Pushing from Washington to Trenton

I must have a perverse sense of humor, but I did see something funny in the recent controversy over New Jersey’s failure to secure $400 million in federal funds from the federal government in connection with the Race to the Top program. The State’s Education Department submitted the figures for the wrong program year, confusing 2011 with 2009, in New Jersey’s grant application, causing a five-point deduction in the state’s application for education stimulus funds. Finger pointing ensued, with educational leaders outraged with the rigid approach that resulted in NJ’s disqualification. NJ Governor Christie created a memorable photo opportunity when he tapped his finger on the 1,000+ pages of the Race to the Top application, highlighting its needless complexity. Of course, both sides missed the point: improving education is the goal, not figuring out how to shuffle funds between Peter and Paul.

But for anyone who has ever been through the process of dealing with federal disaster relief agencies, both the Federal Emergency Management Agency and the Small Business Administration, it is humorous. The federal government’s interest is in preserving its own bureaucracy, not in aiding disaster relief. You need a PhD in bureaucratese to navigate this opaque system. So to see the state bureaucrats at a disadvantage in dealing with federal bureaucrats brought a smile to my face. Because we are all at a disadvantage in dealing with federal bureaucrats.

The Honorable Geert Visser, consul general for the Netherlands in Houston, gave an interview to the Houston Chronicle in which he revealed that his government extended an official offer of assistance to the U.S. three days after the oil well explosion in the Gulf Coast. The administration wrote back to decline the offer. Now, after nearly two months of an oil gush that is savaging the wildlife and economy of the Gulf Coast states, our government is reconsidering the Dutch offer. No doubt the Dutch are horrified by what they are seeing on the news, as this paralysis and political blame would not be tolerated in the Netherlands, where the government gives an oil company twelve hours to contain a spill. If the oil company’s response is insufficient, the government steps in, assumes control of the cleanup and bills the oil company to ensure that taxpayers are reimbursed.

The Netherlands is certainly experienced with building dikes and managing water, as most of its terrain lies below sea level. The Netherlands had proposed a plan for building sand barriers affording some protection to the vulnerable marshlands. The Dutch were also willing to provide equipment to implement the plan, including ships equipped with oil-skimming booms. But our government got in the way. Dutch ships were prevented from approaching the U.S. coast by an anachronism of maritime law, the Jones Act, which limits access to the U.S. coast to U.S. ships. This week, the federal government allowed for U.S. ships to be equipped with four pairs of the skimming booms delivered from the Netherlands, which should be put in use in the Gulf Coast very soon. Each pair can process 5 million gallons of water daily, removing 20,000 tons of oil and sludge each day that they are in use.

The plan for the sand barriers was enthusiastically endorsed by Louisiana Governor Bobby Jindal and tentatively endorsed by the Coast Guard. A Dutch marine contractor has worked out a plan for building 60-mile long sand dikes within three weeks, which plan is opposed by American dredging companies that want to do the work themselves. But they lack the dike-building experience of the Dutch. This, of course, is a sad replay of what occurred in the aftermath of Hurricane Katrina, when the U.S. government declined offers of assistance from the German government. The Germans had emergency relief equipment and evacuation plans ready to be deployed, but Washington insisted that it had everything under control. The people of Louisiana are paying a very high price for this silliness.

The only thing more horrifying than the human tragedy in Haiti is the so-called “disaster aid” that compounds the suffering of those who have already lost what little they have. Unfortunately, bureaucracy is the first order of relief efforts. USA Today reports that the U.S. Agency for International Development (part of the U.S. State Department) ordered U.S. soldiers to stop distributing food packages to desperate Haitians. However, the troops continued to give bottled water because they were not forbidden to do so. Sound crazy? Not really. Did you know that counselors of our Small Business Development Centers were forbidden to help their colleagues in the Gulf Coast assist their small business clients in the aftermath of Hurricane Katrina? The U.S. Small Business Administration prevented the counselors from crossing state lines. So many counselors went as unpaid volunteers. Bureaucracies have inflexible rules that get in the way of offering help. But had we acted honorably, the Haitians might not today be in such desperate straits. Tageschau Deutschland is reporting that U.S.-backed governments of developing countries received aid that motivated the relocation of the poor to areas particularly prone to natural hazards. Even worse, a public display of aid assistance may be used to weaken demands to accept more immigrants from Haiti to the U.S. where they would have a credible shot at rebuilding their lives. It is sad, but true, that the poorest are the most vulnerable to disasters, whether in the U.S. or overseas and that relief aid more often than not serves the interests of the donors, not the recipients.

