Congress was wrong to leave PPP disbursement up to banks

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The coronavirus pandemic has exposed the weaknesses of federal crisis response capabilities across the entire U.S. economy.

Nowhere has this weakness been more evident than in the government’s efforts to rescue the small businesses that account for almost half of U.S. jobs and economic activity.

Instead of providing quick, efficient and fair employee retention assistance directly through employers — like the method used in the European Union and elsewhere globally — the U.S. relies on bank lenders as the primary conduit for delivery of assistance to employers and their employees.

This reliance on lender intermediaries means that assistance must come in the form of “loans” rather than direct support payments. It also exposes how frequently the government’s policy goals conflict with lenders’ economic goals and incentives. This is an inefficient and ineffective solution for the problem it intended to solve.

There are numerous issues emerging from the use of banks to distribute the first, and now second, round of emergency small- business assistance under the Paycheck Protection Program. But lawmakers who created the PPP through the first coronavirus relief bill should likely be forgiven for not creating a better method out of thin air. An emergency is an emergency after all.

But the practice of channeling small-business and employee support assistance through banks is going to become very problematic very fast if the crisis drags on.

The government can continue to use banks to deliver aid to small businesses if it has to, but it shouldn’t try to outsource the hardest political and policy decisions to banks. If this continues, the vulnerable small businesses that lawmakers want to help the most will end up paying the price.

As the coronavirus crisis stretches on, and the need for additional small-business support grows, the government has one absolutely critical decision to make: whether to try preserving every small business that was in operation through mid-March 2020 or assist only those that will remain viable when the government assistance ends, based on choosing the likely “winners” and “losers” post-crisis.

If Congress and the executive branch decide to go with the status quo and support every existing small business, then there’s a clear template for using the banks as the conduit for assistance.

Loans with blanket small-business eligibility will require a complete assumption of credit and market risk by the government, acting either through the Small Business Administration or the Federal Reserve banks with Treasury support. This is similar to the approach to small business that government has taken so far with the PPP.

It carries with it serious problems with over-inclusivity and ongoing cost but has the advantage of simplicity and speed.

If the crisis continues into 2021, it might make sense to replace the short-term PPP approach with longer-term guaranteed loans with subsidized interest rates, maximum fees and partial (or complete) loan forgiveness tied to employment retention, or other conditions.

But what if the government decides instead that it can’t afford to save every small business, or that the coronavirus crisis has changed the U.S. economy in some fundamental way that can’t be undone? Then it might choose to follow a Darwinian approach and seek to provide support only to those small businesses that are likely to be viable at the end of the crisis, based on who’s likely to survive. This poses more profound questions surrounding who would make that judgment call.

The simplest approach — and one more likely to attract to legislators trying to pass the buck — would be to delegate the decisions about small-business winners and losers to banks, by requiring them to retain significant credit exposure to borrowers under a government-supported program. The logic of this approach is that lenders are experts at assessing future risk so they should handle it.

Here is where using the banks as a conduit for government policy courts big trouble.

Bank lenders are hard-wired to maximize shareholder value — not social value — and their decisions are inevitably based on their own capital, profitability and customer relationship needs.

While it’s debatable whether this is the best model for corporate governance, it’s absolutely certain that in the midst of an unprecedented health and economic crisis, banks on their own would have lent a fraction of the hundreds of billions advanced so far by the PPP to small businesses. This state of affairs will only change when some combination of testing, vaccine development and phased-in business reopenings gives clarity to American behavior in the post-coronavirus economy.

Imagine how a bank would predict today which small businesses are likely to be survivors post-crisis and deserve loans and which should be left to shutter.

The bank can’t use credit scoring, because backward-looking statistical scoring models are useless when radical change like COVID-19 scrambles the regressions. It would be equally challenging to rely entirely on business cash flows when unpredictable government shutdown decisions can cause wild revenue and expense fluctuations.

Today’s temporary winners (i.e., mask distributors) may be tomorrow’s losers. And some businesses that are dead today could be fully viable after the crisis ends.

When the credit outlook is this opaque, banks will take risk positions only in new loans that they believe will add to short-term shareholder value and support their stock price. That usually means making as few loans as possible, and results in a failed government small-business support program.

More fundamentally, it’s critical to question whether existential decisions about which small businesses get a government-guaranteed loan and survive versus which don’t and fail in an unprecedented economic crisis, should be made by private actors.

These are public-resource allocation decisions that require public and political solutions, not private ones. Politicians hate hard, no-win decisions with indeterminate costs and benefits for good reason. But those are the choices representatives are elected to make when times are hardest, choices that shouldn’t be left to banks.

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Small business lending Small business Paycheck Protection Program SBA Banking Credit quality Economy Coronavirus