Let’s refresh our memories regarding the origin of the mortgage crisis. There had always been pressure on the federal government to make home ownership “more affordable” by loosening underwriting standards, beginning with the Community Reinvestment Act. This act was repeatedly revised, but the thrust of it was to allegedly reduce redlining of mortgage applications based on race.
Make no mistake: There is no room for race being a factor in the granting of credit. What matters with credit is nothing more nor less than a borrower’s ability to repay a loan. That comes in the form of quantitative analysis and risk management. When politics gets involved, only bad things can happen.
And they did.
The loosening of mortgage underwriting standards resulted in people (of all ethnicities) who had no business owning a home to obtain mortgages, often based on fabricated information. The CRA permitted zero-down loans. Regulators explicitly informed lenders that adhering to the Community Reinvestment Act could be accomplished by lending more than 80% of a home’s value. Income requirements were relaxed, also due to regulatory guidance. Then credit history requirements went away.
Thanks to the loosening of underwriting standards required by the CRA, it opened the doors to abuse by all the other culprits in the crisis — investment banks, brokers, private lenders, credit agencies, credit insurers and many others.
The mortgage industry blew up. So did investment banks. So did banks.
The American taxpayer picked up the bill.
But now, we might be forced to relive history by those who refused to learn from it. Now the same thing is happening at the Small Business Administration, from which I expect the same result.
Once again, government has made policy based on politics.
A Brewing Storm in SBA Loans
The SBA has introduced a new “streamlined” process for its most popular loan, the SBA 7(a) Loan. Under the new “SBA One” process, the agency has loosened some underwriting requirements.
The changes are poorly designed. Risk is increased with new SBA rules, which no longer require cash flow or debt service analysis on loans under $350,000 if borrowers meet credit standards.
That’s a terrible idea. Any mainstream business lender requires this analysis. The lender needs to see if cash flow from the business will be ample and consistent enough to repay the loan!
Another dumb move: “SBA will no longer require that the personal resources of owners be used to reduce the SBA funded portion of the total financing package” unless a lender believes that prudent funding would require it.
A borrower should have to put up their own assets before asking the taxpayer to fund a loan for him.
Hey, I get the idea behind this new plan SBA loans are not easy to get. I’ve personally visited with bankers, and SBA loans fit into very specific boxes. Although it is banks and other authorized lenders that actually fund the loans, the government covers up to 85% of defaults. Despite the government’s insurance, you still must have equity ownership and put up collateral, and you still are the ultimate recourse for default.
To that end, there’s plenty of reason to make SBA loans easier to obtain, but not at risk to the American taxpayer, and certainly not as the result of politics.
In this case, the politics of race are being interjected. The SBA program’s changes “will simplify and streamline the lending process, which will incentivize banks to do more small-dollar loans in order to get more loans into the hands of traditionally underserved entrepreneurs,” SBA administrator Maria Contreras-Sweet said.
In D.C., “underserved” means “minority.” Contreras-Sweet herself said these changes should, in fact, benefit minority-owned businesses.
And in case you still think this isn’t politically driven, ask why Contreras-Sweet delivered the announcement at the George Soros-funded, left-wing Center for American Progress.
These changes come without Congressional approval. That’s the problem with government agencies. They have no oversight.
I support government programs that directly serve entrepreneurs. I support the SBA programs and think they can be simplified and expanded. However, I expect changes to be driven by the same terms private lending would be — making capital available based on risk management, not politics. The result of this loosening of underwriting standards will be increased defaults.
As for stock picks, there’s not much to play here. In theory, business development companies (BDCs) might initially see less interest from borrowers, then an upsurge if there’s the expected increase in defaults on SBA loans.
Perhaps that’s a reason to go long UBS E-TRACS Wells Fargo Business Development Company ETN (BDCS), which pays a 7.49% yield, or the UBS E-TRACS 2x Wells Fargo Business Development Company ETN (BDCL), the leveraged version of the ETN, which pays 16.22%. Hard-money lenders like Microfinancial (MFI) should ultimately see more business, as well.
The opinions contained in this column are solely those of the writer.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of Asymmetrical Media Strategies, a crisis PR firm, and PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets at @ichabodscranium.