[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
HEARING ON ACCESS TO CAPITAL
FOR SMALL BUSINESS
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
WASHINGTON, DC, MAY 17, 2001
__________
Serial No. 107-8
__________
Printed for the use of the Committee on Small Business
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COMMITTEE ON SMALL BUSINESS
DONALD MANZULLO, Illinois, Chairman
LARRY COMBEST, Texas NYDIA M. VELAZQUEZ, New York
JOEL HEFLEY, Colorado JUANITA MILLENDER-McDONALD,
ROSCOE G. BARTLETT, Maryland California
FRANK A. LoBIONDO, New Jersey DANNY K. DAVIS, Illinois
SUE W. KELLY, New York WILLIAM PASCRELL, New Jersey
STEVEN J. CHABOT, Ohio DONNA M. CHRISTIAN-CHRISTENSEN,
PHIL ENGLISH, Pennsylvania Virgin Islands
PATRICK J. TOOMEY, Pennsylvania ROBERT A. BRADY, Pennsylvania
JIM DeMINT, South Carolina TOM UDALL, New Mexico
JOHN THUNE, South Dakota STEPHANIE TUBBS JONES, Ohio
MIKE PENCE, Indiana CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey DAVID D. PHELPS, Illinois
DARRELL E. ISSA, California GRACE F. NAPOLITANO, California
SAM GRAVES, Missouri BRIAN BAIRD, Washington
EDWARD L. SCHROCK, Virginia MARK UDALL, Colorado
FELIX J. GRUCCI, Jr., New York JAMES R. LANGEVIN, Rhode Island
TODD W. AKIN, Missouri MIKE ROSS, Arkansas
SHELLEY MOORE CAPITO, West Virginia BRAD CARSON, Oklahoma
ANIBAL ACEVEDO-VILA, Puerto Rico
Doug Thomas, Staff Director
Phil Eskeland, Deputy Staff Director
Michael Day, Minority Staff Director
C O N T E N T S
----------
Page
Hearing held on May 17, 2001..................................... 1
Witnesses
Ferguson, Hon. Roger W., Vice Chairman, Board of Governors,
Federal Reserve System......................................... 3
Dunkelberg, Dr. William, Chief Economist, National Federation of
Independent Business........................................... 17
Shapiro, Mr. Leslie, President, Padgett Business Services
Foundation..................................................... 20
Johnson, Mr. Arthur, Chairman and CEO, United Bank of Michigan... 22
Tatum, Mr. Douglass, Partner and CEO, Tatum CFO Partners, LLP.... 24
Appendix
Opening statements:
Manzullo, Hon. Donald........................................ 35
Velazquez, Hon. Nydia........................................ 37
Prepared statements:
Ferguson, Hon. Roger W....................................... 39
Dunkelberg, Dr. William...................................... 52
Shapiro, Mr. Leslie.......................................... 61
Johnson, Mr. Arthur.......................................... 65
Tatum, Mr. Douglass.......................................... 76
HEARING ON ACCESS TO CAPITAL FOR SMALL BUSINESS
----------
WEDNESDAY, MAY 17, 2001
House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 10:21 a.m. in Room
2360, Rayburn House Office Building, Hon. Donald Manzullo
(Chairman of the Committee) presiding.
Chairman Manzullo. Good morning. This hearing will now come
to order. On behalf of the members here today and myself, I
welcome our witnesses, and thank you for your participation in
this hearing.
This hearing is on capital, which is the lifeblood of small
businesses. The testimony from the witnesses today will center
on some very interesting issues, such as whether or not in this
three-legged stool, it's lack of demand, whether or not it's
inflation, or fear of inflation, or whether or not the banks
themselves simply are not interested in lending money. And Dr.
Ferguson, I'm sure, will have all the answers to those
questions because I do not care how much we get into the issue
of available capital we get into the theoretical realm, and
sometimes that is about as far as we could take it.
We are going to take a look at why the Federal Reserve
decreased interest rates. We will look at how federal and
private policies affect non-governmental lending and whether
small businesses are accessing necessary credit and capital
through private lending sector in the recent slowing economy.
So, it is going to be a very interesting hearing.
Our Subcommittee Chairs, DeMint and Toomey, I commend them
for their work in the area and their anticipated joint
subcommittee hearing and legislation. Mr. DeMint and Mr. Baird
are developing to bridge the gap medium-sized businesses have
and access in capital investment.
It is my distinct pleasure to recognize, after the opening
statement from Mrs. Velazquez, the Federal Reserve Vice-
Chairman, Dr. Roger W. Ferguson, Dr. Jr. Ferguson took office
October of 1999 as Vice-Chair of the Board of Governors of the
Federal Reserve for a four-year term ending October 5, 2003. I
will further elaborate on his distinguished record before he
testifies, but first I will recognize my friend, the Ranking
Member from New York, for any statement that she may wish to
make.
Ms. Velazquez. Thank you, Mr. Chairman, and welcome, Dr.
Ferguson.
Access to capital is one of the critical components to
business success. A business that can obtain funding quickly
and at a reasonable cost has a much greater chance of
succeeding. Unfortunately, for many small businesses, getting
access to cash flow is not always that easy. One only needs to
look at the fact that the vast majority of business start-ups
are done not by conventional loans, but by credit cards to
realize this.
Make no mistake, lending for business start-up and
expansion is very much a high-risk--high reward venture. I
believe that many of our financial institutions are looking for
innovative ways to assist small businesses to obtain the funds
they need to start and grow their business.
Unfortunately, banks cannot do it alone. Not only do they
operate at a time when federal regulators prod banks to tighten
loan underwriting criteria--the must also operate in a new era
created under Graham-Leach-Bliley that has spawned a very
competitive environment for the deposit that make it possible
for lenders to make loans.
Today, with so many different competing interests vying for
those increasingly scarce funds, it is no wonder both lenders
and borrowers are frustrated. This is where the SBA loan
programs come into play, with their ability to guarantee funds
that allow banks to set aside less of their scarce deposits and
maximize their lending potential.
By doing this, we increase the ability of our financial
institution to offer loan opportunities for small businesses.
This partnership has been so successful that currently SBA loan
programs account for 40 percent of all long term small business
loans nationwide. It is because of this relationship that you
cannot talk about access in the private lenders market without
considering it within the context of SBA's loan programs.
That is why the proposal by the Bush administration to
increase fees is not only harmful to our small business owners,
but it is harmful to our lending system. time and time again
when fees on these programs have been increased, the ability
for banks to offer loans has plummeted. At a time when our
economy is creating more questions than answers, we need a
strong and well functioning guarantee loan system to ensure
that our small businesses have access to the capital they need
to survive.
In closing, it is clear that access to capital for small
business is truly access to opportunity, which is why this
committee has spent so much time working to ensure that our
nation's small businesses can access the funds they need to
start and grow their businesses.
I want to thank the witnesses for coming here today and I
look forward to their testimony. Thank you.
[Ms. Velazquez's statement may be found in appendix.]
Chairman Manzullo. Thank you.
It is my pleasure to introduce Dr. Roger W. Ferguson, Jr.,
Doctor in Law and Ph.D. He served as the chairman of a group of
ten working party on financial sector consolidation formed in
September of 1999 at the request of the finance ministers and
the central bank governors of the G-10; holds a B.A. in
Economics from Harvard University; Juris Doctorate in Law and a
Ph.D. in Economics. He was a member of the board of McKinzey &
Company, an international management consulting firm. From 1984
to 1997, Dr. Ferguson served as the director of research and
information systems, overseeing a staff of 400 research
professionals. From 1981 to 1984, he was an attorney with the
New York City Office of Davis, Polk & Wardell.
Dr. Ferguson, welcome to the hearing today. We eagerly look
forward to your testimony. Thank you.
STATEMENT OF ROGER W. FERGUSON, JR., VICE CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. Ferguson. Thank you, Mr. Chairman, and also Ranking
Member Velazquez.
Chairman Manzullo. I believe that you had wanted to read
your complete statement which will be about seven or eight
minutes so I am not going to put the five-minute clock on.
Mr. Ferguson. Fine. Thank you very much. I appreciate that.
And I do--I am pleased to appear before this committee to
discuss the availability of credit to small businesses.
Before turning to the latest information on credit market
conditions, however, I think it is important to highlight the
special characteristics of small businesses that make them such
an important part of our economy and at the same time create a
heterogeneous set of financial needs and credit demands. Much
of the information that we have on small business financing
comes from surveys, including the Federal Reserve's Survey on
Small Business Finance, the latest of which was completed last
year.
No doubt I am preaching to the choir here when I tell this
group how important small businesses are in our nation's
economy. The statistics collected by the Census and Small
Business Administration are indeed remarkable. These data
reveal that there were more than 24 million nonfarm business
tax returns filed in the United States in 1999. More than 99
percent of those returns were for small businesses, that is,
firms with fewer than 500 employees. Roughly half of these were
self-employed persons and about a third were part-time. Based
on SBA estimates, small businesses employ more than half of the
private work force and are responsible for around 50 percent of
all sales and private gross domestic product, a share of output
that has remained fairly stable over time.
With half of our nation's private, nonfarm output coming
from small businesses, obviously our economic well-being
depends greatly on this sector. But small businesses do more
for us than can be captured in these statistics. Small
businesses are a source of new ideas and products. The list of
innovations developed by these enterprises in fields such as
software, computer technology, aerospace, and pharmaceuticals
is quite impressive. The possibility that an idea or new
product will eventually transform a small business into a large
corporation is a great motivator of change and risk taking.
Beyond that, small enterprises make a huge contribution in the
form of the support and synergies they provide operating side
by side with large businesses.
An essential feature of a thriving small business sector is
the ability of firms to start up, to grow, and to change
ownership. Just as essential to the dynamism of our economy of
these firms to downsize when that improves profitability or to
exit the markets when the resources are more highly valued
elsewhere. There is a tremendous amount of turnover of small
businesses. In 1999, approximately half a million firms--
excluding self-employed for which numbers are not available--
closed for one reason or another--perhaps they merged or were
acquired by a larger firm, perhaps they failed, or the owner
found other reasons to move on. At the same time, more than
half a million new businesses were created.
The continuous entry and exit of firms is a clear sign that
resources are responding to shifting demands of consumers and
businesses and to changes in the cost of production. The flow
of labor and capital form less productive to more productive
uses is the cornerstone of a dynamic and healthy economy. A
downside of this churning is the greater uncertainty that
attaches to the earnings and risk profile of each individual
small business.
