[Senate Hearing 110-776]
[From the U.S. Government Printing Office]





                                                        S. Hrg. 110-776

           THE IMPACT OF THE CREDIT CRUNCH ON SMALL BUSINESS

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

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                          AND ENTREPRENEURSHIP
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 16, 2008

                               __________

      Printed for the use of the Committee on Small Business and 
                            Entrepreneurship


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 senate





                   U.S. GOVERNMENT PRINTING OFFICE
44-801 PDF                  WASHINGTON : 2009
----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, 
Washington, DC 20402-0001





            COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
                       ONE HUNDRED TENTH CONGRESS
                             SECOND SESSION

                 JOHN F. KERRY, Massachusetts, Chairman
CARL LEVIN, Michigan                 OLYMPIA J. SNOWE, Maine
TOM HARKIN, Iowa                     CHRISTOPHER S. BOND, Missouri
JOSEPH I. LIEBERMAN, Connecticut     NORMAN COLEMAN, Minnesota
MARY LANDRIEU, Louisiana             DAVID VITTER, Louisiana
MARIA CANTWELL, Washington           ELIZABETH DOLE, North Carolina
EVAN BAYH, Indiana                   JOHN THUNE, South Dakota
MARK PRYOR, Arkansas                 BOB CORKER, Tennessee
BENJAMIN L. CARDIN, Maryland         MICHAEL B. ENZI, Wyoming
JON TESTER, Montana                  JOHNNY ISAKSON, Georgia
                 Naomi Baum, Democratic Staff Director
                Wallace Hsueh, Republican Staff Director















                            C O N T E N T S

                              ----------                              

                           Opening Statements

                                                                   Page
Kerry, The Honorable John F., Chairman, Committee on Small 
  Business and Entrepreneurship, and a United States Senator from 
  Massachusetts..................................................     1
Thune, The Honorable John, a United States Senator from South 
  Dakota.........................................................    27
Snowe, The Honorable Olympia J., a United States Senator from 
  Maine..........................................................    30

                           Witness Testimony

Mishkin, Frederic S., Board of Governors of the Federal Reserve 
  System, Washington, DC.........................................     4
Preston, Steven C., Administrator, U.S. Small Business 
  Administration, Washington, DC.................................    18
Kirk, Carolyn A., Mayor, Gloucester, Massachusetts...............    37
Bornstein, Samuel D., Professor of Accounting and Taxation, 
  School of Business, Kean University............................    43
Blankenship, Cynthia L., Vice Chairman and Chief Operating 
  Officer, Bank of the West, Irving, Texas.......................    52
O'Connell, Daniel, Secretary, Executive Office of Housing and 
  Economic Development, Boston, Massachusetts....................    65
Mitchell, Robert L., Founder and Chief Executive Officer, 
  Mitchell and Best Homebuilders LLC, Rockville, Maryland........    78
Landis, Marilyn D., President, Basic Business Concepts, Inc., 
  Pittsburgh, Pennsylvania.......................................    90

          Alphabetical Listing and Appendix Material Submitted

Bornstein, Samuel D.
    Testimony....................................................    43
    Prepared statement...........................................    46
    Responses to post-hearing questions from Senator Kerry.......   119
Blankenship, Cynthia L.
    Testimony....................................................    52
    Prepared statement...........................................    55
    Responses to post-hearing questions from Senator Kerry.......   116
Kerry, The Honorable John F.
    Opening statement............................................     1
    Post-hearing questions posed to:
        Cynthia Blankenship......................................   115
        Samuel Bornstein.........................................   118
        Marilyn Landis...........................................   136
        Robert Mitchell..........................................   137
        Frederic Mishkin.........................................   138
        Daniel O'Connell.........................................   141
        Steven Preston...........................................   143
Kirk, Carolyn A.
    Testimony....................................................    37
    Prepared statement...........................................    40
Landis, Marilyn
    Testimony....................................................    90
    Prepared statement...........................................    93
    Responses to post-hearing questions from Senator Kerry.......   136
Levin, Carl
    Prepared statement...........................................   112
Mishkin, Frederic
    Testimony....................................................     4
    Prepared statement...........................................     6
    Responses to post-hearing questions from:
        Senator Kerry............................................   138
        Senator Snowe............................................   139
Mitchell, Robert
    Testimony....................................................    78
    Prepared statement...........................................    80
    Responses to post-hearing questions from Senator Kerry.......   137
O'Connell, Daniel
    Testimony....................................................    65
    Prepared statement...........................................    67
    Responses to post-hearing questions from Senator Kerry.......   141
Preston, Steven C.
    Testimony....................................................    15
    Prepared statement...........................................    18
    Responses to post-hearing questions from
        Senator Kerry............................................   143
        Senator Snowe............................................   151
Snowe, Olympia
    Opening statement............................................    30
    Post-hearing questions posed to:
        Governor Frederic Mishkin................................   139
        Steven Preston...........................................   151
Thune, John
    Opening statement............................................    27

                        Comments for the Record

National Small Business Association (NSBA) 2008 Survey of Small 
  and Midsized Businesses........................................   160

 
           THE IMPACT OF THE CREDIT CRUNCH ON SMALL BUSINESS

                              ----------                              


                       WEDNESDAY, APRIL 16, 2008

                      United States Senate,
                    Committee on Small Business and
                                          Entrepreneurship,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:41 p.m., in 
room 428-A, Russell Senate Office Building, Hon. John F. Kerry, 
chairman of the committee, presiding.
    Present: Senators Kerry, Cardin, Snowe, and Thune.

  OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY, CHAIRMAN, 
SENATE COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP, AND A 
            UNITED STATES SENATOR FROM MASSACHUSETTS

    Chairman Kerry. This hearing of the Small Business 
Committee will come to order. I apologize for being a little 
late. We had a vote on the floor. Senator Snowe, the Ranking 
Member, is introducing a nominee at one of the other 
committees, but as soon as she is done, she will join us.
    I want to thank Governor Mishkin from the Federal Reserve 
Board and our friend, SBA Administrator Preston, and all of our 
witnesses for coming here today and taking time to share with 
us their thoughts about the current situation facing small 
businesses with the credit crunch.
    Needless to say, the effort of this hearing is to really 
try to focus on--both to learn to what degree from small 
businesses there is an impact and also to draw attention to 
what is increasingly in the eyes of the members of the 
committee a problem that we are facing back home in all of our 
communities.
    Yesterday, I was visiting with the members of the Real 
Estate Roundtable over here in town, major hotel developers, 
commercial real estate developers, home builders, others, and 
we will hear from home builders in our next panel, but the 
evidence of the credit crunch and its downstream implications 
is mounting.
    Yesterday on the front page of the New York Times, right-
hand column, there was a major story about the fallout in 
retail in America today, and as I talk to people and try to 
figure it out, it is very, very clear that what began on Wall 
Street and what was focused in many ways on sort of the bigger 
picture of the securitization and the portfolios that held 
subprime loans has really spread way down into Main Street 
America in very significant ways, and the spillover of this 
impact just can't be disregarded. It can't be taken lightly.
    I am hearing more and more evidence of a broad-spread 
credit crunch. I think the real estate folks yesterday 
indicated to me that last year, there was something like $300 
billion of deals that were consummated within that entire year. 
So far this year, in the first quarter, there is a total record 
of something like $9 billion, perhaps, and that is being 
generous, and some say if you looked under the nine, you might 
find it sort of questionable to what degree. Well, obviously if 
you extrapolate out, you know that is $36 billion versus $300-
and-some billion on a year if it holds that way. Nobody can--I 
can't tell you whether it will or won't.
    What I do know is that many people in business are telling 
me that both the combination of the fear and the inability to 
gauge risk is causing people to just pull back and has stopped 
transacting, that people can't necessarily get a price. They 
can't get a sense of what is in the value and therefore it is 
very hard to be able to make those deals.
    In the most recent survey of banks, the Federal Reserve 
found that almost one-third of the nation's lenders have 
tightened their lending standards for small business loans, and 
today, the National Small Business Association released the 
results of its annual survey, which showed that 55 percent of 
small businesses surveyed said they face difficulty in 
obtaining a loan due to the credit crunch.
    The continuing decline in home values has obviously made 
matters worse. Approximately 30 percent of all small business 
owners rely on home equity loans in order to finance their 
small business operations. But as home values decline, many of 
those small business entrepreneurs have to find an alternative 
financing source. Some of them will use high-rate credit cards, 
while others will simply delay or even cancel a planned 
investment. So that means missed opportunities not only for 
small business, but for all of the job growth in the ailing 
economy, which has already shed over 230,000 jobs since 
January.
    Theoretically, the SBA loan program ought to be one of the 
key players in the effort to fill the gap left by the 
tightening credit market, but evidence indicates that that may 
not have occurred this time around. SBA loan activity is down 
program-wide. Activity in the SBA's 7(a) loan program, the 
largest single source of long-term capital for small 
businesses, appears to be in a free fall. The number of 7(a) 
loans approved by SBA lenders has decreased by about 18 percent 
compared with the same period last year. In terms of dollars, 
the 7(a) program is down by over $641 million, which is a 
decrease of almost ten percent. That sharp decline suggests 
that, whether temporary or permanent, we may want to consider 
some changes that might help stimulate that lending and provide 
more small businesses with financing they need.
    Now, in fairness, if you are looking at the inability to 
measure risk that I just talked about and you are looking at 
the sort of lack of an end in sight to the devaluation and the 
spiraling, it is difficult. It is complicated--I am going to 
acknowledge that up front--to be able to say that you have 
confidence in putting more money out into something where that 
person may not have the returns on that investment that, in 
fact, qualify that loan. So this is a delicate balance and it 
really mandates both large and small approaches.
    Over the past few months, the members of this committee 
have proposed several measures to try to provide stimulus to 
lending programs. In January, I introduced the Small Business 
Stimulus Act of 2008, which was cosponsored by Senators Levin 
and Landrieu, and that bill would have boosted 7(a) loan 
activity by reducing the lender and borrower fees charged by 
the SBA, and that would provide, I think, much-needed support 
for the micro loan program.
    In February, I introduced a modified stimulus bill which 
added provisions aimed at increasing loan activity in the 504 
loan program. I also joined my colleagues, Senators Landrieu 
and Coleman, in cosponsoring a bill introduced by Ranking 
Member Snowe which included changes to the tax code that would 
have benefitted small businesses.
    The President's budget for next year reduces SBA funding 
and raises lender fees to the maximum amount allowed, which 
may, in fact, be contrary to what we need at this particular 
moment in time because it could have been used to reduce the 
newly imposed oversight fees for SBA lenders.
    We have a question whether or not the SBA has refused to 
take appropriate action in responding to the needs of this 
credit crunch and we would like to explore today sort of what 
the difference might or might not be between the Fed, which has 
taken some bolder moves but which obviously may have greater 
facility in doing so.
    We are going to hear the testimony from Governor Mishkin on 
the Fed's latest actions and how they affect the state of small 
business in the country, especially the credit markets.
    Our second panel of witnesses is going to share with us 
first-hand accounts of the tightening market for small business 
loans, and I also hope they will share with the committee the 
steps they believe ought to be taken to stimulate that 
activity, because we hope to draft legislation coming out of 
today's hearings if, in fact, it is warranted and can be 
effective.
    I believe this hearing and the legislation that grows out 
of the testimony we hear today have the potential to provide 
some additional kick at levels of our economy where it really 
needs it, and I look forward to working with Ranking Member 
Snowe and Administrator Preston to figure out what the best 
ways are we might be able to do that. Hopefully, we can arrive 
at a baseline of understanding of what is happening and what 
might or might not make that difference.
    As I mentioned, Ranking Member Snowe will be joining us in 
a little while, so we are going to go straight to you, Governor 
Mishkin, and then to you, Administrator Preston, and we 
appreciate both of you being here. Thank you.

