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Cleaning House

In his battle to close the SBA, President Reagan has turned on his own appointees, offended his business constituency, and welched on a deal with Congress. Even so, he's probably right.
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Washington is a monument town. The Lincoln, the Jefferson, and the Washington are of the simpler variety. Less frequently visited by tourists, yet more expensive to maintain, are the bureaucratic monuments to political influence and self-interest that line the broad avenues of the capital: the Veterans Administration, the Export-Import Bank, the Departments of Education and Energy.

And, of course, the Small Business Administration. As federal agencies go, the SBA is small potatoes. The cost of running it and its programs is about $1 billion this year. For the past few years, Ronald Reagan has been trying to eliminate the agency, transferring a few of its most popular programs to the Commerce Department, selling off its loan portfolio, and relying on the private sector to pick up the slack in terms of financing small business. Yet even in the context of unprecedented Presidential popularity, a huge budget deficit, plummeting interest rates, and a thriving economy, the SBA, wounded and demoralized, still manages to hang on.

The agency's survival is a metaphor for the nearly complete political paralysis that has set in along the Potomac. The daily dispatches dutifully record the twists and turns of the budget battle that has been going on now for years -- of "climactic" White House meetings, break-through compromises, and resolutions of reconciliation. But in the end, nothing is agreed upon except passage of continuing appropriations to keep various government agencies going for another month, or three months, or even a year. The President is pitted against the Congress, Congress is divided against itself, and the bureaucracies and interest groups continue to dig the trenches a little deeper and pile the sandbags a little higher around threatened programs like the SBA.

The Administration's attitude toward the agency was summed up last year by budget director David Stockman, who called the agency "a billion-dollar rat hole" that "indiscriminately sprays a faint mist of subsidized credit into the weakest and most prosaic nooks and crannies of the nation's $4-trillion economy." Stockman's thrust was that SBA programs diverted capital from good credit risks to bad, and represented an unnecessary government intrusion into the private capital markets for the benefit of less than 1% of the nation's small businesses. "If the SBA disappeared," argued Office of Management and Budget spokesman Ed Dale, "hardly anybody would even notice it."

Unfortunately for the Administration, however, they noticed. "They" include the 3,000 employees of the SBA. "They" are the lobbyists of the U.S. Chamber of Commerce, the National Federation of Independent Business, and small-business organizations in every state, whose members look to the SBA, if not for financing, at least for the bureaucratic recognition of their importance to the economy. The opposition also includes bankers, who find that loans guaranteed by the SBA can yield higher profit margins than conventional loans. Last but not least are the Small Business Committees of the House and Senate, whose primary reason for being is to improve the standing of their members with small-business people back home. Without an SBA to oversee, the committees would have virtually no jurisdiction.No SBA, no committees.

Ironically, the Administration's assault on the SBA comes at a time when it has somewhat improved the agency's operation. Time was when the SBA was truly "a multibillion-dollar slush fund for Washington-wise operators," as one critic has called it. SBA loans went to all manner of sharpies who used the cash, according to a newspaper report, to buy yachts and finance live sex acts on a Times Square stage. By and large, that level of abuse has been curbed. But a study by the OMB last year still uncovered an abundance of loans to car washes, bars, restaurants, beauty shops, and bowling alleys -- often in areas saturated with similar enterprises whose owners had found financing without government subsidy. Even physicians and dentists got in on the act, obtaining $126 million in 1984. Lawyers lagged badly behind with only $11 million.

Most shocking have been the failure rates. As recently as 1983, one in every four SBA recipients were delinquent on loans. Defaults, cumulatively, have cost the Treasury $1.4 billion since 1972. Now, because of tougher requirements, default rates on new loans have dropped from an historic average of 18% to less than 10%.

The man who takes some credit for such improvements, and sees room for more, is former SBA administrator James C. Sanders, a California insurance executive who says Stockman's crusade against the agency took him by surprise. Unable to convince the Administration to retain the better programs in a trimmed-down, independent SBA, Sanders resigned this past March. The day after his departure, half his regional administrators were sacked for opposing the Administration's SBA shutdown proposal.

Among the programs Sanders wanted to rescue was a network of 500 Small Business Investment Companies around the country. SBICs use both public and private funds to provide one-fifth of the nation's venture capital. Since they began in 1958, they have pumped $6 billion into some 70,000 businesses, generating a big payoff for a relatively modest government investment. Such programs, Sanders argued, "make economic sense to Main Street America."

The folks at Apple Computer, Federal Express, and Cray Research no doubt agree: all of them received SBIC financing. John F. Carlson, for example, Cray's executive vice-president, told the Senate Small Business Committee that an SBIC loan was "a make-or-break" component of the financing that spawned the nation's top supercomputer manufacturer. He continued: "The taxpayer's investment of less than $500,000 . . . is currently yielding a direct revenue return of over $30 million per year in corporate and personal income taxes."

