U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: (202) 512–1800 Fax: (202) 512–2250

Mail: Stop SSOP, Washington, DC 20402–0001

74–011 2001

HEARING ON ACCESS TO CAPITAL

FOR SMALL BUSINESS

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

WASHINGTON, DC, MAY 17, 2001

Serial No. 107–8

Printed for the use of the Committee on Small Business

(

(II)

COMMITTEE ON SMALL BUSINESS

DONALD MANZULLO, Illinois, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

JOHN THUNE, South Dakota

MIKE PENCE, Indiana

MIKE FERGUSON, New Jersey

DARRELL E. ISSA, California

SAM GRAVES, Missouri

EDWARD L. SCHROCK, Virginia

FELIX J. GRUCCI, JR., New York

TODD W. AKIN, Missouri

SHELLEY MOORE CAPITO, West Virginia

NYDIA M. VELAZQUEZ, New York

JUANITA MILLENDER–MCDONALD,

California

DANNY K. DAVIS, Illinois

WILLIAM PASCRELL, New Jersey

DONNA M. CHRISTIAN-CHRISTENSEN,

Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

JAMES R. LANGEVIN, Rhode Island

MIKE ROSS, Arkansas

BRAD CARSON, Oklahoma

ANIBAL ACEVEDO-VILA, Puerto Rico

DOUG THOMAS, Staff Director

PHIL ESKELAND, Deputy Staff Director

MICHAEL DAY, Minority Staff Director

(III)

C O N T E N T S

Page

Hearing held on May 17, 2001 ............................................................................... 1

WITNESSES

Ferguson, Hon. Roger W., Vice Chairman, Board of Governors, Federal Reserve System ......................................................................................................... 3

Dunkelberg, Dr. William, Chief Economist, National Federation of Independent Business ................................................................................................. 17

Shapiro, Mr. Leslie, President, Padgett Business Services Foundation ............. 20

Johnson, Mr. Arthur, Chairman and CEO, United Bank of Michigan ............... 22

Tatum, Mr. Douglass, Partner and CEO, Tatum CFO Partners, LLP ............... 24

APPENDIX

Opening statements:

Manzullo, Hon. Donald .................................................................................... 35

Velazquez, Hon. Nydia ..................................................................................... 37

Prepared statements:

Ferguson, Hon. Roger W .................................................................................. 39

Dunkelberg, Dr. William .................................................................................. 52

Shapiro, Mr. Leslie ........................................................................................... 61

Johnson, Mr. Arthur ......................................................................................... 65

Tatum, Mr. Douglass ........................................................................................ 76

(1)

HEARING ON ACCESS TO CAPITAL FOR

SMALL BUSINESS

WEDNESDAY, MAY 17, 2001

HOUSE OF REPRESENTATIVES,

COMMITTEE ON SMALL BUSINESS,

Washington, DC.

The Committee met, pursuant to call, at 10:21 a.m. in Room

2360, Rayburn House Office Building, Hon. Donald Manzullo

(Chairman of the Committee) presiding.

Chairman MANZULLO. Good morning. This hearing will now come

to order. On behalf of the members here today and myself, I welcome our witnesses, and thank you for your participation in this

hearing.

This hearing is on capital, which is the lifeblood of small businesses. The testimony from the witnesses today will center on some

very interesting issues, such as whether or not in this three-legged

stool, it’s lack of demand, whether or not it’s inflation, or fear of

inflation, or whether or not the banks themselves simply are not

interested in lending money. And Dr. Ferguson, I’m sure, will have

all the answers to those questions because I do not care how much

we get into the issue of available capital we get into the theoretical

realm, and sometimes that is about as far as we could take it.

We are going to take a look at why the Federal Reserve decreased interest rates. We will look at how federal and private policies affect non-governmental lending and whether small businesses

are accessing necessary credit and capital through private lending

sector in the recent slowing economy. So, it is going to be a very

interesting hearing.

Our Subcommittee Chairs, DeMint and Toomey, I commend

them for their work in the area and their anticipated joint subcommittee hearing and legislation. Mr. DeMint and Mr. Baird are

developing to bridge the gap medium-sized businesses have and access in capital investment.

It is my distinct pleasure to recognize, after the opening statement from Mrs. Velazquez, the Federal Reserve Vice-Chairman,

Dr. Roger W. Ferguson, Dr. Jr. Ferguson took office October of

1999 as Vice-Chair of the Board of Governors of the Federal Reserve for a four-year term ending October 5, 2003. I will further

elaborate on his distinguished record before he testifies, but first

I will recognize my friend, the Ranking Member from New York,

for any statement that she may wish to make.

Ms. VELAZQUEZ. Thank you, Mr. Chairman, and welcome, Dr.

Ferguson.

2

Access to capital is one of the critical components to business

success. A business that can obtain funding quickly and at a reasonable cost has a much greater chance of succeeding. Unfortunately, for many small businesses, getting access to cash flow is not

always that easy. One only needs to look at the fact that the vast

majority of business start-ups are done not by conventional loans,

but by credit cards to realize this.

Make no mistake, lending for business start-up and expansion is

very much a high-risk—high reward venture. I believe that many

of our financial institutions are looking for innovative ways to assist small businesses to obtain the funds they need to start and

grow their business.

Unfortunately, banks cannot do it alone. Not only do they operate at a time when federal regulators prod banks to tighten loan

underwriting criteria—the must also operate in a new era created

under Graham-Leach-Bliley that has spawned a very competitive

environment for the deposit that make it possible for lenders to

make loans.

Today, with so many different competing interests vying for

those increasingly scarce funds, it is no wonder both lenders and

borrowers are frustrated. This is where the SBA loan programs

come into play, with their ability to guarantee funds that allow

banks to set aside less of their scarce deposits and maximize their

lending potential.

By doing this, we increase the ability of our financial institution

to offer loan opportunities for small businesses. This partnership

has been so successful that currently SBA loan programs account

for 40 percent of all long term small business loans nationwide. It

is because of this relationship that you cannot talk about access in

the private lenders market without considering it within the context of SBA’s loan programs.

That is why the proposal by the Bush administration to increase

fees is not only harmful to our small business owners, but it is

harmful to our lending system. time and time again when fees on

these programs have been increased, the ability for banks to offer

loans has plummeted. At a time when our economy is creating

more questions than answers, we need a strong and well functioning guarantee loan system to ensure that our small businesses

have access to the capital they need to survive.

In closing, it is clear that access to capital for small business is

truly access to opportunity, which is why this committee has spent

so much time working to ensure that our nation’s small businesses

can access the funds they need to start and grow their businesses.

I want to thank the witnesses for coming here today and I look

forward to their testimony. Thank you.

[Ms. Velazquez’s statement may be found in appendix.]

Chairman MANZULLO. Thank you.

It is my pleasure to introduce Dr. Roger W. Ferguson, Jr., Doctor

in Law and Ph.D. He served as the chairman of a group of ten

working party on financial sector consolidation formed in September of 1999 at the request of the finance ministers and the central bank governors of the G–10; holds a B.A. in Economics from

Harvard University; Juris Doctorate in Law and a Ph.D. in Economics. He was a member of the board of McKinzey & Company,

3

an international management consulting firm. From 1984 to 1997,

Dr. Ferguson served as the director of research and information

systems, overseeing a staff of 400 research professionals. From

1981 to 1984, he was an attorney with the New York City Office

of Davis, Polk & Wardell.

Dr. Ferguson, welcome to the hearing today. We eagerly look forward to your testimony. Thank you.

STATEMENT OF ROGER W. FERGUSON, JR., VICE CHAIRMAN,

BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

Mr. FERGUSON. Thank you, Mr. Chairman, and also Ranking

Member Velazquez.

Chairman MANZULLO. I believe that you had wanted to read your

complete statement which will be about seven or eight minutes so

I am not going to put the five-minute clock on.

Mr. FERGUSON. Fine. Thank you very much. I appreciate that.

And I do—I am pleased to appear before this committee to discuss

the availability of credit to small businesses.

Before turning to the latest information on credit market conditions, however, I think it is important to highlight the special characteristics of small businesses that make them such an important

part of our economy and at the same time create a heterogeneous

set of financial needs and credit demands. Much of the information

that we have on small business financing comes from surveys, including the Federal Reserve’s Survey on Small Business Finance,

the latest of which was completed last year.

No doubt I am preaching to the choir here when I tell this group

how important small businesses are in our nation’s economy. The

statistics collected by the Census and Small Business Administration are indeed remarkable. These data reveal that there were

more than 24 million nonfarm business tax returns filed in the

United States in 1999. More than 99 percent of those returns were

for small businesses, that is, firms with fewer than 500 employees.

Roughly half of these were self-employed persons and about a third

were part-time. Based on SBA estimates, small businesses employ

more than half of the private work force and are responsible for

around 50 percent of all sales and private gross domestic product,

a share of output that has remained fairly stable over time.

With half of our nation’s private, nonfarm output coming from

small businesses, obviously our economic well-being depends greatly on this sector. But small businesses do more for us than can be

captured in these statistics. Small businesses are a source of new

ideas and products. The list of innovations developed by these enterprises in fields such as software, computer technology, aerospace, and pharmaceuticals is quite impressive. The possibility that

an idea or new product will eventually transform a small business

into a large corporation is a great motivator of change and risk taking. Beyond that, small enterprises make a huge contribution in

the form of the support and synergies they provide operating side

by side with large businesses.

An essential feature of a thriving small business sector is the

ability of firms to start up, to grow, and to change ownership. Just

as essential to the dynamism of our economy of these firms to

downsize when that improves profitability or to exit the markets

4

when the resources are more highly valued elsewhere. There is a

tremendous amount of turnover of small businesses. In 1999, approximately half a million firms—excluding self-employed for which

numbers are not available—closed for one reason or another—perhaps they merged or were acquired by a larger firm, perhaps they

failed, or the owner found other reasons to move on. At the same

time, more than half a million new businesses were created.

The continuous entry and exit of firms is a clear sign that resources are responding to shifting demands of consumers and businesses and to changes in the cost of production. The flow of labor

and capital form less productive to more productive uses is the cornerstone of a dynamic and healthy economy. A downside of this

churning is the greater uncertainty that attaches to the earnings

and risk profile of each individual small business.

This has significant implications for the financing of small businesses. Indeed, while a number of factors need to be in place for

a small business sector to thrive, including a mobile labor force and

a sound infrastructure of laws and regulations, perhaps the most

important ingredient is access to capital and credit.

