[Senate Hearing 110-605]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-605
 
SMALL BUSINESS ADMINISTRATION: IS THE 7(a) PROGRAM ACHIEVING MEASURABLE 
                               OUTCOMES?

=======================================================================

                                HEARING

                               before the

                FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT
                   INFORMATION, FEDERAL SERVICES, AND
                  INTERNATIONAL SECURITY SUBCOMMITTEE

                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                            NOVEMBER 1, 2007

                               __________

       Available via http://www.gpoaccess.gov/congress/index.html

       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs

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        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
THOMAS R. CARPER, Delaware           GEORGE V. VOINOVICH, Ohio
MARK L. PRYOR, Arkansas              NORM COLEMAN, Minnesota
MARY L. LANDRIEU, Louisiana          TOM COBURN, Oklahoma
BARACK OBAMA, Illinois               PETE V. DOMENICI, New Mexico
CLAIRE McCASKILL, Missouri           JOHN WARNER, Virginia
JON TESTER, Montana                  JOHN E. SUNUNU, New Hampshire

                  Michael L. Alexander, Staff Director
     Brandon L. Milhorn, Minority Staff Director and Chief Counsel
                  Trina Driessnack Tyrer, Chief Clerk


FEDERAL FINANCIAL MANAGEMENT, GOVERNMENT INFORMATION, FEDERAL SERVICES, 
                AND INTERNATIONAL SECURITY SUBCOMMITTEE

                  THOMAS R. CARPER, Delaware, Chairman
CARL LEVIN, Michigan                 TOM COBURN, Oklahoma
DANIEL K. AKAKA, Hawaii              TED STEVENS, Alaska
BARACK OBAMA, Illinois               GEORGE V. VOINOVICH, Ohio
CLAIRE McCASKILL, Missouri           PETE V. DOMENICI, New Mexico
JON TESTER, Montana                  JOHN E. SUNUNU, New Hampshire

                    John Kilvington, Staff Director
                  Katy French, Minority Staff Director
                      Claudette David, Chief Clerk


















                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Carper...............................................     1
    Senator Coburn...............................................     3

                               WITNESSES
                       Thursday, November 1, 2007

William B. Shear, Director, Financial Markets and Community 
  Investment, U.S. Government Accountability Office..............     5
Grady Hedgespeth, Director of Financial Assistance and Office of 
  Capital Access, U.S. Small Business Administration.............     7
Veronique de Rugy, Senior Research Fellow, The Mercatus Center at 
  George Mason University........................................     9
Anthony R. Wilkinson, President and Chief Executive Officer, 
  National Association of Government Guaranteed Lenders..........    10

                     Alphabetical List of Witnesses

de Rugy, Veronica:
    Testimony....................................................     9
    Prepared statement...........................................    60
Hedgespeth, Grady:
    Testimony....................................................     7
    Prepared statement...........................................    57
Shear, William B.:
    Testimony....................................................     5
    Prepared statement...........................................    33
Wilkinson, Anthony R.:
    Testimony....................................................    10
    Prepared statement...........................................    81

                                APPENDIX

GAO Report, July 2007, titled ``Small Business Administration, 
  Additional Measures Needed to Assess 7(a) Loan Program's 
  Performance....................................................    90


SMALL BUSINESS ADMINISTRATION: IS THE 7(a) PROGRAM ACHIEVING MEASURABLE 
                               OUTCOMES?

                              ----------                              


                       THURSDAY, NOVEMBER 1, 2007

                                   U.S. Senate,    
          Subcommittee on Federal Financial Management,    
                Government Information, Federal Services,  
                                and International Security,
                            of the Committee on Homeland Security  
                                          and Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:05 p.m., in 
Room SD-342, Dirksen Senate Office Building, Hon. Thomas R. 
Carper, Chairman of the Subcommittee, presiding.
    Present: Senators Carper and Coburn.

              OPENING STATEMENT OF SENATOR CARPER

    Senator Carper. The hearing will come to order. Welcome one 
and all.
    I am pleased to see all of our witnesses. I am especially 
pleased to see William B. Shear, who I once tried to introduce 
at another hearing as the one and only Billy Shear. The hearing 
was canceled. We had to stop the hearing because we then needed 
unanimous consent on the Senate floor to have Committee 
hearings that day and so we had to postpone it. It is going to 
be a pleasure introducing you today, and we are all glad that 
you are here.
    I especially want to say thanks to Dr. Coburn for 
suggesting that we return to this issue. As it turned out, it 
is one that a fair amount of work has been done, is being done, 
and legislation even introduced, we just learned today, that 
further attempts to address some of these issues.
    I am not sure who it was, I think it was Vince Lombardi--at 
least I always attribute it to him--who used to say--or the 
famous football coach of the Green Bay Packers--who used to 
say, ``Unless you are keeping score, you are just practicing.'' 
I have used that quote at a couple of hearings before and I 
think it certainly applies today.
    I approach this hearing--I am happy we are having it. I 
talked to one member of our staff who didn't get all juiced up 
about this particular hearing. I love this issue as a 
recovering governor. One of the things I focused on for 8 years 
was economic development, job creation, and job retention. Part 
of the ability of companies to get started, to be successful, 
to grow, to provide jobs, to provide employment opportunity, 
and give back to the community, was access to capital. So this 
is something that I have thought a little bit about and am very 
much interested in.
    Part of what we want to do is just if it isn't perfect, 
make it better. We have a program, the 7(a) program, that is, I 
think, a pretty good program, not perfect. There are some ways 
we could make it better and we hope to maybe walk out of here 
with some ways to do just that.
    People measure success in different ways. I believe this 
program has been successful. If you look at some of the 
testimony here, I think there are about 100,000 loans that have 
been made. Some $14 billion were guaranteed through the program 
just this last year alone, a lot of money. If I wanted to, I 
could spend a whole lot of time here in my statement reading 
through some of the 7(a) success stories that we have seen in 
Delaware, just that I literally saw last week and around the 
country over the years.
    But unfortunately, as we will all hear today, we don't 
always know how all the businesses receiving these 7(a) loans 
fared. If we look at the default rate for the program, it is 
clear that most succeed, but there are certainly some that do 
not.
    In order for the Small Business Administration and the 
lending community to better do their jobs, we probably need 
more information on the many successes and occasional failures 
among the 7(a) loan recipients. This information will tell us a 
good deal more than we know now about the effectiveness of the 
program. It will also help us to learn from our mistakes.
    It is my hope that with better performance data on the 7(a) 
program, something I believe that all of our witnesses agree is 
needed, and I know one of our witnesses is not convinced we 
actually need the program, and we welcome that input, as well, 
but I think all the witnesses, in reading through your 
testimony, agree that we don't do an especially good job--we 
measure inputs pretty well, but we don't necessarily measure 
outputs very well. I always like to say, when I talk to people 
about whatever they are doing in life, I say, how do you 
measure success? I think that is a great question to ask with 
respect to this program.
    So it is my hope that with better performance data on the 
7(a) program, something that I believe all of our witnesses 
here today think is needed, we can better target loans to those 
businesses that need help and better ensure that what we are 
doing here is in their interest, and even more importantly, in 
the taxpayers' interest.
    I will just close by noting that I think that government 
does have a role in this area. When I was governor, one of the 
things we did, we looked at Delaware's economy, and we are 
blessed with big companies, big, successful companies, a lot of 
big financial institutions, big chemical companies, science 
companies like DuPont and Hercules and others, auto assembly 
plants and so forth. One of the areas we are not especially 
strong in is new start-up for new businesses and job creation 
that flows out of those new businesses.
    One of the things that we did in my little State was we put 
Small Business Development Centers in all of our counties, 
storefronts where people could walk into, find out how to get 
it incorporated, how to develop a business plan, a marketing 
plan, access to capital issues, all kinds of stuff like that.
    We also created with a partnership with the banks something 
called Capital Access, which reminds me a little bit of this 
program but it is a bit different. When businesses would want 
to go to a bank for a loan, they would just say they wanted to 
borrow, let us say $10,000. They put a very small fraction, a 
small percentage of the loan into a reserve fund. I think the 
bank would have to put a small portion into a reserve fund. The 
idea was the reserve fund would grow, and if we ever had one of 
the loans go bad, then there was the money to make good on the 
loan. So this is something that we have thought a whole lot 
about and worked on, and that is providing access to capital.
    I look forward to this hearing. I am delighted, Dr. Coburn, 
that you suggested it to bring us together and let us get the 
show on the road. You are recognized, my friend.

