GOVERNMENT GRANTS : Obama's small business rescue plan

Barack Obama on Friday proposed emergency assistance for American small business calling for a "small business rescue plan" of tax incentives and loans.

"Small businesses employ half of the workers in the private sector in this country, and account for the majority of the job growth. But we also know that a credit crunch has dried up capital and put these jobs at risk - shops can't finance their inventories, and small firms can't make payroll," Obama said at a rally in Chillicothe, Ohio. "If we don't act, we'll be looking at scaled back operations, shuttered shops, and laid-off workers."

Obama's campaign platform already featured pledges aimed at American small businesses, including proposals for eliminating capital gains tax on gains from investments in start-ups and for a tax credit for businesses that offer workers health care. What's new is his call for an emergency lending facility run by the Small Business Administration to shore up struggling companies imperiled by the credit crunch.

A paper detailing Obama's proposed "Small Business Emergency Rescue Plan," released by his campaign on Friday, expands on the remarks Obama made in Chillicothe.

Obama's new plan calls for the SBA's loan guarantee programs to temporarily eliminate the fees they charge lenders, and for the agency to increase the guarantees it offers to banks that lend to qualifying small companies. Additionally, he wants the SBA to expand its facility for directly lending money to small companies through its Disaster Loan Program.

How American disaster loans work
The SBA Disaster Loan Program usually assists businesses affected by natural disasters: Its recent disaster declarations have covered floods, wildfires and an earthquake. But the program does occasionally offer loans to help with nontraditional disasters. For example, it offers loans to companies unable to meet operating expenses because an essential employee who serves in the military reserves has been called up to active duty.

For American businesses that can't get credit anywhere else, interest rates for the SBA's disaster loans are capped at 4%, and the loan term can stretch as long as 30 years. Those are lower interest rates and longer terms than are offered through the American SBA's much bigger and better known 7(a) loan program. Also, the SBA directly funds its disaster loans; under the 7(a) program, businesses need to secure loans from banks, with the SBA offering a guarantee for part of the loan.

The Disaster Loan Program is significantly smaller than the 7(a) program. Last year, the SBA backed $12.7 billion in small business 7(a) loans, while its disaster program granted $825.8 million in loans to 15,128 applicants. However, only $289.5 million of that total went to businesses - the loans are also extended to homeowners and renters affected by disasters. Home disaster loans accounted for 65% of the total lent through the program in the 2008 fiscal year, which ended last month.

Echoes of Sept. 11
Obama compared his "rescue plan" to steps the government took after Sept. 11 to rush financial assistance to affected small companies.

"Main Street needs relief and you need it now," Obama said. "It's what we did after Sept. 11, and we were able to get low cost loans out to tens of thousands of American small businesses."

The American government's primary small business relief program after Sept. 11 was the Supplemental Terrorist Activity Relief (STAR) loan program enacted in January 2002. That STAR program reduced the fees paid by lenders who made SBA-backed 7(a) loans to companies adversely affected by the terrorist attacks, and set aside a special pool of cash to fund STAR loans. During its yearlong existence, the program made 7,000 loans, totaling $3.7 billion.

But the STAR program later drew widespread criticism for its flawed structure and insufficient oversight. A 2005 review found that many of the loans went to businesses with little apparent connection to the terrorist attacks in Washington, D.C. and New York City. Only 15% of the cases reviewed by the Senate Committee on Small Business & Entrepreneurship showed evidence of adverse effects from the attacks; the rest had insufficient or questionable documentation. Recipients included a Nevada tanning salon, a liquor store in Georgia and a golf course in Texas.

Auditors pinned the blame not on the companies -- many of which were unaware they'd been given loans categorized as STAR loans -- but on weak SBA supervision of how lenders implemented the program.

An Obama campaign spokesman said Obama's program would not be susceptible to the ills that plagued the STAR program because it would have much broader eligibility requirements. Unlike the Sept. 11 attacks, the current financial crisis is hitting American small companies in all locations and industries; any business struggling for working capital has a legitimate claim of being adversely affected by the crisis.

Obama's spokesman estimated the program's price tag at $5 billion. Eliminating loan fees for the SBA's guarantee programs would cost $1 billion, he said, and $4 billion would go toward direct funding of disaster loans.

Would it work?
Obama's plan relies on lower fees and higher guarantees to entice banks to open their vaults and lend more cash. But it's unclear if those inducements would make a difference. As financial conditions worsen, banks have grown more reluctant to offer financing to small companies.

The Federal Reserve's July Senior Loan Officer Opinion Survey found that 65% of banks polled had tightened their lending standard for small business loans within the past three months, and the SBA said last week that the number of loans made through its 7(a) program in the 2008 fiscal year dropped 30% from 2007. As global financial markets continued roiling over the past few weeks, American financial institutions clamped down further on their lending.

Obama's proposal also calls for more direct lending through the American SBA's Disaster Loan Program. That program has a flexible budget, and the SBA consistently gets as much money for it as it requests from Congress.

But a rash of disaster-loan requests could overwhelm the SBA; after Hurricane Katrina, the agency staggered to keep up with an onslaught of more than 400,000 disaster applications. The SBA has since drafted new plans for dealing with a major nationwide disaster, training reserve staffers and strengthening its technology systems.

So far, the SBA's new disaster readiness capacity has not been tested. If the American financial crisis continues spreading and Congress heeds Obama's call, the agency and Acting Administrator Sandy Baruah, who joined the SBA three months ago, would face a dramatic test of their readiness to step in and shore up thousands of the nation's struggling American small businesses.

By Stacy Cowley and Emily Maltby October 11 2008 - CNNMoney.com

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