Rough Waters in Southeast Asia

We know from our experience with hurricanes in the Gulf Coast the long-term damage that can be wrought on vulnerable populations. But the consequences are even more devastating to developing countries that have fewer social safety nets for victims of natural disasters. This week, the National Disaster Coordinating Council reported that the tier of Typhoon Morakot killed ten people in the Philippines.  Five casualties were tourists and their guides who were swept into the water. The heavy rains were responsible for more than ten landslides that destroyed or damaged close to 30 properties.  The storm then picked up wind speeds of 92 mph and made landfall in Taiwan where it killed two people and left behind 51 inches of rainfall. The forecast calls for the storm to drop another 39 inches of rain on Taiwan.  The damage caused by the heavy rainfall is amplified by the recent drought that left the ground unable to absorb water, such that flooding results.  China is next in the path of Typhoon Morakot. Chinese authorities have already begun evacuating residents of islands along the coastal storm path.  Let’s hope that the storm does not claim any more lives and we should all be prepared to give whatever we can to relief efforts.

Not Yet Back to Normal

The Associated Press reports that “one year after Iowa floods, many still wait for help”. By my calculations, they have another five years to go and the help will be far less than they had anticipated. The AP reports of the inadequacies of FEMA (Federal Emergency Management Agency) programs and that long-term assistance has been slow to materialize. HUD (Housing and Urban Development) Secretary Shaun Donovan, visited Cedar Rapids, Iowa to announce new disaster relief grants at which time he acknowledged that there is a problem with the long gap between immediate relief and long-term rebuilding assistance. He attributed this, in part, to the fact that for every single disaster Congress has created a new law and a new allocation system that delays agency response. I am impressed by his candor. Secretary Donovan’s remarks provide insight as to why you cannot rely on government assistance if you want to keep your small business running.

One of the most heartbreaking, but not surprising, cases cited in the AP report was that of a family that is paying its mortgage on a home too damaged to inhabit while paying rent for their immediate living needs. As bad as that is, if you own a small business, you get the double-payment twice, for your home and your office. Homeowner’s and tenant’s insurance should cover the cost of your housing when a disaster displaces you. In my case, when I was evacuated from my home after 9-11, my homeowner’s insurance was responsible for the costs incurred should I have chosen to stay in a hotel. It sounds like this family did not have adequate insurance. At a time when financial regulatory reform is focused on consumer protection, we should place equal emphasis, if not more, on financial literacy. And we should give generously to private disaster relief charities, whose reserves have been exhausted in the recession. I was very happy to see American Airlines call attention to this need in the current edition of its inflight magazine.

Small Business on the Menu

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition, 2008), in the section titled “Sometimes Aid Can Be Harmful”, I wrote “Lesson 1: Time is your most precious asset and it is better spent on growing revenues and pursuing business opportunities than trying to qualify for many aid programs. These programs have onerous documentation requirements, each one is different and they generally yield a poor return on the time invested.” I thought of this sentiment when I read the leader in this week’s Economist which commented that “if Detroit had spent less time lobbying for government protection and more on improving its products, it might have fared better.” The trap is a psychological one: everyone wants to feel that they got something for nothing and having paid taxes, you want to recoup some of that payment. But it is not a wise investment of your time and an investment in this effort probably signals your own assessment of your business prospects. In a recent roundtable discussion of small business issues on the “Money for Breakfast” program of Fox Business News, I disclosed that I had tracked the hours I put into disaster relief programs post-9/11. On a pre-tax, pre-expense basis, I recovered $2.10 per hour of time invested, less than minimum wage. Other small business owners fared even worse. Government program requirements are so convoluted that you often need expert tax, accounting and legal advice to prepare the program applications. Obviously, the expense incurred with such service providers reduces your net proceeds. The Economist lead was titled “Detroitosaurus Wrecks”; unless you see your business going the way of the dinosaurs, invest your time in growing revenues and market share, not dealing with government programs.

Post-Katrina, Less Bureaucratic Pencil-Pushing

According to a statement issued by the Office of the Governor of Texas, Governor Rick Perry “requested that the U.S. Department of Agriculture provide disaster relief assistance for Texas farms and ranches that have suffered economic and physical losses as a result of severe drought conditions. If Perry’s statewide request is approved, qualified farm operators in all Texas counties will be eligible for low-interest emergency loans from the USDA. The agency also offers additional programs, such as technical assistance, to eligible farmers.” This is most severe drought on record, affecting Texas Hill Country in the South-Central part of the State from San Antonio and Austin; 60% of the beef cows in Texas are in the counties with conditions defined as “severe to exceptional drought”. This only adds to the pain of businesses that have already suffered losses from the economic recession. Texas is the country’s largest cattle-producing state and has already lost close to $1 billion because of the continuing drought.

