Nov 6th, 2008
The government is spending $700 billion to increase liquidity so that a business like mine can get a loan to do a project like mine. You, the taxpayer, might wonder how it is working for me so far. In order to explain that, I need to tell you how I get money.
I have a bank. The bank takes deposits and lends that money to businesses like mine. But my bank is worried that I might default and they would end up owning a training facility. That is OK, as long as they didn’t pay too much for it. So they will only finance, let’s say, 50% of the cost of my project.
Now, as a small business, I need to come up with a huge down payment. This is extra tricky because when you buy a fixed asset, you don’t get to write it off that year: Land never gets written off, and you depreciate the construction over 39 years. Thus, not only do I need to retain earnings equal to the downpayment, I need to save an extra 50% for the taxes. This would delay my construction by a decade.
Seeing this problem, the Small Business Administration came up with the SBA 504 loan. They lend me 35%, my bank lends me 50%, and I come up with the remaining 15% of the cost of the project. It is difficult to express how effective this program has been at creating prosperity in America.
In fact, the obvious way to use taxpayer money to end a recession would have been to pump taxpayer money into the SBA loan programs: just lend money to me at a low interest rate, and I’ll invest it (and a big chunk of money from my bank) in a project that creates jobs and growth. (This would have been the surgical approach — the carpet-bomb approach is to buy up bad assets and faltering banks.)
Where does the money for an SBA 504 loan come from? Bonds are sold on the market. For the investor, the nice part about this bond is that it is federally backed: bondholders get paid, even if I default on the loan. Thus, to an investor, there is no real difference between a Treasury Bond and an SBA 504 Bond.
At the beginning of each month, someone at the SBA goes to Wall Street and yells, “Get your SBA 504 Bonds here!” And people rush to buy them. The more people who rush to buy them, the lower the interest rate. Last month, these investors got bonds at 5.5%. After fees and other expenses, small business people got the money for 20 years at 6.6%.
So, the market crashes and there is a “Rush to Quality” and I think to myself, “Aaron, there are going to be a lot of people rushing to buy those SBA 504 bonds. I don’t know what rate I’m going to get from the bank, but I’m sure the 504 loan rate is going to be sweet!”
However, this month when the SBA guy was on the floor yelling, “Get your SBA 504 bonds here!” Treasury Secretary Paulson was also the floor raising money for his bailout. He was yelling, “Get your Treasury Bonds here. I’m giving crazy interest rates! They’ve all got to go!”
The SBA guy had to raise his interest rates to compete with Mr. Paulson. This month, he got the money at 6.77%. This money will go to small business people at a rate of 7.72%.
Thus, the bailout increased the interest rate on SBA 504 loans by 1.1% in a single month. (On a large, 20-year loan, 1.1 percent is a very big deal.) So far, I’m giving this bailout a C-.
A big shout out to Miguel Alandete at REsource Capital Georgia who explained all this stuff to me. This project has given me a chance to learn more about how the world works, and Miguel has been very generous with his time and expertise.