 STATEMENT OF HON. FREDERIC S. MISHKIN, BOARD OF GOVERNORS OF 
           THE FEDERAL RESERVE SYSTEM, WASHINGTON, DC

    Mr. Mishkin. Chairman Kerry and members of the committee, I 
am pleased to appear before you on behalf of the Board of 
Governors of the Federal Reserve System.
    Small businesses play a critical role in the U.S. economy 
and access to credit is essential for their success. My remarks 
today will address the unusual stress imposed on credit markets 
in recent months and how that stress appears to be affecting 
small businesses. So let me turn to small business access to 
credit in the current financial market turmoil.
    As we all know, financial and credit market conditions 
began to deteriorate rapidly in August. Since that time, credit 
supply conditions for small businesses have continued to 
tighten. For example, in the Board's most recent Senior Loan 
Officer Opinion Survey, conducted in January, a net one-third 
of the domestic banks surveyed, a larger fraction than the 
October survey, reported they had tightened their lending 
standards on commercial loans to small firms over the previous 
three months. Significant net fractions of banks also indicated 
that they had tightened price terms on commercial loans to 
small firms. Actual loan pricing data from our quarterly survey 
of terms of business lending are broadly consistent with the 
qualitative data from the Senior Loan Officer Opinion Survey.
    Despite tighter credit conditions and loan terms, growth in 
the dollar amount of commercial loans at U.S. banks was quite 
well maintained in the first quarter of 2008. Particularly 
noteworthy from the point of view of small businesses is the 
fact that after growing almost 20 percent in the first quarter 
of 2007, commercial loans to small banks continued to expand at 
a rate of almost 12 percent in this year's first quarter.
    Another source of information about small business credit 
supply conditions is the monthly survey of the National 
Federation of Independent Businesses. The results of their most 
recent survey suggest that credit supply conditions for small 
businesses have held up fairly well over the past several 
months. For example, over the past few quarters, only about 
three percent of survey respondents have reported that 
financing conditions and interest rates were the main business 
concern.
    On a less positive note, in recent months, the net 
percentage of survey respondents that reported credit was 
harder to obtain over the previous three months and the net 
percentage that expected credit conditions to tighten over the 
next three months have been at the upper end of their ranges 
observed over the past few years.
    Similarly, in the Duke University CFO Magazine Global 
Business Outlook Survey conducted most recently in March, about 
one-third of the survey's chief financial officers of small 
businesses said credit was more costly, less available, or both 
as a result of the credit market turmoil. This proportion is up 
slightly from last September.
    Looking forward, many small businesses use real estate 
assets to secure their loans. Continuing declines in the value 
of their real estate assets clearly have the potential to 
substantially affect the ability of those small businesses to 
borrow.
    In addition, declines in the value of real estate assets 
held by banks and other lenders could affect their willingness 
and ability to supply loans, as real estate losses use up 
capital that could otherwise be used for making new loans. 
Banks across all size groups, including community banks, have 
recently experienced a sharp deterioration of credit quality, 
mostly within loans secured by real estate. Moreover, if banks 
continue to place on their balance sheets some assets they had 
expected instead either to place off their balance sheet or to 
sell to investors, such actions could crowd out loans to some 
small businesses.
    On a more positive note, the vast majority of U.S. banks 
remain well capitalized. Going forward, this should help these 
banks to maintain their lending capacity.
    So let me conclude. In conclusion, since last fall, credit 
supply conditions have almost surely tightened for the vast 
majority of small businesses. On balance, however, credit 
appears to be generally available, but at a higher cost. Thank 
you.
    [The prepared statement of Mr. Mishkin follows:]


    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


    
    Chairman Kerry. Thank you very much, Governor.
    Mr. Administrator.