The financing needs of small businesses are as varied as the population itself. The life cycle of a small business can take many

forms, with very different implications for the types of risk and returns that lenders and investors can expect. For new ventures that

have high risk profiles and high expected returns—as do many

start-up firms in the tech sector—the initial stages require commitments of equity capital, sometimes from family and friends and

sometimes in the form of venture or private equity capital. Further

injections of equity are required in the early stages of growth and

ultimately some form of so-called ‘‘take-out’’ financing is arranged,

such as an initial public offering or a buyout by another firm, that

allows a venture capitalist to extract his or her investment.

The past decade has been impressive for the large amount of equity capital that flowed to venture and high-tech enterprises in this

country. The National Venture Capital Association estimates that

investments in emerging enterprises totaled $214 billion over the

past five years, and exceeded $100 billion last year alone. The

number of companies funded last year was a record 5,300. About

270 companies that originally were backed by venture capital were

purchased by other companies last year. Another 250 were able to

go public through IPOs of stock, even as the market for publicly

traded equity was in the initial stages of its recent decline.

The average age of firms going public was about seven years, but

many were older, which is indicative of the potentially long-term

commitments that investors in venture enterprises must be prepared to make. It is safe to say that the United States has been

a role model for countries in Europe and Asia seeking to develop

markets for equity financing for small businesses.

But for every new, high-growth firm seeking venture capital,

there are hundreds of small businesses in the manufacturing, construction, trade, and service sector that have quite different financing needs. Some of these firms have established operating histories

and marketable assets that make them good candidates for credit

from conventional financial institutions.

5

A few are small corporations that have access to bond market financing, though their bonds are likely to be rated below investment grade. The vast majority are small enterprises with few assets to pledge as collateral and with only limited operating experience from which investors can assess operating performance and

future earnings streams.

Recognizing the importance of small businesses, we endeavor to

understand the sources and uses of credit by different sizes of

firms. To this end, the Federal Reserve has undertaken three national surveys of small businesses, the first in 1987, the second in

1993, and the third which was completed last year. A detailed description of the latest survey, along with preliminary results, was

published in the April 2001 Federal Reserve Bulletin. And this

morning I will highlight just a few preliminary findings and note

that the data have just become available for what promises to be

interesting analytical work.

The survey sampled 3,600 small businesses that were representative of more than 5 million nonfarm, nonfinancial enterprises that

operate for profit. It gathered information on a large number of

firms, including each firm’s use of credit; characteristics such as

the number of employees, or the industry, or the age of the firm;

and its income and balance sheet data as of year-end 1998.

The earlier surveys had been used, for example, to shed some

light on the relationship between a business and its bank or primary lender and to study how financing choices varies with location, age, size or other characteristics.

This latest survey can be used to update these studies and to assess how small businesses may have altered their use of credit and

financial services in response to technological and competitive

changes in the financial environmental.

The preliminary survey results we have glimpsed so far are interesting as much for their consistency with previous surveys as for

the changes they reveal. For example, despite the large amount of

structural change and consolidation in the financial service sector

and the improving accessibility of capital markets to many smaller

firms, commercial banks continued to be the dominant provider of

financial services to small businesses in 1998.

Of the 55 percent of small businesses that obtained credit from

market sources or institutions, nearly three-fourths had some sort

of credit arrangement, such as a line of credit, a loan, or a lease,

with a commercial bank.

Finance companies served about 13 percent of small business

borrowers, and leasing companies served about seven percent.

The survey results also confirmed the growing use of business

credit cards by small businesses. About one-third of all small businesses, more than 50 percent of firms with 20 or more employees,

had business credit cards in 1998.

We included questions on the survey about the problems small

businesses considered to be most pressing. Small businesses in

1998 expressed concern about the quality, cost and availability of

labor and about increased competition from larger, international

and internet firms. Of note, financing was not high on their list of

concerns.

6

It is not surprising that small firms were feeling the pressures

of tight labor markets and increased competition. 1998 marked the

seventh year of a robust expansion. Bolstered by a technology-led

acceleration in productivity, real GDP growth averaged four and

one-quarter percent in the latter half of the 1990s, and the unemployment rate had dropped to four percent by the end of the decade.

Aggregate indicators of credit availability were quite positive in

the mid to late 1990s. Banks were generally easing credit terms,

and business loans grew robustly at both large and small banks.

The surge in equity markets provided a welcome environment for

firms going public for the first time, and firms carrying below-investment-grade bond ratings were able to issue bonds at historically narrow spreads over Treasuries.

While disruptions in global markets in 1998 raised risk premiums on junk bonds and bank loans and threatened a seizing up

in financial markets, ultimately they did not derail the flow of credit, especially to smaller businesses.

Since the 1998 survey, the economic and financial environment

has again changed, and this time in ways that are less conducive

to risk-taking and leverage. It became increasing apparent over the

course of last year that the pace of economic growth was slowing.

Credit markets firmed, including bank lending, partly in response

to concerns that a slowing economy would result in some deterioration in the financial well-being of businesses and their creditors. As

corporate profits fell and businesses revised down their outlook for

sales and earnings growth, investors became less certain about the

returns they should expect on investments.

By late last year, equity markets looked considerably less attractive as a source of financing, especially to firms hoping to go public

for the first time. The volume of IPOs dropped dramatically in the

fourth quarter and remained sparse in the early months of this

year, though it has not dried up entirely.

As prospects for takeout financing through an IPO became problematic, private equity investors became more cautious about committing capital to earlier stages of financing. While venture capital

investments exceeded $100 billion last year, the pace of investment

has slowed in recent quarters and there are reports that some

young firms are finding it hard to get second- and third-stage financing for venture capital projects.

In the capital markets, the default rate on high-yield bonds

climbed markedly last year to its highest level since 1991, boosting

lender concerns about the ability of weaker firms to service their

debt in this environment.

Yields on so-called junk bonds rose appreciably relative to those

on better-rated debt. In consequence, the issuance of these highyield bonds dropped sharply in the fourth quarter. Although the

capital markets continue this year to exhibit considerable selectivity, the flow of credit through bond markets has been strong

over all. Gross bond issuances or offerings by nonfinancial firms totaled nearly $160 billion in the first four months of this year. And,

although they are paying higher risk premiums, non-investmentgrade companies still are able to raise funds; junk bond offerings

have accounted for about 25 percent of the gross issuance this year.

7

Are you aware, the Federal Reserve conducts surveys of senior

loan officers at large banks around the country. These surveys ask

about banks’ credit terms and standards, about loan demand, and

other issues that may be topical. During the market turmoil in late

1998, banks began taking a harder look at the loans that they

make to large and middle market businesses.

While financial markets settled down subsequent to 1998, banks

appear to have maintained a more vigilant posture. Last year, in

an environment of rising delinquency rates on loans and indications of declining credit quality, the net percentage of banks who

reported some firming in their lending standards for large and medium borrowers rose steadily in each of our surveys.

Anecdotal reports suggest that banks were particularly concerned about concentrations of risk in sectors such as telecommunications, where returns have dropped sharply, and in manufacturing

and other sectors highly dependent on energy and petroleum-based

inputs.

Banks also reported firming standards and terms on loans to

small businesses, but to a lesser degree than for large firms. Normally, we expect small businesses to bear the first pulse of credit

tightening. But the downgrading and unexpected shocks affecting

large, investment-grade corporations have led creditors to rethink

the relative risks of lending to large and small firms.

Banks have continued to tighten standards and terms on loans

and credit lines this year. In our May survey, just over one-half of

domestic banks reported tightening their standards on C&I loans

to large and middle-market firms over the past three months, and

36 percent tightened standards to small firms over the same period. Most of the banks that had tightened continued to cite a more

uncertain economic environment, a worsening of industry-specific

problems, and a reduced tolerance for risk.

In their latest reports, bank loan officers also indicated that the

demand for business credit has waned of late, largely owing to reductions in planned investments and diminished financing for

mergers. Just as lenders are treading more cautiously as the economy slows, so too are borrowers. Caution is apparent even among

small businesses.

Importantly, the small business surveys conducted by the National Federation of Independent Businesses in the first quarter revealed that only 13 percent of their surveyed members thought the

current period was a good time to expand, roughly half the percent

of a year earlier.

The small business who thought it was a bad time to expand

cited unfavorable economic prospects and a poor outlook for sales.

Of note, very few—only three percent of the April NFIB survey—

mentioned financing costs as a reason that the current period was

not a good time to expand.

Indeed, the recent NFIB surveys that most of the respondents

have not found financing conditions to be particularly onerous to

date, despite the more cautious posture of financial institutions and

higher risk spreads. For creditworthy businesses, large and small,

the cost of borrowing has declined with the easing of monetary policy, and the associated decline in lending rates since last fall. The

prime lending rate has fallen over now two percentage points since

8

the end of last year, and the average interest rate paid by respondents on the April NFIB survey was down almost one percentage

point over the same period, to its lowest level in nearly a year.

While we may take comfort from the lack of angst expressed by

small borrowers in the NFIB surveys, I expect that many risks

small businesses have found credit a bit harder or more expensive

to obtain. On the other hand, there are few signs of the types of

financial headwinds that prevailed in 1990 and played havoc with

the ability of many creditworthy small and medium firms to renew

credit lines and roll over loans.

In contrast to that period, our financial institutions have had a

long stretch of solid earnings growth during which to build capital

and liquidity positions. In addition, although loan portfolios have

recently begun to deteriorate, delinquency rates of businesses and

real estate loans remain well below those of earlier periods. Commercial real estate markets, in particular, have not gone through

the boom-and-bust excesses of the late 1980s and early 1990s.

So in sum, we have seen greater caution being exercised by both

borrowers and lenders in credit markets recently. Such tightening

might be expected in an economy that has slowed after several

years of rapid expansion and debt growth. Much of the firming to

date has been selective and directed toward companies perceived to

face an uncertain future in the new economic environment and to

leveraged companies that are vulnerable to a period of slowing

sales and profits.

Overall, however, credit flows have been well maintained, and

lending institutions are in a much better financial health than a

decade or so ago. Importantly, reports from small businesses are

relatively upbeat with regard to the availability of credit. Although

risky borrowers face close scrutiny, banks apparently have continued to accommodate the needs of their creditworthy business customers, while bank lending rates, on average, have moved lower.

