SMALL BUSINESS ADMINISTRATION PROGRAMS AND PRIORITIES THURSDAY, FEBRUARY 3, 1977 U.S. SENATE, SELECT COMMITTEE ON SMALL BUSINESS, Washington, D.C. The committee met, pursuant to notice, at 9 a.m., in room 424, Russell Senate Office Building, Hon. Gaylord Nelson, chairman, presiding. Present: Senator Nelson. Also present: William B. Cherkasky, staff director; Allen W. Neece, Jr., legislative counsel; Larry M. Yuspeh, financial analyst; and Larry S. Greenberg, minority counsel. Senator NELSON. The committee will please come to order. Mr. Kobelinski, we are pleased to have you with us this morning. Your statement will be printed in full in the record. You may present it however you desire, and then we will ask questions. STATEMENT OF HON. MITCHELL P. KOBELINSKI, ADMINISTRATOR, U.S. SMALL BUSINESS ADMINISTRATION, ACCOMPANIED BY LOUIS F. LAUN, DEPUTY ADMINISTRATOR, SBA; WILLIAM T. GENNETTI, DEPUTY GENERAL COUNSEL, SBA; AND HERBERT T. MILLS, DIRECTOR, OFFICE OF BUDGET AND FINANCE, SBA Mr. KOBELINSKI. Thank you, Senator, and good morning. I am very pleased to have the opportunity to come before the committee, and to express some views concerning the Small Business Administration's direction and thrust and how it serves the small business community. As a kind of valedictory after my years of service at the SBA I would like to share with you some views that may be in some way perhaps startling and radical. But I believe 24 years since the Small Business Act came into existence, it is time for Congress to have a total fresh look at small business and its needs; to decide whether or not the programs that have been pyramiding, one on top of the other, are still properly serving the needs of the small businessman, and whether we are still properly carrying out the mandate of this Agency. One of the things that has really disturbed me as I look at the realities of the small business sector, is the alarming amount of failures of small business each year. The best estimates are, there are something like 400,000 businesses discontinuing each year. The last census figure, which is in 1953, showed 387,000 small businesses discontinuing, and we are interpolating from that and other data, and so it is an alarming amount of businesses going out of business, and without question, time and again, it is confirmed, at least 90 percent of the cause of this failure, or the discontinuance is business management ability. The ability to manage a business properly: We have not had the resources to get out and address that because we have 88 percent of SBA's resources and personnel concerned with financial problems and loan programs. What I think we should do is change the emphasis; instead of worrying about the increase of the loan portfolio, we should be concerned about the increase in the number of successful businesses. In other words, helping the small businessman by teaching him how to succeed; making it a real game of skill instead of a game of chance. If we take these figures, as estimates, and apply one or two jobs for small business, and figure out what we lose in the way of jobs each year because of the failure of so many small businesses, I think we have reason to be alarmed and concerned that we have got a hemorrhage going on in our economy. We better direct our attention to stopping that leakage, because with 400,000 businesses going out of business, there is no way that any genius can design a program that will create enough new jobs, and fill that bucket of employment, when we have got a hole in the bottom of the bucket. We are losing hundreds of thousands of jobs year in and year out, so we must be concerned about job creation today, because we know that it is one of the Nation's major priorities, the No. 1 priority. With small business having 58 percent of the private sector employment, it has got to be of major impact. So, I am suggesting that perhaps a wiser course, and perhaps a program which might save hundreds of thousands of jobs each year, would be to concentrate on increased productivity, and better management of business, and work toward a balance and stronger economy, and fighting inflation. Inefficiency breeds inflation, we can improve our total economy by making our small businesses more efficient, and competitive in international trade. If we look at this whole problem of productivity, efficiency, marketing, and concentrate our efforts in that direction, we will be doing a greater service for small business. Last year we made about 26,000 loans, 30 percent of which SBA had already extended loan services to before, so now we have maybe 19,000 to 20,000 new small businesses, I do not mean start-ups, but new clients of the SBA, out of the 10 million small businesses. That is a very small fraction that we are serving with our financial programs, both guarantee and direct loans. Of course, I am excluding the disasters, I am just talking about business loans. If we are to really expand, and serve small business, even in the financial area, I think we have got to devise some way to impact on a bigger sector of our small business community. I think the banks are prepared today to address that problem in a much different way than they did 25 years ago when they did not have a competitive banking system. Today you have got a competitive banking system. You have banks advertising, seeking loans. What they want is good loan customers, so if the customer comes in as a qualified borrower, with good management, with a product that he knows, the banker I think will be forthcoming, and if we have a gray area, as we always will, we want to encourage the banker to lend in that gray area. When he is in doubt, we can devise a program which will give the banker some security, some way of protecting himself in order to encourage him to make that loan, in the gray area to the small businessman. So with that kind of a basic approach, I am suggesting two things to Congress in this area; that first of all a major thrust of the agency be directed toward management assistance in the future. At this moment we have about 5 percent of our resources directed in that direction. I am suggesting that we must increase that substantially. When you measure it as the biggest bank for the buck, you can really understand the methods that we use today in management assistance. We are assisting 150,000 to 160,000 small businessmen with just 5 percent of our resources, whereas with 88 percent of our resources, we are helping 19,000 new small businesses in 1 year, so we use a leverage factor, we use volunteers, SCORE, the programs which I suggest should be substantially expanded, and by the use of a very expanded volunteer corps, I think we can really step out and address these problems of technology transfer, marketing assistance, production development. We have not tapped the resources of big business. If you had a fund drive going to build a new dog pound, they would give you two executives to go out and raise money for that. I think we have got to turn to our bigger businesses, and say you have got to share some of your knowledge and knowhow with small business to make small business more efficient generally. So that when you buy from small