This has significant implications for the financing of
small businesses. Indeed, while a number of factors need to be
in place for a small business sector to thrive, including a
mobile labor force and a sound infrastructure of laws and
regulations, perhaps the most important ingredient is access to
capital and credit.
The financing needs of small businesses are as varied as
the population itself. The life cycle of a small business can
take many forms, with very different implications for the types
of risk and returns that lenders and investors can expect. For
new ventures that have high risk profiles and high expected
returns--as do many start-up firms in the tech sector--the
initial stages require commitments of equity capital, sometimes
from family and friends and sometimes in the form of venture or
private equity capital. Further injections of equity are
required in the early stages of growth and ultimately some form
of so-called ``take-out'' financing is arranged, such as an
initial public offering or a buyout by another firm, that
allows a venture capitalist to extract his or her investment.
The past decade has been impressive for the large amount of
equity capital that flowed to venture and high-tech enterprises
in this country. The National Venture Capital Association
estimates that investments in emerging enterprises totaled $214
billion over the past five years, and exceeded $100 billion
last year alone. The number of companies funded last year was a
record 5,300. About 270 companies that originally were backed
by venture capital were purchased by other companies last year.
Another 250 were able to go public through IPOs of stock, even
as the market for publicly traded equity was in the initial
stages of its recent decline.
The average age of firms going public was about seven
years, but many were older, which is indicative of the
potentially long-term commitments that investors in venture
enterprises must be prepared to make. It is safe to say that
the United States has been a role model for countries in Europe
and Asia seeking to develop markets for equity financing for
small businesses.
But for every new, high-growth firm seeking venture
capital, there are hundreds of small businesses in the
manufacturing, construction, trade, and service sector that
have quite different financing needs. Some of these firms have
established operating histories and marketable assets that make
them good candidates for credit from conventional financial
institutions.
A few are small corporations that have access to bond
market financing, though their bonds are likely to be rated
below investment grade. The vast majority are small enterprises
with few assets to pledge as collateral and with only limited
operating experience from which investors can assess operating
performance and future earnings streams.
Recognizing the importance of small businesses, we endeavor
to understand the sources and uses of credit by different sizes
of firms. To this end, the Federal Reserve has undertaken three
national surveys of small businesses, the first in 1987, the
second in 1993, and the third which was completed last year. A
detailed description of the latest survey, along with
preliminary results, was published in the April 2001 Federal
Reserve Bulletin. And this morning I will highlight just a few
preliminary findings and note that the data have just become
available for what promises to be interesting analytical work.
The survey sampled 3,600 small businesses that were
representative of more than 5 million nonfarm, nonfinancial
enterprises that operate for profit. It gathered information on
a large number of firms, including each firm's use of credit;
characteristics such as the number of employees, or the
industry, or the age of the firm; and its income and balance
sheet data as of year-end 1998.
The earlier surveys had been used, for example, to shed
some light on the relationship between a business and its bank
or primary lender and to study how financing choices varies
with location, age, size or other characteristics.
This latest survey can be used to update these studies and
to assess how small businesses may have altered their use of
credit and financial services in response to technological and
competitive changes in the financial environmental.
The preliminary survey results we have glimpsed so far are
interesting as much for their consistency with previous surveys
as for the changes they reveal. For example, despite the large
amount of structural change and consolidation in the financial
service sector and the improvingaccessibility of capital
markets to many smaller firms, commercial banks continued to be the
dominant provider of financial services to small businesses in 1998.
Of the 55 percent of small businesses that obtained credit
from market sources or institutions, nearly three-fourths had
some sort of credit arrangement, such as a line of credit, a
loan, or a lease, with a commercial bank.
Finance companies served about 13 percent of small business
borrowers, and leasing companies served about seven percent.
The survey results also confirmed the growing use of
business credit cards by small businesses. About one-third of
all small businesses, more than 50 percent of firms with 20 or
more employees, had business credit cards in 1998.
We included questions on the survey about the problems
small businesses considered to be most pressing. Small
businesses in 1998 expressed concern about the quality, cost
and availability of labor and about increased competition from
larger, international and internet firms. Of note, financing
was not high on their list of concerns.
It is not surprising that small firms were feeling the
pressures of tight labor markets and increased competition.
1998 marked the seventh year of a robust expansion. Bolstered
by a technology-led acceleration in productivity, real GDP
growth averaged four and one-quarter percent in the latter half
of the 1990s, and the unemployment rate had dropped to four
percent by the end of the decade.
Aggregate indicators of credit availability were quite
positive in the mid to late 1990s. Banks were generally easing
credit terms, and business loans grew robustly at both large
and small banks.
The surge in equity markets provided a welcome environment
for firms going public for the first time, and firms carrying
below-investment-grade bond ratings were able to issue bonds at
historically narrow spreads over Treasuries.
While disruptions in global markets in 1998 raised risk
premiums on junk bonds and bank loans and threatened a seizing
up in financial markets, ultimately they did not derail the
flow of credit, especially to smaller businesses.
Since the 1998 survey, the economic and financial
environment has again changed, and this time in ways that are
less conducive to risk-taking and leverage. It became
increasing apparent over the course of last year that the pace
of economic growth was slowing. Credit markets firmed,
including bank lending, partly in response to concerns that a
slowing economy would result in some deterioration in the
financial well-being of businesses and their creditors. As
corporate profits fell and businesses revised down their
outlook for sales and earnings growth, investors became less
certain about the returns they should expect on investments.
By late last year, equity markets looked considerably less
attractive as a source of financing, especially to firms hoping
to go public for the first time. The volume of IPOs dropped
dramatically in the fourth quarter and remained sparse in the
early months of this year, though it has not dried up entirely.
As prospects for takeout financing through an IPO became
problematic, private equity investors became more cautious
about committing capital to earlier stages of financing. While
venture capital investments exceeded $100 billion last year,
the pace of investment has slowed in recent quarters and there
are reports that some young firms are finding it hard to get
second- and third-stage financing for venture capital projects.
In the capital markets, the default rate on high-yield
bonds climbed markedly last year to its highest level since
1991, boosting lender concerns about the ability of weaker
firms to service their debt in this environment.
Yields on so-called junk bonds rose appreciably relative to
those on better-rated debt. In consequence, the issuance of
these high-yield bonds dropped sharply in the fourth quarter.
Although the capital markets continue this year to exhibit
considerable selectivity, the flow of credit through bond
markets has been strong over all. Gross bond issuances or
offerings by nonfinancial firms totaled nearly $160 billion in
the first four months of this year. And, although they are
paying higher risk premiums, non-investment-grade companies
still are able to raise funds; junk bond offerings have
accounted for about 25 percent of the gross issuance this year.
Are you aware, the Federal Reserve conducts surveys of
senior loan officers at large banks around the country. These
surveys ask about banks' credit terms and standards, about loan
demand, and other issues that may be topical. During the market
turmoil in late 1998, banks began taking a harder look at the
loans that they make to large and middle market businesses.
While financial markets settled down subsequent to 1998,
banks appear to have maintained a more vigilant posture. Last
year, in an environment of rising delinquency rates on loans
and indications of declining credit quality, the net percentage
of banks who reported some firming in their lending standards
for large and medium borrowers rose steadily in each of our
surveys.
Anecdotal reports suggest that banks were particularly
concerned about concentrations of risk in sectors such as
telecommunications, where returns have dropped sharply, and in
manufacturing and other sectors highly dependent on energy and
petroleum-based inputs.
Banks also reported firming standards and terms on loans to
small businesses, but to a lesser degree than for large firms.
Normally, we expect small businesses to bear the first pulse of
credit tightening. But the downgrading and unexpected shocks
affecting large, investment-grade corporations have led
creditors to rethink the relative risks of lending to large and
small firms.
Banks have continued to tighten standards and terms on
loans and credit lines this year. In our May survey, just over
one-half of domestic banks reported tightening their standards
on C&I loans to large and middle-market firms over the past
three months, and 36 percent tightened standards to small firms
over the same period. Most of the banks that had tightened
continued to cite a more uncertain economic environment, a
worsening of industry-specific problems, and a reduced
tolerance for risk.
In their latest reports, bank loan officers also indicated
that the demand for business credit has waned of late, largely
owing to reductions in planned investments and diminished
financing for mergers. Just as lenders are treading more
cautiously as the economy slows, so too are borrowers. Caution
is apparent even among small businesses.
Importantly, the small business surveys conducted by the
National Federation of Independent Businesses in the first
quarter revealed that only 13 percent of their surveyed members
thought the current period was a good time to expand, roughly
half the percent of a year earlier.
The small business who thought it was a bad time to expand
cited unfavorable economic prospects and a poor outlook for
sales. Of note, very few--only three percent of the April NFIB
survey--mentioned financing costs as a reason that the current
period was not a good time to expand.
Indeed, the recent NFIB surveys that most of the
respondents have not found financing conditions to be
particularly onerous to date, despite the more cautious posture
of financial institutions and higher risk spreads. For
creditworthy businesses, large and small, the cost ofborrowing
has declined with the easing of monetary policy, and the associated
decline in lending rates since last fall. The prime lending rate has
fallen over now two percentage points since the end of last year, and
the average interest rate paid by respondents on the April NFIB survey
was down almost one percentage point over the same period, to its
lowest level in nearly a year.
While we may take comfort from the lack of angst expressed
by small borrowers in the NFIB surveys, I expect that many
risks small businesses have found credit a bit harder or more
expensive to obtain. On the other hand, there are few signs of
the types of financial headwinds that prevailed in 1990 and
played havoc with the ability of many creditworthy small and
medium firms to renew credit lines and roll over loans.
In contrast to that period, our financial institutions have
had a long stretch of solid earnings growth during which to
build capital and liquidity positions. In addition, although
loan portfolios have recently begun to deteriorate, delinquency
rates of businesses and real estate loans remain well below
those of earlier periods. Commercial real estate markets, in
particular, have not gone through the boom-and-bust excesses of
the late 1980s and early 1990s.
So in sum, we have seen greater caution being exercised by
both borrowers and lenders in credit markets recently. Such
tightening might be expected in an economy that has slowed
after several years of rapid expansion and debt growth. Much of
the firming to date has been selective and directed toward
companies perceived to face an uncertain future in the new
economic environment and to leveraged companies that are
vulnerable to a period of slowing sales and profits.
