The Occupy movement expressed disapproval of the bailout of the banking system while seemingly ignoring private citizens. Bank-bashing is certainly in fashion, as headlines continue to increases in statewide foreclosures to nearly 3%. Many applaud the Dodd-Frank act’s massive rewrite of the financial system. I am not among them.
With little fanfare, a rule tied to mortgage “simplification” was submitted by the Consumer Financial Protection Bureau. This rule is 1099 pages long. As the former head of a division charged with interpreting and implementing bank regulations, allow me to give you some of the details of this rule that will inevitably limit credit availability to small business.
Commercial lending provides short term financing for small business that range from financing inventories to seasonal cash flow. These loans are generally relatively small, averaging under $60,000. While these loans are relatively expensive (currently in the vicinity of 7%), they provide the cushion many businesses need to weather bumps in their long term growth.
These loans are generally short term, averaging five years or less, and many are secured by real estate owned by the business. If the business needs the money longer than the term of the loan, interest is collected in the form of a “balloon” payment, and the loan is renewed.
Under the new mortgage simplification rule, however, these loans are considered abusive because of their high rates and balloon payments. That leaves these businesses with the only alternative to go to huge banks which syndicate these loans through Fannie Mae and Freddie Mac. Their estimated bailout cost, by the way, is $124 billion.
2. Economies of Scale
The 1,099 page mortgage simplification rule may not be as difficult to implement for JP Morgan/Chase or Bank of America as it is for small or regional banks. Huge banks have huge compliance departments. Small regional banks don’t.
If, for example, Huge Bank has a 40 person compliance department, each person can be responsible for under 30 pages of the new rules. Tiny Bank may have only 1 person responsible for compliance, who will be responsible to implement 1,099 pages. Faced with this daunting task, Tiny Bank B is very likely to do one of two things.
One, Tiny Bank may suspend its small commercial lending that is secured by real estate. Their customers will be forced to bank with Huge Bank.
Or two, Tiny Bank may add personnel to its compliance department. That will increase its costs, lower its profit, and ultimately damage its financial viability.
Small businesses create more jobs than large corporations. This new rule is yet another financial obstacle for small business. Consequently, it is bound to affect job creation.
Interestingly, a tiny bank you’ve likely never heard of, the State National Bank of Big Springs, Texas, has filed suit with the Competitive Enterprise Institute and 60 Plus Association, two free-market entities in Washington D.C., alleging that Dodd-Frank is unconstitutional because it forces its good customers to go to big banks and its poorer customers to be declined credit under this rule.
Yes, there were abuses by big banks. Yes, bank-bashing is all the rage. But without careful consideration of what regulations we pass, we may find the effect to be smaller banks selling themselves to larger ones who have compliance departments large enough to implement our regulations. Or worse, we may damage small business’ access to cash.