              OPENING STATEMENT OF SENATOR COBURN

    Senator Coburn. Well, thank you. I appreciate Senator 
Carper agreeing to have this hearing. This isn't about 
eliminating the SBA program but it has everything to do with 
making sure the SBA program operates within the law, and today 
I see that it doesn't follow GPRA. It doesn't use the 
alternative credit or credit elsewhere formulas properly. And 
in terms of measurement, it doesn't measure outcomes, it 
measures outputs, and outputs are not outcomes.
    The GAO spent a year looking at this and here is a quote 
from their statement. ``All of the 7(a) program's performance 
indicators are output measures.'' What that means is we are 
measuring how much we are sending out the door, but we are not 
measuring what the effects of what we send out the door.
    The thing I am having trouble with is either we don't want 
to measure it because we already know what the answer will be, 
or we just blindly don't want to manage in a way that helps 
guide us, and that is not to question anybody's motive. I am 
not trying to do that. But I am convinced after reading the 
GAO's report, and I have tons of questions today for both GAO 
and the SBA, is how is it that we are not following GPRA? How 
is it that we are not using credit elsewhere and we are not 
measuring it and don't have the tools to measure it to comply 
with the law? It is the law. It is not what Senator Coburn 
wants or Senator Carper wants, it is the law. And how do we 
know whether or not we are having an impact other than the 
amount of money going out of the door?
    The other thing that I am concerned about is that the focus 
is on how much money we can move out the door, not on how many 
actual jobs are created, how many small businesses new capital 
formation, and whether or not those new jobs or that new 
capital formation could have been accomplished outside of the 
7(a) program.
    So I think there are a lot of questions. I appreciate so 
much that the GAO was so thorough in what they do. They know 
the law and they are an honest broker. They are not partisan, 
and I think we can trust where to ask the questions. That is 
what this hearing is about, is where to ask the questions and 
to find out what we are going to get accomplished in terms of 
outcome measurement, what we are going to get accomplished in 
terms of following GPRA, and what we are going to get 
accomplished in terms of alternative credit availability in 
terms of qualifying for 7(a) loans.
    So I appreciate everyone's attendance and their statement. 
I have a full statement I would like to enter into the record 
and I would ask unanimous consent for that.
    Senator Carper. Without objection.
    Senator Coburn. And again, thank you all for being here.
    Senator Carper. All right. I am going to take just a moment 
and introduce our witnesses.
    Our first witness today, made famous in an album released 
40 years ago this year, ``Sergeant Pepper,'' the one and only 
Billy Shear. I love it whenever he comes before us as a witness 
and it reminds me of my youth. But we are delighted that you 
are here. We are really appreciative of the work that GAO has 
done.
    Senator Coburn. Were you at Woodstock?
    Senator Carper. No, I was in the Navy. I was in Southeast 
Asia.
    Senator Coburn. You were tied up, as well.
    Senator Carper. Fortunately, I was not tied up with John 
McCain.
    Dr. Shear is Director of Financial Markets and Community 
Investment at GAO. He has directed the work addressing the 
Small Business Administration, the Federal Housing 
Administration--I may have a question on FHA for you here, too, 
as we look toward reauthorization of FHA--the Rural Housing 
Service, and Community and Economic Development Programs. Dr. 
Shear received his Ph.D. in economics from the University of 
Chicago, formerly served on an adjunct basis as a lecturer in 
city and regional planning at the University of Pennsylvania, 
just north of where my family and I live in Wilmington.
    Our next witness, and I am going to see if I get your name 
right, Hedgespeth?
    Mr. Hedgespeth. Hedgespeth.
    Senator Carper. Hedgespeth. I will practice that a couple 
of times. Thank you. He was appointed SBA's Director of 
Financial. Has anyone ever mispronounced your name?
    Mr. Hedgespeth. Oh, I wish I had a dollar for each time.
    [Laughter.]
    Senator Carper. All right. He was appointed SBA's Director 
of Financial Assistance in the Office of Capital Access in May 
2007. Mr. Hedgespeth is a former Secretary of Economic Affairs 
in Massachusetts and was the founder of the first bank-owned 
urban investment bank. Mr. Hedgespeth's work led to six 
consecutive outstanding Community Reinvestment Act ratings for 
his institution--congratulations--and to it receiving the Ron 
Brown Award for Corporate Social Responsibility. Before coming 
to the Small Business Administration, Mr. Hedgespeth served as 
CFO and Senior Vice President at the Structured Employment and 
Economic Development Company, called SEEDCO, where he has led 
the implementation of a financial accounting system and the 
creation of a new loan fund strategy.
    I want to say Veronique de Rugy, is that right?
    Ms. de Rugy. [Nodding head.]
    Senator Carper. Welcome. We are delighted that you are 
here. I understand you are a Senior Research Fellow at the 
Mercatus Center at George Mason University. I understand that 
you were previously a Resident Fellow at the American 
Enterprise Institute, a policy analyst at the CATO Institute, 
and a research fellow at the Atlas Economic Research 
Foundation, and----
    Ms. de Rugy. I am trying them all.
    Senator Carper. Oh, good. And your research interests 
include the Federal budget, homeland security, tax competition 
and financial piracy issues--privacy issues--probably piracy 
issues, too. Ms. de Rugy earned an M.A. in economics from the 
University of Paris-Dauphine and a Ph.D. in economics from the 
University of Paris-Sorbonne.
    And finally, we have Anthony Wilkinson. There is a name I 
can actually pronounce without a huge amount of problem. He is 
President and CEO of the National Association of Government 
Guaranteed Lenders, the only national trade association that 
represents the Small Business Administration 7(a) industry. Mr. 
Wilkinson has served on both the SBA's National Advisory 
Council and Investment Advisory Council. He also has served on 
the Small Business Advisory Council. And prior to joining his 
association, Mr. Wilkinson spent 13 years with Stillwater 
National Bank. Where is Stillwater National Bank?
    Mr. Wilkinson. Stillwater, Oklahoma.
    Senator Carper. All right. Have you ever been there?
    Senator Coburn. Sure.
    Senator Carper. Once or twice?
    Senator Coburn. I graduated from there.
    Senator Carper. Okay. He served as Senior Vice President 
responsible for the bank's Small Business Administration 
lending activities. He is the past recipient of the Small 
Business Administration's National Financial Services Advocate 
of the Year Award.
    With all those introductions under our belts, again, we are 
delighted that you are all here, appreciate your preparing for 
this important hearing, and we look forward to your testimony 
and to having the opportunity to ask questions once you have 
spoken.
    Your whole statement will be included in the record, and if 
you can wrap it up in about 5 minutes, we are not going to keep 
a real tight clock on you, but about 5 minutes would be fine, 
and then we will finish up and then ask questions.
    Mr. Shear, the one and only.

 TESTIMONY OF WILLIAM B. SHEAR,\1\ DIRECTOR, FINANCIAL MARKETS 
AND COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Shear. Mr. Chairman, Dr. Coburn, and Members of the 
Subcommittee, I am pleased to be here today to share 
perspectives with the Subcommittee as it considers the extent 
to which SBA's 7(a) program is achieving measurable outcomes.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Shear appears in the Appendix on 
page 33.
---------------------------------------------------------------------------
    The 7(a) program guarantees loans made by commercial 
lenders, mostly banks, to small businesses for working capital 
and other general business purposes. The program is intended to 
help these businesses obtain credit that they cannot secure at 
reasonable terms in a conventional lending market.
    My testimony today is based on a report we issued in July 
that examines the 7(a) program. Specifically, my testimony 
addresses, first, the 7(a) program's purpose and the 
performance measures SBA uses to assess the program's results; 
second, evidence of any market constraints that may affect 
small business's access to credit in a conventional lending 
market; third, the segments of the small business funding 
market that are served by 7(a) loans and the segments that are 
served by conventional loans; and fourth, the 7(a) program's 
credit subsidy cost and the factors that may cause uncertainty 
about the program's costs for the Federal Government. In the 
interest of time, in this oral statement, I will summarize our 
results for the first three objectives.
    First, as the program's underlying statutes and legislative 
history suggest, the loan program's purpose is to help small 
businesses obtain credit. The program's design reflects this 
legislative history, but the performance measures provide 
limited information about the impact of the loans on 
participating small businesses. The underlying statutes and 
legislative history of the program help establish the Federal 
Government's role in assisting and protecting the interests of 
small businesses, especially those with minority ownership.
    The program's performance measures focus on indicators that 
are primarily output measures. For instance, they report on the 
number of loans approved and funded, but none of the measures 
look at outcomes such as how well firms do after receiving 7(a) 
loans. As a result, the current measures do not indicate how 
well the agency is meeting its statutory goal of helping small 
businesses succeed.
    With respect to these findings, we made a recommendation to 
SBA. We recommended that SBA complete and expand its current 
work on evaluating the program's performance measures. As part 
of this effort, at a minimum, SBA should further utilize the 
loan performance information it already collects, including but 
not limited to defaults, prepayments, and the number of loans 
in good standing to better report how small businesses fare 
after they participate in the 7(a) program.
    Second, we found evidence, while limited, from economic 
studies suggesting that some small businesses may face 
constraints in accessing credit because of imperfections such 
as credit rationing in a conventional lending market. The 
studies we identified that empirically looked for evidence of 
this constraint within the conventional U.S. lending market 
generally provided some evidence consistent with credit 
rationing. Some studies showed, for example, that lenders may 
lack the information needed to distinguish between creditworthy 
and not creditworthy borrowers, and this could ration credit by 
not providing loans to all creditworthy borrowers in small 
business lending.
    Third, we compared the share of 7(a) loans that went to 
small businesses with certain characteristics to the share of 
conventional loans that went to such businesses. We found that 
a higher percentage of 7(a) than conventional loans went to 
minority-owned and start-up businesses. However, more similar 
percentages of 7(a) and conventional loans went to other 
segments of the small business lending market, such as women-
owned firms and those located in distressed neighborhoods. 
These results may be useful to SBA as it considers how it 
administers the program, including how it oversees 
participating lenders.
    Mr. Chairman, Dr. Coburn, this concludes my prepared 
statement. I would be pleased to respond to any questions that 
you or other Members of the Subcommittee may have.
    Senator Carper. Thank you, Dr. Shear. Mr. Hedgespeth, you 
are recognized and please proceed.

    TESTIMONY OF GRADY HEDGESPETH,\1\ DIRECTOR OF FINANCIAL 
 ASSISTANCE AND OFFICE OF CAPITAL ACCESS, U.S. SMALL BUSINESS 
                         ADMINISTRATION

    Mr. Hedgespeth. Thank you very much, Mr. Chairman, Chairman 
Carper, Ranking Member Coburn. Thank you for inviting me to 
testify about the Small Business Administration's flagship loan 
guarantee program, the 7(a) program. I appreciate the 
opportunity to respond to the Government Accountability 
Office's July 2007 report on the 7(a) guarantee program.\2\
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Hedgespeth appears in the 
Appendix on page 57.
    \2\ The GAO Report appears in the Appendix on page 90.
---------------------------------------------------------------------------
    My name is Grady Hedgespeth and I am the Director of the 
Financial Assistance and Office of Capital Access at the SBA, 
where I oversee $65 billion of the agency's loan programs. I 
joined the SBA in May of this year, bringing 30 years of public 
and private sector experience, including serving most recently 
as CFO and Senior Vice President at the Structured Employment 
and Economic Development Company (SEEDCO), following 20 years 
in banking and the financial services industry and a stint as 
the Secretary of Economic Affairs of Massachusetts. Based on my 
experience, I bring a unique knowledge of the lending industry 
to the SBA and the effect of the SBA programs in that industry.
    The 7(a) loan program, guarantee program, was established 
by Congress in 1953 to provide small businesses with the 
necessary capital that they cannot obtain in the commercial 
lending market. To be eligible for an SBA guarantee, the 
borrower must be a for-profit small business located in the 
United States and be unable to obtain credit elsewhere.
    It is important to note that the SBA does not directly make 
loans. Rather, the SBA works with commercial banks, 
guaranteeing between 50 percent and 85 percent of the loans. 
The precise amount of the loan guarantee depends on the size of 
the loan and the paperwork requirements associated with the 
application.
    Analysis by the GAO finds that, when compared to non-7(a) 
loans, the SBA's 7(a) loans serve a greater percentage of women 
and minority-owned firms, and historically, these categories of 
entrepreneurs have faced more difficulty gaining access to 
capital. While the 7(a) program is not designed to provide a 
preference for historically underserved borrowers, the fact 
that they are receiving SBA assistance at greater proportions 
again demonstrates the program's importance in reaching 
underserved businesses.
    Given the 7(a) program's success, it is also important to 
keep in mind what the program does not do. The 7(a) program is 
not intended to compete with the conventional lending market. 
Rather, the program supplements this market by providing 
incentives for lenders to provide loans to firms that may not 
otherwise qualify for traditional lending products. For banks 
to obtain a 7(a) guarantee, they must apply this credit 
elsewhere standard and certify that they would not make the 
loan without the SBA guarantee.
    According to the GAO report, there are a variety of reasons 
why small firms have trouble obtaining commercial loans and 
thus meet the standard. These factors include lack of 
information about the borrower, lack of a previous relationship 
with the borrower between the borrower and the lender, and lack 
of collateral, and I would also observe that from my personal 
experience, insufficient net operating income is a critical 
factor in this credit elsewhere test being met.
    The SBA continues to work to ensure that the 7(a) program 
carefully administers taxpayer resources. In the fiscal year 
2005, the SBA restructured the 7(a) program into a zero-subsidy 
program. This approach adds stability and independence to the 
program while ensuring that the lending process is not hampered 
by the appropriations shortfall, such as those that occurred in 
2003 and 2004.
    Aside from having a zero-subsidy rate, another safeguard 
for taxpayers is that the 7(a) program is not liable for the 
guarantee if the lender does not comply with the program 
requirements. In addition, SBA continues to streamline and 
automate its loan processing function to reduce administrative 
cost.
    In order to measure our progress, SBA consistently collects 
and reviews data on the 7(a) loan program. While these measures 
provide useful data, we are also looking for new ways to better 
measure our work and identify areas of improvement. Therefore, 
SBA appreciates the GAO's recommendation that SBA establish 
additional performance measures specifically to evaluate the 
effectiveness of the firms in the 7(a) program.
    To this end, the SBA commissioned a study from the Urban 
Institute to analyze the SBA loan programs and to determine the 
market for small business loans and whether SBA is serving that 
market. In brief, what we learned is that there are a 
substantial number of creditworthy businesses that cannot find 
financing through the commercial lending market, and of those 
businesses, the SBA is serving a substantial number.
    We are encouraged by this data and we believe that it 
provides insights that allow us to further the Congressionally-
mandated mission of the guarantee program.
    In response, SBA is reviewing its performance measures to 
determine how best to measure outcomes in terms of the 7(a) 
loan program. Data is needed to be able to identify and measure 
the sustainability of small businesses receiving SBA loans and 
how the agency's loan programs benefit the small business 
economy. The agency is evaluating whether the data currently 
being collected provides adequate information to make these 
decisions. This review will assess past performance, test new 
methodologies that can assist in setting future benchmarks.
    Specifically, SBA is trying to determine how best to 
measure the effect of SBA assistance on the firms that receive 
it. Understanding the agency's impact on the small businesses 
receiving SBA loans will allow us to further tailor our loan 
programs and the guarantee program to ensure the greatest value 
for the taxpayers while continuing to fill a key gap in the 
financial market that allows small businesses to grow.
    I would again like to thank the Chairman and Ranking Member 
Coburn for the opportunity to testify, and of course I will 
welcome your questions. Thank you.
    Senator Carper. Mr. Hedgespeth, thank you very much for 
your testimony and we look forward to asking some questions 
here in a minute.
    Dr. de Rugy, you are recognized and thank you for joining 
us.

