The Small Business Lending Fund: What Went Wrong?

The $30 billion Small Business Lending Fund, which the Obama Administration has been touting since early this year, ignited hope that the fund would help to spur small business growth and hiring—a jolt the sinking economy desperately needed.

But when the program ended a few weeks ago, many were disappointed at its lack of actual lending. Only $4 billion of the fund was lent out to banks—of that $4 billion, only half went to small business loans, the rest went to pay off banks’ debts from the Troubled Asset Relief Program, according to the Wall Street Journal.

So, what happened?

Treasury Secretary Timothy Geithner testified Tuesday before the Senate's Small Business and Entrepreneurship Committee on the use of the fund, saying the 332 small banks that received funds would be leveraging even more capital to small businesses over the next several years.

"We expect the Small Business Lending Fund [SBLF] to leverage approximately $9 billion in additional lending by the end of 2014, and the State Small Business Credit Initiative [SSBCI] to leverage at least $15 billion by the end of 2016," Geithner testified.

Critics are not only voicing concerns about the little amount of money lent out, but also the complicated application loan process for small banks. Many small business owners were denied their loan requests, with little-to-no explanation, according to Paul Merski, chief economist for the Independent Community Bankers of America.

For small banks trying to escape the burden of TARP, using the SBLF money made perfect sense, according to Ray Keating, chief economist for the Small Business & Entrepreneurship Council. Instead of taking on more regulated funding to lend out to small businesses, small banks attempted to loosen their own credit by paying off their TARP debt.

"Why would banks go down that path at all?" Keating said of lending out more money. "They have an enormous amount of regulation as it is, and it’s increasing. The Small Business Lending Fund makes sense, but [banks think:] 'Am I going to invite the government in to do more looking over my shoulder?' That is always the risk of taking handouts or bailouts from the government-- that is the problem.”

Merski said the SBLF was a "mixed bag" of success and failures. More than 330 small banks were granted access to more than $4 billion in capital that wouldn't have otherwise had it, he said. Where the fund failed was its execution and implementation.

"It took an enormous amount of time before the banks could assess what the program was, what the terms were," he said. "Then six months into the program, the Treasury asked for dividend waivers from all the bank regulators, which really threw a monkey wrench into the program."

The Treasury’s request meant that no bank could access the funding without a dividend exemption or waiver from the Fed, throwing in another roadblock for small banks to get their hands on this money, according to Merski.

Merksi likened the action of small banks using SBLF money to pay off their TARP debt to refinancing your mortgage.

"The SBLF was designed to get small business lending going, and it’s better to have someone in the SBLF program than the TARP program. There is this presumption that you took this SBLF money then you're done with your TARP responsibilities. But, you still have to pay the money back-- you're just under the terms of the Small Business Lending Fund now."

Small banks that are now under the SBLF program and fail to increase their lending to small businesses will pay a higher dividend rate, he said.

"Policy wise, why would anyone want any [bank] trapped in the TARP program, where there is no carrot-and-stick for small business lending?" Merski said.

The argument can be made that the demand for small-business loans just isn’t there. The economy and tight credit markets have created two types of loan-seeking small businesses: those that need loans to grow and expand, and those that need them to survive.

"A lot of businesses are just trying to survive, and many haven't survived," said SBE Council’s Keating. "They've put hiring plans on hold. And the small businesses that do want to borrow, are doing so out of desperation, and banks can see that."

When the program was being designed 18 months ago, policymakers were working under the prediction the economic recovery would be more robust, and there would be a higher demand for credit, Merksi said, hence the $30 billion coffers.

"The demand for credit from small businesses just wasn't as strong as they thought," he said. "If the economy was growing much stronger, banks would have needed more capital."

For Keating, this fund was more about politics than prosperity for the U.S. economy.

"It's more politics and grandstanding than what we need to do to get entrepreneurship truly moving ahead," he said. "Over the last few years, we have come to realize that the idea that government can spend its way back to prosperity is ridiculous. Small businesses see the deficit, and think, 'what does this mean for me down the road?'"

Regulation is a major issue for these smaller firms, so taking on more funding from government opens the door for harsher criticism and more regulation in the future, in the same way it does for banks taking funding from D.C., Keating said. (Small business owners) are also uneasy about tax policy and unsure of where it is heading in the future, so borrowing from a program like the SBLF may lead to higher taxes in the future, he said.

Small business owners also aren't showing interest in hiring because they can't calculate the cost of adding an additional employee right now, Keating said. With health-care reform still not being completely clear to these small business owners, it’s unclear what each new person will actually cost the business.