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Reason Foundation

Government Failure in the Loan Market

Millions in 9/11 loans given to unqualified applicants

Adam Summers
January 4, 2006

The extent of government failure and mismanagement never ceases to amaze. The latest example of government incompetence involves the perennial boondoggle Small Business Administration. According to an inspector general's report issued last week, the eligibility of applicants for guarantied loans in the wake of the September 11, 2001, attacks could not be verified in 85 percent of the cases reviewed. The report castigated the SBA for its complete lack of oversight, and for statements made by SBA officials that encouraged lenders to offer loans to businesses that had suffered little or no adverse impacts from the 9/11 attacks.

Sen. Olympia Snowe (R-ME), Chairwoman of the Small Business and Entrepreneurship Committee, announced that her committee would conduct an investigation of the Supplementary Terrorist Activity Relief (STAR) program. Said Snowe, "The apparent widespread abuse of loans provided through the Supplemental Terrorist Activity Relief Act is nothing short of an outrage."

The STAR loan program was authorized as a one-year program in January 2002 to provide loans guarantied by the SBA to small businesses that were "adversely affected by the September 11, 2001, terrorist attacks and their aftermath." This program was separate from a direct loan program, or Economic Injury Disaster Loans (EIDLs), established for the same purpose.

Since it was not clear how to determine whether or not a business was "adversely affected" by the attacks, there was initially little interest from lenders, who feared that the SBA might disagree with their criteria or change the definition after loans had been issued, sticking them with otherwise bad loans. To combat this, the inspector general's report noted, the SBA engaged in a "vigorous marketing campaign" and assured lenders that loan criteria would be relaxed so much as to be virtually non-existent.

When the Associated Press began reporting in September that terrorism recovery loans had been given to businesses such as a Salt Lake City "dog boutique," a South Dakota radio station, a Virgin Islands perfume shop, and over 100 Dunkin' Donuts and Subway sandwich shops across the country, the agency's Office of Inspector General got involved.

In the Inspector General's own words:

In most cases, businesses were not even aware that the funding they had obtained was from STAR loans, and were embarrassed to hear that it had come from a program set aside for those affected by the terrorist attacks.

The SBA's response to the report has not been encouraging. An SBA press release cheerily glossed over or ignored the damning criticisms of the report: "At the request of the Administrator of the U.S. Small Business Administration, the SBA Inspector General conducted a review of a special post-9/11 loan program and did not find that loan recipients were unqualified for the program, although he did note that lender documentation could have been better."

While the inspector general's report was limited to the STAR loan program, the direct loan program has also proven far from stellar. The AP reported in October that the direct loan program was suffering from a 20 percent default rate on the $1.2 billion in loans it had issued in the wake of the 9/11 attacks. This all does not bode well for the disaster loans distributed in response to Hurricanes Katrina, Rita, and Wilma.

The SBA's follies illustrate why the government shouldn't be in the loan business (even for lofty purposes such as "disaster relief") in the first place. The private sector capital market is quite capable of supplying a sufficient number and amount of loans, disaster-related or otherwise. Private lending businesses make these loan decisions based on economic realities, not political fantasies. Put simply, in the private sector, lenders have reasons for not making loans.

This is not to say that the private sector will ignore the financial needs of those beset by disaster or tragedy. On the contrary, they have a strong interest in offering loans to those that will be able to repay them. Note, for example, that many financial and lending companies have established programs specifically to assist victims of Hurricane Katrina and other disasters.

The SBA's strength is not its purported ability to bring prosperity to those unable to obtain capital at market rates, it is its capacity to serve the interests of politicians who wish to posture for various special interest groups. (In this way, it is like every other government agency.)

Historically, it has been used by Republicans to pander to minorities and by Democrats to diminish their anti-business reputation. Setting aside loans for members of the favored minority group of the week (who are unable to qualify for loans in the free market) to encourage business ownership may sound like a noble idea, but there are economic reasons these loans have been deemed too risky in the private sector. By providing such subsidized or guarantied loans, rather than encouraging applicants to first obtain more solid financial footing or business plans, the government often simply dooms these aspiring entrepreneurs to failure, at taxpayers' expense.

Private capital markets are plenty robust and do not need the meddling of government bureaucrats. Substituting arbitrary political standards of loan eligibility for market-based standards only encourages bad debts, increases default rates, and ultimately fleeces taxpayers.

As Jonathan J. Bean noted in Big Government and Affirmative Action: The Scandalous History of the Small Business Administration, "In 1949, the Hoover Commission on government reorganization advocated an end to direct lending by government, because it �invites political and private pressure or even corruption.'"

We would be wise to, at last, heed the words of the Hoover Commission and put an end to the SBA for good to prevent market distortions and further waste of taxpayers' money.

Adam B. Summers is a policy analyst at the Reason Foundation.


Adam Summers is Senior Policy Analyst


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