According to the U.S. Drought Monitor, extreme drought conditions also exist across other areas of Texas and much of the southwestern United States, threatening water supplies and farmers in rapidly-growing urban areas. In California, Governor Arnold Schwarzenegger declared a statewide drought emergency, urging local communities to impose conservation measures to reduce water consumption by 20 percent.

For small-scale farmers, the government assistance programs can be confusing. The Small Business Administration (”SBA”) does not underwrite agricultural loans. For the purposes of SBA’s 7(a) program, a small farm may be considered a small business, but for the purpose of the Economic Injury Disaster Loan, it is not. After Hurricane Katrina, the U.S. Department of Agriculture had to re-write its rules so that it could respond to the needs of small-scale farmers, particularly in the aftermath of a major disaster. It would certainly make government programs more efficient and transparent if the agencies could develop uniform applications.

Gasping for Air

The Small Business Administration continues to work on guidelines for its forthcoming emergency credit facility, tentatively named “America’s Recovery Capital (ARC) Loan Program”.  The legislation enabling this program requires the SBA to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”. The proceeds of these loans are to make up to six months of interest and principal payments on a “qualifying small business loans”. This program was conceived as a stopgap measure to assist small businesses struggling to service existing debt. Congress allocated $255 million in the stimulus to fund the ARC program, paying for the program’s loan guarantees and interest subsidies, thereby levering up the amount available to lend. As the SBA is still developing the ARC loan guidelines, it does not yet know when the funds will be available.  While this may appear to be welcome news to small businesses that have thus far not benefited from the government bailouts, hold your applause. There are several issues to consider:

• Defining “viable businesses” to mitigate moral hazard risk. For the first time in its history, the SBA will offer issuing banks a 100% guarantee on ARC loans that they extend to small business owners. If the business owner defaults, the SBA will repay the bank for the full value of the loan. The SBA will also fully subsidize the interest on the loans, making them effectively free of cost to the small business borrower. No payments on the loans will be due for a year and businesses will have up to five years to repay the loans. However, the full guarantee of the taxpayer to the SBA program raises the moral hazard risk: the risk that banks will lend to borrowers that are not creditworthy because the government will pay the loan losses. This is particularly troubling, as the SBA has already reported soaring default rates on its traditional loan programs. To mitigate this risk, the SBA stipulates that ARC loans are to be extended only to “viable” small businesses, which it defines as those that have “demonstrated an earnings history and a proven record for success that may just need a little extra help to get through a short-term downturn”. (Shouldn’t all loans be limited to “viable” businesses? And how did the SBA determine that the current economic downturn will exist only for the “short-term”?)

We dealt with this issue in the aftermath of 9-11 as disaster aid programs were defined as corporate welfare for the Fortune 500 and loans (with personal guarantees) for the small businesses. However, in order to qualify for the subsidized loans, you had to prove that yours was a “viable” small business. My business, which was newly incorporated and had a short history prior to 9-11-01, did not qualify, nor did other start-ups. (Although eight years later, we are still in business, which is not true for certain of the financial services corporations in the Fortune 500 that received 9/11 handouts.) In other words, in order to qualify for the loan, you had to prove that you didn’t need it.

• Limited qualifications for the use of the loan proceeds. You won’t be able to use the new ARC loans to cover payments on existing SBA-guaranteed debt. The stimulus bill, the American Recovery and Reinvestment Act, contains a provision written into the bill by Congress that explicitly prevents the use of ARC loans to pay down existing SBA debt incurred before the bill’s passage. CNN quoted a staffer with the House Small Business Committee who explained that the provision was mandated by the Congressional Budget Office to comply with pay-as-you-go restrictions against increasing the federal deficit through new direct-spending legislation. He added “it is one of the most complicated things I’ve heard in a long time”. Businesses with existing SBA-loans can still apply for the new ARC loans, but they cannot use the latter to pay down the former.