TESTIMONY OF VERONIQUE DE RUGY,\1\ SENIOR RESEARCH FELLOW, THE 
           MERCATUS CENTER AT GEORGE MASON UNIVERSITY

    Ms. de Rugy. Chairman Carper, Ranking Member Coburn, 
Members of the Subcommittee, it is an honor to appear before 
you today to discuss whether the SBA's 7(a) loan program is 
achieving measurable outcomes.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. de Rugy appears in the Appendix 
on page 60.
---------------------------------------------------------------------------
    I would like to commend this Subcommittee for recognizing 
that outcome measurement is a crucial part of judging the 
success of a program, particularly as I am sure that this 
Subcommittee understands that outcome measurement is only 
useful to the extent that it triggers consequences if the 
Subcommittee finds that the 7(a) loan program under-performs or 
is unnecessary.
    Encouraging lending to small businesses is one of the 
primary purposes of the 7(a) loan program, which works on the 
underlying assumption that inefficiency in the capital market 
caused lenders to pass over a large number of small businesses 
that, if given loans, would generate untapped economic growth.
    Is there, in fact, a market failure that justifies 
government intervention via the SBA? My work concludes that 
there is no significant failure of the private sector to 
allocate loans efficiently. The literature that does refer to a 
market failure that Mr. Shear mentioned is grounded in old 
research that doesn't take much under consideration the 
tremendous developments in information technology that have 
reduced the high cost of access information about small 
business creditworthiness. Lending relationships and credit 
scoring techniques have changed the face of small business 
lending. The result, says Dr. Chad Moutray, Chief Economist for 
the Office of Advocacy at the SBA, is a financial market that 
tends to efficiently allocate capital to small businesses.
    Another way to assess the relevance of the 7(a) loans is to 
analyze its role in the market. If there is a serious need for 
these loans and if the SBA is doing a good job meeting these 
needs, then the SBA's lending share should be quite large. But 
looking at the flow of 7(a) loans, we find, first, the SBA is 
largely irrelevant in the capital market. In a given year, 
roughly one percent of small business loans are SBA loans. The 
private sector finances most loans without government 
guarantee.
    Second, there is no shortage of firms or new start-ups in 
America. The data suggests that even if the 7(a) loan program 
did not exist, entrepreneurs would start new businesses at the 
same rate they do now.
    Third, in 2004, 29 percent of 7(a) loans went to minority 
business owners, but SBA distributed loans to only 3 percent of 
all minority-owned firms that got loans that year. The same 
trend is true for women-owned firms.
    I have been criticized for looking at small business 
lending as a whole. I am told that long-term borrowers are the 
real target that SBA hits upon, not every small business out 
there, but a company that needs long-term financing.
    First, where in the SBA mission does it say that long-term 
borrowers and not small businesses as a whole are its target? 
Well, it is easier to redefine targets rather than address my 
charges. Even in SBA's artificially-defined market of long-term 
loans, the private sector provides 60 percent of such loans 
without the Federal guarantee.
    Second, the literature on the topic indicates that the 
length of the loan doesn't really matter. A small business that 
wants a long-term loan will get a loan with shorter maturity 
and then get it renewed as many times as it takes to meet its 
long-term need. If conventional and SBA lending provide the 
same result, it does not matter if the loans are successive 
short-term ones or a single long-term loan. On the other hand, 
a fairness issue clearly arises.
    To conclude, all of the evidence points in one direction. 
The 7(a) loan program is not having a significant positive 
effect on the market. To prove me wrong, SBA advocates should 
measure the performance of the 7(a) loans based on outcome. It 
should include an analysis of their effect on economic growth 
and a comparison of the benefits of the program to its long-
term cost, all of its cost, whether it is oversight, default, 
all of its cost. What it should not include is a count of the 
number of jobs created. The mere creation of jobs is not an 
appropriate economic policy objective because you can add jobs 
to an economy, yet it creates no value.
    Measuring the performance of SBA loans should also include 
looking at who are the true beneficiaries of the program. My 
research points at 10 of America's biggest banks, not small 
businesses.
    Entrepreneurship is one thing that Americans definitely 
know how to do without the government's help. Small businesses 
are doing a great job and will continue to do so with or 
without the SBA. Thank you.
    Senator Carper. Thank you, Dr. de Rugy. Our final witnesses 
is Mr. Wilkinson. Mr. Wilkinson, you are recognized.

   TESTIMONY OF ANTHONY R. WILKINSON,\1\ PRESIDENT AND CHIEF 
     EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF GOVERNMENT 
                       GUARANTEED LENDERS