Overall, however, credit flows have been well maintained,
and lending institutions are in a much better financial health
than a decade or so ago. Importantly, reports from small
businesses are relatively upbeat with regard to the
availability of credit. Although risky borrowers face close
scrutiny, banks apparently have continued to accommodate the
needs of their creditworthy business customers, while bank
lending rates, on average, have moved lower.
Mr. Chairman, thank you very much for your attention.
[Mr. Ferguson's statement may be found in appendix.]
Chairman Manzullo. Well, I want to commend you on your
clarity of the presentation, Dr. Ferguson.
Ms. Velazquez.
Ms. Velazquez. Thank you, Mr. Chairman.
Dr. Ferguson, the merchant banking proposal, as initially
proposed, will have four financial holding companies that
either own or invest in small business investment companies to
deduct 50 percent of the total value of their investment from
TO-1 regulatory capital.
As I understand, however, in issuing its revised capital
proposal for nonfinancial equity investment, the regulators
created a carve-out for SBICs.
Would you please describe to this committee exactly how the
new capital proposal would apply to SBICs?
Mr. Ferguson. Okay. If you would give me--yes, I would be
happy to describe it.
Graham-Leach-Bliley, as you know, allows--as you have
described it--does allow bank holding companies to make equity
investments without an SBIC license. And banks may elect to
either have an SBIC, but they cannot invest directly. The
holding company can invest directly or through an SBIC.
It is important to know, by the way, that the SBIC activity
predates Graham-Leach-Bliley, as you observe.
Now, you raise a very important issue with respect to
capital, and that was one of the most important issues that we
faced implementing Graham-Leach-Bliley, because we wanted to
set capital requirements that were appropriate and recognized
the will of Congress but also recognized the risk that might
exist in merchant banking.
You are right to point out that the board originally or
initially proposed a uniform 50 percent capital charge to all
equity investments that were made SBICs. And then in debating
this and listening to commenters, we discovered that there was
a great deal of concern, as you have suggested, about this
higher regulatory capital charge, and particularly, there was a
concern that this would perhaps reduced the commitment of
banking organizations to SBIC financing.
Ms. Velazquez. Yes.
Mr. Ferguson. And so what we have done is we have listened
to, as you observed, the commenters and moved a bit in that
direction. And so we believe, with the new proposals with
respect to capital, that we will have a relatively level
playing field, that we will not tip banks' preferences away
from the SBIC, but at the same time we believe that the risks
that are inherent in merchant banking, and there are some,
would also be appropriately recognized by these capital
standards.
And so I think, if I can sum up, we started with one
perspective. We listened to commenters. We recognized the will
of Congress. We recognized the importance of SBICs which
predated Graham-Leach-Bliley, and I think we have now moved to
a position where there will be an appropriate balance between
SBIC financing and non-SBIC financing while the risks that are
inherent in merchant banking, and we believe there are some,
will be appropriately recognized with respect to capital.
Ms. Velazquez. Thank you. I am happy to hear that.
In the March 2001 Federal Reserve survey, 43 percent of the
banks that responded reported that they tightened their credit
standards. This was about the same percentage of banks that
reported tightening their standards in the January 2001 survey.
However, the result of a recent survey conducted by the
FDIC shows that about the same percentage of financial
institutions are loosening their commercial credit standard as
are tightening them.
What do you make of this mixed survey results?
Mr. Ferguson. I think you are right to point out that there
are mixed survey results, and I would add to that, for example,
the set of surveys from the NFIB that suggested small
businesses do not put credit concerns as high on their list.
I believe a number of things are emerging here. First, we
should put this in an historical context. In 1998, banks
started to tighten because we had had a period in fact in which
they had been loosening their terms and conditions, and some of
their credit standards, and perhaps as they looked at the
turmoil that emerged in 1998 and the risks that became earlier
in 1998, they decided it was appropriate to readjust and move
their standards back to the direction of a bit more tightening,
but again, from a very low base.
I believe that one of the things that we are seeing is that
banks are still prepared to lend to their most creditworthy
customers. I think they are tightening their terms and
conditions somewhat over what had existed in 1998, but that has
been a long-term process, several years now, and it came after
a period in which they had been easing and credit had been
expanding relatively rapidly.
I sense that one of the other things that we are seeing is
that in a period in which interest rates have been coming down,
we have seen the prime rate come down, for example, and so
there are a number of different factors that are emerging where
the pricing may be moving down to a more attractive range
because of decreases in prime rates while banks are, if you
will, sharpening their pencils with respect to understanding
the real business prospects of the counterparties that come
forward with proposals or requests for credit.
I think we are also seeing one other thing, which is--that
is a supply story. There is also a demand side story which I
have tried to indicate, which I think some businesses are
deciding that their demand for capital have been reduced as
their prospects become a little less certain.
Ms. Velazquez. However, there have been so much discussion
of our credit crunch, and some people are blaming the
regulators. When do you first notice a trend of creditors
tightening their commercial loan standards?
Mr. Ferguson. First, I do not believe that we are in the
midst of a credit crunch nor do I think we face one.
As I have said, we first noticed this tightening of credit
standards back in 1998, so this was not a recent trend. And as
I said, it came off of a period in which standards had been
eased quite noticeably.
And so to some extent we are getting the return to
standards that reflected that perhaps earlier the standards
were not as tight as they could have been.
But I want to return to what I had said originally, which
is I do not believe that we are in the midst of a credit
crunch. I think that set of phrases or comments strikes me as
not accurately reflecting reality.
We also are coming off of a period when banks have had very
good profits and profitability, when the credit capital cushion
within banks is quite firm, and I believe that they will
continue to lend when they see creditworthy customers.
Ms. Velazquez. Thank you. Thank you, Mr. Chairman.
Chairman Manzullo. Thank you.
Mr. Toomey.
Mr. Toomey. Thank you, Mr. Chairman, and thank you, Dr.
Ferguson, for your testimony today.
Some of the data that you refer to in your testimony
suggests perhaps more encouraging news than I would have
anticipated.
When I reflect on my own personal experience as a small
business owner, one of the issues I am concerned about are
those companies that are too small to attract the interest of
venture capitalists generally, but are nevertheless often
shunned by banks, in part because they may be in an industry
that has a high failure rate. Therefore, banks tend to simply
refuse to lend to the industry en mass.
An example is an industry that I have been in for a number
of years, the restaurant industry. Many family-owned
restaurants, small restaurants, start-up restaurant companies
will go to banks who will simply say, you know, really you seem
like a very nice person and you have got a great track record,
but we have a categorical policy of not lending to restaurant
companies.
It strikes me that a more, perhaps a better policy would be
to lend at much higher rates, to have some greater compensation
to offset the added risk. And I am wondering if we have any--if
our regulation, if our regulators, if through either implied or
explicit policies, we discourage lending that might make good
sense if it were--you know, if the rewards were commensurate to
the risk because I do see this problem for these categories of
companies.
Could you comment on that?
Mr. Ferguson. Well, sir, I would hope that there is nothing
in the regulatory environment that discourages appropriately
priced lending to creditworthy counterparties. As an economist
and also as a regulator, I firmly believe that a modern
capitalist society works best if all creditworthy borrowers
have access to credit at prices and on terms and conditions
which reflect accurately the risks associated with those
institutions and their prospects as both they and their
potential lender perceive those prospects.
Now, I think a number of things do happen. Sometimes
potential borrowers and potential lenders do not perceive the
prospects of a credit as being exactly the same, and so there
are sort of disappointments that do emerge. But I would think
what are focusing on in the regulatory community is to have
access to credit that is fair, that is equitable at prices that
reflect the underlying risk.
One of the things that we have been heavily focused on,
particularly with respect to the larger institutions, for
example is a much more risk-sensitive risk-based approach to
capital. We are encouraging all institutions, large and small,
to have the most modern, sophisticated risk management
technologies and capabilities in order to in part answer that
question.
The other thing I would point out is while it is
appropriate, and we have appropriately recognized the very
important role that commercial banks play with respect to
lending to small enterprises. There are a number of other
avenues to capital for small businesses, and I'm not speaking
of venture capital, but we also know, for example, that trade
credit is used by about 60 percent of small businesses.
Obviously there is also in some cases credit card capabilities,
lending from owners and others.
And so while it's appropriate to look at banks because they
play a very important role with respect to credit, they are not
the only source of credit for small businesses.
So I guess in summary I would say what I would hope we
accomplish as regulators is to have banks and others extending
credit on terms that reflect risk, looking on a case-by-case
basis, and then also we have in our society a range of sources
of capital as well.
Mr. Toomey. I do not disagree with anything you are saying.
I am just wondering if that is really working, when banks, many
banks in a given community will take entire industries and
simply categorically refuse to lend to them. It strikes me that
that is not a rational pricing. There ought to be some price at
which some of the banks would lend.
Mr. Ferguson. Sir, I agree with exactly your last point,
which is that if it is not rational, as you observe, if there
is a positive rate of return to be gained by extending credit
to individual institutions, to individual counterparties, then
banking or another institutional step in and undertake an
effort do that.
Now, it may not be as quick as we would like, and let me
add one other thing that has happened. We have seen during this
period of our survey that the lines of credit outstanding to
small enterprises has been going up. I attribute that in part
to the fact that we have, for example, the ability to do
banking through the internet and other technologies, the
adoption of credit scoring models for banks for small
businesses, which allow banks to make finer differentiations.
And so I agree with you, if there is a rational behavior
because we have a free market system eventually there will be
an institution that wants to come in and lend appropriately and
new technologies that are allowing for better distinctions.
I should be clear, I do not think that regulators should
try to micro manage lending decisions and encourage banks to
make decisions that they would not otherwise make, but we
should keep the banks' eyes focused on the fact that they have
an obligation to intermediate, and that is their purpose for
being, and that they should make risk-based judgments about
their counterparties.
Mr. Toomey. Thank you.
Chairman Manzullo. Thank you, Mr. Toomey.
Mr. Pascrell.
Mr. Pascrell. Thank you, Mr. Chairman.
Two things: I found, Mr. Chairman, the report by the
Federal Depository Insurance Corporation pretty interesting
because their data is every six months. It brings us pretty
much up to date in all the areas, from agriculture to
construction loans, to credit card loans.
But credit card loans, what about the cost? You talk about
that on page six, there has been an increase in business credit
loans. Is that not kind of expensive, Mr. Ferguson?