business, you will buy at better prices, so that your small businessman will be more productive, more efficient, the whole economy will benefit in that way, and we will not instead be considering to foreign suppliers who are working on efficiency and productivity, instead of improving the productivity of our small businesses. And so I believe we have got a major task though to reorient the services of the agency that way. It may be surprising, but in the last 3 years, with rare exception, every person added to the SBA has been added to our portfolio management sector. They have been added as bill collectors, in other words, they have been added as part of our collection effort to collect on old loans. This growth I think will continue as we build and build a larger portfolio under the operational scheme that we are following now, which is a direct loan program, along with a guarantee program, which leaves the bank with an option after the borrower defaults, of just turning the portfolio over to the SBA, getting its check for the 90 percent guarantee portion, in effect saying, here is your check, here is the headache, you worry about it from now on. Senator NELSON. May I interrupt? In the last hearing we had, you said you had a credit insurance idea. I have not had a chance to read your testimony. Would you explain exactly how that would work, what it might cost, precisely what that proposal is? Mr. KOBELINSKI. I have some greater detailed information on this on its way from our office, Senator, but I will give you an outline of that program. Instead of this scheme where the banker does turn over the portfolio to us, and we have to worry about it, and we pay out the 90-percent guarantee, and build an ever-larger portfolio to manage, I believe an insurance concept would help us in this respect, that we would still cover that gray area for the commercial banker, because he would have the insurance scheme available to him, but under the insurance scheme the banker would do the liquidating. The banker would, under the terms of the policy, have to agree to make the effort to collect those dollars, including the possible use of his own counsel, and the possible use of his own collection agency. He would do the whole collection effort and liquidate any collateral, and only after the loss was established, could he turn to the SBA to claim his loss, and that would be the net bottom line loss. In that basic difference is the savings, because instead of building a huge force of people-study loans, working on collections, working on liquidations, we would leave that in the private sector, and be an insuror. Now, we had a task force at work studying the various insurance credit programs that are in existence, and there are a number of them. For instance, FHA title I, which is a home improvement program, operates much in this way. I have used that program myself as a banker for years. The credit is under certain parameters set out for title I lending. the banker makes the loan and merely reports under the insurance form that he has made the loan; and he has to liquidate it, and only after he has established a loss does he go to the Government for his claim. Senator NELSON. What risk does he assume? Mr. KOBELINSKI. The banker assumes a risk of 10 percent at minimum of the exposure, and, of course, he has a set of regulations, so to speak, that he must follow in his lending, with the reasonable assurance of payment in the judgment of the banker. Of course there he is lending to a borrower who has a piece of real estate as collateral, and he has the option of taking a secondary lien on the property. Senator NELSON. What is his risk: does he have to lose his 10 percent? Mr. KOBELINSKI. Yes. Senator NELSON. He loses 10 percent of the deal? Mr. KOBELINSKI. Yes, let us get that accurate for you, Senator. If the loss on a title I, and I am not that much a title I expert. Let's move off of title I for a moment, let me move into some of the other programs, and how I would see this program would be working. I would see him taking the 10 percent loss. I would see him, the banker, having the 10 percent exposure. He would take a 10 percent loss, and he would recover from the Government 90, 80, 70, and I would think the bank should also have the option of taking a lesser coverage, so that he may not have a 90 percent coverage, and this would of course have an impact on the insurance rate paid. Now, a couple of factors come into play. We have looked at other programs, we have looked at mortgage insurance, and this is in the private sector, we have looked at credit insurance companies, there are a couple of commercial companies that write credit insurance on receivables for credit, and there is also the Foreign Credit Insurance Association, which is sponsored or underwritten by the Export-Import Bank, and we have looked at that program. Now, in all of these, there are differences. Each one has its own object, and for instance in the FCIA program at this time, there is a 15 percent retention by the exporter, and there is a 15 percent by the bank, so that you have a couple of other people sharing the risk, and that is minimum. In some cases the coverage is even lower. We will have to adjust this program to our needs here. The actual task force study is going to take some more weeks, and time Senator NELSON. So there is a precise study on this insurance? Mr. KOBELINSKI. We have a staff task force on precisely this credit insurance for SBA, which we will bring to the committee, and share with the committee as soon as we complete it. I have had this group at work for about 5 or 6 weeks now, and it is a considerable amount of area that they have to cover in devising such a program. Senator NELSON. When will the study be completed? Mr. KOBELINSKI. I would hope that we could give you some kind of preliminary outline of how this insurance program would work, and some estimates of what kind of premium that might have to be charged, possibly by the end of this month. Senator NELSON. Is the task force discussing this with any bankers and associations of bankers? Mr. KOBELINSKI. Our plan was to devise a proposed policy with some proposed premiums, a scheme of how this would work, and then bounce it off of our National Advisory Council Finance Committee, which is composed primarily of bankers, and also discuss it with the American Bankers Association. In other words, present them with a package, and say react, how do you feel this package would be accepted in the banking community. One of the things about insurance, of course, is that the broader your base, the better the risk is spread, the lower the premium can be. So these are two things we are concerned with in addressing how broad must the universe be. For example, we are primarily concerned with term lending. We thought we would exclude probably three short-term loans of up to 3 years from coverage. Senator NELSON. What do you mean by loans up to 3 years? Mr. KOBELINSKI. Short-term loans. If you are going to have an insurance base, an underwriting base, you cannot just let the banker select the very, very high risk without giving or getting any of the better risks. So one alternate is that |