    Mr. Wilkinson. Thank you, Mr. Chairman and Senator Coburn. 
I appreciate the opportunity to testify today. You do have my 
written testimony. I would like to include, if SBA has not 
already, a copy of the Urban Institute report on the 7(a) and 
504 programs.
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    \1\ The prepared statement of Mr. Wilkinson appears in the Appendix 
on page 81.
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    Senator Carper. Without objection, it will be included.
    Mr. Wilkinson. Thank you very much. I would like to state 
some facts about the 7(a) program, many of which are 
highlighted in the GAO report.
    First, the SBA 7(a) and 504 programs annually provide the 
small businesses over 40 percent of their financing needs with 
maturities of 3 years or greater. This makes SBA the single 
largest provider of long-term credit to small business in this 
country.
    Another fact is that SBA programs are not meant or designed 
to replace all other forms of credit to small business. From 
the Urban Institute report: one, they have a definition of the 
SBA market segment as small businesses that have a demand for a 
loan; two, met the credit elsewhere requirement; and three, 
were as creditworthy as other firms that receive small business 
loans.
    It is simply incorrect to argue that the program is not 
doing its job or meeting a specific need. The examples of SBA's 
program successes are innumerable and range from small local 
companies like Eskimo Joe's, that Dr. Coburn knows well, to 
large conglomerates like Nike and Columbia Sportswear. Each of 
these companies is an example of SBA programs helping companies 
provide stable employment, improved technology, and national 
productivity.
    Next, the small business capital market cannot be 
considered to be well-functioning as segments of creditworthy 
businesses are denied access to credit on reasonable terms and 
conditions. The SBA programs provide credit to minority-owned 
businesses at a rate that is three times that of conventional 
lending. This fact is supported by the GAO report and the 
recently published Urban Institute report. In addition, 25 
percent of 7(a) loans went to small business start-ups, while 
the overall lending market served almost exclusively 
established firms. Also, 49 percent of 7(a) loans made in 
fiscal year 2006 went to geographic areas that SBA considered 
underserved by the conventional market.
    Next, according to CBO and SBA, since the beginning of 
credit reform in 1992, borrowers and lenders have paid well 
over $1 billion more in fees than was required under the 
Federal Credit Reform Act. That Act assures that the taxpayer 
has no estimated liability for 7(a) loans.
    With respect to the concern that 7(a) loans have an 
inordinately high default rate, it should be noted that 
according to the President's fiscal year 2007 budget 
submission, the repurchase rate on 7(a) loans is projected to 
be 6.96 percent for the entire life of the cohort, less a 52 
percent recovery rate. The annual default rate for conventional 
loans is typically in a 0.25 to 0.5 percent range. While there 
appears to be a significant disparity between the repurchase 
rate and the conventional default rate, it should be noted that 
it is an inaccurate comparison. The 7(a) repurchase rate 
represents the life of the lending pool while the commercial 
default rate is for one year.
    So to make an apples-to-apples comparison, the effective 
life of a 7(a) cohort is about 7 years, making the 7(a) annual 
loss rate, using the banker method, of less than 0.5 percent 
per year. This compares favorably to the conventional small 
business loss rate and is far better than the credit card loss 
rate that annually runs 4 percent or greater.
    One frequently overlooked fact is that the program mandates 
that all lenders, whether they sell loans or not, are 
responsible for prudent loan making and prudent loan servicing. 
SBA's guarantee is a contingent guarantee, which means that if 
a lender fails to fully meet its responsibilities, SBA can and 
does reduce the amount of the guaranteed payment to lenders. 
Therefore, the very nature of the guarantee relationship serves 
to assure that lenders engage in quality lending.
    Last, I would like to read the conclusion from the Urban 
Institute report, two short paragraphs. The SBA loan programs 
are designed to enable private lenders to make loans to 
creditworthy borrowers who would otherwise not be able to 
qualify for a loan. As a result, there should be differences in 
the type of borrowers and loan terms associated with SBA 
guaranteed and conventional small business loans. Our 
comparative analysis shows such differences.
    Overall, loans under the 7(a) and 504 programs were more 
likely made to minority-owned, women-owned, and start-up 
businesses, firms that have historically faced capital gaps, as 
compared to conventional small business loans. Moreover, the 
average amounts for loans made under the 7(a) and 504 programs 
to these types of firms were substantially greater than 
conventional small business loans to such firms. These findings 
suggest that the 7(a) and 504 programs are being used by 
lenders in a manner that is consistent with SBA's objective of 
making credit available to firms that face a capital 
opportunity gap.
    Mr. Chairman, that concludes my remarks and I would be 
happy to answer questions.
    Senator Carper. Good. Thank you very much, Mr. Wilkinson.
    I think it was Harry Truman who used to say the only thing 
that is new in the world is the history we never learned. I 
want us just to go back to the beginning of this program, which 
I believe had its genesis in 1953, and I am not sure who to ask 
to respond, but just explain to us why the program was created, 
the 7(a) program, what purpose it sought to meet, and then just 
share with us some of the major changes that have occurred in 
the program, most recently, I think, in 2005, and I think 
legislation may have been introduced today by Senators Olympia 
Snowe and John Kerry that would make some further changes in 
the program.
    If somebody can share with us a brief outline of those 
changes, I would appreciate that. But let us just have a little 
bit of a sketch going back. What was this program supposed to 
accomplish in 1953? How has it changed over the years, Dr. 
Shear?
    Mr. Shear. Sure. Nineteen-fifty-three, when the Small 
Business Administration was developed, it had an overall 
mission of helping support the small business sector. So I will 
just start with that mission of the overall agency, and I think 
it is relevant to this hearing because some of the objectives, 
based on the legislative history, what we tend to focus on, let 
us say they kind of differ a little bit across the table here. 
I will put it that way. But the overall was to support small 
business and its role and its vibrancy in the national economy.
    The 7(a) program, when it was created, the objectives are a 
little bit more specific. I am not quite sure exactly when the 
specific objectives that we are addressing in our report came 
into being, but it became more toward trying to serve borrowers 
that couldn't get credit at suitable terms elsewhere. So I 
think that has been around for a long time. I don't know if it 
goes back to 1953.
    I will jump forward to more current history. In the 1990s, 
one thing that happened at SBA that was typical of Federal loan 
insurance and guarantee programs, and for that matter--and I 
will stick to those, was that for efficiency reasons and 
because of technology, government agencies started delegating 
authority to lenders to make decisions that the Federal 
Government used to make in terms of approving loans and the 
whole loan process.
    Much of our work over the years, like through the 1990s, 
was looking at when SBA delegated this authority to lenders, it 
did not--it forgot the lender oversight part and it has been 
largely since 1998 that SBA has made inroads in terms of lender 
oversight. And I think it is relevant to this hearing because 
when you have the Federal Government at risk, it is important 
to make sure that the Federal Government's risk exposure is 
limited and also that the mission of the program, because they 
serve a public mission, and you have this delegated authority 
to lenders, is being followed.
    Now, more recently, going into recently, it used to be what 
is called the subsidized program, that based on credit reform, 
which came in in the 1990s where you are in a world of 
estimates, and that is one of the other topics that is in our 
report--Mr. Wilkinson talked about it--is that starting in 
2005, it went from a program with a positive subsidy to a 
program with a zero subsidy----
    Senator Carper. Starting when? Two-thousand-and-five?
    Mr. Shear. Two-thousand-and-five was the first year of zero 
subsidy.
    Mr. Wilkinson. That is correct.
    Mr. Shear. Now, part of the question here is that it is 
probably going to change the dynamic of how SBA serves 
borrowers and even begs the question even further, how can SBA, 
when it changes the programs, when it introduces new elements 
of the program, which is how is it going to affect the 
borrowers that ultimately are going to be served? How are 
lenders going to react to that? And how is SBA going to measure 
how well it is serving its mission, specifically to serving 
borrowers that can't get credit elsewhere in the conventional 
market? So it is kind of a new paradigm with some of the new 
programs, with the zero subsidy, and the whole question of the 
credit elsewhere test becomes more important than it has been 
in the past.
    I hope I didn't sound too much like a college professor.
    [Laughter.]
    Senator Carper. Does anyone want to add or take away from 
that history?
    Mr. Wilkinson. Well, fortunately, I can say that I have not 
been around since 1953. I have been active in the program since 
1986 and I think Mr. Shear did a very nice job of explaining 
where this program has come from.
    Loan volumes did not pick up in this program until the late 
1980s and then into the 1990s when SBA embarked on what it 
called its quality lending era and really tried to clean up 
underwriting issues and the program has blossomed since then. 
And over the last 15 years or so, SBA every year seems to come 
up with a way to streamline loan processing, and they are 
getting better and better every year, and that has helped 
attract lenders to the program.
    As Mr. Shear talked about being on appropriations, that was 
an annual fight to go get money that ultimately, as you look at 
the reestimates in the budget every year, we were fighting for 
money that we sent back to Treasury. Everybody finally figured 
that out and we have gone to a zero subsidy.
    Senator Carper. Was that in 2005?
    Mr. Wilkinson. That would have been part of the omnibus 
appropriation bill that was signed into law in December 2004, 
so for fiscal year 2005----
    Senator Carper. All right.
    Mr. Wilkinson. [continuing]. Was the first year we went to 
zero subsidy. Before that, we were subject to all kinds of 
program stops and program restrictions. We capped loan sizes, 
all kinds of things that forced lenders away from the program 
and left many borrowers where they could not get any financing 
at all. Since going to zero subsidy in December 2004, we have 
not had any stoppages or caps and we have been able to lend at 
the authorized level.
    Senator Carper. All right. How do you measure success? I 
asked something about whether it is a government program or 
something outside of government, a lot of times I will ask 
people, how do you measure success in what you are doing, and 
how do we measure success with respect to the 7(a) program, and 
how should we measure success?
    Mr. Hedgespeth. Well, we currently measure success--and I 
think this is a point we will agree to--in many ways in terms 
of measuring not outputs, but, in fact, the building block to 
outputs, that we measure things like new loans approved to 
start-up businesses, loans funded to start-up small businesses, 
the number of loans approved to existing small businesses, the 
number of loans approved to small businesses facing specific 
opportunity and competitive gaps, such as has been testified to 
as women-owned, minority-owned firms.
    We also do track jobs and we track jobs with the firms our 
borrowers themselves reporting to the banks, some 300,000 of 
them since the program's inception on the jobs that they are 
adding as a result of the funding that SBA provided. In 2006--I 
am sorry, in 2007, that number was 206,600 jobs. This year, our 
numbers are going to come in somewhere around 300,000 for the 
fiscal year that just ended. That is substantial economic 
activity proving the success of this program.
    Now, we have tried in the Urban Institute data study to 
stretch that out to what happens in successive years and those 
are measures that we are going to continue to look at to see 
that we can track small businesses. It is very difficult data 
to obtain and our consultant, the Urban Institute, had trouble 
in the process themselves. But we are committed to continue to 
try to track our firms.
    Senator Carper. All right. Let me just basically ask, and I 
would ask you to be brief in responding, but how should we 
measure success in this program? Mr. Hedgespeth has been good 
to run through a variety of--but how should we? Let me just 
start with Dr. Shear.
    Mr. Shear. Okay, thank you. We recommended at a minimum 
that now that SBA has technologically, through Dun and 
Bradstreet, the ability to look at how well the borrowers are 
doing and how long they stay in business, at a minimum, you 
measure success by those borrowers that you are reaching. Are 
they successful at staying in business? Are they defaulting on 
their loans? Are they prepaying after a period of time, which 