STATEMENT OF HON. STEVEN C. PRESTON, ADMINISTRATOR, U.S. SMALL 
            BUSINESS ADMINISTRATION, WASHINGTON, DC

    Mr. Preston. Thank you, Chairman Kerry. Thank you also, 
Governor Mishkin, for coming. I also just want to thank the 
members of the second panel. You have put together a good group 
of people who do a lot of good work for small businesses.
    I think as we look at this situation right now, clearly 
over the past several years we have seen a very strong period 
of economic growth, a period of low unemployment, and a period 
of very good broad economic conditions. Most recently, however, 
in the fourth quarter, we saw GDP growth fall to 0.6 percent, 
and if you are a small business owner, we are looking at higher 
prices at the pump, higher prices in the supermarket, and home 
prices are down. Those are all factors which clearly affect the 
cost of running a small business and the markets for many of 
their products.
    In June, the President signed the bipartisan economic 
growth package which will inject $152 billion into the economy. 
The package will support not only consumer and business 
spending, but it is also going to provide important tax 
incentives for businesses to make investments in new equipment 
this year with the depreciation and expensing benefits. We hope 
that the boost from the stimulus package will help buoy the 
economy in the coming months, but also very importantly give 
small businesses an incentive to invest back in their business 
because of those cash benefits.
    Confidence in the economy is particularly important for 
small businesses. In deciding whether to invest in expanding a 
business, which may require taking on new debt, it is very 
important that business owners have that confidence in the 
economy and that the customers will be there to justify those 
investments.
    I think a lot of us have seen a number of surveys out there 
by NFIB and NSBA and the Chamber. All of those indicate that 
confidence among small businesses has declined in recent 
months, and I think it also shows that general concern about 
the economy has increased.
    In addition, what I think is real important for our group, 
is it shows that small businesses' intention to hire and 
intention to invest back in expansion of their business has 
also declined. Those are very much the kinds of decisions which 
drive the need for capital which our programs support. That is 
very consistent with what we have heard from our lenders and 
our borrowers.
    We have had hundreds of outreach meetings with lenders to 
discuss what is going on in the marketplace. Many of the 
lenders have indicated they have seen this uncertainty and it 
has resulted in less demand for credit in the small business 
community. Many lenders have actually indicated that they are 
having some challenges putting good capital to work right now 
in the marketplace. That is also supported by the Fed January 
2008 Senior Loan Officer Opinion Survey, which shows one-fourth 
of both large and small domestic banks saw weaker demand from 
small firms. However, demand is not the only factor, but it is 
an important one.
    The survey also found that some domestic institutions have 
tightened their standards, as Governor Mishkin said. That is 
consistent with what Secretary Paulson stated when he commented 
recently that he believes the sentiment has swung to risk 
aversion. It is also consistent with my own conversations with 
lenders.
    Many of our lenders have experienced a significant increase 
in credit losses in their portfolios and they have responded by 
tightening credit standards. We see a reflection of this in our 
own portfolio. Clearly, the greatest declines that we are 
seeing in our portfolio are in areas where we see the greatest 
risk.
    In addition, small businesses who are facing challenges due 
to the economy or who have less collateral because their home 
values have declined, no longer are able to meet the same 
credit standards that they were before. So they don't look as 
good on paper as they might have a year ago when a bank is 
considering a credit decision.
    That flow of capital between banks and small businesses is 
obviously critical for growth. We have been working very 
diligently with lenders to ensure that capital is available to 
those small business owners who want it and need it. We have 
held roundtables in cities around the country, major lending 
centers, smaller communities, as well. We have held very in-
depth relationship review meetings around the country in our 
field. We have had--in just the last month, we have had over 
800 meetings in our field to sit down with lenders to talk 
about their strategies, to talk to them about the quality of 
their portfolios, to encourage them to expand the use of SBA 
product where it is appropriate, and to make sure we understand 
if there is anything that we need to do to support them to 
expand the use of our program. Those sessions have given us a 
great opportunity to both articulate the value of our 
guaranteed lending and also to discuss the issues that they 
have that are of concern to them.
    Beyond that, I would like to emphasize that we conducted 
very extensive lender outreach in late 2006 and early 2007 to 
make sure we understood before any of this happened how to 
expand our presence in the lending community. We are addressing 
many of the issues we heard from lenders where they told us--
when they explained to us what was inhibiting their 
participation in our programs back then, and we have gotten 
great feedback on the progress we have made.
    We are purchasing their loans much more quickly. We had 
some terrible backlogs in our guaranteed purchasing operations. 
We are turning those very quickly. We are providing much better 
on-site bank support for our field network. We have simplified 
our policies. We have just rolled out a whole new set of 
policies last month. We are moving away from paper to 
electronic transactions and we are rolling out new programs, 
like Patriot Express and Rural Lender Advantage.
    Much of the industry, especially the small banks, were very 
disappointed when Low-Doc was discontinued. We lost over 400 
active lenders from 2005 to 2006, most of them small lenders. 
Since then, we have piloted something called Rural Lender 
Advantage to bring back those lenders into the programs. Based 
on the pilot, we are making some adjustments to simplify that 
program based on the industry feedback. But effectively, it 
provides lenders with a simplified application. It is 
electronic. We turn around the decisions very quickly. We 
provide them with a lot of customer support. We give them the 
same guarantee structure as the old Low-Doc. We actually 
increased the maximum from 150 to 350 thousand, but it allows 
us to ensure that we have got consistent underwriting standards 
so that the program is more viable than the Low-Doc program 
was.
    So, like you say, SBA is working very hard on a number of 
fronts to support the lending community in a very hands-on way, 
but in a more structural way, as well. Certainly we stand ready 
to handle an increase in volume, whatever this committee and 
Congress and the President decide to do. We certainly would 
look forward to that, and I would also like just to thank you 
for the opportunity to share our thoughts on this important 
topic.
    [The prepared statement of Mr. Preston follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
    Chairman Kerry. Well, thank you very much, Administrator.
    Let me see if we can sort of flesh out a few of these 
things here, if possible. Mr. Mishkin, what in your judgment--
obviously, the Fed has moved in a lot of different ways. Some 
people have suggested the Fed may have already exhausted the 
remedies available to us. Do you think that is accurate?
    Mr. Mishkin. I think that that is not quite correct. 
Clearly, the nature of the shock to the financial system is 
actually very major and there are aspects of this that, in 
fact, are out of our control, in particular the fact that 
people are having trouble valuing assets. The credit risk has 
gone up to a major extent.
    However, monetary policy is effective in dealing with 
these----
    Chairman Kerry. Can I just stop you there for one quick 
second before we go on. I want to get back to the rest, but----
    Mr. Mishkin. Sure.
    Chairman Kerry [continuing]. How do you get, then, to this 
point? Do you just have to wait until the market settles that 
you are suddenly able to measure this risk, or are there steps 
that could be taken that could help to eliminate this 
imponderable, this fear factor and get people to being able to 
value things more effectively?
    Mr. Mishkin. I think that there is part of the risk that we 
can't do anything about. In fact, the way I have thought about 
this is there are two elements of this risk. One is what I call 
valuation risk--the fact that you have to figure out the value 
of these underlying assets--and that can be very difficult to 
do. But there is also an element of macroeconomic risk, which 
is that there is a feedback between what happens in terms of 
the overall economy and the credit markets. So if people are 
very concerned that the economy will get into real trouble, 
that means that they are actually going to say there is more 
risk and, in fact, it is even more difficult for them to value 
assets.
    Chairman Kerry. Right.
    Mr. Mishkin. So part of our job at the Federal Reserve is, 
in fact, to reduce this macroeconomic risk, and there are two 
elements of this. One is monetary policy, which we have 
aggressively eased from what was going on before August, and, 
improvement in the functioning of financial markets, 
particularly in terms of liquidity facilities. And both of 
those have been important steps in this direction.
    Chairman Kerry. But there are some limits, I assume, as to 
how far the Fed can go on the monetary piece.
    Mr. Mishkin. Well, clearly, you can't get interest rates 
below zero, so, in fact, we call that the zero lower bound on 
interest rates. But we actually have interest rates at two-and-
a-quarter percent and clearly there is some room to lower them 
if it is needed.
    Furthermore, we are continually looking at steps to make 
the markets function better and I think we have been quite 
creative in the steps that we have taken so far. But, in fact, 
we will continue to look at everything that can take to getting 
the financial markets back to a more normal situation.
    Chairman Kerry. Do you see specific steps which either the 
Fed or the FDIC or the Congress could take at this point that 
would more rapidly get capital into--that would begin to allow 
that capital to move more rapidly into people's hands and ease 
the crunch?
    Mr. Mishkin. Well, there clearly are issues that the 
Congress is looking at--such as whether they can make, the 
housing market work better--which we encourage you to do and 
would clearly have an impact on credit markets.
    Chairman Kerry. In your testimony you talked about a 
tightening of credit standards, higher rates, higher costs for 
credit, and the decline in the use of real estate assets as 
collateral in order to do that. So you have got these three 
elements. Is there one that is more important than another as 
to most affecting the access of a small business to credit?
    Mr. Mishkin. Well, it is hard to say which of these is more 
important. I think the most important issue affecting small 
businesses is what will happen to the overall economy and the 
availability of credit. In fact, there has been more difficulty 
in their access to credit, but the situation is not dire. 
Credit is still being issued and small businesses are able to 
get access to credit.
    What I think is a bigger concern for small businesses is 
whether, in fact, they are going to have demand for their 
products. So in that sense, a key issue for the Federal Reserve 
and a key role in terms of helping us to promote small business 
is to make sure that the economy stays on an even keel.
    Chairman Kerry. So in thinking about responses to this, how 
do you deal with the sort of sense that at one moment, we are 
cruising along. People are borrowing. People are investing. 
Small businesses have their contracts, their sales. The outlook 
is relatively decent. And then you have this uncertainty in one 
particular part of the market, the subprime, the real estate, 
where a bunch of folks aren't too sure what is in their 
portfolios, what the values are and so forth, and you sort of 
pull the rug out from under all these other assumptions that 
are being made.
    To what degree are we now trapped in a self-fulfilling 
prophecy syndrome, where because people are looking out there, 
the interest rates what they are still, and the market has a 
bubble, then everybody says, well, I can't tell. Therefore, I 
am not borrowing, or I am not lending, and you just cascade 
downwards.
    Mr. Mishkin. Well, clearly, one of the things that happened 
is this disruption--in terms of the subprime market--has 
actually spread much wider and----
    Chairman Kerry. Why has it? A lot of people don't 
understand that.
    Mr. Mishkin. I think the reason it has spread wider is 
because it actually revealed that the securitization model, 
which is a key part of providing funds to the capital markets 
nowadays, actually is flawed. And the subprime lending was 
frequently driven by the fees that the originators were 
getting, and not worrying about whether, in fact, the ultimate 
holder of the loan would get that back----
    Chairman Kerry. Subprime is a nice word, term of art, for 
describing loans that shouldn't have been made.
    Mr. Mishkin. I think I would differ with you on this in the 
following sense----
    Chairman Kerry. Wasn't the whole concept of subprime that 
people get credit where they wouldn't otherwise qualify for the 
credit?
    Mr. Mishkin. I think that the issue is that there clearly 
is a lot of subprime lending that should not have been done, 
and in that sense, I agree with you completely. There is an 
issue about the quality of information in the marketplace, 
basically through technology, which actually may allow people 
who previously were not able to get credit to get credit if it 
is actually underwritten to them properly, so----
    Chairman Kerry. Let us flesh that out a little bit.
    Mr. Mishkin. So in this episode, the problem is not so much 
that all of the subprime borrowers were bad borrowers. But many 
of the lenders actually lent to people who, in fact, should 
never have gotten the loans. As I said, some of the reasons 
this happened was because the incentives of the originators of 
these loans were not always in the interest of either the 
person who eventually held the loan or even in the interest of 
the borrowers.
    The problem then is that then revealed there are similar 
kinds of problems elsewhere in the capital markets in terms of 
securitization, where people were assuming that the credit 
rating agencies were going to get it right and weren't doing 
due diligence on their own. It then actually spread much wider, 
creating some problems in terms of bank capital, because banks, 
in fact, owned portfolios of these assets and had losses as a 
result. This ate into some of their capital. So that have 
actually resulted in some of the credit restrictions that you 
talked about at the very outset, which, in fact, has created a 
problem not only for the real estate sector, but actually for 
the small business sector, as well.
    Chairman Kerry. And do you agree that the small business 
sector winds up getting caught up in that psychology----
    Mr. Mishkin. Absolutely. I think that, first of all, small 
businesses are a key element of the strength of the economy in 
this country. I actually come from a small business background. 
I worked for several years in my father's small factory in 
Manhattan; they used to have them there. And we know that a lot 
of the growth in the U.S. economy and a lot of the very rapid 
growth in entrepreneurial activity has actually occurred in 
small businesses.
    So clearly, what started in one part of the economy, which 
had really very little to do with small businesses, has ended 
up creating problems for small businesses for the economy as a 
whole. Clearly, one of the key missions for the Federal Reserve 
is to try to keep the macroeconomic risk in the economy reduced 
so that, in fact, we can have recovery of activities for small 
businesses and for businesses in general.
    Chairman Kerry. But a significant part of that recovery, by 
your earlier testimony and by what we have discussed here, is 
the inability to be able to actually value, correct?
    Mr. Mishkin. Absolutely.
    Chairman Kerry. Is there a way for the Fed or even the SBA 
to create some protocol that begins to establish how one does 
value at this point or to create value at this point?
    Mr. Mishkin. I think----
    Chairman Kerry. The Fed has more ability to create the 
value.
    Mr. Mishkin. Right. I think that what much of this in terms 
of valuation has to be done by the markets. What the Federal 
Reserve can do is--by restoring confidence in what will happen 
to the economy in the future--help make it easier for the 
markets to do their job. But the reality is that the financial 
markets have to figure out what the value of assets are, where 
the losses are, and the Federal Reserve----
    Chairman Kerry. Are they being too cautious in doing that? 
Is there a way to break the cycle?
    Mr. Mishkin. I don't know if the right word would be 
cautious, but clearly it is a very difficult issue for them to 
sort out. Clearly, having more transparency in the system would 
be helpful to them in doing this. So there are issues in terms 
of whether the financial systems can be made to work better in 
this regard.
    Chairman Kerry. As you know, the next loan officers' survey 
from the Fed is going to come out next month. Based on what you 
have seen thus far, do you anticipate that the trend towards 
tighter lending standards is going to be sustained?
    Mr. Mishkin. Well, unfortunately, I don't have any 
information yet about what is going on in that survey, so I 
really can't comment on what----
    Chairman Kerry. Do you have any anecdotal or----
    Mr. Mishkin. I think the only anecdotal information we have 
been hearing in some of these other surveys is that small 
businesses are facing more uncertainty in terms of their 
ability to get credit.
    Chairman Kerry. So what do you do about the frustration of 
a small business person who has got contracts, product, 
workers, but they can't get the working capital to continue to 
do what they know they can do?
    Mr. Mishkin. Well, unfortunately, we can't directly help 
small businesses, but, in fact, if we fulfill our mission of 
both maintaining price stability and sustainable employment, 
then it can happen. So it is indirect, but I still think 
important.
    Chairman Kerry. What indicators are you going to be looking 
for to get a sense of whether or not you should take stronger 
steps in terms of--I mean, small businesses are 98 percent of 
our businesses. They are obviously going to be impacted by 
macro forces over which they have no control. What are you 
going to be looking for here?
    Mr. Mishkin. Well, we actually look at a whole range of 
information to make assessments about what is going on in the 
economy, including, by the way, talking to small businesses. 
The Federal Reserve Banks have committees where they meet with 
small businesses. When I was at the Federal Reserve Bank in New 
York about ten years ago, we had periodic meetings with an 
advisory committee from the small business and agricultural 
sector, and that was very helpful to us in providing 
information about those sectors.
    Of course we look at the national statistics. We very much 
look at what is going on in credit markets so that we are not 
just looking at where the real economy is now, but at 
information in financial markets which may tell us something 
about where the economy may be heading in the future. So we do 
use a lot of science, but there is also a lot of art to 
monetary policy and we actually use both very extensively.
    Chairman Kerry. What would your message be to small 
business owners listening today as to what they might look to 
as potential options that could change the view for them?
    Mr. Mishkin. Well, I think that they have to, first of all, 
most importantly, look to their own markets, and in looking to 
their own markets make an assessment so that they have a good 
feel for what will happen. One of the strengths in the economy 
in recent months has been the export sector. And, in fact, 
small businesses do a lot of exporting. So looking for new 
markets is something that they can also do to improve their 
profitability and their ability to invest.
    Chairman Kerry. You have seen both the stimulus package and 
the housing package that have been, one passed and the other 
being worked on here. Are there steps, other steps that might 
be more constructive by the Congress than those you have seen?
    Mr. Mishkin. Well, I think at this stage, it is, I think, 
worthwhile to see exactly how well the packages that have been 
passed work. The stimulus package is not going to kick in for a 
couple of months. We are hopeful that it will help the economy 
get through this period of slow growth. And I think when we see 
what happens there, then we will have a little bit better idea 
what we might need to do in the future.
    Chairman Kerry. Administrator Preston, I will just ask you 
a question and then I will turn to Senator Cardin and then come 
back, but there is a chart over here that indicates the--and 
maybe we can get the chart up--that indicates the decrease in 
the number of 7(a) loans approved by the lenders, about 18 
percent down from the same period last year. I mentioned that 
represents about $641 million. Do you have any judgment to 
offer the committee about whether or not the fees have been a 
factor in that downward trend?
    Mr. Preston. I certainly don't think it is the primary 
factor or even an overwhelming factor. What we have 
consistently heard----
    Chairman Kerry. But a factor?
    Mr. Preston. I think on the margin, any additional fee has 
an effect. But what we have consistently heard from the lenders 
is either demand is down or we stretched too far and we have 
had a pull-back. And when we look at where our loans have 
declined, it is almost all smaller unsecured lines of credit, 
mostly through sort of credit-scored products. And if we look 
at the lenders where the decline happened, about 70 percent of 
the decline came from three lenders that have pulled back very 
dramatically, in the number of loans. The dollar value, decline 
is a little bit less dramatic than that, but it is also heavily 
concentrated.
    So, you know, the other thing we are hearing, and I know we 
are talking about kind of broader macro issues to an extent, 
but what we have seen very clearly is it is not a one-size-
fits-all behavioral adjustment on the part of banks. Many of 
them had different practices in using our programs. Many of 
them were a lot more aggressive than others. A lot of lenders 
are saying they haven't changed their credit standards one bit 
and they are pushing hard to find good value. Others have said, 
we got so far ahead of ourselves, and we are pulling back 
dramatically and figuring out what we need to do.
    So I think it is important to understand where it is 
pocketed and where it is not, and we do see, continued, I 
wouldn't say strength, but a much lesser decline in larger 
loans, certainly any loans that have collateral in them, among 
most institutions since a handful are driving the decline.
    Chairman Kerry. Senator Cardin, are you ready to go? I will 
come back afterwards if you are set to go.
    Senator Cardin. Thank you, Mr. Chairman.
    Chairman Kerry. Do you want to press your button there?
    Mr. Preston. I had that same problem a minute ago.
    Senator Cardin. Thank you for turning me on, Mr. Chairman. 
I appreciate it.
    Chairman Kerry. It is my job.
    [Laughter.]
    Senator Cardin. Let me first thank our witnesses. To 
Administrator Preston, my staff has shared with me the letter 
that you sent back to me in response to the question from the 
prior hearing dealing with minority participation in our loan 
programs. I haven't had a chance to absorb all of this, but 
clearly, it looks like the trend lines are favorable and I 
thank you for supplying the specific information for the 
country and for Maryland. I look forward with you in making 
sure that opportunities are provided, particularly to minority 
businesses in this country, in the most effective way, and I 
thank you for that response.
    I just want to follow up on the Chairman's point, if I 
might just for a moment. One of my concerns is that small 
business owners, the statistics sometimes don't really reflect 
what is happening there. We see the statistics, but business 
owners are proud people and they are in real trouble today and 
they are trying to figure out a way to stay afloat. When there 
is a credit crunch, they still need credit, and in many cases, 
they go to much more expensive credit sources. They use their 
credit cards and pay a much higher rate, which is only going to 
cause a greater difficulty for them being able to keep their 
business afloat.
    So I am just interested as to whether you are seeing trends 
with small businesses today where they are substituting some of 
this credit for more expensive credit, which could really 
affect their ability to stay in business.
    Mr. Preston. Yes. I think that is a great question and it 
actually dovetails well with another question that I wanted to 
comment on that Senator Kerry had asked. I think we kind of 
lump small business into one big chunk, but I think the surveys 
are kind of showing us that the somewhat larger small 
businesses that have a little bit more balance to them continue 
to have good relationships with banks. Their markets are 
impacted, their sales are impacted economically, but the credit 
as I see it and from what I have read, and as I have listened 
to people, that doesn't seem to be as much where the squeeze 
is.
    When you go further down to the smaller small businesses, 
that is where you see a lot more people financing off of credit 
cards, a lot more off of home equity lines. A lot more people, 
if they are going to go to the bank they need that home equity 
as a source of collateral for a bank loan. And my concern is it 
is more at that end of this spectrum that we are beginning to 
see some more of the challenges. And to the extent that bank 
credit is not available for those people, you would expect them 
to go to credit cards. I don't have any empirical evidence to 
tell you that it is happening, but we see the logic behind 
that.
    And so if you match that with my earlier point that not all 
banks are behaving the same way, that is why it has been so 
important for us to get out there and meet with hundreds of 
banks to say, let us look at what is happening in your 
portfolio. Let us look very individually, bank by bank, how you 
are lending to small businesses, how you use our programs, and 
how you can expand your capital to small business by working 
more closely with us, because they all use our programs 
differently, too.
    You know, just like lending is one business at a time, our 
relationship with those banks is similar. So we are really 
trying to get out there and work that issue, but I think your 
concern is very real. And I know you are going to be talking to 
some people from the building industry afterwards. We are 
seeing the impact in our portfolio much more heavily in 
construction and in hospitality and a few industries that seem 
to be getting harder hit.
    Senator Cardin. I know that Chairman Kerry has legislation 
that he is advancing that will try to make the tools more 
readily available to small businesses during these economic 
problems. I would just urge us all to really think beyond maybe 
traditional thinking here, because I really do think the 
economic conditions here are different than we have seen in 
past recessions. We know that we rely upon small business for 
economic growth. I am just worried that we might be missing the 
problems that small businesses are currently facing and I think 
the Chairman's approach is an excellent approach to try to 
provide greater help from the SBA and from the Federal sources 
removing some of the perhaps obstacles for small businesses 
taking advantage of these tools.
    But I would just urge you to try to get as much information 
as possible about what is happening out there and whether small 
businesses are using alternative sources for credit that really 
could be causing a serious problem for their future stability 
and growth and making it more difficult for us to come out of 
this economic downturn.
    Thank you, Mr. Chairman.
    Chairman Kerry. Thank you very much, Senator Cardin. I 
appreciate that.
    We have been joined by the Ranking Member. Senator Thune, 
if you don't mind, I am going to turn to her, or you guys fight 
it out. It is your side. [Laughter.]
    Senator Snowe. We never fight on our side. [Laughter.]