Mr. Chairman, thank you very much for your attention.

[Mr. Ferguson’s statement may be found in appendix.]

Chairman MANZULLO. Well, I want to commend you on your clarity of the presentation, Dr. Ferguson.

Ms. Velazquez.

Ms. VELAZQUEZ. Thank you, Mr. Chairman.

Dr. Ferguson, the merchant banking proposal, as initially proposed, will have four financial holding companies that either own

or invest in small business investment companies to deduct 50 percent of the total value of their investment from TO–1 regulatory

capital.

As I understand, however, in issuing its revised capital proposal

for nonfinancial equity investment, the regulators created a carveout for SBICs.

Would you please describe to this committee exactly how the new

capital proposal would apply to SBICs?

Mr. FERGUSON. Okay. If you would give me—yes, I would be

happy to describe it.

Graham-Leach-Bliley, as you know, allows—as you have described it—does allow bank holding companies to make equity investments without an SBIC license. And banks may elect to either

9

have an SBIC, but they cannot invest directly. The holding company can invest directly or through an SBIC.

It is important to know, by the way, that the SBIC activity predates Graham-Leach-Bliley, as you observe.

Now, you raise a very important issue with respect to capital,

and that was one of the most important issues that we faced implementing Graham-Leach-Bliley, because we wanted to set capital requirements that were appropriate and recognized the will of Congress but also recognized the risk that might exist in merchant

banking.

You are right to point out that the board originally or initially

proposed a uniform 50 percent capital charge to all equity investments that were made SBICs. And then in debating this and listening to commenters, we discovered that there was a great deal

of concern, as you have suggested, about this higher regulatory

capital charge, and particularly, there was a concern that this

would perhaps reduced the commitment of banking organizations

to SBIC financing.

Ms. VELAZQUEZ. Yes.

Mr. FERGUSON. And so what we have done is we have listened

to, as you observed, the commenters and moved a bit in that direction. And so we believe, with the new proposals with respect to capital, that we will have a relatively level playing field, that we will

not tip banks’ preferences away from the SBIC, but at the same

time we believe that the risks that are inherent in merchant banking, and there are some, would also be appropriately recognized by

these capital standards.

And so I think, if I can sum up, we started with one perspective.

We listened to commenters. We recognized the will of Congress. We

recognized the importance of SBICs which predated GrahamLeach-Bliley, and I think we have now moved to a position where

there will be an appropriate balance between SBIC financing and

non–SBIC financing while the risks that are inherent in merchant

banking, and we believe there are some, will be appropriately recognized with respect to capital.

Ms. VELAZQUEZ. Thank you. I am happy to hear that.

In the March 2001 Federal Reserve survey, 43 percent of the

banks that responded reported that they tightened their credit

standards. This was about the same percentage of banks that reported tightening their standards in the January 2001 survey.

However, the result of a recent survey conducted by the FDIC

shows that about the same percentage of financial institutions are

loosening their commercial credit standard as are tightening them.

What do you make of this mixed survey results?

Mr. FERGUSON. I think you are right to point out that there are

mixed survey results, and I would add to that, for example, the set

of surveys from the NFIB that suggested small businesses do not

put credit concerns as high on their list.

I believe a number of things are emerging here. First, we should

put this in an historical context. In 1998, banks started to tighten

because we had had a period in fact in which they had been loosening their terms and conditions, and some of their credit standards, and perhaps as they looked at the turmoil that emerged in

1998 and the risks that became earlier in 1998, they decided it was

10

appropriate to readjust and move their standards back to the direction of a bit more tightening, but again, from a very low base.

I believe that one of the things that we are seeing is that banks

are still prepared to lend to their most creditworthy customers. I

think they are tightening their terms and conditions somewhat

over what had existed in 1998, but that has been a long-term process, several years now, and it came after a period in which they

had been easing and credit had been expanding relatively rapidly.

I sense that one of the other things that we are seeing is that

in a period in which interest rates have been coming down, we

have seen the prime rate come down, for example, and so there are

a number of different factors that are emerging where the pricing

may be moving down to a more attractive range because of decreases in prime rates while banks are, if you will, sharpening

their pencils with respect to understanding the real business prospects of the counterparties that come forward with proposals or requests for credit.

I think we are also seeing one other thing, which is—that is a

supply story. There is also a demand side story which I have tried

to indicate, which I think some businesses are deciding that their

demand for capital have been reduced as their prospects become a

little less certain.

Ms. VELAZQUEZ. However, there have been so much discussion of

our credit crunch, and some people are blaming the regulators.

When do you first notice a trend of creditors tightening their commercial loan standards?

Mr. FERGUSON. First, I do not believe that we are in the midst

of a credit crunch nor do I think we face one.

As I have said, we first noticed this tightening of credit standards back in 1998, so this was not a recent trend. And as I said,

it came off of a period in which standards had been eased quite noticeably.

And so to some extent we are getting the return to standards

that reflected that perhaps earlier the standards were not as tight

as they could have been.

But I want to return to what I had said originally, which is I do

not believe that we are in the midst of a credit crunch. I think that

set of phrases or comments strikes me as not accurately reflecting

reality.

We also are coming off of a period when banks have had very

good profits and profitability, when the credit capital cushion within banks is quite firm, and I believe that they will continue to lend

when they see creditworthy customers.

Ms. VELAZQUEZ. Thank you. Thank you, Mr. Chairman.

Chairman MANZULLO. Thank you.

Mr. Toomey.

Mr. TOOMEY. Thank you, Mr. Chairman, and thank you, Dr. Ferguson, for your testimony today.

Some of the data that you refer to in your testimony suggests

perhaps more encouraging news than I would have anticipated.

When I reflect on my own personal experience as a small business owner, one of the issues I am concerned about are those companies that are too small to attract the interest of venture capitalists generally, but are nevertheless often shunned by banks, in part

11

because they may be in an industry that has a high failure rate.

Therefore, banks tend to simply refuse to lend to the industry en

mass.

An example is an industry that I have been in for a number of

years, the restaurant industry. Many family-owned restaurants,

small restaurants, start-up restaurant companies will go to banks

who will simply say, you know, really you seem like a very nice

person and you have got a great track record, but we have a categorical policy of not lending to restaurant companies.

It strikes me that a more, perhaps a better policy would be to

lend at much higher rates, to have some greater compensation to

offset the added risk. And I am wondering if we have any—if our

regulation, if our regulators, if through either implied or explicit

policies, we discourage lending that might make good sense if it

were—you know, if the rewards were commensurate to the risk because I do see this problem for these categories of companies.

Could you comment on that?

Mr. FERGUSON. Well, sir, I would hope that there is nothing in

the regulatory environment that discourages appropriately priced

lending to creditworthy counterparties. As an economist and also

as a regulator, I firmly believe that a modern capitalist society

works best if all creditworthy borrowers have access to credit at

prices and on terms and conditions which reflect accurately the

risks associated with those institutions and their prospects as both

they and their potential lender perceive those prospects.

Now, I think a number of things do happen. Sometimes potential

borrowers and potential lenders do not perceive the prospects of a

credit as being exactly the same, and so there are sort of disappointments that do emerge. But I would think what are focusing

on in the regulatory community is to have access to credit that is

fair, that is equitable at prices that reflect the underlying risk.

One of the things that we have been heavily focused on, particularly with respect to the larger institutions, for example is a much

more risk-sensitive risk-based approach to capital. We are encouraging all institutions, large and small, to have the most modern,

sophisticated risk management technologies and capabilities in

order to in part answer that question.

The other thing I would point out is while it is appropriate, and

we have appropriately recognized the very important role that commercial banks play with respect to lending to small enterprises.

There are a number of other avenues to capital for small businesses, and I’m not speaking of venture capital, but we also know,

for example, that trade credit is used by about 60 percent of small

businesses. Obviously there is also in some cases credit card capabilities, lending from owners and others.

And so while it’s appropriate to look at banks because they play

a very important role with respect to credit, they are not the only

source of credit for small businesses.

So I guess in summary I would say what I would hope we accomplish as regulators is to have banks and others extending credit on

terms that reflect risk, looking on a case-by-case basis, and then

also we have in our society a range of sources of capital as well.

Mr. TOOMEY. I do not disagree with anything you are saying. I

am just wondering if that is really working, when banks, many

12

banks in a given community will take entire industries and simply

categorically refuse to lend to them. It strikes me that that is not

a rational pricing. There ought to be some price at which some of

the banks would lend.

Mr. FERGUSON. Sir, I agree with exactly your last point, which

is that if it is not rational, as you observe, if there is a positive rate

of return to be gained by extending credit to individual institutions,

to individual counterparties, then banking or another institutional

step in and undertake an effort do that.

Now, it may not be as quick as we would like, and let me add

one other thing that has happened. We have seen during this period of our survey that the lines of credit outstanding to small enterprises has been going up. I attribute that in part to the fact that

we have, for example, the ability to do banking through the internet and other technologies, the adoption of credit scoring models for

banks for small businesses, which allow banks to make finer differentiations.

And so I agree with you, if there is a rational behavior because

we have a free market system eventually there will be an institution that wants to come in and lend appropriately and new technologies that are allowing for better distinctions.

I should be clear, I do not think that regulators should try to

micro manage lending decisions and encourage banks to make decisions that they would not otherwise make, but we should keep the

banks’ eyes focused on the fact that they have an obligation to intermediate, and that is their purpose for being, and that they

should make risk-based judgments about their counterparties.

Mr. TOOMEY. Thank you.

Chairman MANZULLO. Thank you, Mr. Toomey.

Mr. Pascrell.

Mr. PASCRELL. Thank you, Mr. Chairman.

Two things: I found, Mr. Chairman, the report by the Federal

Depository Insurance Corporation pretty interesting because their

data is every six months. It brings us pretty much up to date in

all the areas, from agriculture to construction loans, to credit card

loans.

But credit card loans, what about the cost? You talk about that

on page six, there has been an increase in business credit loans.

Is that not kind of expensive, Mr. Ferguson?

Mr. FERGUSON. Well, what I have said on page six is that there

has been an increase in the use of credit cards. I should be clear.

Credit cards are used for a number of different purposes.

Mr. PASCRELL. Right.

Mr. FERGUSON. To some extent, for loans, I’m sure for some, but

also there is some advantages that come with credit cards in terms

of cash management and recordkeeping, et cetera. So we should be

careful about jumping to that conclusion too quickly.