could be a success of the program that you would say that these 
firms that have been helped have been able to kind of graduate 
to conventional credit? So at a minimum, we would look at that. 
Some of the other measures would probably require some 
reference to the conventional lending market, and I will stop 
my answer at that for now.
    Senator Carper. All right, thank you. Dr. de Rugy, how 
should they measure success? I realize that in your testimony 
that this is not a program that you are especially enamored 
with, but if we are going to have this program, how should we 
measure success?
    Ms. de Rugy. We certainly shouldn't measure it the way the 
SBA is measuring it. Everything I have heard is, in fact, a way 
to count something, but it is not counting success, like 
counting the number of jobs that were created in a given year. 
If we don't know what is happening the next year, it is not 
very useful.
    What we need to know, considering what I understood to be 
the goal of the 7(a) loans, which is to give credit to people 
who are overlooked by commercial banks and who, in fact, could 
be creditworthy, or are creditworthy even though they don't 
look creditworthy, and to see how much economic growth--I mean, 
the reason why we want to give money to these people is because 
we are told they can generate economic growth, so that is what 
we need to measure. And it is really hard, but this is what 
outcome measuring is about. It is not just like looking at--
there is one job created this given year and so we need to have 
first a much more dynamic perception of what is being created.
    But more importantly, we need also to measure, to actually 
take this benefit of the program and measure it against the 
cost of the program, and that means the cost of the default, 
which now supposedly are covered by this zero-subsidy fee and 
the lender fee, but also the cost of the oversight of the 
program. We need to take under consideration what happens if 
the economy tanks, which is--I mean, I am in the United States 
because I believe this is a country where that will not happen, 
but if it does happen and all or a vast majority of SBA 
borrowers default at the same time, right at the moment where 
the Federal Government is going to have to pay a higher 
unemployment benefit and things like this, I mean, we need to 
take under consideration this cost. It is not only about 
measuring what has been spent, it is also about measuring it 
against what it cost.
    Senator Carper. Thank you. We can go back in time, I think, 
to 2001 where most people say the economy tanked pretty low.
    Ms. de Rugy. Yes.
    Senator Carper. It would be interesting to look back at the 
data and see what happened.
    Ms. de Rugy. Actually----
    Senator Carper. My time is expired and I am on Dr. Coburn's 
time, so let me just ask Mr. Wilkinson to respond and then I 
will give it to Dr. Coburn. Thank you.
    Mr. Wilkinson. I think it would be helpful to know exactly 
what it is we are looking for, as well. I hear the term, what 
the effect is on economic growth. I am not quite sure what we 
are after. The SBA has all kinds of data. I know I can tell you 
today what our currency rate is, what our repurchase rate has 
been, what our loss rate has been going back in time. We know a 
lot of this information. Where we are supposed to operate in 
terms of inside that information, I have asked several times 
for, like what is a target delinquency rate? Some would argue 
that today we are already too low, that we are missing some 
borrowers that we should be helping.
    But that said, one of the measurements of success for us as 
lenders is we have borrowers who are paying their loans on 
time, and the vast majority of 7(a) borrowers are paying their 
loans on time. And I can tell you another measurement of 
success for us would be the number of start-ups that we finance 
because we are able to use the SBA program that we simply 
cannot do under a conventional basis. So there are a whole 
bunch of start-up businesses that are out there today that 
would not be there if we did not have a program like the 7(a) 
to help them out.
    Senator Coburn. Let me jump in on that for a second.
    Senator Carper. Yes, jump right in.
    Senator Coburn. If they are creditworthy--under the law, 
they are supposed to be creditworthy--why can't you finance 
them? Is it that you choose not to or that you choose only if 
you have got a government guarantee to finance them? And if 
that is the only reason you are financing them, then you have 
violated the law in terms of creditworthiness. We have been 
talking about the wrong things here. The SBA program is very 
clear in what it is supposed to do and the measurement of 
outcomes, as the GAO has said, are not there.
    You are talking about outcomes measurement if you are doing 
business in the SBA and the SBA is talking about how many loans 
they do and how fast they do them and how easy it is to 
process. That is not the outcomes that we are looking at and 
talking about in this hearing.
    Mr. Wilkinson. What outcome are we looking for?
    Senator Coburn. There is a Federal law. It is called GPRA, 
and it requires every agency--this agency has known about it 
for 15 years--to develop outcome measurements. Now, what the 
law says is we are to be creating through SBA loans to people 
who are creditworthy who are missed by conventional lenders. 
That is what the purpose of the SBA is. That is what the 
statute says. The statute also says under GPRA, which is the 
Government Performance and Results Act, is every agency will 
develop outcomes. There is no outcome that has been developed 
by SBA.
    That is why we are having the hearing. It is not that we 
don't want to do SBA loans. It doesn't have anything to do with 
it. It has to do with you cannot manage what you don't measure, 
and if you measure something that is not an outcome but is just 
a performance indicator of how far you do outputs, you wouldn't 
loan money to any business in Oklahoma that was doing that 
because you would be saying they are measuring the wrong thing.
    So the purpose of the hearing today, and I thank you for 
the history because I think it tells a whole lot of why we are 
not in compliance. We are not trying to shoot anybody here. We 
are trying to make sure every branch of the Federal Government 
and every agency understands that because of the tremendous 
impact of dollars that are going to be coming our way in terms 
of the baby boomers under entitlement spending, every agency 
has to be able to manage what it does well. The testimony from 
the GAO says that there is not one performance outcome measure 
that meets GPRA done at the SBA, and I don't think that--am I 
stretching that?
    Mr. Wilkinson. Mr. Shear just said one of the performance 
measures he would like to see is how well borrowers are doing. 
What does that mean? I can tell you how current they are.
    Senator Coburn. No. What it means, in light of what the 
goals of the program are, how well are we doing filling the 
need for those people who are creditworthy but yet can't get 
financed, and that is the goal. If you look, this is a real 
revealing chart in the testimony by GAO. It shows 
creditworthiness and then it shows versus comparable 
conventional credit and you see a shift towards a lower 
creditworthiness in SBA lending. But the law says and the 
intention of SBA is to loan money to people who are 
creditworthy who can't get conventional credit.
    So what we are asking for, and the whole purpose for trying 
to have this hearing is to try to get SBA to say, yes, we don't 
have an outcome measurement that we are using every month in 
complying with the Government Results and Performance Act to 
say, here is how we can know what we are doing. What that 
measurement is, is we know we are loaning more money, we know 
maybe the performance rate on it is better. We know we are 
probably helping more people than what we were. But the 
purpose--what has to be measured is what is the sphere of 
people who are creditworthy who cannot get money. That is the 
goal. So you have to measure the results against that goal.
    There is no question the SBA has done a good job of 
improving a lot of things inside SBA. They have done a good 
job. All the bankers in Oklahoma tell me that. That is not what 
I am trying to get to here today. I am trying to get us to a 
point where we are measuring so we know what we are doing 
within the confines and direction of what the SBA is supposed 
to be doing with its 7(a) loan program, and that is loaning to 
people who are creditworthy who cannot get loans.
    Mr. Wilkinson. The default teste that we would use is if I 
am a borrower who could get conventional financing without the 
SBA guarantee, I would do so because I don't have to pay a SBA 
guarantee fee. If I can't get financing conventionally, then I 
would accept----
    Senator Coburn. So then how do you explain the risk curve 
that is shown here by the GAO?
    Mr. Wilkinson. I don't know--which page are you on?
    Senator Coburn. It is page 29 of their report. What they do 
is compare the percentage of loans made based on 
creditworthiness.
    Mr. Hedgespeth. If I may, Dr. Coburn, the interesting thing 
about the way the GAO used that report and those statistics, I 
would actually agree with you to say that is justification 
that, in fact, we are serving that niche that is just beyond 
conventional financing but wouldn't qualify using regular bank 
tests. The GAO looks at that same data and says there is no 
difference between the SBA data and conventional lending data. 
So I would absolutely agree with you.
    And what is important about that, and really to the heart 
of your question, how do you know you are meeting the credit 
elsewhere test and lending to creditworthy borrowers? Because 
the standard SBA term is longer than the conventional term, it 
actually makes more deals work. So you have a borrower--I 
mentioned in my testimony where net operating income is a 
critical measure of whether or not a loan is approved, and 
these are constraints that are put on banks by their 
regulators.
    Senator Coburn. Okay. So here is a measurement. The law 
says the Small Business Act prohibits anyone from getting a 
7(a) loan who can get credit from another source, right? That 
is the law. It is what it says. How does SBA make sure that 
provision is followed and that lenders are not giving loans to 
businesses who can get some credit somewhere else? Are there no 
businesses who have gotten a 7(a) loan this last year who don't 
have a credit elsewhere that they would have qualified? Where 
is the measurement on that?
    Mr. Hedgespeth. I agree that is something that we 
absolutely have tried to do and tried to measure within the 
Urban Institute study to establish a baseline----
    Senator Coburn. But the Urban Institute study doesn't 
count. Under GPRA, you have to say what your outcome 
measurements are and then you have to report and perform on 
what those outcome measurements are. You can't just have a 
study and say, here is what the Urban Institute says. You have 
to, under the law, set that up.
    When is SBA going to set up a set of outcome measurements 
that coincide with what SBA's legislative intent is and then 
manage it based on the measurement of those outcome measures?
    Mr. Hedgespeth. Well, again, I am somewhat the new kid on 
the block----
    Senator Coburn. I know you are, and my frustration isn't 
with the SBA. My frustration is we know we have $250 billion of 
waste, fraud, abuse, or duplication just in the discretionary 
portion of the budget, and so I am working hard in every area 
at every level to make sure--not to go after agencies, just to 
say are you measuring and are you managing based on what you 
are measuring? Every bank does that. Every business does that. 
And we ought to have every aspect of the Federal Government 
doing that. And besides, it is the law and SBA has been in 
noncompliance for 15 years under GPRA.
    Mr. Hedgespeth. Well, I know that the Urban Institute 
study, the discussion of it started in 2003, and the intent of 
commissioning the study was to allow us to have a baseline so 
that we could, in fact, then look at which performance measures 
made sense. We had them investigate a number of different 
possible scenarios to try to see where we could have a 
methodology that is repeatable and where we can, in fact, put a 
goal for ourselves that you could hold us accountable for.
    We absolutely are not resistant to that, and as Director of 
the Office of Financial Assistance, it is going to be my 
responsibility to help the agency think through this report and 
to establish measures that we can feel that we can be held 
accountable.
    Senator Coburn. See, the question that somebody like Dr. de 
Rugy would ask is if you look at measuring credit elsewhere, if 
you are not looking at that, you don't know if the people in 
the market need the SBA or the banks need the SBA. You won't 
know. And so do we have the SBA as a program for banks or do we 
have the SBA as a program to truly meet that part of the 
capital need for creditworthy individuals who are passed over 
by the banks?
    And what has happened, good steps have moved to try to 
change that. How do we measure credit elsewhere worthiness, and 
is that a performance measure, and how do you set, here is what 
we want it to be, here is what the law says the requirements of 
SBA loaning are, and how are we going to compare how we are 
doing every year to that?
    It is not how much money we loan. The real deal is how much 
capital formation came out of a SBA loan? That is what the real 
deal is. And it is not jobs. It is how much long-term capital 
formation, how much innovation created capital came out of 
that. Jobs are a measure of that. But what we are really 
getting to is what do we do in terms of growing our economy in 
terms of capital formation, because that is the ultimate 