 OPENING STATEMENT OF HON. JOHN THUNE, A UNITED STATES SENATOR 
                       FROM SOUTH DKAOTA

    Senator Thune. Thank you, Mr. Chairman and Senator Snowe. 
Thank you for holding the hearing, and I want to thank our 
panelists for coming today, as well.
    This is a critically important issue and I think my State 
is probably no exception. When you look at the impact of small 
businesses on the economy across the country and where the jobs 
are created, you see they are created in small businesses. So 
making sure that we have got a good strong small business 
sector of our economy with the availability of capital and 
liquidity is really critical. So examining this issue in 
greater detail and identifying what some of the problems and 
issues are and then trying to fashion some solution to those, I 
think this too is extremely important. So I want to thank you 
for holding the hearing and I want to thank you for sharing 
your insights. I know we are going to hear from a panel of 
business owners and people who are directly impacted by the 
credit crisis in a little bit.
    Dr. Mishkin, have you noticed any trends as to what areas 
of the country or what business sectors are most affected by 
the credit crunch?
    Mr. Mishkin. Well, clearly the sector of the economy that 
has been most affected is the housing sector. We have seen a 
very, very dramatic stop in housing starts. There is still a 
lot of inventory of houses on the market, which is a drag on 
that sector.
    Chairman Kerry. Is your mike on?
    Mr. Mishkin. Yes, it is lit.
    Chairman Kerry. Pull it a little closer. Thank you.
    Mr. Mishkin. So clearly, this sector has really been quite 
an important drag on the economy. Last year, it basically 
lowered economic growth by about one percentage point. So that 
is really the sector that has been most heavily impacted by 
what has happened.
    But clearly, there are other sectors of the economy that 
have also weakened. Household spending has been quite weak in 
the last couple of months, and so there have been spillovers 
elsewhere, as well.
    Senator Thune. How about areas geographically?
    Mr. Mishkin. Well, geographically, we concluded there are 
big differences in different parts of the country. So if you 
are, for example, growing corn, you are doing quite well right 
now, so many of the agricultural States are doing quite well. 
If you are pumping oil, you are also doing quite well. But on 
the other hand, if you are manufacturing goods and you can't 
sell as many of them, that is a real problem for you.
    So there are certain parts of the country, clearly, that 
have suffered more than others. The Midwest clearly has some 
serious problems, besides the fact that their weather is not so 
great. But in general, in any kind of a situation where there 
has been a slowing of growth, some parts of the country get hit 
worse than other parts of the country. Small businesses 
actually have to look to their local market as well as the 
national market.
    Senator Thune. I think one of the concerns with the 
mortgage crisis as it relates to small businesses is that home 
values have decreased and many small businesses rely on home 
equity for credit. Can you explain how this affects the small 
business credit crunch and does that problem spill over into 
other areas of the country which are not being as directly 
affected by the mortgage crisis, at least not presently?
    Mr. Mishkin. Yes. The issue of what happens in the real 
estate sector is very important to small businesses because 
frequently the collateral that they use to back up the loans 
and therefore get lower interest rates is, in fact, tied up to 
real estate. And if the value of that goes down, either the 
lender is not as sure that they will pay them back and 
therefore will actually charge them a higher rate, or they will 
have access to less credit, and this is clearly an issue in the 
current environment.
    And then, also, many of the small businesses are involved 
in producing goods that are used in the real estate sector. So 
if you are in a part of the country particularly that has 
problems in that regard, it is actually a much tougher 
environment for you as a small business.
    Senator Thune. But do you see this being a problem which 
certainly is more intense in certain areas of the country, sort 
of being nationalized? Obviously, if you are a small business 
in an area where you are really experiencing this mortgage 
crunch, your availability of credit if you use home equity as a 
way of financing some of your operations is a problem. But is 
that starting to impact others, trickling out or having a 
domino effect----
    Mr. Mishkin. Yes. It is a national problem--think about the 
household. The household also has lost collateral when the 
value of their housing goes down, and that means that there is 
likely to be less spending. Even when households spend, they 
don't just spend in their own community.
    Senator Thune. Right.
    Mr. Mishkin. They actually spend on goods throughout the 
country. So indeed, you are exactly right that the problems 
which started just in one small part of the financial sector 
have actually spread much more widely in both the financial 
system and also in terms of the overall economy.
    Senator Thune. Administrator Preston, I know some of the 
witnesses on the second panel are going to discuss their 
personal experiences on the subject, but can you tell me what 
you have heard at the SBA from lenders about the demand for 
loans?
    Mr. Preston. Demand is down very noticeably and certainly 
there are a number of factors we think are driving it. Some of 
the surveys would indicate that there is a lesser propensity to 
hire right now, a lesser propensity to invest back in the 
business. Those are the kinds of things that typically give 
rise to borrowing needs, and certainly in a slowing economy 
that is not as surprising.
    The other thing I would tell you is we have taken a look at 
our loan programs back in the early 1990s and from 2000 and 
2001, the last couple of times where we have seen a real 
economic downturn. In both cases, we saw a fairly significant 
downturn in our lending, which is very much in line with what 
we are seeing right now. That doesn't mean it is good, but 
certainly some people have commented anecdotally they thought 
we were sort of countercyclical and we sort of came into our 
own. But certainly when we have gone back and looked at the 
evidence, that is not the case.
    Senator Thune. It has been suggested that there be a 
lowering of fees as one solution to the credit crunch. Can you 
tell what effect, if any, lowering of fees on SBA loans has had 
on loan demand in the past as you have looked at your portfolio 
over time?
    Mr. Preston. Our portfolios had very consistent fees for 
many, many years other than the 2003 and part of 2004 time 
frame, when there was a shorter-term reduction in fees. Our 
loan volume actually grew throughout that period of time. But 
when the fees went up, our loan portfolio continued to grow. So 
it was sort of in the middle of a longer-term growth period and 
so when the fees went up, the loan volume did not go down. It 
continued to go up.
    We are overwhelmingly hearing from lenders it is either 
credit or demand. Now, there are certainly people on the margin 
who I am sure would like us to lower fees, and obviously it 
makes them economically somewhat more attractive, but we don't 
think it is going to have a major impact on volume for a number 
of reasons.
    Senator Thune. I am sure my time has expired, Mr. Chairman. 
Thank you.
    Chairman Kerry. Thank you very much, Senator Thune.
    Senator Snowe.

