank­ing res­cue assis­tance is being used to sup­port domes­tic man­u­fac­tur­ing and jobs or to bail out long sup­ply chains of for­eign com­peti­tors. If bailout pack­age funds are used to finance long sup­ply chains for imported goods, the gov­ern­ment will be indi­rectly sub­si­diz­ing for­eign man­u­fac­tur­ers at the expense of domes­tic com­pa­nies. The bailout bill could turn one of the few “sil­ver lin­ings” of the credit cri­sis into a dark cloud if pol­icy mak­ers are not careful.