measure.
    Does everybody in the lending community ascertain and 
certify--I know they certify, but do they actually do the work 
on credit elsewhere?
    Mr. Wilkinson. Well, they have to certify on the 
application that they would not make that loan under the 
similar terms and conditions.
    Senator Coburn. Okay. But does that mean credit elsewhere 
or just for that one lending institution? In other words, if we 
have one lending institution that----
    Mr. Wilkinson. One lender couldn't certify what another 
lender might or might not do.
    Senator Coburn. Okay. So we are really not talking about 
credit elsewhere. We are talking about credit at the one person 
that is applying for the SBA loan, which is the whole point. If 
you go back to what the statute says, it talks about you have 
to determine that there is no credit available elsewhere, not 
just at the one lending institution. The one lending 
institution has an obvious bias. They are going to get a loan 
to somebody that they otherwise wouldn't loan to without the 
SBA, right?
    Mr. Wilkinson. So how many institutions should a small 
business be forced to go----
    Senator Coburn. I don't know, but----
    Mr. Wilkinson. [continuing]. To establish that fact?
    Senator Coburn. That is the question that SBA should set up 
to establish whether it has met the goals of the legislation. 
That is the outcome measures. And how are we ever going to know 
if we are not looking at that?
    I am not critical. I know a lot of positive--you listed 
lots of anecdotal evidence of companies in Oklahoma that have 
grown mightily because of an SBA loan. That does not prove the 
fact that they might not have gotten one somewhere else. They 
just didn't.
    Mr. Wilkinson. Well, I can tell you as a lender, there are 
several that were not going to get any financing if it were not 
for the SBA.
    Senator Coburn. Okay, and I don't dispute that, and I am 
not saying that anecdotally that doesn't say that. But where is 
the measurement of all those that are successful versus all 
those that aren't and what has been the overall impact in terms 
of capital formation? So we are asking the agency, there is a 
Federal law that says you have to do this. One, you are out of 
compliance on that. GAO says that. You all know you are out of 
compliance on GPRA and you have been, even though you got a 
PART score, which I talked to OMB, how did they get a PART 
score if they are out of compliance on GPRA, which that tells 
you that maybe the PART program has a hole in it, as well. 
Would you like to comment on that, Mr. Shear?
    Mr. Shear. I really can't----
    Senator Coburn. You don't want to----
    Mr. Shear. [continuing]. Comment specifically. No, that is 
specifically about how PART assesses the SBA program and 
whether--I know that when PART goes in and takes a look 
generally at programs, it looks for performance measurement. 
But specifically, the PART assessment on SBA, I am just not 
equipped to react to it.
    Senator Coburn. Okay.
    Ms. de Rugy. Can I ask a question?
    Senator Coburn. Sure.
    Ms. de Rugy. In terms of measurement, I think--of the 
outcome, I think it is one thing to be able to prove that the 
people wouldn't be able to get credit elsewhere, but I think 
what is also very important is to prove that this person who 
really couldn't, that it was cost effective for taxpayers to 
take that risk with that person.
    Senator Coburn. Well, that is fine, but if we do a 
performance, they are supposed to be creditworthy, right?
    Mr. Wilkinson. Yes.
    Ms. de Rugy. But my question is--while I am listening to 
all this --what is the mechanism that makes a bank suddenly, 
because there is a guarantee, capable of assessing the 
creditworthiness of a person while they weren't before, because 
the theory, right, is that this person is going to be 
overlooked as uncreditworthy or not worth taking a risk, and 
that is an information problem. What explains that suddenly you 
are capable of making this assessment that this borrower is 
creditworthy? I am absolutely confused.
    Senator Coburn. Well, no, the difference there would be is 
we believe that we will take this credit risk because we have 
got some help in sharing the risk of it.
    Mr. Wilkinson. Correct.
    Senator Coburn. I mean, that is the calculation.
    Ms. de Rugy. But then the question is not that we weren't 
able to identify that this person was creditworthy, so we were 
before but we were not willing to take that risk.
    Senator Coburn. The difference, and here is the difference, 
and maybe Director Hedgespeth can comment on it. Sometimes 
banks will take a risk but at an interest rate that kills the 
viability of the project. So that is where the calculation 
comes in, is at 12 percent when the prime rate is 6 percent, is 
it a viable business loan, versus at a rate of 9 percent when 
the prime rate is 6 percent with a government guarantee, you 
now have something that is capable.
    So you raise a real question about what do we mean by 
creditworthy. Creditworthiness changes depending on the risk 
and the loan rate in terms of payout and carrying the interest. 
Can you carry this at 12 percent? No. But if you got an SBA 
loan, you can carry it at 9 percent, and the bank is ready to 
move you down. That is why we see so much go into it, because 
the mix of the payment goes down and makes it affordable. So I 
am not having any real problems with that.
    I just want to get back. Does the SBA under your new 
Director have plans to put outcome, not output, outcome 
measures in at the levels for performance for 7(a)?
    Mr. Hedgespeth. I absolutely hope that during my tenure we 
are going to absolutely do that. The Urban Institute study is 
something we want to digest and look at the pieces that make 
sense in terms of having a repeatable, sound methodology that 
will give you, as well as the rest of the Members of Congress, 
a confidence that we have an outcome measure that is not 
subject to misinterpretation or manipulation, as is required by 
the PART, and that gets to the heart and soul of what our 
mission is. That is absolutely our desire.
    Senator Coburn. As I look at the Urban Institute study and 
read that, I think what it shows is you are reaching your 
intended market. I don't think there is any question about it.
    Mr. Hedgespeth. Thank you.
    Senator Coburn. But what it doesn't say is whether or not 
you are actually having a positive impact. There is no 
assessment in that Institute study on a positive impact, 
especially if you use it in terms of long-term capital 
formation, and that has to be our goal. And it is going to take 
creative people in your agency to say, and good economists to 
say, how are we going to measure whether or not this is really 
having an impact? There is no question in isolated instances we 
have a tremendously positive impact on long-term capital 
formation, but how is the program doing as a whole?
    And that is our job up here, is to look at programs and 
make sure we have performance measures and outcome measures so 
that did we accomplish what we intended to accomplish when we 
put the American citizens at risk. I mean, that is what it is 
really about.
    Over what period of time should the SBA be required to come 
back and have outcome measures?
    Mr. Hedgespeth. I am not sure I have a good or adequate 
response because we want to make sure that we have both 
measures that work and that you will be comfortable with, and 
also knowing that it took us since 2003 just to get this first 
baseline, I don't think waiting another 4 years is going to be 
acceptable to you.
    Senator Coburn. No, sir, it is not.
    Mr. Hedgespeth. And so that is something that I would hope 
that you would allow us to respond more fully in follow-up 
remarks to this Subcommittee as we have had a chance to digest 
it.
    Senator Coburn. Fine. And, see, I don't want us to have to 
have another Subcommittee hearing on this. What I would like is 
for us to have an agreement that the SBA is going to, like on 
an every 3-month basis, give Senator Carper and I, here is 
where we are, here is where we are going, here is what our goal 
is, and here is--in other words, put some performance measures 
on outcomes on getting to that. Design it, put the metrics on 
it, and say here is where we are going and here is how we are 
doing.
    Mr. Hedgespeth. Well, I think you know this Administrator 
is very fond of metrics that hold the agency accountable and 
that seems totally within the spirit of his leadership.
    Senator Coburn. Thank you, and I have gone way over my 
time. Thank you, Mr. Chairman.
    Senator Carper. Mr. Wilkinson, talk to us, if you will, 
about some of the things that your members working through the 
7(a) program are doing to help business. Just give us some 
examples.
    Mr. Wilkinson. Well, again, we are lending it to new 
business start-ups and to early stage companies at a far 
greater rate than the conventional market is, so we are----
    Senator Carper. Quantify that for us, if you will.
    Mr. Wilkinson. Quantify that?
    Senator Carper. Yes.
    Mr. Wilkinson. Minority lending is about three times 
greater in the 7(a) program than it is in the conventional 
market. About 25 to 35 percent of our 7(a) loans are going to 
new business start-ups, and in the conventional market, that is 
almost non-existent. A very small percentage of conventional 
lending goes to a new business start-up and SBA uses new 
business start-up to mean a brand new business up to 2 years, 
so a very early stage company.
    So we are helping the youngest firms get off the ground, a 
wide variety of industries, from service to retail, you name 
it, we will do it. And the SBA guarantee provides that extra 
credit enhancement that allows a lender to make a deal, and we 
think we have done a fabulous job. We think we are making all 
kinds of loans to small businesses that are generating jobs and 
creating capital formation and we welcome the opportunity to--
--
    Senator Coburn. We just don't know that, though.
    Mr. Wilkinson. Right, but we will welcome the opportunity 
to work with you and the SBA to come up with how we would 
measure that. I know SBA has Tax ID numbers on every business 
we finance, and I don't know whether they can access tax return 
records, etc.
    Senator Coburn. No, they can't.
    Mr. Wilkinson. But let me just say, we are happy to work 
with you on coming up with outcome measurement.
    Senator Carper. Okay. Let me just ask those of you who run 
these 7(a) programs from the banking side, what do you offer 
that the conventional market cannot offer?
    Mr. Wilkinson. A loan. Typically, they cannot find----
    Senator Carper. No. My guess is that folks can get a loan 
in a lot of cases, but the interest----
    Mr. Wilkinson. Well, sometimes what----
    Senator Carper. [continuing]. And my guess is----
    Mr. Wilkinson. The other part of that answer would be we 
would finance a long-term asset with a long-term loan as 
opposed to making a borrower come back every 30 days and renew 
a loan. And for those of us that have lived through the 1980s 
in Oklahoma, we know a lot of small businesses got clipped 
because they had loans with maturities, loans that did not 
match the term of their asset, and so even though they had a 
long-term asset, they had a short-term loan and they couldn't 
get it renewed by any lender in the State. What the SBA program 
does is finance a long-term asset appropriately with a long-
term loan.
    Senator Carper. Okay. Dr. de Rugy argued in her testimony 
at one point that many small businesses, including some who 
receive these 7(a) loans, I presume, have the ability to obtain 
credit really from conventional lenders. She mentions credit 
cards as one option.
    As an aside, we have a new recycling program in the City of 
Wilmington, curbside recycling. We put all the recyclables into 
a single stream. Containers are picked up every week. They are 
actually picked up and the folks who do the pickup who used to 
just pick up trash to go to the landfill, now once a week they 
pick up the recyclables. They have device barcoding. They 
measure how much weight is in everybody's can, if you will, and 
barrel and they credit back to the individual residents points, 
something like a frequent flyer system, and you earn points 
which can be used for restaurant discounts, theater tickets, 
all kinds of stuff. It is actually a very clever program. The 
folks who actually collect the recyclables sell them and 
actually make money now with better prices for commodities.
    But the guy who started the part of the business where they 
do the incentives for folks to recycle, he actually started his 
business with a bunch of credit cards and that is how he got 
started. It is interesting. I have talked to any number of 
entrepreneurs who got started and get all these credit card 
applications in the mail. Most people just throw them away or 
shred them, and some people save them and they use them, as you 
know, to start small businesses.
    But Dr. de Rugy mentioned credit cards as one option. She 
also says that potential borrowers might have better luck over 
time if they build a relationship with their bank, and I would 
just ask for our other three witnesses, what are your thoughts 
with respect to that argument? What steps does the Small 
Business Administration and lenders that it works with take to 
make sure that businesses that truly don't need 7(a) loans 
don't get them?
    Mr. Shear. Grady is looking at me. I will start.
    [Laughter.]
    One of the most, if you just go back to what we cite in the 
paper, Stigletz and Weiss which deals with what economists call 
asymmetric information, lack of information in the marketplace 
that might cause the market imperfections, lack of credit, it 
would be start-up businesses. It is probably one of the most 
