Federal Plan to Aid Small Businesses Is Flawed, Lenders Say
Officials Call It a Work in Progress

By David Cho
Washington Post Staff Writer
Wednesday, April 1, 2009

Two weeks after President Obama announced a $15 billion initiative to spark lending for small businesses, every major provider of these kinds of loans says the plan will not work as designed.

The conditions attached to the program, which require these financial firms to surrender ownership stakes to the government and limit executive pay, are so off-putting that these companies say they will not participate.

Industry officials and congressional sources said these issues were raised with the administration before the small-business initiative was unveiled. Nonetheless, administration officials accelerated the announcement, moving quickly to show they were using financial rescue funds to aid not only big Wall Street firms but Main Street businesses as well, sources familiar with the matter said.

Administration officials acknowledge the initiative is not yet ready and say they are reworking the proposal.

On the day of the unveiling, Obama said: "We will immediately unfreeze the secondary market for SBA [Small Business Administration] loans and increase the liquidity of community banks."

An administration official said it is premature to speculate on the program, noting that Obama's team has repeatedly announced the broad outlines of its financial rescue initiatives and then worked out the details later.

"The president believes small businesses are an important engine for economic growth and recovery," White House spokeswoman Jennifer Psaki said by e-mail. "He remains committed to unlocking the credit market for small-business loans, and believes this small-business lending initiative will prove critical to that effort."

Getting credit flowing again to small businesses is crucial to the administration's plans to stem the soaring unemployment rate and turn around the economy. More than half of all U.S. workers are employed at companies with fewer than 50 employees. But the lending markets for these firms have been shut off since September because the credit crisis made investors skittish about all kinds of loans. Many are now laying off workers. Others are closing their doors.

Small business lenders get much of the financing for their loans from middlemen, which buy the debt and package it into securities to be traded by private investors.

The administration's program attempts to help these financial firms by guaranteeing losses on SBA loans and reducing the fees they pay to provide this type of debt. The linchpin of the plan is the government's offer to buy the loans that are clogging the books of the middlemen and the lenders, which would free them to offer more credit to businesses.

Although industry and government officials support this approach, some noted that the specific program won't work because it is funded by the $700 billion Troubled Assets Relief Program, which would require firms that sell their SBA loans to the government to hand over ownership stakes and curb executive pay.

The pay limits were made more restrictive when Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, added an amendment in February that severely limited bonuses at firms receiving emergency federal aid.

The top six middlemen now say they would rather hold onto the small-business loans and make money off the interest payments than sell to the government and submit to its restrictions, according to documents and interviews with the firms and their associations. This group, which includes SunTrust Bank, Coastal Securities and Signature Bank, has 80 percent of the market share in this business. Associations say most of the smaller players are also unlikely to participate.

Joseph J. DePaolo, chief executive of Signature Bank, said the decision by Congress to crack down on Wall Street bonus payments in recent weeks has made him wary of participating in any government program, let alone the small-business initiative. The limits on compensation are a significant factor for his firm because it rewards its bankers according to how much business they bring in. That pay scheme is critical to attracting and retaining its employees, he said.

"Why would you participate?" DePaolo said. "How can you do business if the government at any time can change the rules of the game to protect its investment? That unknown today . . . puts us in a position that we don't feel is prudent."

An administration official added that the Treasury has been acting quickly on all of its rescue programs, not just the small-business initiative.

"When the final terms of the small-business program are announced, we're confident that the program will be successful in providing credit to small businesses so they can grow, thrive and help this economy recover," said Andrew Williams, a Treasury spokesman.

Treasury officials now "are searching for ways to get around a strict interpretation of the TARP law," said Tony Wilkinson, chief executive of the National Association of Government Guaranteed Lenders, which has been in contact with the administration. But all of the alternatives under consideration could upset lawmakers or fail to attract participants.

One idea is to set up a body that could buy up the loans on behalf of the government, Wilkinson said. Small-business lenders could sell their loans to this new entity but would avoid executive pay curbs and other restrictions because the vehicle technically would not be part of the government.

The Treasury could also tap private investment to buy the loans or set up a joint venture with the Federal Reserve to try to get small-business lending restarted. Some lawmakers, including Rep. Nydia M. Velázquez (D-N.Y.), who chairs the House Committee on Small Business, said the administration could also focus on getting SBA lending restarted through the economic stimulus bill.

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