  OPENING STATEMENT OF HON. OLYMPIA J. SNOWE, A UNITED STATES 
                       SENATOR FROM MAINE

    Senator Snowe. Thank you, Mr. Chairman. Thank you for 
holding a very critical hearing that is most timely, given what 
is taking place in our economy. I appreciate your efforts here 
today to discuss the credit crunch and the impact it is having 
on small business and I want to welcome our panelists. 
Administrator Preston and Dr. Mishkin, thank you very much for 
offering your views at a crucial time for our nation's economy.
    Obviously, small business is an essential and crucial 
aspect of our well-being economically. It is disconcerting when 
you see the evidence out there that this downturn is going to 
be most pronounced on small businesses. I certainly want to 
make sure that we are doing everything that we can, whether 
through the Small Business Administration or through Congress. 
We must work on the issues that we can address and remedy with 
respect to the use of the loan guarantee programs in easing the 
restrictions, the lender oversight fees, the process, 
streamlining it more so it makes it user friendly, and customer 
friendly.
    The other part of this problem right now is in respect to 
lenders, and that there are so many that are not participating. 
We see the drop-off in the 7(a) program, more than 368 over the 
last two years, and a decline in the Express program. It is 
significant. It illustrates that we have some challenging 
problems that we could remedy now.
    Certainly, the legislation Senator Kerry, and I, and 
everyone here on the Committee supported would help small 
business borrowers. This legislation, pending before the 
Senate, would streamline the process. We would like to execute 
the Small Business Lending Reauthorization Improvements Act. 
There are a number of provisions in there that could help and 
benefit small businesses. We have been trying to negotiate an 
agreement to get it through the full Senate even though it has 
passed this Committee unanimously.
    I hope the SBA could further streamline their process, and 
could we not suspend lender oversight fees? These are huge 
barriers to small businesses accessing the programs and loan 
guarantees rather than relying on credit cards and home equity 
loans, which we see as a continuing rise in that direction. It 
is problematic when you are given the cost and the risks 
associated with using credit cards and home equity loans. There 
is no question that this type of business borrowing is going to 
be far more costly. And it is, given what credit card companies 
are charging these days and all the different practices that 
are out there that drive up the costs.
    So I would like to explore with you, first of all, 
Administrator Preston, what could be done immediately. Let us 
just take the time frame of 45 days in terms of what could be 
done within your agency, one, to streamline the process, 
because that is a problem for lenders, and also small 
businesses trying to use these programs. If you are seeing a 
drop-off, it could be a number of reasons, but obviously it is 
the barriers, such as the SBA's excessive paperwork.
    The second part this is the lender oversight fees that are 
also a barrier, which I know have been raised recently. The one 
on the 7(a) annual lender fees going up to 0.55 from 0.49, and 
then, of course, the other one is charging lenders $9 million 
for lender oversight fees in the 7(a) program. That is going to 
drive people out of this program. It is just going to make it 
that much more prohibitive in terms of using SBA loans.
    So is there something that could be done now, within 45 
days, that you could execute? I mean, we have our job to do on 
this side, there is no question, in getting these bills passed 
and I think it would help to raise the loan limits and so on. 
We have tried to expedite that process. Is there anything we 
could be doing, or you could be doing?
    Mr. Preston. Well, yes. We are doing a number of things 
right now which I think are going to be helpful. One of the 
things we are pushing very hard on is to expedite the roll-out 
of a highly-simplified process for rural lenders. In fact, we 
just finished piloting it in Senator Thune's State and five 
contiguous States.
    Many of you recall the Low-Doc product a number of years 
ago. When Low-Doc was discontinued in 2005, we lost over 400 
banks in 2006 in our active lenders. So when you look at when 
we actually lost lenders, it was from 2005 to 2006 and most of 
those were Low-Doc lenders. And the reason is clear, it was a 
simple application and it was easy to do. It wasn't, to your 
point, difficult to comply with. The problem was it had very 
high credit losses and was driving costs up in the portfolio.
    So what we have done is we said, well, what worked about 
Low-Doc and what didn't. And we have piloted this program--we 
call it Rural Lender Advantage, even though it is for any 
community bank--which is a very simplified form. They can do it 
electronically. We commit to a very rapid credit decision, 
turn-around. We have a customer help desk in place, so any 
small lender who isn't familiar with our programs who doesn't 
know how to fill it out, we will get on the phone with them. We 
have trained our entire field network on how to help lenders 
with their lending program. So they can call our field office 
for help. And we commit to a quick turn-around.
    So we piloted it in that area of the country. We got a lot 
of feedback from lenders. We had a lot of outreach. They told 
us how we could make it better. Right now, it is in internal 
clearance. As soon as it comes out of internal clearance, we 
are going to do a nationwide roll-out and we will have a very 
active process to engage small lenders back into our programs.
    Senator Snowe. So when would that take place?
    Mr. Preston. I would hope that--we are pushing very hard to 
begin adding regions of the country early next month. Like I 
said, right now, literally, it is in internal clearance, so I 
am pretty hopeful it is going to be a good recruiting tool.
    The other thing I would mention is----
    Senator Snowe. So that would be the pilot program?
    Mr. Preston. The pilot----
    Senator Snowe. Is that completed yet?
    Mr. Preston. The center part of the United States is 
finished----
    Senator Snowe. It is finished, so then you would execute it 
nationally?
    Mr. Preston. We want to roll it out much more broadly. And 
so, you know, Low-Doc was roughly speaking, ten percent of the 
number of loans we did.
    The other thing is, and I mentioned it before you came in, 
is last month, we reached out and had sit-down detailed 
relationship meetings with over 800 lenders to begin to work 
them through how to use our products more broadly and to get 
out there and expand what we can do for them.
    You have talked about streamlining. I think you are 
familiar with some of the challenges we have had in our 
guaranteed purchasing operations, very long backlogs. We are 
turning those in 22 days. It is a big part of getting people 
back in our programs, because when they send us a purchase, 
they want us to honor it.
    All across the agency, we are going more to electronic 
interactions. We are simplifying our processes. We are making 
our agency much easier to work with, and we have trained about 
1,000 people in the field to be better at working with people 
locally, some of whom are banks. So I really think we are 
putting shoulder to the wheel to push our programs out.
    Senator Snowe. And have you been able to get any lenders 
back on board?
    Mr. Preston. As we closed 2007, we had an increase in 
lenders. Now that we have finished this round of outreach, once 
we have this Rural Lender Advantage tool, we are going into 
very active recruiting mode. So as of the end of last year, 
yes, not dramatic----
    Senator Snowe. Can you tell us how many?
    Mr. Preston. I think it was--yes, I can, but if you ask 
your next question, I will have it to you probably in a second.
    Senator Snowe. Well, I guess the point is we have a very 
targeted and directed program to enlist lenders back on board, 
addressing some of the issues that are within your capacity to 
do so. That is critical. We don't want a fall-off at this 
crucial point because you can lose small businesses, you can 
lose jobs. You really have to make a concerted effort to try to 
get them back on board, because obviously there are problems, 
and that is what we are going to hear in the second panel, that 
there are serious problems with the program, not to mention the 
lender oversight fees, which are a barrier. Can you suspend 
those fees?
    Mr. Preston. Those fees, very roughly speaking, right now 
are about $10 million a year. I am less concerned about the 
impact of those--not all--the smaller banks don't pay those 
fees, don't pay the on-site fees. We don't do on-site reviews 
unless a bank hits a certain size, and so it is not a big cost 
for the larger banks. It is not a cost at all for the smaller 
banks.
    I will say there is a tier of banks that are small-ish, and 
I can give you kind of the size--maybe that have to $10 to $25 
million in guarantees from us--that I think it is a cost for, 
and we are working on a project right now to understand if 
there is a way we can soften the blow for that tier of banks, 
because the issue is once we have to go on-site and do a 
review, it becomes expensive. But as you know, we have been 
working very hard to increase significantly the quality of 
oversight we do, and as a result, we are going to banks a lot 
more. We are doing a lot more reviews of their portfolios 
because, as we have talked in the past in these hearings, it is 
important for us to make sure we are doing the right kind of 
oversight.
    Senator Snowe. Do you support the legislation that we are 
trying to get through in the Senate that passed unanimously 
from this Committee and has been pending since September? The 
Small Business Lending Reauthorization. It goes to the heart of 
all the lending programs.
    Mr. Preston. Ma'am, I would have to look----
    Senator Snowe. It increases the maximum loan size for the 
7(a) loans to $3 million, allows 7(a) bonds to be traded in the 
secondary market, increases liquidity, simplifies size standard 
requirements for the 7(a) program, makes it easier for 504 
developers to make loans in low-income communities, and 
addresses a number of other issues. I won't go through them 
all. But it really would be helpful here to----
    Mr. Preston. I would be happy at any time----
    Senator Snowe [continuing]. Break the deadlock, I mean. I 
don't know, is there resistance from the administration on this 
issue?
    Mr. Preston. I would be happy to come over at a moment's 
notice and go through all those provisions with you. I think it 
has some very good stuff in it and we would love to----
    Senator Snowe. It is too bad that it is an all-or-nothing 
proposition, that we can't get this legislation through. It is 
a moment in time where we have to do everything we can to 
support these programs, boost the economy, help small 
businesses create jobs. There is no reason for this to be 
languishing. I know that there are some concerns in the 
administration, but we ought to be able to work them through 
and get this done. I mean, it has been languishing since last 
September.
    Mr. Preston. Right. I apologize----
    Senator Snowe. In the meantime, so many things are 
happening out in the economic landscape that are so pivotal to 
the well-being of small businesses and to their existence. And 
here is a good example of that. It passed unanimously out of 
this Committee. That is illustrative of the support that it 
has. So I just don't understand why we can't get this through. 
Is there a way of working that out sooner rather than later?
    Mr. Preston. Like I said, I am not--honestly, I don't know 
the state of play on the bill and I would be happy to meet with 
your staff and work through it.
    Senator Snowe. Well, can we--this is important.
    Mr. Preston. Yes.
    Senator Snowe. I think we really should. Let us get it 
done. Let us show the ``can do'' spirit. That is my feeling 
here. You know, there are so many things going on out there. 
People need support and help and there is no reason, with a 
bill that has passed out of the Committee unanimously, that has 
broad support, that if there are some issues here, we shouldn't 
be able to address them. But it shouldn't be just, hanging in 
limbo because the administration has some concerns. We ought to 
be able to work it through.
    Mr. Preston. Yes. Frankly, I didn't--I am not sure that our 
staffs have fully gotten together on it and I am committed to 
do this----
    Senator Snowe. You will as of today?
    Mr. Preston. Yes, absolutely.
    Senator Snowe. Well, my staff says you have gotten together 
multiple times, so----
    Mr. Preston. All right.
    Senator Snowe [continuing]. Whatever it be, let us change 
it today.
    Mr. Preston. Can I just mention one other thing?
    Chairman Kerry. Mr. Administrator, can I just say to you, 
we passed this bill. When you were up here previously I asked 
you about this. Your staff has never, ever communicated to us 
any issue whatsoever with the bill. So if you have an issue, we 
have got to know what it is, and I would like to have an 
agreement, if I can, with Senator Snowe. We are at Wednesday 
now. Why don't we say by next Monday, if you have got an issue, 
would you tell us what it is?
    Mr. Preston. Yes, absolutely.
    Chairman Kerry. Otherwise, you are going to support it, 
correct?
    Mr. Preston. We will go through it with you chapter and 
verse in terms of what we understand the administration's 
position to be and where we need to go with it.
    To your earlier question, Senator Snowe, we had 200 lenders 
make a loan in the first half of 2008 that did not make loans 
last year, in the first half of last year, and at the end of 
2007, we saw a two percent increase in our lenders. So it is 
not dramatic, but it is after a period of decline.
    Senator Snowe. Thank you. Thank you, Mr. Chairman.
    Chairman Kerry. Can I follow up on that, if I may? I am 
really concerned about the trend line. You know, since 2005, 
you have lost 390 lenders. And then for 2008, the pace as we 
look at it now is about 100 more lenders are on tap to have 
been lost for the third straight year.
    Now, when we talk to these folks, one of the principal 
reasons that they give us for dropping out of the program is 
because of the increased fees, lender oversight fees, and the 
unduly burdensome paperwork. Those are the three things we hear 
from these banks. We have lost many more participant banks than 
we have gained. So that is not a great trend line for an entity 
and a program that ought to be growing and appealing to more 
and more people.
    I think a lot of us feel very strongly, Mr. Administrator, 
that these fees--you know, when the economy gets tight like 
this and we all take a look at somebody who is going to be 
foreclosed--a few weeks ago, Mayor Menino and I hosted a 
weekend event at the Roxbury High School where, for the first 
time, we had a whole bunch of home owners who were able to come 
into a room and we got the ten major lenders and sat them down 
in private rooms. Everybody was screened. They brought their 
paperwork with them. And they literally negotiated right there 
in this high school and people walked out smiling because they 
were able finally to get somebody on the phone and not have a 
punch two to go to six, to go to five, and punch one and you 
don't get anybody. They talked to somebody who actually 
negotiated.
    And the result is they are staying in their home because 
they are able to afford a fixed-price mortgage at the revalued 
price that doesn't reflect the predatory practice that--I mean, 
one of these women was paying a 13 percent mortgage. You tell 
me any of your friends who are paying 13 percent. Others are 
paying 9.25 and so forth and about to go up. And these are 
people, both members of the family working, hard working, 
playing by the rules, $5,000 a month for their mortgage, and 
they are about to get kicked out of their home because of the 
lack of reasonableness.
    Now, for those people, the difference between the ARM that 
would have taken them up and the fixed rate was the difference 
in their ability to stay in the home. That is true of a lot of 
small business people who are looking at the potential of 
taking out a loan or maybe following through with an expansion, 
but if they look at the fees and they look at the additional 
fee and things they sort of back off.
    And it seems to me in this moment, in the mood we are in 
where we have got to--we have got to kind of change the 
psychology of the country. I agree with Senator Snowe. It is a 
time for people to say, we have got to break this cycle and the 
way to break it is to restore confidence, and the way to 
restore confidence is give people a sense that you are on their 
side and working with them to facilitate their ability, if they 
have got a going concern and they meet all the other 
creditworthy issues, that they can stay in there.
    So I would ask you to think carefully about this issue of 
whether or not these fees and other things don't make a 
difference, particularly since you are losing lenders at a 
greater rate than you are gaining them and they are telling us 
the reason they are dropping out is because of the increased 
fee.
    Mr. Preston. Let me make a couple of points. I wouldn't 
underestimate Senator Snowe's point of being an entity that is 
easy to do business with and streamlined. I would be amazed if 
any lender group came forward and said over the last year and a 
half that we hadn't made tremendous strides in being more 
sensitive to the industry, simplifying our policies. We hadn't 
updated our policies in over 15 years. They are all updated. 
They are simplified. Responsiveness to banks that we are 
purchasing loans from, clarity around how we do business, much 
greater customer support, much higher quality training of our 
people to go to banks and help them through their issues. On 
the side of being an effective, easy-to-use partner that 
provides great support, I think we have made incredible 
progress. I really do.
    And on the fee side, granted our fees were somewhat lower 
in 2003 and 2004. I guess the question to think about is when 
we look at sort of order of magnitude, and generally when we 
talk about an impact on our fees, we are looking at reducing 
our up-front fees by a half to one percent. So moving from two 
points to one point. And the question is, how much is that 
actually going to drive borrowing behavior with people--how 
much does that make it affordable to them, by going from two 
points to one point.
    I actually think what we are going to see is a lot more 
conventional loans coming into our portfolio, many of which 
lenders would do otherwise. And I have talked to many lenders 
about this issue and I think that is a very likely outcome of 
this.
    I will say on the lender oversight fees, to your point, 
Senator Snowe, I do think there are a group of lenders for whom 
this is a challenge and I think it is kind of the small to 
medium-sized and I do think we have to look at that. We are 
reviewing alternatives right now on how we can either make 
those on-site reviews less frequent or reduce the fees 
somewhat. But for the small lenders that don't get hit with it 
and for the large lenders, I think it mostly gets absorbed into 
the size of their portfolio.
    I don't think this is going to be an overwhelming driver of 
volume, though. I really don't. I think it is going to be 
engaging the banks by being a good partner and getting the 
banks to see that our programs help them to make credit 
decisions that they are not making right now. I think it is a 
credit issue.
    Chairman Kerry. Well, I hear you. I hear what you are 
saying, but I am not sure that the realities of the marketplace 
say that that is accurate or that experience does. Let me just 
refer you. In 2001, after the tax in New York and here, Senator 
Bond and I pressed and passed legislation after 9/11 to reduce 
the lender fees by 50 percent because of the jarred economy, et 
cetera. We had a 50 percent increase in the number--excuse me. 
We cut by 50 percent. There was a 23 percent increase in 
lending and SBA did about $2,900,000,000-and-some worth of 
lending under that guise. I think we went up from 2001, from 
nine, up to 12 in the next year, and then it was 11 the year 
after that.
    So I think that the evidence is that it makes a difference, 
and I think when you add it to the other piece, it is 
problematical. We can argue about it. Obviously, you have a 
different point of view. But I think the evidence indicates 
that when money is tight and cash flow is tight and working 
capital is tight and the economy is uncertain, those fees can 
make a big difference.
    Senator Snowe, do you have any--I want to leave the record 
open. I want to get the other panel on, and we have some 
things, so I think it is important to do that.
    Mr. Preston. Okay.
    Chairman Kerry. So I would like to leave the record open 
for a couple of weeks, if we can, and other colleagues can 
submit questions.
    We are very appreciative to you for taking the time to be 
here, both of you. I know it is important.
    Do you have anybody from your shop, particularly SBA, who 
are going to stay here?
    Mr. Preston. Yes, and we will also reach out to your staffs 
on the bill.
    Chairman Kerry. Great. Thank you.
    Mr. Preston. So I apologize if there has been a disconnect 
there.
    Chairman Kerry. That is terrific. I appreciate it.
    If we could ask the second panel to come forward and just 
take seats and we will get you arranged with names.
    Meanwhile, let me just say, this second panel is larger 
than we usually have and the reason is we really want to get a 
comprehensive picture of the credit crunch impact on small 
business. So we are going to hear from Marilyn Landis, who is 
the President of Basic Business Concepts; then from Robert 
Mitchell, the founder and CEO of Mitchell and Best 
Homebuilders; Daniel O'Connell, Secretary of the Massachusetts 
Office of Housing and Economic Development; and then we will 
hear from Cynthia Blankenship, Vice Chairman of the Bank of the 
West; then from Professor Sam Bornstein from Kean University in 
New Jersey; and finally from the Mayor of Gloucester, 
Massachusetts, Carolyn Kirk.
    We are very appreciative to all of you for your patience 
and for your distance traveled and for coming here to share 
with us. I think it is important testimony, and we would like 
to remind you that if you could try to summarize in about the 
five minutes, all of your written testimony will be placed in 
the record as if stated in full.
    Mayor, do you want to start off?

