Stop Trashing the Programs That Help Small Business

(Bloomberg Opinion) -- The challenge facing U.S. economic policy right now is that the government is building a new car while driving it at the same time. There are bound to be expensive repairs and some collisions along the way. The good news is that the car is headed in the right direction.

Take the performance so far of one of this vehicle’s most critical parts: the programs supporting small business. They are flawed but they can be improved.

The Paycheck Protection Program is designed to provide forgivable loans to businesses with fewer than 500 employees for payroll expenses, rent, utilities and mortgage-interest payments, provided that those companies do not lay off their workers. It is the most important government effort to stop small businesses from going under and to keep workers attached to their employers.

Media reports have painted a picture of chaos in launching the program. But it is succeeding to a greater degree than the coverage would have you believe. Congress allocated $349 billion in forgivable loans, and the program ran out of money late last week, less than two weeks after it began. During that time, nearly 5,000 lenders approved 1.7 million loans.

Eighty-eight percent of the loans were for amounts less than $350,000, and three-quarters were for less than $150,000, suggesting that many are going to smaller businesses. Fifty-five percent of the total amount of money given to small businesses involved loans under $1 million.

But inadequate funding has been a challenge from the start. The original decision to allocate only $349 billion to the program may have discouraged many of the smallest businesses from applying for fear that the money would have been allocated to better-placed firms and would have run out before they had a chance to apply. And politics stymied efforts last week to appropriate additional financing. At the time of this writing, it looks as if Congress will allocate an additional $310 billion to the program this week.

Along with funding challenges, the Treasury Department’s implementation of the program has been rocky, and could leave behind the most vulnerable small businesses, which don’t have access to top-shelf financial and legal counsel. By failing to convince banks that they would not be held financially accountable if borrowers misrepresented themselves on their loan applications, Treasury has encouraged banks to focus lending on their existing customers.

And by creating a requirement that payroll expenses constitute 75 percent of the amount of the loan that is forgiven — a rule that appears nowhere in the law itself — Treasury created arbitrary distinctions between businesses. For example, a business in a city with high rent — like New York and San Francisco — loses out. These regulatory problems can and should be fixed.

The second place small businesses could turn is to the Federal Reserve’s new “Main Street” lending facility. The Fed’s term sheet for the program allows companies with up to 10,000 employees, or up to $2.5 billion in revenue in 2019, to qualify as eligible borrowers. Yet this facility is explicitly marketed to Main Street. When you look under the hood, there are troubling signs that it may not offer much help to the most vulnerable small businesses.

For one, it has a minimum loan size of $1 million. Pizza parlors and barbershops with a dozen or so employees won’t want to take out a loan this big.

The program has $75 billion in capital from the Treasury, which the Fed claims will allow it to lend $600 billion. Under the current parameters, this amount of capital and level of lending allow for a default rate of around 13%. That loss rate (and capital buffer) would only be adequate if the program’s portfolio was heavy on companies whose solvency is not in question.

But many truly Main Street businesses — the ones the plan should aim to help — are facing the real risk of insolvency. This amount of capital may be adequate if the Fed targets companies with closer to 10,000 employees. The math doesn’t work if the goal is to lend to small borrowers, like those eligible for the Paycheck Protection Program.

Rectifying that will expose the Treasury to credit losses, which it likely wants to avoid. But Congress provided this capital for the purpose of aiding the recovery, and Treasury should be prepared to lose it. If economic recovery is the goal, and business solvency is the problem, losses are inevitable. Indeed, a $600 billion program including more genuine small-business lending would likely exhaust the $75 billion the Fed has put up in capital. 

The $2 trillion economic package Congress passed three weeks ago allocated a total of $454 billion to support Fed lending in an alphabet soup of new facilities. The Treasury Department still hasn’t decided what to do with $259 billion of that fund. Using it to
support the Fed’s Main Street program would allow for a $334 billion capital buffer, which in turn would let the Fed redesign the program to take more risk — and put the Fed in a better position to help mitigate the massive wave of small-business failures that is coming. In addition, the Fed will need to make sure that regulations don't make banks too wary to lend to these borrowers.

Congress, not the Fed, should decide how much taxpayer money should be spent on preserving small businesses. If the $454 billion runs out, it can decide whether to appropriate additional funding.

Overall, Congress and the Fed have reacted to the Covid-19 crisis with remarkable speed and with programs that approach the economic challenges in the right way. As it travels this unfortunate road, the U.S. is learning what is working and what needs to be changed.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute. He is the author of “The American Dream Is Not Dead: (But Populism Could Kill It).”

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