logical places to look first if you want to have a credit 
guarantee program such as this.
    But one of the reasons to kind of follow how well do those 
businesses do and what is the track record here is the question 
of whether businesses are kind of graduating when you would 
expect them to rather than them using the loans as like bridge 
loans and things like that. So some of it is just looking at 
the portfolio.
    But one of the important things of credit elsewhere here is 
coming up with a working definition. Over all the years we have 
been looking at lender oversight issues, we have failed to see 
a really transparent credit elsewhere test, ever since going 
back to the early 1990s when they just said, come in with three 
lenders that you were denied a loan. Well, the world is a 
little more complicated now, so part of this is getting a 
focus. What is the expectation from lenders to make sure that 
it is credit that really supplements what is going on in the 
marketplace and trying to identify, what niche are you trying 
to serve and what evidence do you have that businesses might 
need that help and be able to graduate from that help over time 
versus businesses that might just say, well, the bank doesn't 
want to give them a 10-year loan with a 10-year maturity 
without a guarantee. Well, it might be what types of businesses 
can do well maybe with shorter-term credit.
    So this is the type of evaluative approach that we are 
trying to get at, and if nothing else, we would like more 
transparency in how the credit elsewhere test is being applied.
    Senator Carper. Would anyone else want to respond to the 
comments on this point by Dr. de Rugy?
    Mr. Hedgespeth. I definitely would like to speak to this 
credit elsewhere and creditworthiness test. I mean, the very 
fact that the overall balance of the SBA portfolio pays back 
really pretty close to the overall pay-back rate of 
conventional lending strongly suggests that these are 
creditworthy borrowers.
    Senator Carper. What is the default rate, about 7 percent?
    Mr. Hedgespeth. That is the repurchase rate, but as the 
overall long-term default rate, at least right now, I have it 
running at 2.49 percent, but that is over the entire life of 
the loan, and as Tony testified, when you look at banks, they 
are doing it on a year-by-year basis. So either you accumulate 
their stuff up to a total or you take our total and work it 
back in terms of one-seventh of the amount that we have as a 
default rate and you get to be very close in terms of payout 
history.
    But this issue of can you overcome the lack of willingness 
for a bank to lend under their conventional standards by 
somehow getting to know the bank better and to develop a 
relationship, I can tell you from my experience in Boston in 
helping to open up inner city markets to Bank Boston, to Bay 
Banks, to Fleet Boston, that they had a friend at the bank. 
They had me. But it took a partnership with the SBA to get our 
credit folks comfortable with making deals, and we did a number 
of them only because we were able to share that risk and apply 
less of the capital of the bank to underwrite the deal and to 
basically shore up the profitability because there was a belief 
that it would not pay as well.
    And so SBA, I have seen in just institution after 
institution, becomes a way for the credit establishment of 
those banks to get comfortable with the kind of lending that 
conventional wisdom said they can't do.
    When I was coming up in undergraduate school, Gary Becker, 
the economist from the University of Chicago, was very famous 
for saying----
    Senator Carper. Just yesterday or the day before he was 
awarded, I think, the Presidential Medal of Freedom.
    Mr. Hedgespeth. Very much so. He stated that in a market 
with perfect information, there can be no discrimination. But 
growing up in what you would consider, sir, a slum, I 
considered my neighborhood in Norfolk, Virginia, I can tell 
you, there was a lot of discrimination in lending institutions 
and I have spent my entire career trying to make Gary Becker 
right, and it has taken a lot of effort to move institutions 
beyond what they were comfortable in doing to move to new 
markets, to move to lending to more women-owned businesses, 
minority-owned businesses, inner city businesses. And the SBA 
was an absolutely critical partner in my 20 years of banking 
experience in doing that, and I did it at each one of my 
institutions profitably, but if I didn't have that partnership, 
we would have never gotten started.
    Senator Carper. All right. Mr. Wilkinson, did you want to 
say anything, and then I will yield to Dr. de Rugy.
    Mr. Wilkinson. Well, I would just--small businesses that 
are relying on credit card debt, that is really an unstable 
source of financing. They really need to establish a 
relationship----
    Senator Carper. Pretty expensive, too.
    Mr. Wilkinson. It is pretty expensive. But that said, 7(a) 
loans aren't cheap, either. The fees that we have to pay into 
SBA for the guarantee, if I am a borrower that can find 
financing without paying that fee, I would probably go that 
direction. So I think there is a built-in safeguard for 
businesses that could find conventional financing elsewhere not 
coming to the 7(a) program because they would be reluctant to 
pay the high fees. Some of our fees are as high as three-and-a-
half, three-and-seven-eighths points on the loan. So it is 
pretty expensive financing on the highest-end borrowers.
    Senator Carper. Dr. de Rugy.
    Ms. de Rugy. I wanted to go back to this idea of the 
relevance of the 7(a) loans. I mean, I am confident that there 
are some borrowers out there who are, in fact, creditworthy and 
don't necessarily look to commercial lenders without the 
guarantee. However, I think we should not overlook the fact 
that the commercial banks are doing a tremendous job, and the 
reason why they are is because, in fact, they have a lot of 
those credit scorings and there is a relationship.
    This is the reason why 53 years ago, I might not have been 
here saying that there wasn't a need for the SBA lending 
programs because, in fact, we didn't have all these ways to 
create relationships and to lower the cost to have access to 
information. Now we do, and when we look at what commercial 
banks are doing, they are a tremendous help to small 
businesses. In fact, they are so much so that according to the 
GAO report with the latest data, the 7(a) loans only represent 
1.3 percent of all loans to small businesses, and I think this 
should not be overlooked. I mean, I think it is a very 
important point.
    In the same way, I am amazed to hear some of the members of 
the panel say that without the 7(a) loan, there wouldn't be any 
start-ups in the United States. I think we are losing track of 
what we are talking about. Are we actually saying here that 
without the 7(a) loan, there would be no business starting? No. 
There is no way we can be saying that. In fact, the data that I 
looked at, and granted it was for fiscal year 2004, says 
exactly the opposite. In fact, 7(a) loans make a very small 
difference, if any difference at all. I think the scale of 
things is important.
    My concern today, and I have looked a lot at the bank, I 
mean, we are talking about the fact that, yes, the bank issuing 
7(a) loans is more expensive and that supposedly is a guarantee 
that borrowers would not accept to get 7(a) loans if they could 
get credit elsewhere. I am sorry. I am a woman with no 
experience in lending and borrowing and things like this and 
recently I had to actually go borrow money for my house, buy a 
car. I knew nothing about it. I had to rely on the honesty of 
the bank to tell me what I could do. It hasn't let me to 
acquire all this information, and I rely on the specialist that 
I go to deal with.
    What guarantees me, because my research has actually led to 
show that banks, very few banks who are issuing 7(a) loans are 
making huge profits, and I want to state for the record that I 
am not at all against big banks making profits. It appears that 
it is actually a very profitable business for SBA lenders to 
issue loans for the one who can overcome the cost of actually 
jumping through the hoops issuing SBA loans. How do we know 
that these banks, in fact, are not steering away from 
conventional loans that would be less expensive or a small 
segment of borrowers and they are not steering them towards a 
loan that is way more profitable for them?
    And this is the reason why if, honestly, if the car I just 
bought on Tuesday--I felt I was so hopeless, I had to rely on 
the people I dealt with. I had no choice. I didn't know very 
much. I have to assume that they informed me correctly, and the 
truth of the matter is I wouldn't know if they didn't. If it 
were so huge, maybe I would know. But when we are in this very 
gray area, how do you know? And if banks have such--a small 
amount of banks who are the biggest banks in America have such 
a financial incentive to actually steer you away, the fact that 
SBA loans have a higher rate and cost more is not to me a 
guarantee that we are issuing SBA loans to the right people.
    Senator Carper. Let me yield back to Dr. Coburn. Thank you.
    Senator Coburn. I think, Mr. Chairman, it has been a great 
exchange. The point is, and the thing I would like to hear from 
the SBA is that we have got a time line on when we are going to 
have a definition of credit elsewhere and a significant test as 
a measurement on that and full compliance with GPRA. The 
problem with GPRA is there are no teeth. It is a great law, but 
if an agency like SBA chooses to ignore it, there are no 
consequences. Well, there are going to be in terms of the next 
appropriation bill, the next authorization bill, if we don't 
get there.
    So what I will do is submit my questions for the record. I 
think we have had a great exchange. I thank everybody's input.
    I had an experience, a very unsatisfactory experience with 
buying a business that had an SBA loan. If you are not normally 
used to dealing with SBA requirements and come in and take over 
a business that has an SBA loan, it is no fun, and I paid it 
off. I got out of there. I didn't want that over-regulation.
    Final point I would make, as the GAO has said, if you don't 
have metrics to measure true outcomes, not outputs, you don't 
know whether or not you are accomplishing your stated purpose, 
and we all know that. We all use that in whatever we do, 
whether it is in a banking business or in a manufacturing 
business or at the GAO they actually measure their own output. 
I know, I have talked to their boss and they have metrics.
    So the point is, is to move the SBA to get it to the point 
where it is compliant with the law and has good definitions so 
that they can create good metrics so we can really know the 
difference. And Dr. de Rugy may be right, may be wrong, but 
nobody knows until we start accurately measuring, and that was 
the whole point of me requesting the GAO study in the first 
place. Until we get metrics, we can have anecdotal stories, it 
can be great business for some, but we don't really know. We 
know that there are a lot of people that have benefited from 
it, including the banks, but we don't know if they might not 
have benefited without it.
    So the whole goal is not to undermine SBA, it is to get the 
metrics so we can say, hey, atta boy. The ``atta boys'' we have 
now is on output, not outcomes, and there is no question--and 
let me compliment SBA. They have made great strides----
    Senator Carper. They have.
    Senator Coburn. [continuing]. In terms of improving, and so 
that should not be lost in it.
    Mr. Chairman, I thank you for having this hearing. I will 
submit some questions for the record. I would love a 
concurrence that we will get about an every 3-month update on 
what you are doing on this rather than having to make you come 
down here and testify and prepare for it.
    Mr. Hedgespeth. Yes, Senator.
    Senator Coburn. All right. Thank you.
    Senator Carper. I don't know if anybody has anything else 
you want to briefly add. I have maybe one or two more questions 
and then we will wrap it up.
    Mr. Wilkinson, I don't know if you want to go back and make 
a comment. One of the things that came to mind as Dr. de Rugy 
was talking about bank profitability, she doesn't have anything 
against big banks making money. Neither do I. But how 
profitable is this business to banks and are they making a 
bundle off of it?
    Mr. Wilkinson. Well, each bank would have their own costs 
that they would have to deal with, but one of the issues that 
we in SBA are looking at now is the shrinking number of banks 
participating in the program. We are down to 2,500, I think, 
that are actively participating, and taking a look----
    Senator Carper. Out of about how many banks, 10,000?
    Mr. Wilkinson. I think we are down in the 9,000s now, 
something like that. But, if a bank can't make a profit at this 
line of business, they are going to get out of it. It is a more 
difficult business because SBA has got a pile of rules and 
regulations that you need to know and understand, so there is a 
learning curve up front. But again, each bank would have their 
own cost issues.
    I did want to comment on Ms. de Rugy's piece that the 
banking environment, at least the one that I am involved with, 
is a highly competitive marketplace, and if you try to drive a 
small business into a higher-priced loan than they can get, or 
they can get it cheaper somewhere else, they are going to the 
lowest-cost source as long as it makes sense in terms of the 
payment plan.
    The other part of this is on the credit scoring she brought 
up. That is a classic example of credit elsewhere, in my 
opinion. Many of the numbers of loans today are approved by 
institutions who use the SBA Express product and they have 
internally a minimum credit score, so if you score, for 