Mr. Ferguson. Well, what I have said on page six is that
there has been an increase in the use of credit cards. I should
be clear. Credit cards are used for a number of different
purposes.
Mr. Pascrell. Right.
Mr. Ferguson. To some extent, for loans, I'm sure for some,
but also there is some advantages that come with credit cards
in terms of cash management and recordkeeping, et cetera. So we
should be careful about jumping to that conclusion too quickly.
With respect to your question, as I have said, there are a
number of ranges of opportunities for capital to exist. Yes, it
is absolutely true that credit card interest rates are higher
than some other interest rates, but the obligation, if you
will, of the business person involved to look at the range of
credit options open to them, commercial bank, lending, trade,
credit, lending from other financiers of one sort or another,
including for some venture capitalists, loans from owners, and
figure out how they want to optimize that mix.
And if a business owner decides that given his range of
options and opportunities some use of loans that are accessed
through a business credit card or through a personal credit
card is part of what they think is appropriate for running
their business, then I think that's a rational business
judgment that should be made.
You are right to talk about the pricing differential, but
we should be very careful not to think that most small business
credit comes through that channel since in fact we know that's
not true.
Mr. Pascrell. I am also concerned about when there is a
slow-down in the economy, those smaller, more vulnerable
companies will find somewhat of a tightening in basic market
that they are into in terms of getting capital or access to
capital that they may use be incurred or they may on their
own--I think you know where I am heading--to use a credit card
which is going to put them more in jeopardy.
And what is your reaction to that? I mean, should we
discourage such?
Mr. Ferguson. Well, I think we should do a number of
things. First is--again, this will harken back to what I have
said here, we should first look at the facts of the current
situation when, indeed, we are having an economy that is
growing below potential, but what we are hearing from small
businesses is that they do not believe that their access to
credit has dried up.
We have also seen that, just as the terms and conditions
have tightened a little bit or some, I shouldn't--from where
they were in 1998, they have tightened from where they were in
1998 for sure, the pricing has also changed as we have had an
interest rate environment in which interest rates have been
coming down.
Secondly, I do think we should encourage banks to look at
each applicant that comes to them on a case-by-case basis,
trying to understand as best they can the prospects for sure,
and then price appropriately.
I think if there is a sign that banks are not lending
through one channel but encouraging lending through another
channel, then I think that is not--that is not necessarily the
best approach for the way a bank should use its capabilities.
Mr. Pascrell. How do we know whether that is the case or
not?
Mr. Ferguson. It is very hard for us to know with the data
that we have. I think we can figure it out to some extent
through the channel, through the information that comes from
the NFIB, for example, which does not show that that seems to
be emerging.
Now, we will find for some individuals they make a
prospective judgment of their prospects and decide that they
temporarily want to take on slightly higher credit card debt
because they have an optimistic view that going forward they
will have a position to pay that debt down.
And I think one of the things we do want to do is we want
to educate all potential lenders--potential borrowers, be they
small businesses or otherwise, to the appropriate use of
various credit card channels or various card channel, I am
sorry, credit channels. And one of the things the Federal
Reserve has been doing is we have undertaken a very aggressive
approach to its educating small businesses and others on their
options and opportunities so that they do not make unwise
business judgments.
Mr. Pascrell. Yes, I think that is probably--to the Chair,
that is probably one of the best kinds of advice you could
give, particularly when this economy turns.
And my final question, Mr. Chair, if I may, do you see any
contracting of the new venture businesses over the last six
months?
Mr. Ferguson. Well, as I said in my testimony, up through
last year there had been record amounts of venture capital
being made available, including last year about $100 billion.
It has in fact come off some this year. We hear that from the
National Venture Capital Association. There is anecdotal
reporting. Even in today's Wall Street Journal there was an
article about that. So it is quite clear that venture
capitalists are again being somewhat more discerning, we will
put it that way, with respect to their willingness to
participate in venture capital activities.
Mr. Pascrell. One final question, Mr. Ferguson. Things are
tightening up in certain areas. Would you be so bold as to
recommend to this committee and to the Congress should we be
tightening up on the amount of money available through the
federal government to guarantee loans, or should we be at this
point expanding those opportunities, in your estimation?
Mr. Ferguson. To be very honest with you, sir, I will not
be so bold as to do that. [Laughter.]
You have asked the question in that direction, the answer
is I will not be so bold as to do that. I will leave it to our
elected representatives to decide how to use the taxpayers'
money and to what you think of as the best advantage.
Mr. Pascrell. Very good answer.
Mr. Ferguson. That was a very good question, and I
appreciate you for asking it. Thank you.
Chairman Manzullo. Ambassador, I appreciate that answer.
[Laughter.]
Ms. Napolitano.
Mrs. Napolitano. I would say that is a very good dance. In
fact, that was part of my question, is based on, especially in
my state, in California, the economy has been sustained and
increased because of small business, and the fact that small
business availed themselves of SBA loans. And given the fact
that we are looking at budget cuts in our programs in our
agency, that is part of my question is will there be an impact?
Do you foresee, and I am not asking you to speculate, I am just
asking you as an individual who deals with the issue of small
business day-in--or not day-in small business, but the economy
itself?
And the question that goes with that is that has the
Community Reinvestment Act been effective in increasing lending
to low income and minority-owned business? And do you think it
can be modified to be made more effective because most of the
new businesses are women-owned businesses that are increasing
as are minority-owned business?
Mr. Ferguson. I would not, based on the facts that I have,
and knowing that the Community Reinvestment Act was heavily
looked at during part of the process of financial
modernization, I certainly would not recommend any review of
that at this stage. I think that was looked at very closely
last year, and Congress came to some very wise compromises or
some--that reflected the perspectives that Congress thought was
best.
I think that what we will continue to find, as we have in
the past, is that small businesses are an important part of our
economy. We will find, I believe, that those that have credible
business prospects will look from one source of capital to
another, and I believe that we will continue to find that those
are credible business prospects. We will continue to find some
form of capital available. I cannot predict the pricing. I am
not sure whether they will think it feels as though it is
readily available.
And so in that sense, I believe that, as they have been in
the past through many different ups and downs of the U.S.
economy, small businesses have been an important part of the
strength of the economy, and I expect that to continue going
forward, and I expect access to capital to be an important
issue with respect to them, but the evidence thus far is
through a variety of different periods that businesses have--
not all obviously, as I have said there is a great deal of
churn--but businesses have in fact managed to continue to
contribute at a relatively solid pace to the U.S. economy.
One of the points that I would clearly make, I made it at
the very beginning, small businesses account for about 50
percent of the output in the U.S. economy, and that has been
really a surprisingly steady finding that goes back to--the
data that I looked at goes back to the fifties and sixties. It
came down a little bit and stabilized at around 50 percent.
One of the implications I take from that is that as the
economy goes through various cyclical changes still small
businesses manage to hold onto their market and continue as a
group to provide the same kind of impetus and momentum to the
U.S. economy.
And so I take from that an optimistic message that small
businesses have figured out a way to collectively, not each
one, to do well.
Mrs. Napolitano. Yes, but would that not put a damper on
new entrepreneurship, which has really been the basis of some
of our growth?
Mr. Ferguson. No. As I said, we have not seen any dampening
of new entrepreneurship. Despite the fact that small businesses
have a very high churn, we find almost in any period a large
number of businesses being started and falling off as well.
I gave a talk earlier where I talked about small businesses
in 1990 and 1995, and let me just refer to that to tell you
what we saw at that point.
What I saw at that stage was that, in fact, the number of
small businesses in 1995 was about the same as it has been
1990, but there was a great deal of churn there. And so what
that tells me is that there is no lack of entrepreneurial drive
even as individuals look at the relatively risky world of
starting a small business.
I believe that to be the case because I believe that many
individuals, particularly with the educated population that we
have, think that they have built up a large amount of what
economists would call human capital, and that they often
believe that the best way to get a return on that capital is to
take the risk and start the business themselves, and I think
that will continue.
Chairman Manzullo. I appreciate it.
Mrs. Kelly, please. Thank you.
Mrs. Kelly. Thank you very much, Mr. Chairman.
I am a small businesswoman, and I am also on the banking
committee, and I have been working on that banking committee to
make sure that there is access to capital markets for small
businesses. I am very concerned about that. And I understand,
it is my understanding the primary sources of credit for most
small businesses are commercial banks.
But I am interested in the small businesses who want to
grow more substantially and raise funds in the securities
market. Two main goals of the SEC are to increase consumer
protections and to develop capital markets, as I understand it.
Do you think the SEC fulfilled this role with respect to
the small businesses?
Mr. Ferguson. I wish you had phrased the question
differently.
Mrs. Kelly. Nope.
Mr. Ferguson. To be very honest with you, I cannot say that
I am an expert exactly on how the SEC has done its job, and I
do not, in my position, really want to be in a position of
either confirming or denying how well another agency has done.
Mrs. Kelly. So basically you are neither refusing but you
also do not know?
Mr. Ferguson. Yes, I am not refusing to answer your
question. I am telling you truthfully that I have not done a
detailed study of what the SEC has done, and therefore I feel
very uncomfortable trying to give it an evaluation for you.
Mrs. Kelly. Mr. Ferguson, are you familiar with the changes
to the SEC's Rule 504? Can you comment on them?
Mr. Ferguson. No, I really cannot comment on the changes to
the SEC's Rule 504.
Mrs. Kelly. Could you give us some information at a later
date? Could you come back to us with assembled information on
504?
Mr. Ferguson. Yes, that is a legitimate question. I will
work with our staff to find what information we can on 504, and
we will send you----
Mrs. Kelly. And get it back to my office, please?
Mr. Ferguson. Yes. We will send you a letter on it,
absolutely.
Mrs. Kelly. Thank you. I think it is extremely important to
the access for capital for small businesses that we try to get
that 504 rule working.
Mr. Ferguson. Let me quite clear. I am not--you have asked
a question that I think is quite legitimate. I just do not
happen to have the answer here, but I will work with the staff
to get an answer that we think is responsive to your question.
Mrs. Kelly. Thank you very much. Hope to hear from you
soon.
Chairman Manzullo. Doctor, we have got a vote on. I am
going to waive my questions, and on behalf of the Small
Business Committee thank you very much for appearing before
us,and we appreciate your candor, we appreciate the simplicity of the
words that you use in describing very terse economic terms, and I am
sure we will have you back here. You have a warm welcome mat before
this Committee.