• Rewarding debtors. The House Committee staffer added, “private loans made for any legitimate business purpose — including credit card debts, bank loans and real-estate loans — would be eligible for the program”.  So if you managed your small business prudently and avoided taking on debt of any kind, this program is of no help to you.  If you did take on debt, you should probably be negotiating new terms and forbearance with your creditors, even if you think you won’t need it. Take the breathing room while you can.

And of course, like all government programs, this one is complicated. I would prefer to invest my time in growing my revenues than attempting to decipher the requirements of another government program.

The Best Plans

I had a rather unusual experience with the medical examination required for me to travel for the United Nations Capital Development Fund. On behalf of my first business, Childs Capital LLC, I had accepted an assignment to serve as the Senior Policy Advisor to the United Nations Advisors Group on Inclusive Financial Sectors. This was a follow-on initiative to the UN’s International Year of Microcredit with the goal of expanding access to finance for the poorest people in the developing world. I traveled a great deal for the UN on this assignment, working on projects in Kenya, India and elsewhere. The UN requires medical clearance prior to beginning the contract, including an echocardiogram, which I had performed at the New York Downtown Hospital. The doctor expressed concern about the abnormal results and wondered if I was stressed about anything. Indeed, I was! Next door to the hospital was a construction site with dynamite chargers going off every 3.5 seconds. (I know; I was counting while lying on the examining table with the electrodes attached to my chest.)

After 9-11, billions of dollars in stimulus aid went to subsidize construction projects in Lower Manhattan, apparently in the belief that “if you build it, they will come”. The site adjacent to New York’s Downtown Hospital was to become the Beekman Tower, a Frank Gehry-designed luxury rental building in Lower Manhattan with about 900 apartments.  This was part of a grand plan to make the financial district a “24-hour community”. I could never understand why anyone would want to live in this area. Even now, after all of the billions of dollars that went into these schemes, it is very difficult to buy a newspaper on a Sunday morning in that neighborhood or to find a restaurant that keeps its kitchen open past nine in the evening. It seemed to me the height of arrogance that one would think that central planning would work here where it has failed everywhere else. I was never convinced that policymakers in New York or Washington were any smarter than their counterparts in Moscow, whose economic plans have long since been discredited.

Construction on the foundation of the Beekman Tower began in 2006. Now, in 2009, construction is not finished and the real estate developer has cut this tower from 76 stories to 38, one-half of the height originally planned for this luxury rental building. “Given the current economy, we are conducting a study to assess costs, risks and overall timing,” announced the real estate developer in a written statement. “Work is continuing on the building including on the school and we should have some conclusive answers shortly.” The developer added that work will continue on the lower stories, but added that no additional floors will be added pending an evaluation of costs. Just last year, Forest City Ratner, the real estate developer, obtained $680 million in financing for this project, which was the largest construction loan in its history. It was seen as one of the few projects in New York City that was bucking the overall real estate meltdown as construction continued.

Now, of course, the world has changed. The financial system of the U.S. is effectively insolvent. Certain of the largest employers in the financial district, such as Merrill Lynch, no longer exist. Others, such as AIG, are struggling. Lower Manhattan faces an economic crisis more severe than that caused by the events of 9-11. The irony is that resilient small businesses in the financial district, including my own, were displaced for these “grand scheme” projects that were never really viable in the first place. So now we will create jobs, expand the tax base and support local charities in communities other than Lower Manhattan, leaving behind these half-completed construction projects. The Beekman Tower is not the only Lower Manhattan construction project that has run into trouble. AIG is attempting to arrange a sale-leaseback of two of its Lower Manhattan office buildings, an arrangement that is becoming increasingly popular in a soft real estate market. Both the New York Times Corp. and Citigroup have arranged sale-leaseback transactions for certain of their properties. And the developer of the properties at the World Trade Center site, Larry Silverstein, is reported to be seeking a bailout from the New York Port Authority, which has cash flow problems of its own.

Small businesses were displaced to make way for the New York Times Corp. to build its spectacular new headquarters, in an abuse of eminent domain seizures following the Supreme Court’s landmark Kelo decision. I wonder how different things would be in Lower Manhattan if market mechanisms had been allowed to work through the post-9/11 recovery, if public subsidies to large corporations had not been granted and if the small businesses, which continue to create jobs, would have been left to do our work in peace. These lessons appear to be lost on our policymakers in Washington as they seek to defend the latest outrage in corporate welfare and federal bailouts.

P.S. Nobel Prize-winning economist Gary Becker gave an insightful interview in which he argued that many of the government’s stimulus programs, to mitigate the impact of disaster, are counterproductive.