WASHINGTON — The Obama administration's efforts to expand key Small Business Administration programs suffered a setback Wednesday as lawmakers and the agency's inspector general cited ongoing fraud issues and other obstacles to the plan.

"In some instances, core initiatives have been wracked by fraud," said Small Business Committee Chairman Nydia Velazquez at a hearing on the issue. "In other cases, they have been undermined by questionable practices. It is imperative that these programs be restored to reflect their original mission — strengthening and supporting small businesses."

The president asked Congress in February to allow owner-occupied commercial real estate loans maturing in the next year to be refinanced through SBA's 504 program, which cannot currently be used to refinance debt. He also called for permanently increasing the cap on 7(a) and 504 loans to $5 million from $2 million.

But a report from Peggy Gustafson, the SBA's inspector general, found significant problems with both programs, leading lawmakers to question whether they should be expanded.

A March audit of the 504 program found that lenders may not have used appropriate practices for approving and distributing 68% of sampled loans worth nearly $8.9 million, citing poor underwriting, eligibility and other issues. The IG said that at least 572 loans worth $254.9 million had weaknesses.

A separate IG report for the 7(a) program's fiscal 2008 results found an improper payment rate of 0.53%, representing roughly $4.6 million worth of loans.

SBA Administrator Karen Mills defended the proposed expansion, saying the agency would be focused on guaranteeing loans that are even less risky than it currently accepts.

The IG said the 504 program has particular risk because the SBA relies on certified development companies who work with private lenders to administer the program. Gustafson said the key to managing that risk is effective oversight by the SBA.

"Anytime there is delegated authority there is always a risk in that," she said.

Gustafson suggested increasing oversight of SBA lenders, stronger enforcement early on and regular on-site reviews. At the hearing, she and committee members listed numerous audits of the agency, citing lapses with its loans and lenders. Particularly vexing to many panel members was a March report that claimed some third-party administrators of the 504 program drove luxury cars and received large salaries.

Velazquez said this contradicts with the mission of the program to promote small-business loans.

"For more than a decade there have been inaccuracies by the Small Business Administration … do these findings call into question the agency's credibility?" she said.

Mills acknowledged it was a problem and said the SBA is preparing new guidelines on corporate governance.

"Your point is absolutely correct and this is extremely disturbing," Mills said. "We have to be the standard for the rest of the industry."

Reps. Vern Buchanan, R-Fla., and Ann Kirkpatrick, D-Ariz., suggested a different alternative — direct lending by the SBA to boost small-business lending.

"I hear from a lot of my small businesses," Kirkpatrick said. "They would prefer to apply directly from the SBA and not go through banks because major banks."

But Mills said such a move would be a mistake.

"The issue of executing and operationalizing it has some unintended consequences, some costs, related to it," she said.

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