Mr. Ferguson. I have enjoyed this and I would say the
Federal Reserve always tries to use straightforward words in
describing complex terms. [Laughter.]
Chairman Manzullo. Thank you, Doctor. Thank you,
Ambassador.
Mr. Ferguson. Thank you.
[Whereupon, a recess was taken.]
Chairman Manzullo. We will get our second group of panels
to take a seat.
I was thinking that maybe I should have asked Dr. Ferguson
what is definition of ``irrational exuberance'' was, and I bet
he would have found a diplomatic answer to that also.
Well, welcome back. Our first witness in our second panel
is Dr. Bill Dunkelberg. He is currently professor of economics
at the School of Business at Temple University where he
formerly held the post of Dean and Director of the Center for
Advancement and Study of Entrepreneurship.
Since 1971, he has also been the Chief Economist for the
National Federal of Independent Businesses; served on President
Reagan's transition team as an advisor to the Secretary of
Commerce, and in 1989, was appointed to a two-year term on the
Consumer Advisory Council of the Federal Reserve System.
Dr. Dunkelberg is the past president and fellow of the
National Association of Business Economists, and elected member
of the Conference of Business Economists, the National Business
Economics Issues Council, and senior fellow at the Foreign
Policy Research Institute in Philadelphia.
Welcome, Dr. Dunkelberg. We look forward to your testimony.
STATEMENT OF WILLIAM C. DUNKELBERG, CHIEF ECONOMIST, FEDERATION
OF INDEPENDENT BUSINESSES
Mr. Dunkelberg. Thank you, Mr. Chairman and Committee
Members. It is a pleasure to be here this morning. Yes, it is
still morning. That is good. I apologize, I have a written
statement and will put that in the record, and there are a few
little glitches in the----
Chairman Manzullo. All the written statements will be
admitted into the record, including the written statement of
Vice Chairman Ferguson, and the members of Congress.
Please proceed.
Mr. Dunkelberg. Thank you. You did not mention and I guess
maybe I might not even have it on my resume, I am the founder
of the small business ``Made For Me dot com.'' We have widely
dropped the ``dot com'' from our name. We are just now ``Made
for me.'' But the web site is up and we do use the internet and
we are on our third capital raise now and doing very well. We
make custom-made apparel which is an interesting business to be
in, to say the least.
I also serve on the board of a bank, the largest fishing
tackle manufacturer in the Your Honor, and the largest debt
collector in the United States, so I have a lot of interesting
perspectives on how the economy is doing and what it is doing.
In the discussion that we had----
Chairman Manzullo. This is dead beat fish, is that right?
Mr. Dunkelberg. Fish, that is right. I catch them with the
best reel going.
The discussion of capital, we probably should distinguish
between what we have characterized as kind of start-up capital
versus the financing of an ongoing enterprise, and most of the
discussion, I think, today in testimony has really been focused
on the financing of ongoing enterprises, although we do keep
mentioning venture capital and these kinds of things.
N.F.I.B. did a study back in the mid eighties of new firms
that were members. We had about 5,000 members who had been in
business less than 18 months, that is a new firm, and we
followed the same firms for three years just to see how things
were going.
And I should point out that virtually--that two-thirds of
these people were financed basically by their own personal
savings, median amount of capital expended by the first dollar
in sales is about 20,000, and a quarter of those firms were
started with less than 5,000 in capital. These firms are, of
course, are typically not financed by banks. Banks are not by
regulatory structure in the venture capital business, and
really cannot take those risks.
I was interested in Mr. Toomey's comment about the
restaurant business. Of course, one reason that banks,
especially those 9,000 littler commercial banks that are out
there, often do not lend in categories is there are not enough
firms in the category to diversify your risk. If I loan you
$100, it is an all or nothing deal. You either pay me or you do
not. If I loan everyone in the room $100, then I understand
what the risks are; most will pay, some will not. I know how to
price the loan. And when banks do not understand how to price
the loan, they cannot really make the capital available.
So mostly we will be talking about ongoing capital
financing, that is, access to operating capital and some long-
term funding and so on.
The NFIB began tracking information about the experience
its members were having out in the economy back in 1973, when
we started taking a random sample of then about 350-400
thousand member firms, now well over half a million. And in the
first month of each quarter we would send out a questionnaire
which contained a set of questions that I have outlined in my
testimony that talk about experiences in the credit markets.
And we have done that since 1973, and in 1986, we stated doing
those surveys monthly.
And we have about--depends on your estimate of how many
businesses are out there. We think about having 5 or 6 million
employers in the United States. That is someone who pays social
security tax on at least one person and we have then about one
out of every seven employers as a member these days.
So even though we do not have every small business as a
member, obviously the same economic forces that hit our members
are hitting all the other members, and we can pretty much
characterize through our surveys what is happening out there in
the economy to the sector, this very important sector that Vice
Chairman Ferguson pointed out produces about half the GDP and
employs a much higher fraction of the private sector labor
force.
So we started this back in 1973, and have a long history,
and I have provided in my written testimony some graphics to
show you what those look like, and I will just review the
highlights very, very quickly.
One of the questions we ask is what is the most important
problem facing your business today. We give them 10 choices
plus a fill-in-the-blank, so we find out if things are
changing.
So, for example, in the 1970s we included questions about
energy cost and availability which maybe we should put back in
now, but obviously disappeared as an issue, and we added
instead insurance, the cost and availability of insurance.
But what I want you to see there is that since 1991 less
than five percent of the firms have cited credit availability
and cost as the major problem, and of course, the high was back
in the earlier years of 37, so we get a lot of variance there,
but as Vice Chairman Ferguson pointed out, we have not seen
anybody really citing this as a major issue for their business
for a long time now.
Another question we asked is about regular borrowing. We
asked people about the loan rates that they pay and asked them
to answer the question only if they borrow at least once a
quarter. So we look at the percentage of firms who are actively
entering the capital markets, and interestingly enough, that
peaked out when the prime was at 21, and reached an all-time
low when the prime was at six.
That does not say anything about our interest in borrowing
whether the need to borrow back in the days when inflation
eroded our cash flow at a very high rate, and of course
unexpectedly. As we opened the back doors, inflation came in
and we had to try to pass it on.
We had to do a lot of borrowing even at very high rates
because survival depended on borrowing, but now borrowing
activities have been at historic low levels for years and
years, so our firms are much less frequently accessing the
capital market on a regular basis.
To see how though the Fed is being, we have kind of our
rough indicator question, which is, last time you got a loan
was it easier or harder than the time before, so we get a sense
of how the loan officers are treating them.
And then we look at the net percent of that and that is
graphed for you there too and you can see the high there is
around 27 percent, fortunately, a long time ago. It has been
zero recently, in the last few years, and it has been running
at less than five, net five percent saying harder since 1995.
So I would characterize the 1995 to 2000, right through
now, 2001 period, as being one of the friendliest periods,
friendliest capital market periods that small business has
really experienced.
You will also note that--on the next chart--that the
average interest rate we pay has fallen from 20 percent range
down to 10 percent, which, of course, is very nice. I would
call that particular cost of doing business has become much
lower for us and we are very happy about that.
In terms of expectations, we say, well, do you expect
credit conditions to get worse or better, to be tougher or
easier, and that again has been very stable now for a long
time, running at around minus five percent, which means five
percent more said they expected to be harder than easier, but
most people do not expect any change at all, so that number
reflects really a very small number of people who expect credit
conditions to change.
So you can see that really we have had very good capital
market experiences since 1995, actually since--actually since
1983, when we finally started to get inflation and the economy
in order. Once we had inflation rates down and a more reliable
future and it became easier to run business and do very well,
then capital markets responded accordingly by seeing less risk
and of course making credit more available and at a lower
price.
So overall our experience has been good, and right now we
would--even with all the bad news we see about the economy, it
is pretty clear from our numbers and for our half million firms
that they still are not having problems getting the funds that
they need. The price is still falling. That is great news. We
like lower prices for the credit that we have and we really do
not see any change in that in the foreseeable future.
So I will end my testimony there and take questions.
[Mr. Dunkelberg's statement may be found in appendix.]
Chairman Manzullo. Thank you, Doctor.
Our next witness is Leslie S. Shapiro, President of Padgett
Business Services Foundation. He is a graduate of the
University of Minnesota with a Bachelor's and a Doctorate
Degree from that institution; a member of several bars,
including Washington, D.C. He was with the Department of
Treasury and he was the executive director of the Joint Board
for the Enrollment of Actuaries established pursuant to ERISA
Act of 1974. He is the author of numerous articles, including
``The Ethical Tax Lawyer: Is it an Oxymoron?'' and he as a
follow-up article saying, ``Was the Tax Lawyer Unfairly
Disciplined by Tyrannosaurs Rex in Jurassic Park?''
Mr. Shapiro.
Mr. Shapiro. Remind me to read that one sometime.
[Laughter.]
STATEMENT OF LESLIE S. SHAPIRO, PRESIDENT, PADGETT BUSINESS
SERVICES FOUNDATION
Mr. Shapiro. Thank you, Mr. Chairman, Ms. Velazquez. I am
very pleased to be here this morning. As the Chairman said, I
am Les Shapiro. President of the Padgett Business Services
Foundation.
The Foundation is a entity within the structure of Padgett
Business Services, a corporation headquartered in Athens,
Georgia. Padgett has 275 offices located throughout the United
States, providing accounting and tax services to principally
small business entities.
We define a small business as one with under 20 employees.
As a practical matter, most of our clients have fewer than five
employees.
I am pleased to be here this morning to offer our
observations on a subject we believe to be very important to
small business. It is this belief that prompted us to agree to
amass information and report out on it when asked only last
week to do so. In this regard, we immediately sent a request to
our offices to provide us input relative to their clients'
experiences in seeking and obtaining loans and credit lines.
Consequently, the information we have is only a few days
old. While not fleshed out in detail, we hope it will give you
a snapshot of the experiences of owners of small businesses in
an area so important to their fulfilling the American dream.
There are some givens in the equation we are considering,
and I think some of them have been alluded to by Dr. Ferguson.
Small business is critical to the viability of the nation's
economy. Another is that almost all small businesses need
financing. Further, most of the loans small business owners are
looking for do not involve huge amounts of money. The loan
range being sought normally is $250,000 or less. In most
instances, the amounts are under $100,000. In many of those
instances, there are substantially less than even that amount.
