Instead of arguing over how much to spend on the Small Business Administration, why not reduce costs by raising and lowering fees according to the risk entailed in each loan it guarantees?
In his 2012 budget, President Barack Obama proposed giving the Small Business Administration $985 million. That has set off bickering between the SBA's supporters, who are upset that the new budget would require the agency to cut funding to programs they consider essential, and its critics, who claim that the agency does little and should make do with even less funding. While I'm not happy with the SBA budget, I think both sides in this debate are making tired, inside-the-beltway arguments to spend more or less, instead of coming up with ways to redesign SBA programs to minimize their continuous need for additional funding. I propose changing the SBA's loan guarantee programs to permit the agency to increase the fees it charges lenders to receive SBA loan guarantees and to make those fees proportional to the riskiness of the loans. Before I explain the solution, let me fill you in on the debate. Recent headlines have claimed the President is making drastic reductions to the SBA budget, cutting it by 45 percent. This is political framing. The President's 2012 budget actually calls for a 19.5 percent increase over what the agency was allocated in 2010. (Congress hasn't yet passed a budget for 2011—all funding has been via continuing resolutions.) In 2010 the SBA received a discretionary budget of $824 million, but one-time stimulus funds increased SBA coffers to $1.8 billion. In 2012 the President proposed giving the SBA $985 million. By framing the $985 million budget as down 45 percent from the stimulus-gorged 2010 figure of $1.8 billion, White House officials can make it look as if they are imposing fiscal discipline on the agency. In fact, they are proposing to boost its budget 19.5 percent—to its highest level since at least 2000. Bad Loans Will Erode 2012 Budget
Nevertheless, because the agency would need to use much of its 2012 budget to pay for the cost of previously made—and now bad—SBA-guaranteed loans, it would have to cut spending on some programs, including the Small Business Development Centers and the microloan program. To see why we need to change our approach to SBA loan programs requires an understanding of how these programs work. The main SBA loan program, the 7(a) program, offers a federal guarantee of 85 percent on bank loans of up to $150,000 and 75 percent on those ranging from $150,000 to $5 million. The guarantee ensures that banks will get back what they have lent to small businesses if their loans fail. The loan subsidy in the SBA budget is the amount of money the feds need to allocate to pay for loans that go bad. The problem is that many more SBA loans failed during the recession than went bad during the expansion that preceded it. According to analysis by the Coleman Report, which compiles data and analysis on small business banking, the share of small business loans that went bad was only 2.4 percent in 2004 but by 2008 was 11.9 percent. With failed loans having nearly quintupled, the SBA needs more money to pay off the guarantees it made to banks. Shortfall in Guarantees
The SBA estimates that paying off these guarantees will cost taxpayers $3.7 billion. While that might not sound like a lot, for the entire period from 2000 through 2011, the SBA received only $2.4 billion to subsidize and administer its loan guarantee program. Administrator Karen Mills explains that she had no choice but to ask the President and Congress for an increased loan subsidy. Without it, the SBA will not be able maintain its current level of small business loan guarantees because federal law limits the amounts that the SBA can charge the banks that make small business loans. Take away the subsidy money and we lose the small business loans.
Still, asking taxpayers for the money to make these risky loans isn't the only way to get the money for them. We could change the law to allow the SBA to charge banks more for the guarantees it provides—something that the Administration is proposing. I would make one adjustment to the administration's proposed increase in fees for SBA loan guarantees. Instead of charging the banks the same rate for guaranteeing all loans, which encourages them to make risky loans that we'd be better off if they avoided, we should charge banks more for guarantees on riskier loans. Higher Failure Rate in Some Sectors
Data from the National Association of Government Guaranteed Lenders shows that some SBA-guaranteed loans are riskier than others. No surprise there, right? In some industries, however, none of the loans made from 2000 to 2008 failed while in other industries, all of them did. By charging banks higher fees for making loans to small businesses in riskier industries, we'd give them an incentive to cut back on the riskier loans that got us into trouble and instead expand safer loans that cost taxpayers less to subsidize. According to data provided by NAGGL, just avoiding the 3.6 percent of loans made in industries with historical failure rates exceeding 20 percent would have eliminated $168 million in loan charge-offs from 2000 to 2008. If we price the guarantees correctly, this change won't even lower the total amount of SBA-guaranteed lending. As I've written before, only a small fraction of small business loans are SBA-guaranteed. We face little risk of using up the SBA guarantees on loans to safer small businesses. So the main effect of differential pricing of SBA guarantees would be to lower the amount we need to give the agency to guarantee bank lending. Perhaps Congress should take a little time away from debating the size of the SBA budget to change the law limiting what the agency can charge banks for loan subsidies. By permitting higher fees for riskier loans and lower fees for less-risky ones, we can reduce the SBA budget, lower the odds that taxpayers will be called on to cover the tab for bad small business loans, and continue making the same number of SBA loans we have made in the past. That seems like something the Democrats and Republicans should be able to agree on.