instance, a 690, we will do you conventionally. At 680, you 
default down into the SBA product. I mean, they draw the line, 
this is what we do conventionally. If you can't get to that 
number, you have got to go down and get an SBA guarantee to 
enhance it.
    And a significant number of the number of loans in the 7(a) 
program are done through credit scoring. So I think we are up 
65, 70 percent of those numbers are done through the credit 
scoring process, that by definition, they can't qualify 
conventionally inside those institutions.
    Mr. Hedgespeth. I just have a couple of observations. When 
you look at what the SBA does in practice, the system that we 
have really in partnership with our lending institution 
partners kind of provides working capital, venture capital for 
the average Joe Businessperson in Main Street, America. They 
don't have big boutique private equity firms looking to put 
capital behind those businesses, yet it is the businesses that 
the SBA supports at the edge and the niche that we operate that 
supports a tremendous number of start-up businesses that create 
a lot of the jobs in this economy. In fact, small businesses 
create the majority of the jobs in this economy even though 
they are a very small percentage of it.
    And we must be doing something right, because, Senator, the 
rest of the world is trying to copy our SBA model. We had the 
Deputy Administrator visit Africa recently. The Administrator 
was talking to the head of the EU who was looking at how do 
they create a program like this to basically spur their small 
business economy.
    So I would say that the fact the rest of the world is 
looking at our model ought to give us pause about doing 
anything now that would curtail that.
    Ms. de Rugy. Can I add something to that?
    Senator Carper. Dr. de Rugy, please.
    Ms. de Rugy. Very quickly, there was actually a very 
interesting article in the Economist this week showing exactly 
that, in fact, the conclusion that the EU is starting to reach 
while looking at how entrepreneurship in the United States is 
is that where it works really well is where the government is 
not involved. I would be happy to actually submit that for the 
record.
    Senator Carper. All right. Thank you. As someone who was 
born and raised in France, you may want to tip those French 
people off to watch themselves as they get into this, or wade 
into this water.
    Ms. de Rugy. Yes.
    Senator Carper. Dr. Shear, is there anything you want to 
add?
    Mr. Shear. Let me just make one point about the credit 
scoring. The private market develops mechanisms to address 
asymmetric information. I think the question here for this 
Subcommittee from a market standpoint is to what degree does 
the private market through credit scoring or through the role 
of venture capital firms kind of serve that niche, and I think 
that let us compare here, compare it with the hearing room two 
floors up when we start talking about housing finance.
    The credit scoring models here that are used in the small 
business arena, they have been around for about a decade, but 
they are not at the level that you have in the small business 
lending market. So it still is--it is not quite the same type 
of issues we have in housing finance, and to compare with 
housing finance, no matter what you think of the different 
mortgage institutions, including the FHA, there is more of an 
evaluative approach to saying, what is the role of each of 
these entities, including the FHA, that has been there a long 
time. And in a sense, you could think about that might be 
relevant to looking at SBA now. It seems like SBA is moving in 
that direction and we certainly hope that they move in that 
direction.
    Senator Carper. All right. Thank you. Let me just wrap up 
here. From listening to the testimony of all of you, it sounds 
like the 7(a) program, the program that we have today is a good 
deal different than what we started out with many years ago and 
over time, it has improved, and it has improved as recently as 
2005. For the last couple of years, it sounds, if I heard this 
right, that we no longer appropriate money to cover these loan 
defaults as they occur but the monies are actually collected 
during the course of business and running the program.
    While it sounds like the percentage of small business loans 
that the 7(a) program comprises is fairly small, there are 
quite a few start-up businesses that rely on the 7(a), 
especially those that are looking for credit beyond a couple of 
months or even a year or so. But when you get into multiple 
years, it sounds like this is where a number of start-up 
businesses go for their financing for sort of, I call it 
intermediate terms, time.
    Do I understand that the amount of loan, the percentage of 
the loan that the SBA guarantees is at least 50 percent and it 
can be as high as 85 percent?
    Mr. Hedgespeth. That is correct.
    Senator Carper. One of the questions I wanted to ask is how 
do you determine whether or not it is going to be 50 percent or 
60 or 70 or 80 or 85 percent? How is that determination made? I 
presume it has something to do with risk, risk as it is 
perceived by the banks.
    Mr. Wilkinson. The type of program and size of the loan.
    Mr. Hedgespeth. Yes.
    Senator Carper. I am sorry?
    Mr. Wilkinson. The type of program used and size of loan. 
So if it is a loan made in the SBA Express program, that is 
where lenders can use their own forms. It comes with a 50 
percent guarantee. The other guarantee percentages are based 
off the size of the loan. So if it is a loan of $150,000 or 
less, it could have an 85 percent guarantee, and if it is over 
$150,000, it would be a 75 percent guarantee up to a maximum 
loan size of $2 million.
    Senator Carper. All right. And I understand that the amount 
above prime that can be charged for these loans differs, as 
well. Can somebody tell me what the range is and how the 
determination is made as to what the----
    Mr. Wilkinson. The interest rate is capped at prime plus 
two-and-three-quarters. The average interest rate, I believe, 
is running a little under prime plus two.
    Senator Carper. For some reason I was thinking it was more 
than two-and-three-quarters----
    Mr. Wilkinson. On the smallest loans, there can be an 
interest add-on. So I believe it is $25,000 or less, you can go 
up to prime plus----
    Mr. Hedgespeth. Four.
    Mr. Wilkinson. Prime plus four?
    Senator Carper. The rationale for that is because----
    Mr. Hedgespeth. Because smaller loans are more costly, more 
costly to book.
    Senator Carper. All right.
    Mr. Wilkinson. Can I just comment briefly on the percentage 
of 7(a) loans? The banking industry is set up to do the 90-day 
financings, the 6-month financings. The Federal Reserve study 
shows that of the billions and billions of dollars that bankers 
make conventionally to small businesses, they are typically 150 
days, on average, maturity. So banks get in there, they do the 
contract financing or the seasonal inventory financings. That 
is what banks are set for. They take their short-term deposit 
base and they are good at converting that into short-term 
lending.
    What SBA does is the longer-term lending, financing the 
long-term assets that way. So I don't think it is fair to say 
that we are one percent of all small business financing, 
because that 7(a) is not supposed to be out there making the 
90-day loans. That is not what we are about. Lenders need to 
figure out how to handle that conventionally. But what the 7(a) 
program does is address the long-term end of the market, and 
there we are a significant part of that market. The 7(a) by 
itself is a third of all long-term lending to small businesses. 
I mean, this is the number one source.
    Senator Carper. All right.
    Ms. de Rugy. One-third, so that means that the private 
sector provides two-thirds.
    Mr. Wilkinson. Well, there would be some that can get 
financing conventionally.
    Ms. de Rugy. Can I ask a fairness question?
    Senator Carper. Please.
    Ms. de Rugy. I mean, this is the issue I have with the 
unlevel playing field that the SBA introduces. So if long-term 
financing is what you are after, this is what probably is going 
to really increase the probability of your business becoming 
successful. Why is it, then, that without much trouble, firms, 
small businesses cannot prove to a commercial bank that they 
would be creditworthy, or cannot prove what all the other 
borrowers are proving or passing the test for? Then they have 
access to a better term. They have access to something that is 
going to drastically improve the probability of them surviving. 
Why is it that----
    Mr. Wilkinson. I think if you looked at the terms----
    Ms. de Rugy. [continuing]. Because in the first place, they 
were unable to get a conventional credit, why then would they 
be in the end really better off? It is really unfair to the 
people who actually pass the test of creditworthiness and it 
creates an unlevel playing field.
    Senator Carper. Any responses, please?
    Mr. Wilkinson. Page 33 of the GAO report shows that the 
average conventional small business borrower is about borrowing 
at prime, so they are getting a better deal.
    Senator Carper. As opposed to a prime plus two or three?
    Mr. Wilkinson. Correct.
    Senator Carper. Or four.
    Ms. de Rugy. But in the long-term, that doesn't address the 
long-term issue.
    Mr. Wilkinson. I can tell you as a commercial lender, if 
there was a borrower who could qualify for a prime, we might be 
willing to do a shorter maturity with a longer amortization if 
they could qualify.
    Ms. de Rugy. But you are selling 7(a) loan as a great 
program because it actually provides firms with long-term loans 
which then increase the probability of them staying in 
business. So this is either an important factor or it is not, 
and what you are saying is that people can have access--who 
have access to commercial loans and have proven themselves and 
passed the test, they can't have access to that, and they 
don't. I mean, they usually don't. And there are more hurdles 
for them who are worthy in the first place and it is unfair.
    Senator Carper. All right. Well, I don't know if people 
would call this a lively hearing or not, but for Dr. Coburn and 
I, and I think for our staffs, it is a very interesting one, 
and for a couple of Senators who are very much interested in 
job creation and being able to build a strong economy, raise 
GDP, it is very pertinent and germane.
    Can somebody tell me the nature of the legislation that I 
think was introduced today by Senator Snowe and by Senator 
Kerry?
    Ms. Le. I can tell you.
    Senator Carper. I am going to ask you to just come up and 
maybe pull up a chair and tell us. Identify yourself for the 
record, please, your name and your affiliation.
    Ms. Le. My name is Linda Le. I work for Senator Snowe on 
the Small Business Committee.
    Senator Carper. Oh, good. Welcome.
    Ms. Le. Thank you. The legislation that was introduced 
today with Senator Snowe and Senator Kerry addresses quite a 
few recommendations in this GAO report and in a previous GAO 
report. Specifically, it tries to put in place measurements of 
economic outcomes. It looks at, or we ask for the number of 
jobs created, the number of employees, the assets the 
businesses create, their taxes paid, firms that go out of 
business, firms that prepay their loans, if the loans are in 
good standing, and then if they generate any new businesses 
that are related to the loan they originally took.
    So that is part of what the legislation does. It has some 
other lender oversight factors, as well, but this was done in 
direct response to the GAO study. I also talked to Senator 
Coburn's staff about it and Ms. de Rugy and the banking as we 
tried to formulate what to track.
    Senator Carper. All right. Is it just a coincidence that 
the legislation was introduced today?
    Ms. Le. No.
    Senator Carper. All right.
    [Laughter.]
    I will think about that. Well, I hope our staffs continue 
to talk with you, and who would be your counterpart with 
Senator Kerry?
    Ms. Le. It is Kevin Wheeler.
    Senator Carper. Is Kevin here?
    Ms. Le. Yes, she is.
    Senator Carper. Is your first name Kevin?
    Ms. Wheeler. Yes, it is.
    Senator Carper. Hi, Kevin. I could barely see your lips 
moving when Linda Le was speaking up here, so that is good. 
Well, thank you both for coming and thank you for jumping up 
here and taking a mike, and Dr. de Rugy, thank you for sharing 
your seat and your microphone with Linda Le.
    I think that pretty well takes us to the end of the line 
here. One last question of Mr. Hedgespeth. What is the 
commitment you have made on behalf of SBA to Dr. Coburn and me? 
Would you, in your own words, tell us what it is?
    Mr. Hedgespeth. As I understand our commitment, what I 
agreed to was a quarterly report to you on our progress with 
institutionalizing measures of our performance that are 
outcome-based.
    Senator Carper. I think that is the way I understood it, as 
well.
    All right, folks. We will leave the hearing record open for 
a couple of weeks, give others a chance to maybe ask some 
questions in writing. If you could respond in a timely way, we 
would much appreciate it.
    Thank you all for coming. Some of you have come across the 
ocean to participate in this hearing, it is great to spend this 
time with you and we appreciate your input.
    We have come a long way with this program. It is a lot 
better than it used to be. There are obviously things we can do 
to make it better. If it isn't perfect, make it better, and let 
us just aim for perfection. Thank you all very much.
    And with that, this hearing is adjourned.
    [Whereupon, at 3:44 p.m., the Subcommittee was adjourned.]


















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