With respect to your question, as I have said, there are a number

of ranges of opportunities for capital to exist. Yes, it is absolutely

true that credit card interest rates are higher than some other interest rates, but the obligation, if you will, of the business person

involved to look at the range of credit options open to them, commercial bank, lending, trade, credit, lending from other financiers

13

of one sort or another, including for some venture capitalists, loans

from owners, and figure out how they want to optimize that mix.

And if a business owner decides that given his range of options

and opportunities some use of loans that are accessed through a

business credit card or through a personal credit card is part of

what they think is appropriate for running their business, then I

think that’s a rational business judgment that should be made.

You are right to talk about the pricing differential, but we should

be very careful not to think that most small business credit comes

through that channel since in fact we know that’s not true.

Mr. PASCRELL. I am also concerned about when there is a slowdown in the economy, those smaller, more vulnerable companies

will find somewhat of a tightening in basic market that they are

into in terms of getting capital or access to capital that they may

use be incurred or they may on their own—I think you know where

I am heading—to use a credit card which is going to put them more

in jeopardy.

And what is your reaction to that? I mean, should we discourage

such?

Mr. FERGUSON. Well, I think we should do a number of things.

First is—again, this will harken back to what I have said here, we

should first look at the facts of the current situation when, indeed,

we are having an economy that is growing below potential, but

what we are hearing from small businesses is that they do not believe that their access to credit has dried up.

We have also seen that, just as the terms and conditions have

tightened a little bit or some, I shouldn’t—from where they were

in 1998, they have tightened from where they were in 1998 for

sure, the pricing has also changed as we have had an interest rate

environment in which interest rates have been coming down.

Secondly, I do think we should encourage banks to look at each

applicant that comes to them on a case-by-case basis, trying to understand as best they can the prospects for sure, and then price appropriately.

I think if there is a sign that banks are not lending through one

channel but encouraging lending through another channel, then I

think that is not—that is not necessarily the best approach for the

way a bank should use its capabilities.

Mr. PASCRELL. How do we know whether that is the case or not?

Mr. FERGUSON. It is very hard for us to know with the data that

we have. I think we can figure it out to some extent through the

channel, through the information that comes from the NFIB, for

example, which does not show that that seems to be emerging.

Now, we will find for some individuals they make a prospective

judgment of their prospects and decide that they temporarily want

to take on slightly higher credit card debt because they have an optimistic view that going forward they will have a position to pay

that debt down.

And I think one of the things we do want to do is we want to

educate all potential lenders—potential borrowers, be they small

businesses or otherwise, to the appropriate use of various credit

card channels or various card channel, I am sorry, credit channels.

And one of the things the Federal Reserve has been doing is we

have undertaken a very aggressive approach to its educating small

14

businesses and others on their options and opportunities so that

they do not make unwise business judgments.

Mr. PASCRELL. Yes, I think that is probably—to the Chair, that

is probably one of the best kinds of advice you could give, particularly when this economy turns.

And my final question, Mr. Chair, if I may, do you see any contracting of the new venture businesses over the last six months?

Mr. FERGUSON. Well, as I said in my testimony, up through last

year there had been record amounts of venture capital being made

available, including last year about $100 billion. It has in fact come

off some this year. We hear that from the National Venture Capital

Association. There is anecdotal reporting. Even in today’s Wall

Street Journal there was an article about that. So it is quite clear

that venture capitalists are again being somewhat more discerning,

we will put it that way, with respect to their willingness to participate in venture capital activities.

Mr. PASCRELL. One final question, Mr. Ferguson. Things are

tightening up in certain areas. Would you be so bold as to recommend to this committee and to the Congress should we be tightening up on the amount of money available through the federal

government to guarantee loans, or should we be at this point expanding those opportunities, in your estimation?

Mr. FERGUSON. To be very honest with you, sir, I will not be so

bold as to do that. [Laughter.]

You have asked the question in that direction, the answer is I

will not be so bold as to do that. I will leave it to our elected representatives to decide how to use the taxpayers’ money and to what

you think of as the best advantage.

Mr. PASCRELL. Very good answer.

Mr. FERGUSON. That was a very good question, and I appreciate

you for asking it. Thank you.

Chairman MANZULLO. Ambassador, I appreciate that answer.

[Laughter.]

Ms. Napolitano.

Mrs. NAPOLITANO. I would say that is a very good dance. In fact,

that was part of my question, is based on, especially in my state,

in California, the economy has been sustained and increased because of small business, and the fact that small business availed

themselves of SBA loans. And given the fact that we are looking

at budget cuts in our programs in our agency, that is part of my

question is will there be an impact? Do you foresee, and I am not

asking you to speculate, I am just asking you as an individual who

deals with the issue of small business day-in—or not day-in small

business, but the economy itself?

And the question that goes with that is that has the Community

Reinvestment Act been effective in increasing lending to low income and minority-owned business? And do you think it can be

modified to be made more effective because most of the new businesses are women-owned businesses that are increasing as are minority-owned business?

Mr. FERGUSON. I would not, based on the facts that I have, and

knowing that the Community Reinvestment Act was heavily looked

at during part of the process of financial modernization, I certainly

would not recommend any review of that at this stage. I think that

15

was looked at very closely last year, and Congress came to some

very wise compromises or some—that reflected the perspectives

that Congress thought was best.

I think that what we will continue to find, as we have in the

past, is that small businesses are an important part of our economy. We will find, I believe, that those that have credible business

prospects will look from one source of capital to another, and I believe that we will continue to find that those are credible business

prospects. We will continue to find some form of capital available.

I cannot predict the pricing. I am not sure whether they will think

it feels as though it is readily available.

And so in that sense, I believe that, as they have been in the

past through many different ups and downs of the U.S. economy,

small businesses have been an important part of the strength of

the economy, and I expect that to continue going forward, and I expect access to capital to be an important issue with respect to

them, but the evidence thus far is through a variety of different periods that businesses have—not all obviously, as I have said there

is a great deal of churn—but businesses have in fact managed to

continue to contribute at a relatively solid pace to the U.S. economy.

One of the points that I would clearly make, I made it at the

very beginning, small businesses account for about 50 percent of

the output in the U.S. economy, and that has been really a surprisingly steady finding that goes back to—the data that I looked at

goes back to the fifties and sixties. It came down a little bit and

stabilized at around 50 percent.

One of the implications I take from that is that as the economy

goes through various cyclical changes still small businesses manage

to hold onto their market and continue as a group to provide the

same kind of impetus and momentum to the U.S. economy.

And so I take from that an optimistic message that small businesses have figured out a way to collectively, not each one, to do

well.

Mrs. NAPOLITANO. Yes, but would that not put a damper on new

entrepreneurship, which has really been the basis of some of our

growth?

Mr. FERGUSON. No. As I said, we have not seen any dampening

of new entrepreneurship. Despite the fact that small businesses

have a very high churn, we find almost in any period a large number of businesses being started and falling off as well.

I gave a talk earlier where I talked about small businesses in

1990 and 1995, and let me just refer to that to tell you what we

saw at that point.

What I saw at that stage was that, in fact, the number of small

businesses in 1995 was about the same as it has been 1990, but

there was a great deal of churn there. And so what that tells me

is that there is no lack of entrepreneurial drive even as individuals

look at the relatively risky world of starting a small business.

I believe that to be the case because I believe that many individuals, particularly with the educated population that we have, think

that they have built up a large amount of what economists would

call human capital, and that they often believe that the best way

16

to get a return on that capital is to take the risk and start the business themselves, and I think that will continue.

Chairman MANZULLO. I appreciate it.

Mrs. Kelly, please. Thank you.

Mrs. KELLY. Thank you very much, Mr. Chairman.

I am a small businesswoman, and I am also on the banking committee, and I have been working on that banking committee to

make sure that there is access to capital markets for small businesses. I am very concerned about that. And I understand, it is my

understanding the primary sources of credit for most small businesses are commercial banks.

But I am interested in the small businesses who want to grow

more substantially and raise funds in the securities market. Two

main goals of the SEC are to increase consumer protections and to

develop capital markets, as I understand it.

Do you think the SEC fulfilled this role with respect to the small

businesses?

Mr. FERGUSON. I wish you had phrased the question differently.

Mrs. KELLY. Nope.

Mr. FERGUSON. To be very honest with you, I cannot say that I

am an expert exactly on how the SEC has done its job, and I do

not, in my position, really want to be in a position of either confirming or denying how well another agency has done.

Mrs. KELLY. So basically you are neither refusing but you also

do not know?

Mr. FERGUSON. Yes, I am not refusing to answer your question.

I am telling you truthfully that I have not done a detailed study

of what the SEC has done, and therefore I feel very uncomfortable

trying to give it an evaluation for you.

Mrs. KELLY. Mr. Ferguson, are you familiar with the changes to

the SEC’s Rule 504? Can you comment on them?

Mr. FERGUSON. No, I really cannot comment on the changes to

the SEC’s Rule 504.

Mrs. KELLY. Could you give us some information at a later date?

Could you come back to us with assembled information on 504?

Mr. FERGUSON. Yes, that is a legitimate question. I will work

with our staff to find what information we can on 504, and we will

send you——

Mrs. KELLY. And get it back to my office, please?

Mr. FERGUSON. Yes. We will send you a letter on it, absolutely.

Mrs. KELLY. Thank you. I think it is extremely important to the

access for capital for small businesses that we try to get that 504

rule working.

Mr. FERGUSON. Let me quite clear. I am not—you have asked a

question that I think is quite legitimate. I just do not happen to

have the answer here, but I will work with the staff to get an answer that we think is responsive to your question.

Mrs. KELLY. Thank you very much. Hope to hear from you soon.

Chairman MANZULLO. Doctor, we have got a vote on. I am going

to waive my questions, and on behalf of the Small Business Committee thank you very much for appearing before us, and we appreciate your candor, we appreciate the simplicity of the words that

you use in describing very terse economic terms, and I am sure we

17

will have you back here. You have a warm welcome mat before this

Committee.

Mr. FERGUSON. I have enjoyed this and I would say the Federal

Reserve always tries to use straightforward words in describing

complex terms. [Laughter.]

Chairman MANZULLO. Thank you, Doctor. Thank you, Ambassador.

Mr. FERGUSON. Thank you.

[Whereupon, a recess was taken.]

Chairman MANZULLO. We will get our second group of panels to

take a seat.