It is one of the quaint customs in Washington lobbying circles to lard testimony with statistics like these when voicing support for a threatened program. In this case, Carlson's calculations assumed not only that there would have been no Gray without the SBIC loan, but also that no other company would have sprung up to provide similar products. Carlson also assumed that all of Cray's employees would today be unemployed and paying no taxes if Cray didn't exist. Testifying before another committee, he might have been questioned closely on such assumptions. But to the Small Business Committee, it all made perfect sense.

Better known than the SBIC, although less of a cash drain on the Treasury, is the SBA's loan-guarantee program, administered through local banks. Because the government guarantees 90% of these bank loans against default, banks generally shave a point or two off conventional interest rates for small businesses that qualify. But the real advantage of the program is that it provides small businesses with loans going out 5 to 25 years, loans that otherwise are virtually impossible to obtain. Last year, banks made some 21,000 loans guaranteed by the SBA, for a total of $3.3 billion.

For many banks, these guaranteed loans have become something of a bonanza. Take the case of a $100,000 guaranteed, five-year loan with a variable rate of 11.5% (prime plus 2.5%) -- not an atypical arrangement. With loans like this in demand as reliable streams of income, the bank can turn around and sell the 90% that is government guaranteed on the secondary market -- to pension funds and insurance companies -- at a premium of 105% of par value. In addition, the bank takes 1% of the interest over the life of the loan as a service fee. Thus, on its continuing $10,000 loan exposure, the bank would collect a $4,500 premium, plus $4,500 in servicing fees, and, if all goes well, about $6,000 in interest payments on the unguaranteed portion -- a return of about 150% after five years. Meanwhile, the original $90,000 is quickly available to be lent, packaged, and sold once again on the secondary market.

Would this source of small-business capital dry up if the SBA were eliminated? It is a bit early to say. But Biff Barnard, chief executive officer of First Capital CALBIDCO, a California lender that specializes in making SBA guaranteed loans, says private insurance companies eventually replace the SBA as loan guarantors. That possibility, he cautions, is "still in the talking stages." But if it were to work, he says, a gradual transition of three to five years would be needed -- not the immediate elimination of the SBA program that the Administration now seeks.

Perhaps the best argument for saving the SBA is that the taxpayers already have too much invested in it to turn their backs on it now. The agency's $10-billion loan portfolio -- direct loans, disaster loans, defaulted guaranteed loans taken over from banks -- will bring in about $8 billion to $9 billion over the next decade as loans are repaid. The Administration proposes to sell off the portfolio to private investors. But how much such a distress sale would fetch is still anyone's guess. Estimates range from 19? to 30? on the dollar -- a painful write-off. But for an Administration struggling to staunch the flow of red ink, the prospect of getting $3 billion this year is apparently preferable to $10 billion down the road -- especially with Gramm-Rudman looming large. "We need the money now," snips OMB spokesman Dale.

To John Ball III, Democratic counsel to the Senate Small Business Committee, the plan smacks of political desperation. "As far as the Administration is concerned, I think they'd sell the Capitol and turn it into condos if it meant avoiding new taxes," he says.

The Reaganites, however, see it another way. "Sure, they may get another billion or two [by keeping the agency alive]," concedes Edward L. Hudgins of The Heritage Foundation, a conservative think tank that supports the Administration's position. "But I just worry about keeping the thing standing. It's like a cancer -- if you don't cut it out altogether, it will grow back in a year. A lot of government programs are like that. If you don't cut them out completely, come better times, they'll bounce right back."

Hudgins's suspicion is not merely theoretical. At the end of 1985, a compromise was struck between the White House and Senate Republicans to keep the SBA alive for another three years at one-third its 1985 size, $400 million a year. At the same time, the small-business committees of the House and Senate began work on legislation to create a separate new agency, the Corporation for Small Business Investment (COSBI), that would take over and expand the network of SBICs to raise venture capital from Wall Street, not the U.S. Treasury.

But just when everyone thought that a political solution had been found to the SBA problem, the President's 1987 budget arrived. Again, the agency was slated for elimination. In addition, the Administration is taking a dim view of COSBI. Members of Congress accuse the President of welching on a deal.

It "breaches, in our view, the compromise agreement reached last year," says Sen. Lowell P. Weicker Jr. (R-Conn.), chairman of the Senate Small Business Committee, of his President's position. "We believe it is shortsighted, irresponsible, and unacceptable."

Replies OMB's Dale:" The fact that we endorsed a three-year authorization does not mean that we can never alter it."

And so it goes in Reagan's Washington, where a Republican President finds himself in a nasty little fight against the Republican Senate and the U.S. Chamber of Commerce, cheered on by the editorial page of the liberal Washington Post, which calls the SBA "an exercise in federal nostalgia." It is an era of strange bed-follows.

The SBA is only one of 70 programs, each with its own constituency of citizens, lobbyists, bureaucrats, and politicians, that Reagan proposes to eliminate or drastically reduce. "We're going to fight like hell for all of them," promises Dale, with all the confidence of a New England Patriots fan the week before the Superbowl. And with equal enthusiasm, lobbyists for the National Federation of Independent Business are busy plotting not only the rescue of the SBA, but its elevation to cabinet status.

Is anybody listening?

Last updated: Jun 1, 1986




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