Alternative Approaches to Help Small Businesses

12/9/20

I’ve been taking a lot of heat in my house for criticisms of the Paycheck Protection Plan (see Loans — Not Grants), which is the primary means by which the federal government is supporting small businesses during this Covid-19 crisis. It’s not that I’m not sympathetic to small businesses. It’s that I believe the approach that Congress appears to be favoring is misguided.

I fully appreciate the importance of small businesses. Clearly, for those who own them and those who work for them, these businesses meet the definition of “essential.” Interruption of their operations would necessarily heighten the financial insecurity and/or wellbeing of those stakeholders; and unfortunately, transitioning to another source of income is made more difficult by a general economic slowdown. Looking for alternative employment is often a difficult task in the best of times. That difficulty is magnified, however, under the current set of circumstances.

In addition to these issues relating directly to people’s livelihoods, losing businesses also damages our sense of community. This consideration is particularly acute for those of us who live in cities known for their restaurants, bars, theaters, and museums. Having these attractions falling by the wayside compromises the way of life that we have enjoyed and come to expect. It’s more than understandable to be sympathetic to any effort to maintain the pre-pandemic status quo and forestall whatever shutdowns we can; but as they say, the devil is in the details. It’s not whether small businesses should be assisted, but rather how they should be assisted.

Left to their own devices — i.e., in the absence of any federal assistance — business owners who face a cutback in demand for their products or services typically have to dip into their savings or otherwise borrow in order to keep afloat. In my mind, these responses continue to be the best courses of actions; but in the current environment, private credit markets don’t seem up to the task. First, the process of qualifying for and accessing credit is cumbersome, closing out many companies that don’t have existing banking relationships; and secondly, even if those banking relationships are in place, the greater precariousness of the businesses’ success in the current environment would justify interest rates that may be prohibitive in a good many cases.

Given the importance of small businesses, the federal government needs to step in; but it’s dicey terrain. The government needs to make credit more easily accessible while assuring that the payoff to the lender isn’t excessive. Moreover, the process needs to ration these loans to borrowers who have some reasonable prospect of meeting their obligations, appreciating that some elevated frequency of default will be likely. I have touted the Fed’s Main Street Lending program in past posts as a program that would seem to thread this needle, but it has yet to gain any real traction. In any case, an expansion of lending under this program would seem to me to be a no-brainer.

Besides that avenue, the federal government’s Small Business Administration (SBA) would also seem to be an appropriate instrument for providing additional credit; but this agency has yet to play any significant role. The SBA doesn’t make direct loans, but it supports credit extension by guaranteeing loans, thereby insulating lenders from default risk. Lenders need to retain some skin in the game to assure that they don’t play the system, but with that constraint satisfied this loan guarantee program needs to be dramatically scaled up. While the SBA claims to “empower small business owners to start, grow, expand, and recover,” its budget for FY2021 is a paltry $1 billion. Besides a more generous budgetary allocation, it might be worth considering requiring banks of a certain size to achieve a quota of SBA loans in some proportion of their commercial loan portfolios to assure that the intended target audience is served in a timely fashion.

While I see greater accessibility to credit as a cornerstone of any federal aid package, I’d also like to see something akin to “bankruptcy-lite.” Bankruptcy works somewhat like a reset button, allowing debts and obligations to be restructured to give relief to those whose financial circumstances are unsustainable. Creditors are essentially obligated to bear some of the burden. It may not be ideal, but it serves an essential social purpose. We need a similar mechanism for businesses that are suffering under the pandemic to give these entities a way to restructure terms of leases and debt obligations. For instance, the regulation might provide for leases and interest expenses to be discounted by, say, 25% on a per diem basis, for any period in which a business is mandatorily precluded from operating at full capacity.

Instituting such a program would not be without its problems, as it would override existing, mutually agreed upon contractual arrangements, but that’s what happens with normal bankruptcies. It seems that the conditions we are now experiencing warrant allowing an analogous dispensation.

Both of these policy alternatives — expanding the availability of credit and instituting some kind of bankruptcy-lite regulations — would likely allow for federal dollars to affect a broader population of deserving businesses than would otherwise occur under an extension of the Paycheck Protection Program. Expanding credit opportunities should be the easier implementation of the two, as the infrastructure that would underly this effort is already in place. The bankruptcy-lite proposal, on the other hand, would be harder to get up and running. Still, given the severity of the challenge we are currently facing, I’d hope this idea generates some interest and further consideration.