I was thinking that maybe I should have asked Dr. Ferguson

what is definition of ‘‘irrational exuberance’’ was, and I bet he

would have found a diplomatic answer to that also.

Well, welcome back. Our first witness in our second panel is Dr.

Bill Dunkelberg. He is currently professor of economics at the

School of Business at Temple University where he formerly held

the post of Dean and Director of the Center for Advancement and

Study of Entrepreneurship.

Since 1971, he has also been the Chief Economist for the National Federal of Independent Businesses; served on President Reagan’s transition team as an advisor to the Secretary of Commerce,

and in 1989, was appointed to a two-year term on the Consumer

Advisory Council of the Federal Reserve System.

Dr. Dunkelberg is the past president and fellow of the National

Association of Business Economists, and elected member of the

Conference of Business Economists, the National Business Economics Issues Council, and senior fellow at the Foreign Policy Research

Institute in Philadelphia.

Welcome, Dr. Dunkelberg. We look forward to your testimony.

STATEMENT OF WILLIAM C. DUNKELBERG, CHIEF

ECONOMIST, FEDERATION OF INDEPENDENT BUSINESSES

Mr. DUNKELBERG. Thank you, Mr. Chairman and Committee

Members. It is a pleasure to be here this morning. Yes, it is still

morning. That is good. I apologize, I have a written statement and

will put that in the record, and there are a few little glitches in

the——

Chairman MANZULLO. All the written statements will be admitted into the record, including the written statement of Vice Chairman Ferguson, and the members of Congress.

Please proceed.

Mr. DUNKELBERG. Thank you. You did not mention and I guess

maybe I might not even have it on my resume, I am the founder

of the small business ‘‘Made For Me dot com.’’ We have widely

dropped the ‘‘dot com’’ from our name. We are just now ‘‘Made for

me.’’ But the web site is up and we do use the internet and we are

on our third capital raise now and doing very well. We make custom-made apparel which is an interesting business to be in, to say

the least.

I also serve on the board of a bank, the largest fishing tackle

manufacturer in the Your Honor, and the largest debt collector in

the United States, so I have a lot of interesting perspectives on

how the economy is doing and what it is doing.

18

In the discussion that we had—— Chairman MANZULLO. This is dead beat fish, is that right?

Mr. DUNKELBERG. Fish, that is right. I catch them with the best

reel going.

The discussion of capital, we probably should distinguish between what we have characterized as kind of start-up capital

versus the financing of an ongoing enterprise, and most of the discussion, I think, today in testimony has really been focused on the

financing of ongoing enterprises, although we do keep mentioning

venture capital and these kinds of things.

N.F.I.B. did a study back in the mid eighties of new firms that

were members. We had about 5,000 members who had been in

business less than 18 months, that is a new firm, and we followed

the same firms for three years just to see how things were going.

And I should point out that virtually—that two-thirds of these

people were financed basically by their own personal savings, median amount of capital expended by the first dollar in sales is about

20,000, and a quarter of those firms were started with less than

5,000 in capital. These firms are, of course, are typically not financed by banks. Banks are not by regulatory structure in the venture capital business, and really cannot take those risks.

I was interested in Mr. Toomey’s comment about the restaurant

business. Of course, one reason that banks, especially those 9,000

littler commercial banks that are out there, often do not lend in

categories is there are not enough firms in the category to diversify

your risk. If I loan you $100, it is an all or nothing deal. You either

pay me or you do not. If I loan everyone in the room $100, then

I understand what the risks are; most will pay, some will not. I

know how to price the loan. And when banks do not understand

how to price the loan, they cannot really make the capital available.

So mostly we will be talking about ongoing capital financing,

that is, access to operating capital and some long-term funding and

so on.

The NFIB began tracking information about the experience its

members were having out in the economy back in 1973, when we

started taking a random sample of then about 350–400 thousand

member firms, now well over half a million. And in the first month

of each quarter we would send out a questionnaire which contained

a set of questions that I have outlined in my testimony that talk

about experiences in the credit markets. And we have done that

since 1973, and in 1986, we stated doing those surveys monthly.

And we have about—depends on your estimate of how many

businesses are out there. We think about having 5 or 6 million employers in the United States. That is someone who pays social security tax on at least one person and we have then about one out of

every seven employers as a member these days.

So even though we do not have every small business as a member, obviously the same economic forces that hit our members are

hitting all the other members, and we can pretty much characterize through our surveys what is happening out there in the

economy to the sector, this very important sector that Vice Chairman Ferguson pointed out produces about half the GDP and employs a much higher fraction of the private sector labor force.

19

So we started this back in 1973, and have a long history, and I

have provided in my written testimony some graphics to show you

what those look like, and I will just review the highlights very,

very quickly.

One of the questions we ask is what is the most important problem facing your business today. We give them 10 choices plus a fillin-the-blank, so we find out if things are changing.

So, for example, in the 1970s we included questions about energy

cost and availability which maybe we should put back in now, but

obviously disappeared as an issue, and we added instead insurance,

the cost and availability of insurance.

But what I want you to see there is that since 1991 less than

five percent of the firms have cited credit availability and cost as

the major problem, and of course, the high was back in the earlier

years of 37, so we get a lot of variance there, but as Vice Chairman

Ferguson pointed out, we have not seen anybody really citing this

as a major issue for their business for a long time now.

Another question we asked is about regular borrowing. We asked

people about the loan rates that they pay and asked them to answer the question only if they borrow at least once a quarter. So

we look at the percentage of firms who are actively entering the

capital markets, and interestingly enough, that peaked out when

the prime was at 21, and reached an all-time low when the prime

was at six.

That does not say anything about our interest in borrowing

whether the need to borrow back in the days when inflation eroded

our cash flow at a very high rate, and of course unexpectedly. As

we opened the back doors, inflation came in and we had to try to

pass it on.

We had to do a lot of borrowing even at very high rates because

survival depended on borrowing, but now borrowing activities have

been at historic low levels for years and years, so our firms are

much less frequently accessing the capital market on a regular

basis.

To see how though the Fed is being, we have kind of our rough

indicator question, which is, last time you got a loan was it easier

or harder than the time before, so we get a sense of how the loan

officers are treating them.

And then we look at the net percent of that and that is graphed

for you there too and you can see the high there is around 27 percent, fortunately, a long time ago. It has been zero recently, in the

last few years, and it has been running at less than five, net five

percent saying harder since 1995.

So I would characterize the 1995 to 2000, right through now,

2001 period, as being one of the friendliest periods, friendliest capital market periods that small business has really experienced.

You will also note that—on the next chart—that the average interest rate we pay has fallen from 20 percent range down to 10 percent, which, of course, is very nice. I would call that particular cost

of doing business has become much lower for us and we are very

happy about that.

In terms of expectations, we say, well, do you expect credit conditions to get worse or better, to be tougher or easier, and that again

has been very stable now for a long time, running at around minus

20

five percent, which means five percent more said they expected to

be harder than easier, but most people do not expect any change

at all, so that number reflects really a very small number of people

who expect credit conditions to change.

So you can see that really we have had very good capital market

experiences since 1995, actually since—actually since 1983, when

we finally started to get inflation and the economy in order. Once

we had inflation rates down and a more reliable future and it became easier to run business and do very well, then capital markets

responded accordingly by seeing less risk and of course making

credit more available and at a lower price.

So overall our experience has been good, and right now we

would—even with all the bad news we see about the economy, it

is pretty clear from our numbers and for our half million firms that

they still are not having problems getting the funds that they need.

The price is still falling. That is great news. We like lower prices

for the credit that we have and we really do not see any change

in that in the foreseeable future.

So I will end my testimony there and take questions.

[Mr. Dunkelberg’s statement may be found in appendix.]

Chairman MANZULLO. Thank you, Doctor.

Our next witness is Leslie S. Shapiro, President of Padgett Business Services Foundation. He is a graduate of the University of

Minnesota with a Bachelor’s and a Doctorate Degree from that institution; a member of several bars, including Washington, D.C. He

was with the Department of Treasury and he was the executive director of the Joint Board for the Enrollment of Actuaries established pursuant to ERISA Act of 1974. He is the author of numerous articles, including ‘‘The Ethical Tax Lawyer: Is it an

Oxymoron?’’ and he as a follow-up article saying, ‘‘Was the Tax

Lawyer Unfairly Disciplined by Tyrannosaurs Rex in Jurassic

Park?’’ Mr. Shapiro.

Mr. SHAPIRO. Remind me to read that one sometime. [Laughter.]

STATEMENT OF LESLIE S. SHAPIRO, PRESIDENT, PADGETT

BUSINESS SERVICES FOUNDATION

Mr. SHAPIRO. Thank you, Mr. Chairman, Ms. Velazquez. I am

very pleased to be here this morning. As the Chairman said, I am

Les Shapiro. President of the Padgett Business Services Foundation.

The Foundation is a entity within the structure of Padgett Business Services, a corporation headquartered in Athens, Georgia.

Padgett has 275 offices located throughout the United States, providing accounting and tax services to principally small business entities.

We define a small business as one with under 20 employees. As

a practical matter, most of our clients have fewer than five employees.

I am pleased to be here this morning to offer our observations

on a subject we believe to be very important to small business. It

is this belief that prompted us to agree to amass information and

report out on it when asked only last week to do so. In this regard,

we immediately sent a request to our offices to provide us input

21

relative to their clients’ experiences in seeking and obtaining loans

and credit lines.

Consequently, the information we have is only a few days old.

While not fleshed out in detail, we hope it will give you a snapshot

of the experiences of owners of small businesses in an area so important to their fulfilling the American dream.

There are some givens in the equation we are considering, and

I think some of them have been alluded to by Dr. Ferguson. Small

business is critical to the viability of the nation’s economy. Another

is that almost all small businesses need financing. Further, most

of the loans small business owners are looking for do not involve

huge amounts of money. The loan range being sought normally is

$250,000 or less. In most instances, the amounts are under

$100,000. In many of those instances, there are substantially less

than even that amount.

Our findings show that access to capital has not gotten easier or

even has remained the same. Gone are the days when a small business owner need only show a bank that he or she is a good person

with a good idea. Other factors now must be added, among which

are that the person seeking assistance must have a strong financial

background, and there is a need to furnish compelling support

demonstrating that the good idea will work. Both require staggering paperwork. After all that, applications for financing often

are turned down.