     STATEMENT OF HON. CAROLYN A. KIRK, MAYOR, GLOUCESTER, 
                         MASSACHUSETTS

    Ms. Kirk. Sure. Chairman Kerry, Ranking Member Snowe, I 
thank you for inviting me here today to testify about the 
impact of the credit crunch on small business. My name is 
Carolyn Kirk. I am the Mayor of the City of Gloucester, 
Massachusetts. You may know of Gloucester. The city of about 
30,000 residents is located north of Boston and we are 
America's oldest fishing port. Chartered in 1623, the city has 
a long and storied history of providing fresh fish throughout 
the country and beyond. In our 385-year history, Gloucester has 
lost over 10,000 men to the Atlantic Ocean. The names of those 
known as lost at sea are painted on a mural on the main 
staircase at City Hall and also on a memorial on Stacy 
Boulevard. I invite you all to come and visit our beautiful 
city if you haven't already.
    In Gloucester, the fishing industry has sustained the 
community and its backbone has been small business. From the 
ice company that supplies ice to the fishing boats to preserve 
their catch to the shoreside services that perform boat repair, 
provide fuel or dockage, small business is the engine that has 
driven our economy. With the drastic measures taken by the 
Federal Government in an effort to rebuild fish stocks, the 
economy in Gloucester is at a crossroads, but it is still 
driven by small business.
    To give a city like Gloucester or any American working-
class city whose economy is in transition a fighting chance to 
survive and thrive, we need your help. Today, I am here to 
testify about the impact of the credit crunch on small 
business. The impact is significant and appears in many 
different forms throughout small businesses in Gloucester. In 
preparation for my testimony, I asked small business owners in 
Gloucester to contact me with examples of how the credit crunch 
is impacting them, and this is a sampling of what I heard.
    A number of small business owners state that their 
customers pay more slowly. An owner of an oil delivery company 
reports that the vendors that supply oil to him demand 
immediate electronic payment. However, the homeowners to whom 
he delivers the oil are slow to pay, leaving him with a cash 
flow issue, making it difficult to keep enough money in the 
bank to keep the business going.
    A small business owner just starting out financed equipment 
and materials for the business on credit cards, and the credit 
card companies are shortening their payment cycle to 22 days. 
But her clients are slow to pay, or even if they are on a 30-
day term, it makes the business owner late in her credit card 
payments. She says it is a constant battle with the credit card 
companies and they are the only ones making any money.
    Another small business owner cites other factors which are 
impacting his business, such as inflation. Three years ago, 
eggs cost seven cents. Now, eggs are 21 cents, which is a 300 
percent increase. His monthly electric bill runs an average of 
$1,000 per month. The impact of his higher costs ultimately 
result in higher retail prices to the consumer. Across the 
board, small business owners are feeling the effects not only 
of the credit crunch, but increases in cost such as utilities, 
health insurance, or in my city, the cost of water and sewer 
services, which are skyrocketing.
    As I said, Gloucester was chartered 385 years ago. Today, 
when my engineers replace water lines underground, many of the 
pipes they pull up are stamped 1902. My city has an aging 
infrastructure. A catastrophic failure in our drinking water 
system or our sewage treatment plant could cripple the city and 
bankrupt our citizens, and we are under a Federal consent order 
to separate our sewage from the storm water. This project is 
costing the city tens of millions of dollars and the rate 
payers, who are also our small businesses, are footing the 
bill. This is simply not sustainable for our local economy. 
Gloucester is committed to the Clean Water Act, but we need 
Federal relief in the form of direct grants. It bothers me to 
hear about infrastructure investments our country is making 
around the world when my own city is crumbling around me and my 
residents and small businesses are tapped out.
    I ask that when you deliberate about how to address the 
impact of the credit crunch on small business, that you look at 
all of the factors that are making it difficult for small 
businesses to survive. When the Congress passes a mandate that 
is unfunded, it is the small business owner and the taxpayer 
that picks up the slack. Unfunded mandates in education have 
caused my city to divert spending to mandated education 
programs. We don't spend any money on athletic programs. 
Rather, the students and the parents turn to the small 
businesses for donations, auction items, and money.
    Successful small businesses are resilient. Many can survive 
the credit crunch. But they are also dealing with inflation. 
They are dealing with the more expensive municipal services 
because of spending on infrastructure and the increased costs 
of delivering those services. They are dealing with schools who 
have their hand out, always looking for money. And my 
observation when I look at it is that we are creating private 
wealth and public squalor and many small business owners are 
just caught in the middle. We need to create wealth, jobs, and 
opportunities for our small businesses and reinvest and rebuild 
the domestic economy.
    I applaud the work of this Senate committee and I want to 
just let the record show that I support the initiatives that 
you are trying to push through this Congress. I urge you to 
continue your dedicated work towards reinvesting in America's 
economy and to keep in mind the overall impact of the fiscal 
condition facing our cities and towns, which is how a citizen 
experiences this country, as you make your decisions in the 
110th Congress.
    Thank you for the opportunity today.
    [The prepared statement of Ms. Kirk follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
    Chairman Kerry. Well, thank you, Mayor. That was a very 
graphic and important, eloquent description of the problems 
that you face and I am happy to report I have enjoyed that 
wonderful City Hall, which is really very beautiful and very 
moving. I was there for the dedication of the memorial, so it 
is nice to be reminded of both.
    Senator Snowe, I know, has a huge affinity for everything 
you are talking about because she has great fishing ports and 
villages, too, so we are happy to welcome you.
    Ms. Kirk. Thank you.
    Chairman Kerry. Have you been to Gloucester? I have been to 
Camden. [Laughter.]
    Senator Snowe. Look at that. He set me up for that one. 
[Laughter.]
    No, but I will visit there.
    Chairman Kerry. There you go.
    Professor Bornstein, thanks. I have to step out, 
incidentally. I am going to be able to hear you outside, but I 
have got to join a conference call for a few minutes, but just 
continue on. Senator Snowe will chair and we will continue 
through. You can go ahead.

