[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

                      HEARING ON ACCESS TO CAPITAL

                           FOR SMALL BUSINESS



                               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

74-011                      WASHINGTON : 2001

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                      COMMITTEE ON SMALL BUSINESS

                  DONALD MANZULLO, Illinois, Chairman
LARRY COMBEST, Texas                 NYDIA M. VELAZQUEZ, New York
ROSCOE G. BARTLETT, Maryland             California
FRANK A. LoBIONDO, New Jersey        DANNY K. DAVIS, Illinois
SUE W. KELLY, New York               WILLIAM PASCRELL, New Jersey
PHIL ENGLISH, Pennsylvania               Virgin Islands
PATRICK J. TOOMEY, Pennsylvania      ROBERT A. BRADY, Pennsylvania
JIM DeMINT, South Carolina           TOM UDALL, New Mexico
JOHN THUNE, South Dakota             STEPHANIE TUBBS JONES, Ohio
MIKE PENCE, Indiana                  CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey            DAVID D. PHELPS, Illinois
DARRELL E. ISSA, California          GRACE F. NAPOLITANO, California
SAM GRAVES, Missouri                 BRIAN BAIRD, Washington
EDWARD L. SCHROCK, Virginia          MARK UDALL, Colorado
FELIX J. GRUCCI, Jr., New York       JAMES R. LANGEVIN, Rhode Island
TODD W. AKIN, Missouri               MIKE ROSS, Arkansas
                                     ANIBAL ACEVEDO-VILA, Puerto Rico
                      Doug Thomas, Staff Director
                  Phil Eskeland, Deputy Staff Director
                  Michael Day, Minority Staff Director

                            C O N T E N T S

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


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


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



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


    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 
    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 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 
    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 improvingaccessibility 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.
    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 high-yield 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-investment-grade companies 
still are able to raise funds; junk bond offerings have 
accounted for about 25 percent of the gross issuance this year.
    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 
    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 ofborrowing 
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 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 carve-out 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 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 
    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 Graham-Leach-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 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 
    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 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 
    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 
    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 
    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 
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 
    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 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 
slow-down 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 
    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 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 
    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. 
    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 
    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 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 
    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 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 
    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 
    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, 
    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 
    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 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, 
    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.


    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.
    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 
    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 fill-in-the-blank, so we find out if things are 
    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 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 
    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. 

                      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 
    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 
    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 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 alender 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 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.

                          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 slowdown 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 
    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 
    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.

                         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 
    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 
    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 
    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 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 
absolutelybelieve 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 
    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 
    [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 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 
    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 
    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?
    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-
    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 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 
    Ms. Velazquez. Do you refer businesses to SBA loan 
    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 
    So while I do not think that there is a problem for 
minority-owned 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.
    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 
    Mr. Johnson. Well, I do not have the percentages, but it is 
certainly a business sector that we are very interested in 
    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 
    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?
    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.
    So it is a pretty representative group in that sense.
    Chairman Manzullo. As is your group, is that correct, 
    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 
    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 
    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 
    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.
    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 
    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.
    Mrs. Tubbs Jones. Thank you. Thank you.
    Mr. Tatum. If that makes sense.
    [Whereupon, at 12:20 p.m., the committee was adjourned.]