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Small Business Loan Program Risks Taxpayer Losses, But Looks Free

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Small Business Loan Program Risks Taxpayer Losses, But Looks Free

July 28, 2010

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The U.S. Senate is expected to vote this week to inject $30 billion of federal funds into banks that will make loans to small businesses. Under a key amendment expected to be offered to the Small Business Lending Fund Act, the U.S. Treasury would give small- and mid-sized banks cash to boost lending to small businesses, and in exchange, the banks will give the Treasury preferred stock that pays dividends well below market rates – as low as 1%. Critics have dubbed it another bank bailout like the Troubled Asset Relief Program (TARP) that gave federal loans to big Wall Street banks in 2008. Unlike TARP, however, supporters of the Small Business Lending Fund have one big advantage that they’ve used to push the program through the House and most likely the Senate. It makes money. At least that is how it appears.

Senator George LeMieux, R-Fla., says the program “doesn't run a deficit or increase taxes." And in the same vein, Gene Sperling counselor to the Treasury secretary, told Bloomberg the bill “…is one of the most efficient bang-for-your buck initiatives you can put forward.” Strangely, no one has challenged these claims. But someone must be wondering how the federal government can accept below-market interest rates and dividends on risky preferred stock (which is a loan that technically does not have to be repaid) all the while telling taxpayers it won’t cost them a dime.

It turns out that the Congressional Budget Office came up with that exact question and provided an illuminating answer. To read the agency’s analysis is to see that the proponents of the Small Business Lending Fund have pulled off a major budgeting sleight of hand. What’s more, the proponents have brazenly flaunted their gimmick in asserting that the small business lending program is a money maker.

According to CBO, if the capital injection program in the pending legislation is evaluated using the same methods that a private financial firm would use – that is, accounting for the riskiness of owning the preferred stock and calculating the fees needed to cover that risk – the program is actually $6.2 billion in the hole. That means if the U.S. Treasury held an auction to immediately sell all the preferred stock it received under the program to private investors, taxpayers would lose $6.2 billion. Essentially, the banks that receive the low-cost capital injections under the program are getting a subsidy from taxpayers equal to roughly $6.2 billion.

Unfortunately, that figure cannot be used in the official estimate when the House and Senate vote on the final version of the bill. Instead, CBO is required to evaluate the program on a cash basis, which excludes any fair value assessment of the compensation taxpayers should receive for the risks that they are bearing. The cash budgeting approach shows that $1.1 billion in net earnings over ten years would accrue from the Small Business Lending Fund. The taxpayer subsidy that the program actually provides to banks is all but excluded from the estimate and therefore isn’t part of the official debate in Congress. In other words, the program appears to make money because the budget excludes the subsidy banks are getting from taxpayers. One can only imagine what other policies the federal government could pursue if this accounting advantage goes unchecked.

There is, of course, an easy way to check this budgeting sleight of hand. When Congress enacted the Troubled Asset Relief Program, it required CBO to evaluate any costs for the program using private market values for risk. That requirement was written into the law to avoid a scenario similar to the one now at play with the Small Business Lending Fund. Of course, the House and Senate will need to reconcile their respective versions of the bill through the conference process, so the final outcome remains to be seen. Congress could follow the TARP precedent and mandate a fair value estimate for the bill when a final version is considered again in both Houses, thereby overriding the rules that currently bind CBO. Notwithstanding the policy merits of the pending legislation, taxpayers could then see how much of their money is really at risk and how much they are going to subsidize private banks if the Small Business Lending Fund is signed into law.

Jason Delisle is the Director of the Federal Education Budget Project at the New America Foundation.

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