Our information reflects that many entrepreneurs who do not

have the strong financial backing to which I just referred are asked

to offer their homes and other personal assets. Further, if a lender

is willing to make a loan to small business for expansion, the demands made by the lender may be extremely high.

While there is obvious recognition that a lender has a vested interest in some comfort level in believing an idea will work, our responders feel that the demands they are facing are unrealistic,

often necessitating other avenues to start or expand a business.

To illustrate, why should a small business owner be able to receive immediate financing for a truck being purchased for the owner’s business and not qualify for a business expansion loan for the

same amount as the truck loan because assurance of the success

of the expansion cannot be demonstrated to the satisfaction of the

bank?

Why should small business owners find it more realistic to lease

equipment rather than to endure the anxiety and often futility of

trying to obtain a loan to purchase it? Yet these are the experiences our clients have shared with us.

Of note is that our responders in the main have observed that

small business owners are being driven away from the national

banks, particularly the large ones. This is because of the difficulty

in obtaining financing and the bureaucratic business methods of

those banks.

The almost unanimous finding is that the small business owners

Padgett Offices serve prefer local banks for their financing needs.

Finally, it should be observed, and we have already heard it this

morning, that interest on loans does not seem to be a factor.

Padgett’s clients often extend the credit lines on their credit cards

22

in order to finance expansion of their businesses or to have the financing needed to get their businesses off the ground.

Thank you for this opportunity to testify this morning. As always, Padgett Business Services and the Padgett Foundation will

be pleased to work with you in any capacity you believe will be

helpful, and of course, I stand ready to try to answer any questions

you may have of me.

[Mr. Shapiro’s statement may be found in appendix.]

Chairman MANZULLO. Thank you very much, Mr. Shapiro. Appreciate your testimony. I will be asking a question of you and Dr.

Dunkelberg as to whether or not the surveys that each of you took

are surveying the same types of business people because you came

up with two different conclusions on them.

Our next witness is Arthur Johnson, speaking on behalf of the

American Bankers Association, and we welcome you here today.

Mr. Johnson.

STATEMENT OF ARTHUR C. JOHNSON, CHAIRMAN AND CEO,

UNITED BANK OF MICHIGAN

Mr. JOHNSON. Thank you, Mr. Chairman, and thank you for

holding this hearing.

Meeting the needs of our small business customers is vital to the

health of our local economies and the success of our banks. We understand the importance of bank financing to these firms and the

jobs they created.

United Bank, like banks across the country, has built its reputation on meeting the needs of our customers, not just for today but

for a lifetime. We cannot ignore, however, the fact that the economy has shifted into lower gear. Any experienced driver knows to

slow down when the road gets rough. The same is true of bank

lending as economic conditions get bumpy.

In my testimony today, I would like to make three points:

First, small business lending is a core part of banking’s business.

Small businesses make up three-quarters of all business banking

customers. At United Bank 99 percent of our business lending is

to small businesses, and 35 percent of those are SBA loans. Today,

banks have more than $230 billion in loans outstanding to small

businesses, almost a 10 percent increase from the last year’s level,

and we continue to meet the needs of small businesses.

Second, while small business lending continues to grow, economic

conditions suggest caution. The local economy that my bank serves

is highly dependent upon manufacturing. Having been in business

for over a century, we know that economic downturns hit us sooner

and harder and will last longer than other regions of the country.

Therefore, we must watch for early signs that the winds have

changed.

But let me be very clear. We are in the business of lending and

that is what we intend to do. Good creditworthy borrowers will always have access to funding and we are always mindful of our role

in helping our economy return to sustainable growth.

However, the risks of lending today are certainly greater than

they were a year or two ago. We are looking more carefully at our

loans and asking our customers more questions about their business plans and whether those plans accurately reflect the slowVerDate 11-MAY-2000 08:19 Sep 27, 2001 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 C:\DISC\74011 ATX007 PsN: ATX007
23

down in economic activity. Not surprisingly, business loan demand

nationally has slowed too. Such conservative approaches to both

borrowing and lending are prudent in the face of uncertain economic times.

My third point addresses how congressional action can help

small businesses access to credit. Certainly you deserve great

praise for the merchant banking provisions and the expanded collateral provisions for Federal Home Loan Bank advances enacted

in the Gramm-Leach-Bliley Act last Congress. If properly implemented by regulators, this will provide needed credit and capital

for small businesses.

Protecting the SBA guaranteed loan program is also important

as it can be one of the most cost-effective, high-impact tools that

Congress can provide. The guarantee helps banks protect against

losses and provides credit that would be otherwise unavailable. For

small businesses the assistance can be the difference between survival and failure.

My bank specialized in SBA lending, but have scaled back because of the rising fees in this program recently. The recent budget

proposals which would once again raise fees for borrowers and

lenders, are likely to spoil this product altogether, making what is

now a marginal business completely uneconomical. This may reduce the credit available for these small business borrowers as they

seek access to funds in a slowing economy.

There are also tax incentives that would be helpful. Repealing

the estate tax will help the inner-generational transfer of small

businesses, establishing special farm deposit accounts to help

smooth income for tax purposes would provide a new risk management tool for farmers and ranchers. Expanding industrial revenue

bonds, called AGI bonds, for agricultural borrowers would help.

And expanding the Subchapter S law would provide small businesses a broader range of capital funding options.

Mr. Chairman, small businesses are vital to a strong economy.

We are always looking to meet the needs of creditworthy borrowers, even though we must be cognizant of the changes in economic activity.

Thank you for this opportunity.

[Mr. Johnson’s statement may be found in appendix.]

Chairman MANZULLO. Well, thank you for that excellent testimony.

Our next witness is Douglass Tatum, as CEO of Tatum CFO

Partners. It is a partnership of career financial officers serving

early-stage companies, middle market companies and large corporations. The firm began in Atlanta; has expanded on a national

basis, and has over 300 partners in 23 cities. He is a recognized

expert on financing companies in transition and is a frequent

speaker presenting Tatum’s CFO booklet ‘‘No Man’s Land Where

Growing Companies Fail.’’

You know, I like the names of these books and publications. They

are so candid, to the point.

Mr. Tatum, I look forward to your testimony.

24

STATEMENT OF DOUGLASS M. TATUM, PARTNER AND CEO,

TATUM CFO PARTNERS, LLP

Mr. TATUM. Thank you, Mr. Chairman.

I do not think it is an understatement to quote from your letter

inviting me to testify before this Committee that ‘‘it is imperative

for our Nation’s economy small and mid-sized businesses access the

capital necessary for growth and survival.’’ I would like to make one very, very important differentiation— the difference between a ‘‘small business’’ and a business that is

breaking out and growing.

The National Commission on Entrepreneurship recently conducted focus groups with over 250 CEOs of these growing businesses across the country. In its report, entitled ‘‘Building Companies, Building Communities,’’ the Commission concluded that the

lack of available capital at a reasonable cost is a critical problem

facing entrepreneurs.

The recent U.S. economic expansion has been a period of substantial growth in employment. I think we all realize that. According to the recent studies by the Kauffman Center for Entrepreneurial Leadership and Cognetics, the greatest growth in employment has come from these emerging growth entrepreneurial businesses. If you do a survey of 100 small businesses, only five of

those businesses are growing at 15 percent or more. So, in a survey

asking about capital and its importance, five of those businesses— less than five percent—are going to raise their hands and say, ‘‘It’s

extraordinarily important.’’ Those are the businesses that I want to

talk about.

Now, why is that important? For example. Cognetics data indicates that 84 percent of the net, new job growth from 1992 through

1996 were these rapidly growing firms.

My testimony on these matters before the committee comes from

the perspective of serving as CEO, as you mentioned, of the largest

CFO firm in the country. We have partners in 23 offices, and we

provide assistance for a variety of companies in all the spectrums

ranging from start-up to Fortune 2000 multinationals. In our role

as CFOs, we are responsible for purchasing tens of millions of dollars worth of capital, and we purchase it from both regulated, nonregulated and professional private equity investors such as venture

capitalists.

In addressing the issues surrounding the lack of capital from our

perspective, it is important to summarize the microeconomics of the

borrower first and then the lender.

We would suggest based on our firm’s collective experience that

the bulk of the capital gap problems experienced by entrepreneurial CEOs coincides with his or her company’s sudden growth

accompanied by a transition period during which the company becomes ‘‘too big to be small and too small to be big.’’ We refer to this

economic transition period as ‘‘No Man’s Land.’’ During this period of growth, the company is extremely fragile

and can quickly lose its economic momentum due to a lack of management, human resources, infrastructure, and to the point of this

committee, reasonably priced capital. We have provided the Committee with the firm’s booklet ‘‘No Man’s Land’’; hopefully, it will

give you some perspective on my testimony.

25

The problem with these companies—again I want to remind us

that only five percent of small businesses are growing at 15 percent

or more a year growth—the problem for these companies starts

with growth. Growth in revenue drives growth in assets, creating

demand for capital and perpetually cash-starved borrowers even

with significant profitability.

If you will take a look at the first chart that I have in my written

statement labeled ‘‘Micro–Economics of 15% Sales Growth,’’ that’s

a model of a company starting with about $2.8 million growing at

15 percent a year. What you see there is that profits are going up,

while cumulative cash flow is increasing negative. These companies

are generally thinly capitalized to begin with, and as indicated

above, generally are in a risky transition.

As indicated in our booklet, ‘‘No Man’s Land,’’ the key to raising

capital for these businesses is creating a reduction of risk for the

borrower.

The second chart in the written statement indicates that as the

risk of the business is lowered the access and the pricing of the

capital improves.

The Lenders: Providers of capital to these emerging growth companies address the risk problem through intense account and collateral management. In preparation for this testimony, we polled

several of our partners and other senior industry executives with

extensive experience in both the regulated and nonregulated financial markets. Part of our review included a confidential evaluation

of the economic pricing and microeconomic models of these types of

lenders. In summary, both regulated and nonregulated institutions

provided data indicating that the actual cost of collateral management, account management, and loan acquisition and origination

for loans below a million dollars can be upwards of 1400 basis

point, or 14 percent. These fixed costs, when added to the normal

risk-adjusted interest rates, create an overall cost to the borrower

that becomes the real issue. The costs associated with this risk

management becomes less significant with the increased size of the

loan, creating a funding gap of reasonably priced capital between

what a company typically raises at start-up from banks, government programs, savings, credit cards of up to about $250,000, and

what we estimate to be the level of $1 million that becomes economically viable from both the borrower’s and lender’s perspective.