Our findings show that access to capital has not gotten
easier or even has remained the same. Gone are the days when a
small business owner need only show a bank that he or she is a
good person with a good idea. Other factors now must be added,
among which are that the person seeking assistance must have a
strong financial background, and there is a need to furnish
compelling support demonstrating that the good idea will work.
Both require staggering paperwork. After all that, applications
for financing often are turned down.
Our information reflects that many entrepreneurs who do not
have the strong financial backing to which I just referred are
asked to offer their homes and other personal assets. Further,
if alender is willing to make a loan to small business for
expansion, the demands made by the lender may be extremely high.
While there is obvious recognition that a lender has a
vested interest in some comfort level in believing an idea will
work, our responders feel that the demands they are facing are
unrealistic, often necessitating other avenues to start or
expand a business.
To illustrate, why should a small business owner be able to
receive immediate financing for a truck being purchased for the
owner's business and not qualify for a business expansion loan
for the same amount as the truck loan because assurance of the
success of the expansion cannot be demonstrated to the
satisfaction of the bank?
Why should small business owners find it more realistic to
lease equipment rather than to endure the anxiety and often
futility of trying to obtain a loan to purchase it? Yet these
are the experiences our clients have shared with us.
Of note is that our responders in the main have observed
that small business owners are being driven away from the
national banks, particularly the large ones. This is because of
the difficulty in obtaining financing and the bureaucratic
business methods of those banks.
The almost unanimous finding is that the small business
owners Padgett Offices serve prefer local banks for their
financing needs.
Finally, it should be observed, and we have already heard
it this morning, that interest on loans does not seem to be a
factor. Padgett's clients often extend the credit lines on
their credit cards in order to finance expansion of their
businesses or to have the financing needed to get their
businesses off the ground.
Thank you for this opportunity to testify this morning. As
always, Padgett Business Services and the Padgett Foundation
will be pleased to work with you in any capacity you believe
will be helpful, and of course, I stand ready to try to answer
any questions you may have of me.
[Mr. Shapiro's statement may be found in appendix.]
Chairman Manzullo. Thank you very much, Mr. Shapiro.
Appreciate your testimony. I will be asking a question of you
and Dr. Dunkelberg as to whether or not the surveys that each
of you took are surveying the same types of business people
because you came up with two different conclusions on them.
Our next witness is Arthur Johnson, speaking on behalf of
the American Bankers Association, and we welcome you here
today. Mr. Johnson.
STATEMENT OF ARTHUR C. JOHNSON, CHAIRMAN AND CEO, UNITED BANK
OF MICHIGAN
Mr. Johnson. Thank you, Mr. Chairman, and thank you for
holding this hearing.
Meeting the needs of our small business customers is vital
to the health of our local economies and the success of our
banks. We understand the importance of bank financing to these
firms and the jobs they created.
United Bank, like banks across the country, has built its
reputation on meeting the needs of our customers, not just for
today but for a lifetime. We cannot ignore, however, the fact
that the economy has shifted into lower gear. Any experienced
driver knows to slow down when the road gets rough. The same is
true of bank lending as economic conditions get bumpy.
In my testimony today, I would like to make three points:
First, small business lending is a core part of banking's
business. Small businesses make up three-quarters of all
business banking customers. At United Bank 99 percent of our
business lending is to small businesses, and 35 percent of
those are SBA loans. Today, banks have more than $230 billion
in loans outstanding to small businesses, almost a 10 percent
increase from the last year's level, and we continue to meet
the needs of small businesses.
Second, while small business lending continues to grow,
economic conditions suggest caution. The local economy that my
bank serves is highly dependent upon manufacturing. Having been
in business for over a century, we know that economic downturns
hit us sooner and harder and will last longer than other
regions of the country. Therefore, we must watch for early
signs that the winds have changed.
But let me be very clear. We are in the business of lending
and that is what we intend to do. Good creditworthy borrowers
will always have access to funding and we are always mindful of
our role in helping our economy return to sustainable growth.
However, the risks of lending today are certainly greater
than they were a year or two ago. We are looking more carefully
at our loans and asking our customers more questions about
their business plans and whether those plans accurately reflect
the slowdown in economic activity. Not surprisingly, business
loan demand nationally has slowed too. Such conservative
approaches to both borrowing and lending are prudent in the
face of uncertain economic times.
My third point addresses how congressional action can help
small businesses access to credit. Certainly you deserve great
praise for the merchant banking provisions and the expanded
collateral provisions for Federal Home Loan Bank advances
enacted in the Gramm-Leach-Bliley Act last Congress. If
properly implemented by regulators, this will provide needed
credit and capital for small businesses.
Protecting the SBA guaranteed loan program is also
important as it can be one of the most cost-effective, high-
impact tools that Congress can provide. The guarantee helps
banks protect against losses and provides credit that would be
otherwise unavailable. For small businesses the assistance can
be the difference between survival and failure.
My bank specialized in SBA lending, but have scaled back
because of the rising fees in this program recently. The recent
budget proposals which would once again raise fees for
borrowers and lenders, are likely to spoil this product
altogether, making what is now a marginal business completely
uneconomical. This may reduce the credit available for these
small business borrowers as they seek access to funds in a
slowing economy.
There are also tax incentives that would be helpful.
Repealing the estate tax will help the inner-generational
transfer of small businesses, establishing special farm deposit
accounts to help smooth income for tax purposes would provide a
new risk management tool for farmers and ranchers. Expanding
industrial revenue bonds, called AGI bonds, for agricultural
borrowers would help. And expanding the Subchapter S law would
provide small businesses a broader range of capital funding
options.
Mr. Chairman, small businesses are vital to a strong
economy. We are always looking to meet the needs of
creditworthy borrowers, even though we must be cognizant of the
changes in economic activity.
Thank you for this opportunity.
[Mr. Johnson's statement may be found in appendix.]
Chairman Manzullo. Well, thank you for that excellent
testimony.
Our next witness is Douglass Tatum, as CEO of Tatum CFO
Partners. It is a partnership of career financial officers
serving early-stage companies, middle market companies and
large corporations. The firm began in Atlanta; has expanded on
a national basis, and has over 300 partners in 23 cities. He is
a recognized expert on financing companies in transition and is
a frequent speaker presenting Tatum's CFO booklet ``No Man's
Land Where Growing Companies Fail.''
You know, I like the names of these books and publications.
They are so candid, to the point.
Mr. Tatum, I look forward to your testimony.
STATEMENT OF DOUGLASS M. TATUM, PARTNER AND CEO, TATUM CFO
PARTNERS, LLP
Mr. Tatum. Thank you, Mr. Chairman.
I do not think it is an understatement to quote from your
letter inviting me to testify before this Committee that ``it
is imperative for our Nation's economy small and mid-sized
businesses access the capital necessary for growth and
survival.''
I would like to make one very, very important
differentiation--the difference between a ``small business''
and a business that is breaking out and growing.
The National Commission on Entrepreneurship recently
conducted focus groups with over 250 CEOs of these growing
businesses across the country. In its report, entitled
``Building Companies, Building Communities,'' the Commission
concluded that the lack of available capital at a reasonable
cost is a critical problem facing entrepreneurs.
The recent U.S. economic expansion has been a period of
substantial growth in employment. I think we all realize that.
According to the recent studies by the Kauffman Center for
Entrepreneurial Leadership and Cognetics, the greatest growth
in employment has come from these emerging growth
entrepreneurial businesses. If you do a survey of 100 small
businesses, only five of those businesses are growing at 15
percent or more. So, in a survey asking about capital and its
importance, five of those businesses--less than five percent--
are going to raise their hands and say, ``It's extraordinarily
important.'' Those are the businesses that I want to talk
about.
Now, why is that important? For example. Cognetics data
indicates that 84 percent of the net, new job growth from 1992
through 1996 were these rapidly growing firms.
My testimony on these matters before the committee comes
from the perspective of serving as CEO, as you mentioned, of
the largest CFO firm in the country. We have partners in 23
offices, and we provide assistance for a variety of companies
in all the spectrums ranging from start-up to Fortune 2000
multinationals. In our role as CFOs, we are responsible for
purchasing tens of millions of dollars worth of capital, and we
purchase it from both regulated, nonregulated and professional
private equity investors such as venture capitalists.
In addressing the issues surrounding the lack of capital
from our perspective, it is important to summarize the
microeconomics of the borrower first and then the lender.
We would suggest based on our firm's collective experience
that the bulk of the capital gap problems experienced by
entrepreneurial CEOs coincides with his or her company's sudden
growth accompanied by a transition period during which the
company becomes ``too big to be small and too small to be
big.'' We refer to this economic transition period as ``No
Man's Land.''
During this period of growth, the company is extremely
fragile and can quickly lose its economic momentum due to a
lack of management, human resources, infrastructure, and to the
point of this committee, reasonably priced capital. We have
provided the Committee with the firm's booklet ``No Man's
Land''; hopefully, it will give you some perspective on my
testimony.
The problem with these companies--again I want to remind us
that only five percent of small businesses are growing at 15
percent or more a year growth--the problem for these companies
starts with growth. Growth in revenue drives growth in assets,
creating demand for capital and perpetually cash-starved
borrowers even with significant profitability.
If you will take a look at the first chart that I have in
my written statement labeled ``Micro-Economics of 15% Sales
Growth,'' that's a model of a company starting with about $2.8
million growing at 15 percent a year. What you see there is
that profits are going up, while cumulative cash flow is
increasing negative. These companies are generally thinly
capitalized to begin with, and as indicated above, generally
are in a risky transition.
As indicated in our booklet, ``No Man's Land,'' the key to
raising capital for these businesses is creating a reduction of
risk for the borrower.
The second chart in the written statement indicates that as
the risk of the business is lowered the access and the pricing
of the capital improves.
The Lenders: Providers of capital to these emerging growth
companies address the risk problem through intense account and
collateral management. In preparation for this testimony, we
polled several of our partners and other senior industry
executives with extensive experience in both the regulated and
nonregulated financial markets. Part of our review included a
confidential evaluation of the economic pricing and
microeconomic models of these types of lenders. In summary,
both regulated and nonregulated institutions provided data
indicating that the actual cost of collateral management,
account management, and loan acquisition and origination for
loans below a million dollars can be upwards of 1400 basis
point, or 14 percent. These fixed costs, when added to the
normal risk-adjusted interest rates, create an overall cost to
the borrower that becomes the real issue. The costs associated
with this risk management becomes less significant with the
increased size of the loan, creating a funding gap of
reasonably priced capital between what a company typically
raises at start-up from banks, government programs, savings,
credit cards of up to about $250,000, and what we estimate to
be the level of $1 million that becomes economically viable
from both the borrower's and lender's perspective.
