On March 23 of last year, I posted a blog entry critical of the America’s Recovery Loan Program of the U.S. Small Business Administration. Specifically, I wrote that to mitigate the moral hazard risk (inherent in raising federal government loan guarantees), the SBA stipulates that the 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’?)”

On June 17, 2009, I posted a follow-up entry to write that there may be relatively few qualified applicants to apply for this program given its unusual requirements and that banks would not likely find the 2 percent premium paid by the government sufficient compensation for the onerous underwriting requirements.

Here we are a year later. The Recovery Loan program expires this month and the SBA has approved just fewer than 8,300 loans, even less than the modest number (10,000) of loans that the SBA had funds available to support. The New York Times has reported that meeting the “struggling but viable” criteria proved difficult for small businesses and banks had little appetite for the extensive underwriting requirements. When you contrast this lame “recovery” program with the Troubled Assets Relief Program (TARP) that bailed out Wall Street, it makes it clear where Congress’ priorities lie.

Gulf Coast Oil Spill Transposed

The oil spill resulting from the April 20 explosion on the Deepwater Horizon now covers at least 2500 square miles of water surface. To help visualize the size of the spill, Paul Rademacher created Google Map mashups that show the spill placed over various cities. This image shows the spill if New York were the epicenter. As you can see, it is enormous, covering landmass in four states. As it is on the Gulf Coast, tar balls from the spill are washing up on local beaches with damage evident in Alabama, Louisiana and Mississippi. BP has offered US-based fishermen (the spill has not yet reached international waters) a one-month pay settlement package as compensation. All of the owners of Louisiana small fishing businesses with whom I have spoken have declined the offer, as their ultimate income loss will likely extend over a much longer period. It is important to remember that it is not just the commercial fishing businesses that will be affected. Many downstream businesses, such as seafood retailers and processing plants, face serious financial losses.

Yesterday the fishing waters in the Gulf were closed. With an annual harvest of more than one billion pounds of fish and shellfish, that equates to a lost harvest of 273,000 pounds each day. In response to this economic loss, the Small Business Administration is offering Economic Injury Disaster loans for small businesses in 13 Louisiana parishes and two Mississippi counties. The loans will offer working capital for up to $2 million at a 4% interest rate for a term of up to 30 years. Existing SBA borrowers who have been affected by the oil spill may request a deferment of their loans.

I explain the issues around the SBA’s Economic Injury Disaster Loans in Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition 2009). I am particularly concerned in this case that insurance recoveries for the Gulf Coast fishing businesses may be inadequate to retire the proceeds of the SBA loans. Indeed, when I was just in Louisiana two weeks ago, I learned that insurance for small fishing businesses continues to remain unaffordable in the post-Katrina era. We do have a federal government fund established to finance the cleanup of oil spills. As it is funded by an eight-cent tax levied on each barrel of oil, it is insufficient for an environmental catastrophe such as this one. We need a comprehensive approach to disaster finance in the U.S. and one that is self-sustaining.

They Turn Very Slowly

100% risk-free to the lender and interest-free to the borrower – what is not to like about America’s Recovery Capital Loans, the new program of the U.S. Small Business Administration? Well, for one thing, it is hard to find a bank that will underwrite the loans. SBA loans are guaranteed by the SBA, but issued by participating banks. I have called most of the institutions on the SBA’s preferred lender list and I have yet to identify one that has decided it will participate in the program.  The banks have identified four problems: first, they have to navigate the thicket of SBA rules with little guidance for this new program. That is a lot of work to do for loans capped at $35,000. Second, while the loans are interest-free for the borrowers, the SBA will pay the lenders prime plus 2%, a lower interest rate than the SBA charges for its other loan programs. Third, 100% of the principal is guaranteed and should the default rate continue to rise, a not unlikely prospect given that unemployment is high and rising, bankers don’t want to be blamed for shifting more losses to taxpayers. Finally, there may be relatively few qualified applicants for this program given the criteria established by the SBA and the risk for small businesses to assume more debt in such an uncertain market.

Lots of Paperwork, Few Results

According to a recent survey conducted by Coleman Publishing, 80% of small business lenders are not committing to participate in the emergency loan program of the U.S. Small Business Administration. Known as the “America’s Recovery Capital Program” the emergency loan program for small businesses was authorized in the stimulus bill passed in February. 35% of lenders surveyed decided categorically not to participate in the program; 45% had not taken a decision, as there was a lack of clarity about the program specifics, although loan applications are to be made available to participating banks on June 15. Only 20% of small business lenders surveyed stated that they would participate in the program. The issue is that the SBA itself does not make loans; it guarantees them to participating bank lenders. I had written in a blog entry on March 23 that I thought it unlikely that banks would want to participate in this program. With the principal guarantees on the loans being raised, taxpayers would assume a greater share of the losses. Presumably bank executives are sufficiently savvy to know how the public would assign blame for that outcome. I doubted that they would want to be once again on the receiving end of the pitchfork. Add to that other reasons for the lack of enthusiasm in the banking sector for this program: its complexity, the lack of fees or interest to compensate banks for their investment of resources in processing these loan applications, the definition of viable business and so on.  It is a substantial amount of work for relatively small loans with a limit of $35,000 and funding sufficient for only 10,000 small businesses to participate. That works out to 200 businesses per state. We could have that many small businesses apply for New York alone. This program appears to be an ill-conceived effort to throw a bone to the small business constituency that is understandably outraged about the bail outs of Wall Street and Detroit.