To depart from my written statement for a moment, what we are

seeing is that the initial capital funding is provided primarily on

the assets of the individual. I would call that a ‘‘branch manager

loan.’’ When you get above $250,000 in capital needs and the companies are growing and looking for capital, what happens is that

the bank is forced to look at the business’s assets at that point.

That becomes a ‘‘commercial loan officer’s loan’’. So, with the capital gap between $250,000 and $1 million, it would not surprise me

that there is not a problem out there getting the initial capital

funding. It is between $250,000 and $1 million where we are finding the real problem; and interestingly enough, those companies

are the ones generating the job growth.

I would suggest to you that when your constituents come up and

complain that they can not find capital, you will find them as growing companies versus stable, small companies that are not growing

26

at a significant rate. The ones accessing capital above $250,000 are

who you are really talking to.

There is no doubt that some of these financing needs are being

met by a variety of sources, including the SBA, the SBIC programs,

banks and other nonregulated lenders who I absolutely believe are

highly interested in solving this problem. However, we would argue

that until a more cost-effective risk management process is developed, many of the regulated institutions will continue to use a

rules-based credit scoring as part of their underwriting procedures

for rapidly growing companies, effectively eliminating many of

these companies from consideration. In addition, the general trend

will be to target this type of growth capital to larger business customers and larger loans where the costs outlined above are not as

significant to the overall pricing.

Finally, there is one other item that we believe should be

brought to your attention. In our firm’s opinion, current tax policy

compounds the difficulty in retaining critical capital for a company

during the formative growth phase because it requires an expanding business to pay a tax at a time when it may be cash flow negative and unable for the reasons outlined above to obtain reasonably

priced capital from lending institutions to fund its continued sales

and growth.

Congressman DeMint and Congressman Baird and their staffs

and others have been very helpful in working with our firm to develop and refine a tax deferral proposal for emerging growth businesses designed to address this problem, and we would hope that

this committee would give it appropriate consideration at the time

when the proposal is introduced as a bill.

There’s one other point I would like to add—an excerpt from the

NFIB ‘‘Small Business Policy Guide’’ on the highest priorities for

small business—and I quote, ‘‘Cash, cash, cash, the first canon is

cash. Cash flow is everything in small business. Owners need

money. Cash impacts are particularly notable when businesses are

growing very rapidly. Without cash, not to be confused with illiquid

assets, business owners must either postpone investment and expansion or they must borrow, thereby incurring financing costs precisely when these costs are least needed. And tax policy, to the extent practicable, should alleviate small business cash problems, not

exacerbate them.’’

In conclusion, Mr. Chairman, I really appreciate the opportunity

to appear before your Committee. I will be glad to attempt to answer any questions the Committee may have regarding the capital

needs and financing issues facing growing businesses.

[Mr. Tatum’s statement may be found in appendix.]

Chairman MANZULLO. Thank you, Mr. Tatum.

I would like to conclude this meeting at 12:15, so we have got

about 15 or 16 minutes. And if we could limit the questions to

maybe four minutes, then maybe have a second round so everybody

gets in.

Mr. Akin.

Mr. AKIN. Thank you, Mr. Chairman.

Doug, I was interested in a couple of things. Let me see if I got

what you are saying. When you are water skiing you go from two

skis to one ski, there is a little instability period. You are saying

27

there is a financial instability when you are moving from about

250,000 into the million kind of range. That is where there is a

need, and this need is not in every small business, but it is in five

percent of them which really have the potential for very rapid

growth, and the rapid growth is the very thing that makes them

cash poor.

Have I got this right so far?

Mr. TATUM. Excellent, excellent summary of that.

Mr. AKIN. That was a wind-up, now I have got a question or two.

The question, first of all, is in that area, first of all, how are the

private side from the federal government—I am new on the committee so some of this may be obvious to some of the other members, but how are the privates providing for that need and what do

you see, aside from some potential tweaking of the tax code, that

we ought to be doing to meet that need?

Are we doing a good job in helping in that area or not? And is

it sufficient to let the privates cover a lot of that?

Mr. TATUM. To answer your question, I think that the privates

are intensely trying to figure out how to deal with that. In my discussions with a senior loan executive at a community bank yesterday, probably a billion dollar bank, the portfolio that he has in this

range is only about $6 million. What they are looking at is ways

of cross-selling enough services to those borrowers in order to make

those issues profitable.

In conversations with a large nonregulated lender——

Mr. AKIN. I did not follow your—what is the problem of the bank

with the billion dollars trying to get into that market? What is his

mechanical problem?

Mr. TATUM. The mechanical problem is the intensity of the collateral management needed and who they need to assign to that

account. You need an experienced loan officer. You need collateral

management on the business itself. You have now gone past what

the personal assets of the individual can support.

Mr. AKIN. Okay.

Mr. TATUM. When you look at the cost of actually having the

right kind of person monitoring that loan, and the collateral management that needs to be provided for that loan, it is very difficult

to make any money on that loan without charging interest rates

that exceed 20 percent, and that is the difficulty that they are facing in that gap.

Now, you get to $1 million loan, and those fixed costs become less

and less a part of that amount. What we find anecdotally as chief

financial officers is if we can get a business big enough to where

it can borrow $1 million on its own assets, the private sector—both

commercial banks and nonregulated lenders—will line up to provide financing. It is that difficult between the capital that is being

lent to him early and the transition from the two skis to the one

ski, and it is the cost of the collateral management and account

management is the problem.

Mr. AKIN. So I understand what you are saying, your overhead

in trying to make sure that it is a good loan eats up all of your

profit. You do not have time to go out an micro-management some

little operation and make sure they are doing everything right?

28

Mr. TATUM. It costs as much to do that for, let us say, a $400,000 or $500,000 loan as it does $1 million loan or a $2 million loan, and

I think that is the practical problem.

I do not think it is a regulatory issue. I think there is a recognition that there is a need to get capital there, but the reality is that

these are risky businesses and they require intense collateral management.

Mr. AKIN. Thank you.

Chairman MANZULLO. Thank you very much.

Ms. Velazquez.

Ms. VELAZQUEZ. Thank you, Mr. Chairman.

Mr. Johnson, yesterday we held a hearing on the SBA budget,

and we were—I was raising the issue of the imposing fee to the

SBA 7(a) loan program. And you touched on this point in your testimony, but I would like for you to expand a little more.

In the President’s budget, he proposes to increase borrower and lender fees on the 7(a) loans over $150,000. And the stated intent

behind the fee increase is to encourage smaller loans to go right

through the program.

Do you think that this fee increase would cause 7(a) lenders to make more loans under $150,000, to make more loans?

Mr. JOHNSON. Well, it is certainly possible that it may have the

desired, stated desired impact of increasing lending in the smaller

loan arena. But it would also have the impact of decreasing lending

activity to the larger businesses. And very often we find that, as

I think I mentioned briefly in my testimony, our bank used to be

a very active SBA lender. In fact, through the mid eighties, for nine

years through the mid eighties to the mid nineties our little bank

was the leading originator of SBA 7(a) loans in the State of Michigan.

We have since de-emphasized our SBA 7(a) lending activity

somewhat, largely because rising fees to both our borrowers and

ourselves have made the program less economically viable.

We are in a state where we are in manufacturing. We have a

large amount of lending activity to small businesses who are manufacturers, and those are capital-intensive businesses. So our loans,

our SBA loan history tends to be—even for new businesses—larger

dollar amounts because they need to buy industrial equipment and

a factory to put the equipment in.

And so the damage that could be done to those borrowers would

be very detrimental.

Ms. VELAZQUEZ. Mr. Johnson, if this fee changes go through,

would you still participate?

Mr. JOHNSON. Well, yes, we would, but it would be much de-emphasized.

Ms. VELAZQUEZ. Can you tell me what are some of the major factors that cause a credit officer to consider a commercial loan to be

high risk?

Mr. JOHNSON. Well, it can vary greatly, depending upon the industry that the business is in. But what it basically comes down

to are a couple of factors.

First is what in our judgment is the probability that the loan will

be serviced as agreed. In other words, that the money will be repaid to us in a timely fashion. And second of all, in the event that

29

there is a default what is the likelihood of our ability to be able

to recover the amount of the loan back, even if we have to sell the

collateral and liquidate the business.

Ms. VELAZQUEZ. Thank you, Mr. Johnson.

Mr. Shapiro, in your firm’s experience are small businesses that

are being rejected by traditional private lenders seeking assistance

through SBA’s loan programs are they seeking other avenues to obtain credit?

Mr. SHAPIRO. Some of them are in fact seeking loans from the

SBA and like organizations. Our assignment was with respect to

nongovernment lending institutions. I think they are having not as

difficult a time from SBA in seeking financial assistance.

Ms. VELAZQUEZ. Do you refer businesses to SBA loan programs?

Mr. SHAPIRO. Our office owners in fact do. Wherever money may

be available is where we refer them.

Ms. VELAZQUEZ. Thank you. Thank you, Mr. Chairman.

Chairman MANZULLO. Thank you.

Congresswoman Tubbs Jones.

Mrs. TUBBS JONES. Thank you. I am going to be brief because I

know the time is of the essence. Good morning, gentlemen. Thank

you for coming to present. I hail from the City of Cleveland, and

working very hard to empower or do economic empowerment for

my community.

I would like to raise the question specifically with regard to minority businesses. If small businesses are having the dilemmas

that you suggest, have you done any assessment on the impact on

small African–American businesses? Do you have suggestions of

different changes we could make? Would you be willing to join with

us in sending a letter to President Bush about the impact that the

cuts that the SBA has had, cut on SBA has had on your ability to

do your job as part of the Small Business Administration? Your organization or whatever, anybody can take a jump at this.

Mr. Tatum? Mr. Johnson? Mr. Tatum?

Mr. JOHNSON. I guess it is my observation that in a period of economic downturn those businesses that are most likely to have problems obtaining credit are those businesses that are either less mature, they are newer, or those that have a smaller capital cushion,

less equity, and there tends to be quite a bit of cross-over there.

I mean, there is a high correlation between the amount of capital

they build up through profitable operations over the years, and the

age of the business.

So while I do not think that there is a problem for minorityowned businesses because they are minority-owned business, I can

see because there has been such a dramatic rise in minority-owned

business formation over the last several years that a large number

of minority-owned businesses would fall into that immature category that may experience more difficulty in.