To depart from my written statement for a moment, what we
are seeing is that the initial capital funding is provided
primarily on the assets of the individual. I would call that a
``branch manager loan.'' When you get above $250,000 in capital
needs and the companies are growing and looking for capital,
what happens is that the bank is forced to look at the
business's assets at that point. That becomes a ``commercial
loan officer's loan''. So, with the capital gap between
$250,000 and $1 million, it would not surprise me that there is
not a problem out there getting the initial capital funding. It
is between $250,000 and $1 million where we are finding the
real problem; and interestingly enough, those companies are the
ones generating the job growth.
I would suggest to you that when your constituents come up
and complain that they can not find capital, you will find them
as growing companies versus stable, small companies that are
not growing at a significant rate. The ones accessing capital
above $250,000 are who you are really talking to.
There is no doubt that some of these financing needs are
being met by a variety of sources, including the SBA, the SBIC
programs, banks and other nonregulated lenders who I
absolutelybelieve are highly interested in solving this problem.
However, we would argue that until a more cost-effective risk
management process is developed, many of the regulated institutions
will continue to use a rules-based credit scoring as part of their
underwriting procedures for rapidly growing companies, effectively
eliminating many of these companies from consideration. In addition,
the general trend will be to target this type of growth capital to
larger business customers and larger loans where the costs outlined
above are not as significant to the overall pricing.
Finally, there is one other item that we believe should be
brought to your attention. In our firm's opinion, current tax
policy compounds the difficulty in retaining critical capital
for a company during the formative growth phase because it
requires an expanding business to pay a tax at a time when it
may be cash flow negative and unable for the reasons outlined
above to obtain reasonably priced capital from lending
institutions to fund its continued sales and growth.
Congressman DeMint and Congressman Baird and their staffs
and others have been very helpful in working with our firm to
develop and refine a tax deferral proposal for emerging growth
businesses designed to address this problem, and we would hope
that this committee would give it appropriate consideration at
the time when the proposal is introduced as a bill.
There's one other point I would like to add--an excerpt
from the NFIB ``Small Business Policy Guide'' on the highest
priorities for small business--and I quote, ``Cash, cash, cash,
the first canon is cash. Cash flow is everything in small
business. Owners need money. Cash impacts are particularly
notable when businesses are growing very rapidly. Without cash,
not to be confused with illiquid assets, business owners must
either postpone investment and expansion or they must borrow,
thereby incurring financing costs precisely when these costs
are least needed. And tax policy, to the extent practicable,
should alleviate small business cash problems, not exacerbate
them.''
In conclusion, Mr. Chairman, I really appreciate the
opportunity to appear before your Committee. I will be glad to
attempt to answer any questions the Committee may have
regarding the capital needs and financing issues facing growing
businesses.
[Mr. Tatum's statement may be found in appendix.]
Chairman Manzullo. Thank you, Mr. Tatum.
I would like to conclude this meeting at 12:15, so we have
got about 15 or 16 minutes. And if we could limit the questions
to maybe four minutes, then maybe have a second round so
everybody gets in.
Mr. Akin.
Mr. Akin. Thank you, Mr. Chairman.
Doug, I was interested in a couple of things. Let me see if
I got what you are saying. When you are water skiing you go
from two skis to one ski, there is a little instability period.
You are saying there is a financial instability when you are
moving from about 250,000 into the million kind of range. That
is where there is a need, and this need is not in every small
business, but it is in five percent of them which really have
the potential for very rapid growth, and the rapid growth is
the very thing that makes them cash poor.
Have I got this right so far?
Mr. Tatum. Excellent, excellent summary of that.
Mr. Akin. That was a wind-up, now I have got a question or
two.
The question, first of all, is in that area, first of all,
how are the private side from the federal government--I am new
on the committee so some of this may be obvious to some of the
other members, but how are the privates providing for that need
and what do you see, aside from some potential tweaking of the
tax code, that we ought to be doing to meet that need?
Are we doing a good job in helping in that area or not? And
is it sufficient to let the privates cover a lot of that?
Mr. Tatum. To answer your question, I think that the
privates are intensely trying to figure out how to deal with
that. In my discussions with a senior loan executive at a
community bank yesterday, probably a billion dollar bank, the
portfolio that he has in this range is only about $6 million.
What they are looking at is ways of cross-selling enough
services to those borrowers in order to make those issues
profitable.
In conversations with a large nonregulated lender----
Mr. Akin. I did not follow your--what is the problem of the
bank with the billion dollars trying to get into that market?
What is his mechanical problem?
Mr. Tatum. The mechanical problem is the intensity of the
collateral management needed and who they need to assign to
that account. You need an experienced loan officer. You need
collateral management on the business itself. You have now gone
past what the personal assets of the individual can support.
Mr. Akin. Okay.
Mr. Tatum. When you look at the cost of actually having the
right kind of person monitoring that loan, and the collateral
management that needs to be provided for that loan, it is very
difficult to make any money on that loan without charging
interest rates that exceed 20 percent, and that is the
difficulty that they are facing in that gap.
Now, you get to $1 million loan, and those fixed costs
become less and less a part of that amount. What we find
anecdotally as chief financial officers is if we can get a
business big enough to where it can borrow $1 million on its
own assets, the private sector--both commercial banks and
nonregulated lenders--will line up to provide financing. It is
that difficult between the capital that is being lent to him
early and the transition from the two skis to the one ski, and
it is the cost of the collateral management and account
management is the problem.
Mr. Akin. So I understand what you are saying, your
overhead in trying to make sure that it is a good loan eats up
all of your profit. You do not have time to go out an micro-
management some little operation and make sure they are doing
everything right?
Mr. Tatum. It costs as much to do that for, let us say, a
$400,000 or $500,000 loan as it does $1 million loan or a $2
million loan, and I think that is the practical problem.
I do not think it is a regulatory issue. I think there is a
recognition that there is a need to get capital there, but the
reality is that these are risky businesses and they require
intense collateral management.
Mr. Akin. Thank you.
Chairman Manzullo. Thank you very much.
Ms. Velazquez.
Ms. Velazquez. Thank you, Mr. Chairman.
Mr. Johnson, yesterday we held a hearing on the SBA budget,
and we were--I was raising the issue of the imposing fee to the
SBA 7(a) loan program. And you touched on this point in your
testimony, but I would like for you to expand a little more.
In the President's budget, he proposes to increase borrower
and lender fees on the 7(a) loans over $150,000. And the stated
intent behind the fee increase is to encourage smaller loans to
go right through the program.
Do you think that this fee increase would cause 7(a)
lenders to make more loans under $150,000, to make more loans?
Mr. Johnson. Well, it is certainly possible that it may
have the desired, stated desired impact of increasing lending
in the smaller loan arena. But it would also have the impact of
decreasing lending activity to the larger businesses. And very
often we find that, as I think I mentioned briefly in my
testimony, our bank used to be a very active SBA lender. In
fact, through the mid eighties, for nine years through the mid
eighties to the mid nineties our little bank was the leading
originator of SBA 7(a) loans in the State of Michigan.
We have since de-emphasized our SBA 7(a) lending activity
somewhat, largely because rising fees to both our borrowers and
ourselves have made the program less economically viable.
We are in a state where we are in manufacturing. We have a
large amount of lending activity to small businesses who are
manufacturers, and those are capital-intensive businesses. So
our loans, our SBA loan history tends to be--even for new
businesses--larger dollar amounts because they need to buy
industrial equipment and a factory to put the equipment in.
And so the damage that could be done to those borrowers
would be very detrimental.
Ms. Velazquez. Mr. Johnson, if this fee changes go through,
would you still participate?
Mr. Johnson. Well, yes, we would, but it would be much de-
emphasized.
Ms. Velazquez. Can you tell me what are some of the major
factors that cause a credit officer to consider a commercial
loan to be high risk?
Mr. Johnson. Well, it can vary greatly, depending upon the
industry that the business is in. But what it basically comes
down to are a couple of factors.
First is what in our judgment is the probability that the
loan will be serviced as agreed. In other words, that the money
will be repaid to us in a timely fashion. And second of all, in
the event that there is a default what is the likelihood of our
ability to be able to recover the amount of the loan back, even
if we have to sell the collateral and liquidate the business.
Ms. Velazquez. Thank you, Mr. Johnson.
Mr. Shapiro, in your firm's experience are small businesses
that are being rejected by traditional private lenders seeking
assistance through SBA's loan programs are they seeking other
avenues to obtain credit?
Mr. Shapiro. Some of them are in fact seeking loans from
the SBA and like organizations. Our assignment was with respect
to nongovernment lending institutions. I think they are having
not as difficult a time from SBA in seeking financial
assistance.
Ms. Velazquez. Do you refer businesses to SBA loan
programs?
Mr. Shapiro. Our office owners in fact do. Wherever money
may be available is where we refer them.
Ms. Velazquez. Thank you. Thank you, Mr. Chairman.
Chairman Manzullo. Thank you.
Congresswoman Tubbs Jones.
Mrs. Tubbs Jones. Thank you. I am going to be brief because
I know the time is of the essence. Good morning, gentlemen.
Thank you for coming to present. I hail from the City of
Cleveland, and working very hard to empower or do economic
empowerment for my community.
I would like to raise the question specifically with regard
to minority businesses. If small businesses are having the
dilemmas that you suggest, have you done any assessment on the
impact on small African-American businesses? Do you have
suggestions of different changes we could make? Would you be
willing to join with us in sending a letter to President Bush
about the impact that the cuts that the SBA has had, cut on SBA
has had on your ability to do your job as part of the Small
Business Administration? Your organization or whatever, anybody
can take a jump at this.
Mr. Tatum? Mr. Johnson? Mr. Tatum?
Mr. Johnson. I guess it is my observation that in a period
of economic downturn those businesses that are most likely to
have problems obtaining credit are those businesses that are
either less mature, they are newer, or those that have a
smaller capital cushion, less equity, and there tends to be
quite a bit of cross-over there. I mean, there is a high
correlation between the amount of capital they build up through
profitable operations over the years, and the age of the
business.