 STATEMENT OF SAMUEL D. BORNSTEIN, CPA, MBA, BME, PROFESSOR OF 
 ACCOUNTING AND TAXATION, SCHOOL OF BUSINESS, KEAN UNIVERSITY, 
                       UNION, NEW JERSEY

    Mr. Bornstein. My name is Sam Bornstein. I am a Professor 
of Accounting and Taxation at Kean University. Good afternoon, 
Chairman Kerry, Ranking Member Snowe, and members of the 
committee. Thank you for inviting me to discuss the credit 
crunch and its impact on small business.
    For the past 30 years, I have been a professor of 
accounting and taxation, as well as a CPA and consultant in 
public practice. This unique combination of experience as an 
educator and a practitioner has given me an interesting 
perspective and insight into this topic. Since 2000, I have 
researched the small business failure phenomenon. In recent 
years, my research has evolved into the impact of the subprime 
mortgage crisis on small business.
    The credit crunch can trace its beginnings to the inception 
of subprime mortgages. During the period of mid-2002 to 
September 2005, when interest rates were exceptionally low and 
there was a booming real estate market, we experienced the 
biggest refinancing boom in history. Loan underwriting 
standards were often ignored. Even the least credit-worthy 
borrower had access to this easy money. Loans were made 
regardless of bad credit histories and low or no documentation 
of income. Small business owners were drawn into subprime 
mortgage financing by the ease in which they could access cash 
to quench their continuous need for capital.
    Studies showed that small business owners often used their 
homes as collateral on small business loans. For many small 
business owners, refinancing their homes was the easiest way to 
meet their cash flow needs. Small businesses chose this option 
over other traditional sources of financing, such as regular 
commercial or SBA-guaranteed loans, because home equity loans 
did not require the same level of cumbersome paperwork, 
including financial statements, income documentation, and an 
established credit history.
    With the subprime mortgage crisis, the resulting credit 
crunch, and the slowing economy, small business owners were hit 
hard when home equity financing dried up. Credit cards became 
the number one source of small business financing. Credit cards 
facilitate easy access to capital, especially at the inception 
of a business. But, there is a downside! In a 2007 study of the 
bankruptcy filings of small business owners, there was a 
striking level of credit card debt for small businesses in 
bankruptcy. The average outstanding credit card debt for small 
business owners in bankruptcy exceeded $55,000, while for small 
business owners not in bankruptcy, it was only $17,000.
    Although credit card usage can be an effective means by 
which to acquire capital, managing this type of debt requires 
careful planning. There are risks involved which the small 
business owners are not prepared nor financially knowledgeable 
to handle. Too much debt is the major cause of small business 
bankruptcy.
    In the course of my research, I discovered a connection 
between small business failure and the subprime mortgage 
crisis, which was confirmed by a 2007 study of the bankruptcy 
filings of small business owners. The study found that in 
bankruptcy, small business owners had approximately $200,000 
more total debt than wage earners. This can be attributed to 
their home equity refinancing during the subprime mortgage era. 
As many as 80 percent of Americans refinanced their homes 
during that time, included in this statistic are small business 
owners who cashed out the equity in their homes to capitalize 
their newly-created or existing businesses.
    A landmark study of consumer bankruptcy concluded that 
small business failure was the cause of personal bankruptcy of 
one-in-five individuals, and they accounted for more than half 
of all debts in bankruptcy. The Federal Reserve Bank of 
Cleveland research study found that there was a disturbing 
correlation between bank failures and small business failure.
    In business, you can't manage if you can't measure. The 
antidote to small business failure is the knowledge and 
understanding of practical accounting and its tools and 
techniques, which provide the business owner indications of 
where the business has been, where it is, and where it is 
going.
    In a nationwide survey of approximately 1,000 small 
business owners and managers, whose businesses failed, when 
asked as to why their small businesses failed, more than half 
of the individuals interviewed said that ``lack of financial 
management expertise'' was the primary cause.
    In conclusion, credit alone does not guarantee small 
business success. With the availability of credit, there is an 
urgent need for financial literacy education. Small business 
plays a significant role in our economy. In this time of tight 
credit and economic downturn, it is important not only to 
facilitate access to capital, but financial literacy education 
should also be recognized as vital to the survival of small 
business. The Small Business Administration is in the best 
position to consider new and innovative approaches to deliver 
effective financial literacy education to small business. With 
the proper understanding and knowledge of accounting and its 
tools and techniques, small businesses will avoid the greatest 
threat to their survival, insolvency and bankruptcy.
    [The prepared statement of Mr. Bornstein follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
    Senator Snowe [presiding] Very compelling Thank you, Mr. 
Bornstein.
    Mr. Bornstein. Thank you. Thank you very much.
    Senator Snowe. Ms. Blankenship.

 STATEMENT OF CYNTHIA L. BLANKENSHIP, VICE CHAIRMAN AND CHIEF 
       OPERATING OFFICER, BANK OF THE WEST, IRVING, TEXAS

    Ms. Blankenship. Thank you. Mr. Chairman, Ranking Member 
Snowe, and members of the committee, I am Cynthia Blankenship. 
I am Vice Chairman and Chief Operating Officer of Bank of the 
West in Irving, Texas. I am also Chairman of the Independent 
Community Bankers of America. I am pleased to appear today on 
behalf of ICBA and its nearly 5,000 members nationwide to 
present the views of community bankers on the credit markets 
and small business lending.
    Bank of the West is part of a two-bank holding company with 
assets of $250 million. We have eight locations in the Dallas-
Fort Worth area and serve the small business community with a 
strong focus on SBA lending. Bank of the West has been a long-
time partner with the Small Business Administration and is 
strongly committed to helping small businesses and our 
communities by using the 7(a) and 504 loan programs. Bank of 
the West has more than $8 million in loans in its portfolio and 
it services these loans. This represents nearly five percent of 
our total loans.
    Credit availability is the lifeblood of our economy. 
Unfortunately, the broad credit markets are still sorting out 
problems caused by the subprime meltdown and toxic investments 
made by many of the largest financial institutions. The current 
turmoil in our economic and financial markets nationwide raises 
genuine concerns about the availability of much-needed capital 
for small business. While much focus has been on helping the 
housing sector, policy makers must also focus on the needs of 
the small business sector during this economic slowdown.
    At a time when the economy is faltering and credit is 
becoming more difficult for small business, a sharp decline in 
the number and dollar amount of SBA loans is troubling. The SBA 
loan program should act to bolster small business credit in 
economic downturns. Instead, the number of SBA loans being made 
is plummeting. Against the long-term protest of the community 
banking sector, increased SBA loan fees, reduced staff budget 
funding, elimination of the successful Low-Doc program, and 
increasing regulatory burdens have all hobbled the SBA's 
viability when it is needed most.
    Simply stated, costly and negative changes to the SBA loan 
programs have forced hundreds of community banks to drop out of 
the SBA programs while a handful of the nation's largest banks 
further dominate SBA lending. The number of lenders making at 
least one SBA 7(a) loan has dropped almost in half, from 5,288 
in 2001 to less than 2,700 today. While there are more than 
8,500 FDIC-insured banks, just ten banks were making 60 percent 
of all SBA loans. The top 25 banks were making two-thirds of 
all SBA loans.
    This gross imbalance has come home to roost. Many of these 
same largest financial institutions have tripped up on the 
toxic investments and subprime lending. Consequently, they have 
been forced to pull in their lending across the board, which 
includes small business and SBA lending.
    Conversely, despite media dominance about a credit crunch, 
common-sense community bank lenders are very much alive and 
well, with capital to lend to small businesses. However, the 
high fees and other SBA program obstacles must be reversed to 
preserve the affordability for SBA loans for banks and small 
business borrowers alike.
    Now, more than ever, it is vital that the SBA program is 
robust. During this challenging economic climate, the ICBA 
respectfully offers several recommendations to help boost SBA 
programs. These recommendations include: Offering a super-SBA 
7(a) loan program for one year as an economic stimulus to help 
business access needed capital; restoring a reasonable budget 
appropriation of $250 million to help lower the sharp fee 
increases on both 7(a) lenders and borrowers; enacting the 
pending SBA reauthorization legislation; enacting the Small 
Business Lending Stimulus Act of 2008, S. 2612, that would 
lower SBA loan fees similar to what was done to help small 
businesses post-9/11; permanently reinstating the successful 
Low-Doc program.
    The ICBA believes these recommendations will reinvigorate 
the much-needed SBA lending to boost our economy. GDP growth 
slowed to a minuscule 0.6 percent in the fourth quarter of 
2007. Unemployment has jumped 5.1 percent, and small business 
optimism is plummeting. Soaring energy costs are further 
challenging many small businesses. Changing economic times call 
for policy responses that will address not only Wall Street, 
but also small businesses on Main Street.
    In conclusion, many of our nation's small businesses are 
facing difficult economic times and obtaining credit is getting 
more problematic. Boosting small business activity is exactly 
what is needed to turn the economy around. Community banks, 
like Bank of the West, are well positioned and prepared to 
help. However, we must ensure that lenders' and borrowers' SBA 
program fees are reasonable.
    ICBA sincerely thanks you for the opportunity to testify.
    [The prepared statement of Ms. Blankenship follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    
    Senator Snowe. Thank you very much. That is very 
constructive testimony.
    Mr. O'Connell.