Mrs. TUBBS JONES. But the Federal Reserve did in fact do a

study that said that the lending to minority businesses, lending to

minority persons, first of all, and then to minority businesses was

not equitable over the last few years. I do not remember exactly

when that report came out. I remember Mr. Greenspan speaking

to that.

30

So if that is the case, along with the situation, economic situation

we find ourselves in, does that mean economic—I mean, minority

businesses are taking double whacks to the extent that the economy is not in great shape. Would you agree or disagree?

Mr. JOHNSON. Well, it would be my observation that the bankers

that I am—in my bank——

Mrs. TUBBS JONES. Representing the bankers.

Mr. JOHNSON [continuing]. And the bankers that I am representing are interested in making loans to any and all creditworthy persons.

Mrs. TUBBS JONES. I am not questioning—please be clear, I am

not questioning whether or not you lent—well, maybe I should.

How many of your loans are—do you make to minority businesses?

Mr. JOHNSON. Well, I do not have the percentages, but it is certainly a business sector that we are very interested in serving.

Mrs. TUBBS JONES. Okay, I do not mean to cut you off but I am

short on time.

Mr. Tatum, in the work that you do, do you do work with minority businesses? And what has been your experience, if any different

from what you have testified to already? And real quick add on, did

the new markets initiative proposals brighten your eyes about opportunity to provide support to businesses, disadvantaged businesses?

Mr. TATUM. I believe that the capital markets are color blind,

and that they will seek those businesses that represent returns for

them very efficiently.

It is interesting, in my opinion, and this is anecdotal so I do not

have any kind of research to support this, but I think business

start-ups is a cultural thing. That is something that we should encourage. The minority community is increasing its participation,

which is extraordinarily healthy.

Chairman MANZULLO. Let me cut you off there. I am going to let

Congressman Baird get a question before we have to go vote.

Mr. TATUM. I apologize.

Mr. BAIRD. Mr. Chairman, thank you, Ranking Member Velazquez.

I want to particularly compliment the panelists and the Chair

and Ranking Member for this. Mr. Tatum, I appreciate you acknowledging the work you have done, along with Congressmen

DeMint and I.

It is my belief from talking to a number of small businesses that

while we have done a lot to help businesses get started through the

SBA program, rapidly growing businesses who sort of got their feet

under them, had the first two or three survive that critical cutoff

point, I really believe that is where the greatest small business employment currently resides.

The first year you are there you are with your wife, your kids,

your next door neighbor, your credit cards. It is after you have survived that three years, that is when you start employing people,

that is when you grow. And the bill we are working on, Mr. DeMint

and I, and I hope this committee can have a hearing on it, could

you expand on that issue, that sector a little bit, and how we might

help those folks?

31

Mr. TATUM. We believe that this is the most important issue to

look at because the research that we are reviewing from the

Kauffman Foundation and others indicates that those businesses

are generating the majority of job growth. Those businesses are

perpetually cash starved by virtue of growth, and the capital markets are struggling with how—because of the risk—to cost effectively get capital into those businesses.

We would argue that allowing those businesses to preserve capital is a timing issue. We think the proposal is revenue-neutral

over time, and allowing those businesses to preserve capital has

huge consequences to the economy.

Right now, even under current conditions, there are emerging

growth businesses that are growing. They are the only businesses

that are adding employees in a downturn. I have been a CFO of

larger organizations. Those larger businesses tend to adjust their

economic models quickly by downsizing. The emerging growth businesses are adding employees, and they are extraordinarily cash

starved. Some of the tax issues that you have been working on

would, I believe, help to solve that capital funding problem.

Mr. BAIRD. So, in other words, some of our SBA programs currently focus on an area where we have the highest risk maybe of

lack of success, but the sector where we have got the most rapid

growth is the area precisely where we have the least access to capital.

Mr. TATUM. Absolutely, and it has the most economic impact on

the economy.

Mr. BAIRD. Excellent. Thank you, Mr. Chairman.

Chairman MANZULLO. Well, thank you.

I wanted to comment on the survey. Mr. Shapiro, your survey

was done among—how many businesses participated in that?

Mr. SHAPIRO. There were approximately 1500. I think the purpose of our discussion. we are probably not that far apart, and that

was the point you made earlier.

Chairman MANZULLO. For those of you, could you—Doctor, you

said that there was no credit crunch among your participants, but

Mr. Shapiro, you said there was? Could you resolve that?

Mr. DUNKELBERG. Well, I am not sure we can resolve it sitting

here.

Chairman MANZULLO. Is it different sized businesses or what is

it?

Mr. DUNKELBERG. NFIB has about 500 to 600 thousand member

forms. I do not keep track of it——

Chairman MANZULLO. The average employee is at three?

Mr. DUNKELBERG. The average employment of those firms, the

average employment is about 13 or 14.

Chairman MANZULLO. Oh, I see.

Mr. DUNKELBERG. Ninety percent are under 40 employees, and

so it’s very small, though somewhat larger than what Census says

is out there, but it is a very, very large—— Chairman MANZULLO. Okay.

Mr. DUNKELBERG [continuing]. Body of firms, and probably

misses the very, very small firms. And the distribution by industry,

construction, manufacturing, agricultural and so on, it is pretty

much the same as Census says is out there.

32

So it is a pretty representative group in that sense.

Chairman MANZULLO. As is your group, is that correct, Shapiro?

Mr. SHAPIRO. Yes, it is.

Chairman MANZULLO. Okay.

Mr. SHAPIRO. But let me point out that I do not know when the

NFIB survey was conducted. Ours was conducted last week.

Mr. DUNKELBERG. Ours is every month.

Mr. SHAPIRO. Well, I do not know which ones you are using for

your analysis, though.

Chairman MANZULLO. Are you agreeing or disagreeing?

Mr. SHAPIRO. Well, I think we are not that far apart. We were

told to obtain stories, and we had to extrapolate from those stories

the information in—— Chairman MANZULLO. Okay.

Mr. SHAPIRO [continuing]. Our conclusions. And normally the

people who respond in that setting will give us the negative stories,

not the happy stories.

Chairman MANZULLO. Yes.

Mr. SHAPIRO. So we did not conclude that it was getting worse.

Chairman MANZULLO. Yes.

Mr. SHAPIRO. Although there could be an indication, we tried to

be very careful in our written statement.

Chairman MANZULLO. That is about your conclusion too, is it not,

Dr. Dunkelberg?

Mr. DUNKELBERG. It is not getting worse, that is correct.

Chairman MANZULLO. Okay.

Mr. SHAPIRO. It has not gotten better, but we are not sure that

it is gotten worse. It is hard to draw a line in the sand as to when

it may have started getting worse, you know, two years ago, one

year ago, a month ago, we are not sure.

Chairman MANZULLO. Let me throw something out here and

then we are going to have to adjourn. One of the witnesses that

we had or scheduled was Sunil Puri from Rockford, Illinois. He is

unfortunately in the hospital. I had calls with him a couple of

months ago and he is a professional developer, so he would have

to get capital to develop his shopping centers. Then the people who

would occupy those shopping centers, those stores, would have to

get capital.

He said the train has been cut off. It has been going on for six

months now. It has been very difficult for him to get development

capital, and he is very substantial, very successful, a lot of assets.

And the retail stores that would open up, they have also been cut

off.

Mr. DUNKELBERG. I think if you look at the mid-market kinds of

borrowers, and of course the Fed survey of the 52 largest

banks——

Chairman MANZULLO. Right.

Mr. DUNKELBERG [continuing]. Tells you that there has been a

restriction in credit availability for big projects which really depend

on the health of the economy to borrow a lot of funding.

Chairman MANZULLO. I do not know how big a project is when

you are trying to——

Mr. DUNKELBERG. Pretty big on shopping center.

Chairman MANZULLO. Well, shopping, that is the big loan.

33

Mr. DUNKELBERG. Yes.

Chairman MANZULLO. But then even the little guys that would

open up the individual stores, they cannot get loans themselves.

And his testimony would have been, you know, to that effect from

the developing side, and also to the people who would open up

those retail stores that has been a severe crunch of credit.

Mr. DUNKELBERG. I would also suggest that, of course, the economic activity regionally has high variance, and right now I think

most of us would agree that those states in the middle of the country called the Midwest are ‘‘in a recession’’ because of their heavy

dependence on manufacturing, but that is not the case all over the

country, and we are looking at numbers, of course, that characterize the whole country.

Chairman MANZULLO. That could be, and we do not have time

perhaps—we have another hearing, there is a whole genre of community or mutual banks throughout the country that they cater to

the little guy because their clientele essentially is the little person,

and they—I do not want to say of a different mission, but they do

tend to gravitate towards the small towns, to embrace the small

businesses. They still believe at times in character security, and

sometimes character security is better than security on a new

truck, as far as I am concerned. But I am not the one that does

the underwriting on it.

So, you know, we have a real flow that is going on right here,

and I just want to again thank you for your participation and for

the excellent testimony.

Mrs. TUBBS JONES. Mr. Chairman, even though we are almost

done, can I get him to finish his answer to that last question I was

asking for the record? I mean, you can go ahead, I can hear it. All

I want is on the record to end the questioning. He was talking

about that the minority community, that lending, that capital lending is culturally, and I wanted to hear the end of that.

Mr. TATUM. The entrepreneurs are rewarded and not penalized

for trying to start businesses in this country. It is a cultural thing.

The minority community has just started to participate in that.

That is anecdotal. I do not have the research for that.

Mrs. TUBBS JONES. What do you mean it is a cultural thing?

Mr. TATUM. In other words, in some cultures if you start a business and fail, you are ostracized. In this country you can start a

business and fail, and try again and fail, and try again and get it

right by the third time. You get a second and third chance. So that

I think business start-ups happen because we culturally admire

people who take those chances.

Out of that—out of that cultural start-up comes a group of small

businesses that shoot out of that.

Mrs. TUBBS JONES. Okay.

Mr. TATUM. Those businesses are the ones that start generating

all the jobs growth. They have a different set of needs. And out of

those group becomes those ones that the venture capitalists are interested in, the IPO markets. And so what you want to be able to

do is have the minority population participate in through all that,

and they are just getting started in the bottom layer.

34

Mrs. TUBBS JONES. Thank you. Thank you.

Mr. TATUM. If that makes sense.

[Whereupon, at 12:20 p.m., the committee was adjourned.]

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98