So while I do not think that there is a problem for
minority-owned businesses because they are minority-owned
business, I can see because there has been such a dramatic rise
in minority-owned business formation over the last several
years that a large number of minority-owned businesses would
fall into that immature category that may experience more
difficulty in.
Mrs. Tubbs Jones. But the Federal Reserve did in fact do a
study that said that the lending to minority businesses,
lending to minority persons, first of all, and then to minority
businesses was not equitable over the last few years. I do not
remember exactly when that report came out. I remember Mr.
Greenspan speaking to that.
So if that is the case, along with the situation, economic
situation we find ourselves in, does that mean economic--I
mean, minority businesses are taking double whacks to the
extent that the economy is not in great shape. Would you agree
or disagree?
Mr. Johnson. Well, it would be my observation that the
bankers that I am--in my bank----
Mrs. Tubbs Jones. Representing the bankers.
Mr. Johnson [continuing]. And the bankers that I am
representing are interested in making loans to any and all
creditworthy persons.
Mrs. Tubbs Jones. I am not questioning--please be clear, I
am not questioning whether or not you lent--well, maybe I
should. How many of your loans are--do you make to minority
businesses?
Mr. Johnson. Well, I do not have the percentages, but it is
certainly a business sector that we are very interested in
serving.
Mrs. Tubbs Jones. Okay, I do not mean to cut you off but I
am short on time.
Mr. Tatum, in the work that you do, do you do work with
minority businesses? And what has been your experience, if any
different from what you have testified to already? And real
quick add on, did the new markets initiative proposals brighten
your eyes about opportunity to provide support to businesses,
disadvantaged businesses?
Mr. Tatum. I believe that the capital markets are color
blind, and that they will seek those businesses that represent
returns for them very efficiently.
It is interesting, in my opinion, and this is anecdotal so
I do not have any kind of research to support this, but I think
business start-ups is a cultural thing. That is something that
we should encourage. The minority community is increasing its
participation, which is extraordinarily healthy.
Chairman Manzullo. Let me cut you off there. I am going to
let Congressman Baird get a question before we have to go vote.
Mr. Tatum. I apologize.
Mr. Baird. Mr. Chairman, thank you, Ranking Member
Velazquez.
I want to particularly compliment the panelists and the
Chair and Ranking Member for this. Mr. Tatum, I appreciate you
acknowledging the work you have done, along with Congressmen
DeMint and I.
It is my belief from talking to a number of small
businesses that while we have done a lot to help businesses get
started through the SBA program, rapidly growing businesses who
sort of got their feet under them, had the first two or three
survive that critical cutoff point, I really believe that is
where the greatest small business employment currently resides.
The first year you are there you are with your wife, your
kids, your next door neighbor, your credit cards. It is after
you have survived that three years, that is when you start
employing people, that is when you grow. And the bill we are
working on, Mr. DeMint and I, and I hope this committee can
have a hearing on it, could you expand on that issue, that
sector a little bit, and how we might help those folks?
Mr. Tatum. We believe that this is the most important issue
to look at because the research that we are reviewing from the
Kauffman Foundation and others indicates that those businesses
are generating the majority of job growth. Those businesses are
perpetually cash starved by virtue of growth, and the capital
markets are struggling with how--because of the risk--to cost
effectively get capital into those businesses.
We would argue that allowing those businesses to preserve
capital is a timing issue. We think the proposal is revenue-
neutral over time, and allowing those businesses to preserve
capital has huge consequences to the economy.
Right now, even under current conditions, there are
emerging growth businesses that are growing. They are the only
businesses that are adding employees in a downturn. I have been
a CFO of larger organizations. Those larger businesses tend to
adjust their economic models quickly by downsizing. The
emerging growth businesses are adding employees, and they are
extraordinarily cash starved. Some of the tax issues that you
have been working on would, I believe, help to solve that
capital funding problem.
Mr. Baird. So, in other words, some of our SBA programs
currently focus on an area where we have the highest risk maybe
of lack of success, but the sector where we have got the most
rapid growth is the area precisely where we have the least
access to capital.
Mr. Tatum. Absolutely, and it has the most economic impact
on the economy.
Mr. Baird. Excellent. Thank you, Mr. Chairman.
Chairman Manzullo. Well, thank you.
I wanted to comment on the survey. Mr. Shapiro, your survey
was done among--how many businesses participated in that?
Mr. Shapiro. There were approximately 1500. I think the
purpose of our discussion. we are probably not that far apart,
and that was the point you made earlier.
Chairman Manzullo. For those of you, could you--Doctor, you
said that there was no credit crunch among your participants,
but Mr. Shapiro, you said there was? Could you resolve that?
Mr. Dunkelberg. Well, I am not sure we can resolve it
sitting here.
Chairman Manzullo. Is it different sized businesses or what
is it?
Mr. Dunkelberg. NFIB has about 500 to 600 thousand member
forms. I do not keep track of it----
Chairman Manzullo. The average employee is at three?
Mr. Dunkelberg. The average employment of those firms, the
average employment is about 13 or 14.
Chairman Manzullo. Oh, I see.
Mr. Dunkelberg. Ninety percent are under 40 employees, and
so it's very small, though somewhat larger than what Census
says is out there, but it is a very, very large----
Chairman Manzullo. Okay.
Mr. Dunkelberg [continuing]. Body of firms, and probably
misses the very, very small firms. And the distribution by
industry, construction, manufacturing, agricultural and so on,
it is pretty much the same as Census says is out there.
So it is a pretty representative group in that sense.
Chairman Manzullo. As is your group, is that correct,
Shapiro?
Mr. Shapiro. Yes, it is.
Chairman Manzullo. Okay.
Mr. Shapiro. But let me point out that I do not know when
the NFIB survey was conducted. Ours was conducted last week.
Mr. Dunkelberg. Ours is every month.
Mr. Shapiro. Well, I do not know which ones you are using
for your analysis, though.
Chairman Manzullo. Are you agreeing or disagreeing?
Mr. Shapiro. Well, I think we are not that far apart. We
were told to obtain stories, and we had to extrapolate from
those stories the information in----
Chairman Manzullo. Okay.
Mr. Shapiro [continuing]. Our conclusions. And normally the
people who respond in that setting will give us the negative
stories, not the happy stories.
Chairman Manzullo. Yes.
Mr. Shapiro. So we did not conclude that it was getting
worse.
Chairman Manzullo. Yes.
Mr. Shapiro. Although there could be an indication, we
tried to be very careful in our written statement.
Chairman Manzullo. That is about your conclusion too, is it
not, Dr. Dunkelberg?
Mr. Dunkelberg. It is not getting worse, that is correct.
Chairman Manzullo. Okay.
Mr. Shapiro. It has not gotten better, but we are not sure
that it is gotten worse. It is hard to draw a line in the sand
as to when it may have started getting worse, you know, two
years ago, one year ago, a month ago, we are not sure.
Chairman Manzullo. Let me throw something out here and then
we are going to have to adjourn. One of the witnesses that we
had or scheduled was Sunil Puri from Rockford, Illinois. He is
unfortunately in the hospital. I had calls with him a couple of
months ago and he is a professional developer, so he would have
to get capital to develop his shopping centers. Then the people
who would occupy those shopping centers, those stores, would
have to get capital.
He said the train has been cut off. It has been going on
for six months now. It has been very difficult for him to get
development capital, and he is very substantial, very
successful, a lot of assets. And the retail stores that would
open up, they have also been cut off.
Mr. Dunkelberg. I think if you look at the mid-market kinds
of borrowers, and of course the Fed survey of the 52 largest
banks----
Chairman Manzullo. Right.
Mr. Dunkelberg [continuing]. Tells you that there has been
a restriction in credit availability for big projects which
really depend on the health of the economy to borrow a lot of
funding.
Chairman Manzullo. I do not know how big a project is when
you are trying to----
Mr. Dunkelberg. Pretty big on shopping center.
Chairman Manzullo. Well, shopping, that is the big loan.
Mr. Dunkelberg. Yes.
Chairman Manzullo. But then even the little guys that would
open up the individual stores, they cannot get loans
themselves. And his testimony would have been, you know, to
that effect from the developing side, and also to the people
who would open up those retail stores that has been a severe
crunch of credit.
Mr. Dunkelberg. I would also suggest that, of course, the
economic activity regionally has high variance, and right now I
think most of us would agree that those states in the middle of
the country called the Midwest are ``in a recession'' because
of their heavy dependence on manufacturing, but that is not the
case all over the country, and we are looking at numbers, of
course, that characterize the whole country.
Chairman Manzullo. That could be, and we do not have time
perhaps--we have another hearing, there is a whole genre of
community or mutual banks throughout the country that they
cater to the little guy because their clientele essentially is
the little person, and they--I do not want to say of a
different mission, but they do tend to gravitate towards the
small towns, to embrace the small businesses. They still
believe at times in character security, and sometimes character
security is better than security on a new truck, as far as I am
concerned. But I am not the one that does the underwriting on
it.
So, you know, we have a real flow that is going on right
here, and I just want to again thank you for your participation
and for the excellent testimony.
Mrs. Tubbs Jones. Mr. Chairman, even though we are almost
done, can I get him to finish his answer to that last question
I was asking for the record? I mean, you can go ahead, I can
hear it. All I want is on the record to end the questioning. He
was talking about that the minority community, that lending,
that capital lending is culturally, and I wanted to hear the
end of that.
Mr. Tatum. The entrepreneurs are rewarded and not penalized
for trying to start businesses in this country. It is a
cultural thing. The minority community has just started to
participate in that. That is anecdotal. I do not have the
research for that.
Mrs. Tubbs Jones. What do you mean it is a cultural thing?
Mr. Tatum. In other words, in some cultures if you start a
business and fail, you are ostracized. In this country you can
start a business and fail, and try again and fail, and try
again and get it right by the third time. You get a second and
third chance. So that I think business start-ups happen because
we culturally admire people who take those chances.
Out of that--out of that cultural start-up comes a group of
small businesses that shoot out of that.
Mrs. Tubbs Jones. Okay.
Mr. Tatum. Those businesses are the ones that start
generating all the jobs growth. They have a different set of
needs. And out of those group becomes those ones that the
venture capitalists are interested in, the IPO markets. And so
what you want to be able to do is have the minority population
participate in through all that, and they are just getting
started in the bottom layer.
Mrs. Tubbs Jones. Thank you. Thank you.
Mr. Tatum. If that makes sense.
[Whereupon, at 12:20 p.m., the committee was adjourned.]
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