Credit Shortage or Regime Uncertainty?

We are now mired in the third year of a recession produced when a housing bubble inflated by easy credit finally burst — as it was bound to do sooner or later. From the very beginning, government officials, among whom I include the people who run the Federal Reserve System, have proceeded as if the way to correct a problem created by easy credit is by easing credit. Hence, the plethora of unprecedented Treasury and Fed lending programs and the “quantitative easing” the Fed has used to acquire a variety of iffy securities, especially mortgage-related securities held by Fannie and Freddie, as well as by commercial and investment banks. Whenever Ben Bernanke has spoken about the crisis, he has made repeated reference to the Fed’s measures to keep credit flowing to businesses and consumers, and he has undoubtedly tried to practice what he has preached.

The problem has been that the institutions, especially the commercial banks, in which the $1 trillion plus in Treasury and Fed payouts has lodged have shown little disposition to lend or invest these funds; instead, they have been content to let them sit as excess reserves in their accounts at the Fed.

Recently, Congress approved a bill to make funds available to community banks for lending to small businesses. Although this initiative was no doubt intended as a sop to small-business lobbyists, who have complained throughout the recession that the government’s assistance has been channeled mainly to big banks and other large institutions, the question that now arises is:  Will the banks and the small businesses avail themselves of the opportunities this program creates? The answer appears to be that for the most part they are not interested, because in the present conditions, borrowing will not solve a pressing problem for them and indeed might well entangle them in a new problem with regulators.

An article on this matter by Pallavi Gogoi was published recently in the Los Angeles Times. I paste it below, unaltered except that I have highlighted certain passages. In my mind, this report provides further grist for the mill of those, like me, who see regime uncertainty as a significant factor impeding the investment revival that will be required if we are to have a genuine economic recovery. But you be the judge.

NEW YORK (AP) — President Barack Obama’s $30 billion small community business lending program faces one big challenge: many of the community banks and businesses it’s supposed to help don’t want it.

The lending program is part of a bill that passed the House of Representatives on Thursday and now awaits the president’s signature. The legislation contains a mix of tax cuts and credits aimed at helping small businesses. The centerpiece of the bill is an effort to make billions of dollars available to community banks for loans to small businesses.

It seems like a simple effort to unclog a credit pipeline that has been blocked since the financial meltdown two years ago. But interviews with seven community bankers, as well as small business owners, show a reluctance to participate.

“People in my constituency can’t get credit, and this will get money out to small businesses, who are the engine of job creation for this country,” said Republican Sen. George LeMieux of Florida, who co-authored the amendment that created the lending program.

Bank executives say their customers don’t want loans, even at low interest rates, because the sluggish economy has chilled expansion plans. Some say the federal money isn’t worth it because they fear it will come with too much regulatory oversight.

“We have taken a strategic decision not to have our primary regulator, the government, also be a partner in our bank,” said William Chase Jr., CEO of Triumph Bank in Memphis.

Chase said the bank already has enough capital to meet the paltry demand for loans. “Our business customers are mired in uncertainty and are reluctant to invest in their businesses,” Chase said.

Ninety-one percent of small business owners surveyed in August by the National Federation of Independent Business (NFIB) said all their credit needs were met. Only 4 percent cited a lack of financing as their top business problem. Plans for capital spending were at a 35-year low.

Jack Rajala just laughs when asked if he wants to take out a loan today. He’s in a fight to save his family’s lumber business that has been buffeted by the recession and housing meltdown.

“I’ve seen many ups and downs; this is unquestionably the toughest,” said the 71-year-old Rajala, the third-generation owner of Rajala Companies of Deer River, Minn. Since 2008, his company closed two factories and halved the number of employees to less than 100 as orders plummeted for windows, floors and door frames. Annual revenue is down 50 percent since 2008 to $5 million, and the company is losing money.

Rajala is symbolic of the challenges faced by Obama’s small business lending initiative. The $30 billion fund will be run by the Treasury Department, and money will be awarded to banks deemed strong by regulators. Banks that have less than $10 billion in assets are eligible.

“It will provide incentives to invest and create jobs for 4 million small businesses,” Obama said at a news conference Sept. 10. “It will more than double the amount some small business owners can borrow to grow their companies.”

Obama has to bridge the gulf between money that’s available and the needs of businesses. The NFIB survey found businesses don’t intend to borrow until they have more customers.

Community banks will have to pay an annual dividend of 5 percent to the U.S. Treasury. However, when banks increase their lending to small businesses, their dividend rate declines on a sliding scale. So, if a bank increases its small-business lending portfolio by 2.5 percent, the dividend payment goes down to 4 percent and so on, said Paul Merski, chief economist at the Independent Community Bankers of America, the lobbying group for small banks.

The dividend payment increases to 7 percent if banks don’t lend to small businesses.

“The crucial questions facing business owners are does it make sense to make an investment right now, and will it generate positive returns?” Josh Lerner, professor of finance and entrepreneurial management at Harvard Business School.

Noah Wilcox, CEO of Grand Rapids State Bank, with two branches in Minnesota, said he already has more capital at his $250 million bank than he can lend out.

“Many of our clients, business owners, put their projects on ice in 2008 because their job number one is to see their company through to the other side of this economic crisis,” said Wilcox.

And then there’s concerns that the government money will have strings attached.

The fears stem from what happened under TARP, the Troubled Asset Relief Fund, formed at the height of the financial meltdown to pump money into banks. Banks that accepted TARP money had to later cut dividends to shareholders and limit compensation to top executives. They were also penalized for early repayment.

In this new legislation, the government is taking steps to avoid the tarnish that accompanied TARP. The key part of this effort: Banks can return the money without penalty if rules governing the small business loans change.

But Chase, the bank CEO in Memphis, isn’t convinced.

“The rules can be changed any time,” said Chase.