Dems' Small Business Act Repeats Freddie & Fannie Mistakes

The Democrats new small business lending plan threatens to create a new speculative bubble similar to the one Fannie and Freddie created.

Republicans were right to oppose a new small business lending plan that looks likely to become law soon; but they should have likened it to Fannie Mae and Freddie Mac rather than the Troubled Assets Relief Program (TARP) used to bailout big financial institutions.  The bill the Senate passed late last night doesn’t bail anyone out but, if it’s successful (yes, successful), it could impose an enormous liability on the economy by laying the groundwork for a speculative bubble similar to the one Fannie and Freddie created.

To be sure, the bill has a nice façade and good intentions. Many worthy small businesses have bona fide problems getting credit and the new law would help them through a rube-Goldberg like mechanism that will make $30 billion in Treasury funds available to community banks that increase their lending to small businesses. Unlike TARP, furthermore, it isn’t a bailout; safeguards in the bills’ legislative language mean that really troubled small banks don’t qualify.

Since tightened lending standards and decreased home equity have made it harder for small businesses to get loans, the flow of credit to small enterprises will probably increase and small business job creation could accelerate.  The Congressional Budget Office, furthermore, predicts that the fund could well produce profits for Treasury in the end.

And that’s the danger.  Although the mechanism works differently, the fundamental idea is the same as the one behind Fannie and Freddie: the public sector will encourage more lending of a certain type and send capital towards lending institutions to make it happen. At first, this could work. Certainly, Americans around the country have ideas worthy of $30 billion in new loans. But, if it grows, such a “fund” could end up creating a bubble. Fannie and Freddie evolved from similarly worthy ideas to help more people become homeowners. At first, they helped only people who could afford homeownership but couldn’t get loans. But, in the long term, they helped encourage sloppy lending and a speculative bubble.

None of this is inevitable since the mechanism in the bill does sunset after 10 years. But, if businesses and banks like it (and why shouldn’t they?) and it turns a profit, hardly anybody would oppose extending or enlarging it.  In fact, if it produces net profits for Treasury, it could become a “payfor” to cover popular spending or contribute to tax cuts.  And the private sector could become dangerously reliant on government for credit.

If Congress really does want to encourage more small business lending it should look elsewhere: a proposal to let credit unions extend their own business lending and unleash capital that’s otherwise dormant (something Sen. Mark Udall tried to add to the bill) and a drastic simplification of the Small Business Administration’s micro-loan program both deserve serious consideration.  But the Small Business Lending Fund seems like a bad idea.