 STATEMENT OF DANIEL O'CONNELL, SECRETARY, EXECUTIVE OFFICE OF 
    HOUSING AND ECONOMIC DEVELOPMENT, BOSTON, MASSACHUSETTS

    Mr. O'Connell. Good afternoon, Chairman Kerry and Ranking 
Member Snowe. My name is Dan O'Connell. I serve as Secretary of 
Housing and Economic Development for the Commonwealth of 
Massachusetts. The Secretariat oversees the Departments of 
Business Development, Housing and Community Development, and 
Consumer Affairs and Business Regulation.
    I commend you for scheduling this timely hearing to discuss 
the impact of the disruption of the credit markets on small 
business financing. The importance of small business to the 
national economy is well known. Small businesses continue to 
play a key role in the Commonwealth's economy, as well.
    As of September of 2004, there were over 200,000 small 
businesses in Massachusetts employing over 2.4 million people. 
Our smallest businesses, those employing 20 individuals or 
less, employ 28 percent of our total workforce in the State. 
The continued emergence of new small business as well as the 
healthy growth of existing business is critical to our economy 
and is a significant source of new jobs.
    Small businesses are feeling the effects of the credit 
crunch. The Massachusetts Business Development Corporation, 
which works closely with our Secretariat, informs us that small 
business loans that they have closed in the first three months 
of this year are up from $1,750,000 a year ago to $6,125,000 
for the same period this year. Small businesses typically turn 
to the Business Development Corporation when bank loans are not 
available, so this increase is direct evidence of the 
tightening of bank credit.
    BDC's Massachusetts Small Business Capital Access loan 
guarantees are also up 12 percent from a year ago, offering 
further evidence that banks are requiring credit enhancement 
before agreeing to grant credit to many small businesses.
    As I have traveled around the State of Massachusetts from 
Holyoke to Lawrence to Fall River in the last month, I have 
been meeting with small business groups and community bankers. 
The story is the same throughout the State. The balance sheets 
of the community banks are relatively healthy. They didn't get 
drawn into the subprime lending business as much as some of the 
larger banks and financial institutions did. But there is a 
crisis of confidence. They don't know where the bottom is. They 
don't know where the pricing is. And so they are hesitant to 
make loans to long-term customers, and those customers are 
suffering because of this.
    The Massachusetts Association of Community Development 
Corporations, which we regularly partner with and are the key 
source of micro loans in the Commonwealth of Massachusetts, are 
seeing an increase in applications for owners who would have 
typically tapped the equity in their homes, either through a 
refinancing or through a home equity line. These credit sources 
do not seem to be available in the same way they were even a 
year ago.
    The Massachusetts Small Business Development Center Network 
reports that lenders are pressing their clients, small business 
owners and entrepreneurs, for greater cash reserves or 
collateral for their loans, shorter repayment periods, and more 
cautious estimates of projected revenue when evaluating loan 
applications. All of these trends have picked up in the past 
one to three months as the national economy has slowed.
    At the State level, the Commonwealth of Massachusetts has 
two significant programs designed to address credit needs of 
small business. The Massachusetts Small Business Capital Access 
Program has been very active and is currently working with over 
100 banks. The Massachusetts legislature recently gave approval 
to recapitalize our CAP program with $5 million in additional 
funds.
    We also have a program called the Massachusetts Banking 
Partners Small Business Loan Program. This partnership program 
is run by our mainly local and community banks and provides 
credits to them for their Community Reinvestment Act efforts. 
That program is focused on the needs of very small businesses 
located in low- and moderate-income census tracts.
    Despite these efforts, and perhaps more than ever before, 
the SBA loan and Technical Assistance Program are essential to 
the success of small business across America. The legislation 
that has been proposed by this committee reducing fees, 
increasing funding for micro loans, and making availability of 
refinancing of debt at lower rates, are very important and 
critical to the health of small business.
    Again, thank you for calling today's hearing. As we 
continue to work our way through our current economic 
difficulties, small businesses will continue to face increasing 
credit challenges. It is these small businesses that can play a 
significant role in our economic recovery by adding new and 
sustainable jobs. Thank you.
    [The prepared statement of Mr. O'Connell follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    Chairman Kerry [presiding]. Thank you very much, Mr. 
Secretary. I appreciate it.
    Mr. Mitchell.

 STATEMENT OF ROBERT L. MITCHELL, FOUNDER AND CHIEF EXECUTIVE 
    OFFICER, MITCHELL AND BEST HOMEBUILDERS LLC, ROCKVILLE, 
                            MARYLAND

    Mr. Mitchell. Thank you, Chairman Kerry, Ranking Member 
Snowe, and members of the committee. My name is Bob Mitchell. I 
am Chairman and CEO of Mitchell and Best Homebuilders, a 33-
year-old home building firm located in Rockville, Maryland, and 
a past President of the National Association of Home Builders, 
NAHB. Thank you for the opportunity to be here today to talk 
about the impacts of the credit crunch on the small home 
builder businesses and potential solutions for the Congress to 
consider.
    A pricing-induced housing downturn that began in 2005 has 
been exacerbated by the credit crunch that started in mid-2007. 
This will continue to be the most significant factor affecting 
the home building industry into the foreseeable future. That 
means depressed home prices, more deterioration in mortgage 
credit quality, sharply reduced credit availability, and much 
tighter credit standards for those who can still qualify.
    Home builders all over the country are experiencing a 
negative shift in terms of availability on loans for land 
acquisition, land development, and home construction, commonly 
known as AD&C loans. In addition, builders with outstanding 
AD&C loans are facing additional challenges as lenders receive 
appraisals reflecting lower values on lots and homes. Lenders 
are asking builders to fully or partially pay down the 
outstanding loans while in extreme cases denying requests for 
loan extensions. Most small home building companies don't have 
the resources to survive in such an environment for any 
extended period of time.
    Let me share a few observations from my own personal 
experience in this area. Home building requires a longer 
planning and approval process. The cycle is much longer than in 
most other industries. That means we are investing in today for 
tomorrow.
    There is currently a dislocation in the housing market 
where entry-level home buyers cannot access mortgage credit to 
purchase a home. In turn, home owners higher up the ladder 
cannot sell their current home. I call it the food chain of 
housing. They cannot sell their current home in order to make 
their next home purchase. Thus, the credit crunch shuts down 
the normal progression of home selling and home buying that we 
experienced in America.
    When the credit markets break down in the midst of a 
housing dislocation, home builder investment is extremely 
difficult to maintain. For me and for many home builders, the 
housing downturn, as I said, began two years ago and the credit 
crunch we are now experiencing is a significant additional 
problem. I have exhausted my company's resources and am now 
forced to take more extreme measures to keep afloat. For 
example, I have laid off 40 percent of my employees and tapped 
my personal assets to maintain solvency. My lenders are being 
as flexible as they can. However, if the housing market does 
not stabilize soon, they and I will eventually run out of 
options.
    Avoiding excess regulatory restrictions on federally 
insured banks, which are currently the predominant source for 
our AD&C loans, is an urgent priority. However, the difficulty 
of builders in obtaining housing production financing during 
this time also vividly highlights the need to develop 
additional sources of AD&C credit. My written statement 
includes a number of specific recommendations for increasing 
the range of suppliers of housing production credit.
    The Senate has taken several steps to ease the financial 
losses that home builders like many small businesses are facing 
during this economic downturn. I cannot overstate how important 
it is for business owners to have the ability to claim and 
carry back net operating losses deductions to years when 
significant taxes were being paid. NAHB applauds the Senate for 
approving a temporary expansion of the NOL carry-back period as 
a part of the Foreclosure Prevention Act of 2008, and I would 
especially like to thank Senators Snowe and Kerry for their 
leadership on advancing an expanded NOL carry-back.
    As Congress continues to look for additional ways to ease 
the credit crunch on small businesses, they should consider 
policies that stimulate home purchases in the immediate future. 
A temporary home tax credit would reduce excess inventory and 
relieve pressure on falling home prices by ending the waiting 
strategy of some potential buyers who are taken out of the 
market. An effective home buyer tax credit would restore 
confidence in the housing market for home owners, home buyers, 
and financial institutions, mitigating some of the factors 
responsible for the current credit crunch.
    NAHB appreciates, and I do, also, the efforts by Congress 
to address the problems related to small businesses and the 
credit crunch and we look forward to working with legislators 
on the most effective way to help America's small businesses 
during this time.
    Again, thank you for the opportunity to testify today, 
Senators.
    [The prepared statement of Mr. Mitchell follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    Chairman Kerry. We are delighted. Thank you very much.
    Ms. Landis.

   STATEMENT OF MARILYN D. LANDIS, PRESIDENT, BASIC BUSINESS 
            CONCEPTS, INC., PITTSBURGH, PENNSYLVANIA

    Ms. Landis. Chairman Kerry, Ranking Member Snowe, thank you 
for inviting me here today to discuss the impact of the credit 
crunch on America's small businesses. My name is Marilyn Landis 
and I am the Chair of the National Small Business Association. 
I also am the owner of Basic Business Concepts, a consulting 
and financial management company that provides temporary chief 
financial officer, CFO, assistance to other businesses, 
primarily in Pennsylvania and Ohio.
    Even in the best of times, access to capital is one of the 
largest impediments facing America's small businesses, 
hindering both aspiring and thriving entrepreneurs. This 
perennial problem is exacerbated during troubled economic 
periods. According to a national survey of small and mid-sized 
business owners recently commissioned by the NSBA and unveiled 
today, and I would ask that it be read into the record, please, 
55 percent of small and mid-sized small business owners have 
had difficulty securing credit in the last six months, and this 
finding is consistent across firm size and firm revenue size.
    One of the biggest barriers to small business financing is 
requiring debt be secured by equity and fixed assets. Many 
small businesses lack the kind of equity necessary for 
traditional bank loans. This gap in debt-equity financing 
especially hinders growing businesses, as these entrepreneurs 
typically do not have the assets necessary to acquire sizeable 
loans.
    Aggravating this state of affairs is the recent tightening 
of lending standards by banks. Even for those small business 
owners fortunate enough to qualify under the tightened 
standards, there is bad news, as banks are raising the cost of 
their credit lines and the premiums they charge for higher-risk 
loans. In addition to tightening their lending standards, more 
and more banks simply are dropping out of the lending programs 
offered by the SBA.
    While insufficient access to capital has long been a lament 
in the small business community, the current capital vacuum has 
created a new predicament for small business owners, the use of 
credit cards. According to the NSBA survey, credit cards are a 
primary source of financing for America's small businesses. In 
fact, 44 percent of small business owners identified credit 
cards as a source of financing that their company has used in 
the previous 12 months, more than any other source of 
financing, including business earnings.
    Banks require business borrowers to have either equity in 
hard assets or historic cash flow to support their loan 
requests. Rapidly growing service or technology companies that 
are not traditional brick and mortar, like mine, have neither. 
We are forced to use bank credit lines, which if not secured 
with equity in a home, are increasingly credit card accounts. I 
can personally attest to this phenomena. Two banks recently 
offered me a credit line and sent me a credit card.
    Unfortunately, the credit card industry's underwriting 
practices----
    Chairman Kerry. Zero APR, no doubt.
    [Laughter.]
    Ms. Landis. Wait, I will go on. Unfortunately, the credit 
card industry's underwriting practices and their reliance on 
risk analysis are an imperfect answer for small business access 
to capital needs.
    For example, I have an American Express--I have been an 
American Express customer since 1989. In January of 2007, 
American Express increased my credit line based on my 
responsible credit history. They increased it to $7,000. Later 
that year, they increased it to $11,400. This increase was 
helpful, as I spent most of 2007 trying to expand my business. 
I hired two more people and opened two more offices. I also 
began expanding the zone of my business into New England and 
began traveling regularly--and exhaustively--to the region. As 
a result of my increased traveling, I began to run much higher 
monthly balances on my Bank of America credit card that I was 
using for business. I still paid on time, mind you, I just 
gradually was increasing the monthly balance, paying it off, 
but increasing it each month.
    Despite being told by American Express that my credit line 
was valid as long as my credit was in good standing, I received 
a letter earlier this year informing me that as a result of the 
review of my account, my American Express line of credit had 
gone from $11,400 to $4,200. I was informed that this action 
was taken for the following consumer agency reporting reasons: 
Too many accounts with balances, too many inquiries the last 12 
months, too many accounts recently opened, and the proportion 
of balances to the credit limit. There was no mention, as there 
is no history, of slow or non-pay.
    Further, in December of 2007, I received a similar letter 
from another unrelated credit card informing me that effective 
January of 2008, my annual interest rate had skyrocketed from 
the promotional 3.99 percent to 27.99. This increase was 
attributed to information obtained from a major credit 
reporting agency. Again, keep in mind, I had no record of slow 
pay or non-pay. I am being penalized for growing.
    America's small business owners think there are a number of 
steps that Congress could take to help to help alleviate the 
effects of this credit crunch. One is strengthen the SBA's 
lending programs and other federally backed loan programs for 
entrepreneurs. The fee the SBA charges both lenders and 
borrowers must be reduced and the lending process must be 
streamlined.
    Second, reform the practices of the credit card industry. 
In order to address the practices that are making a small 
business increasingly difficult and hindering the economic 
development of the nation's small businesses, NSBA supports the 
credit card reform initiatives going forward. NSBA also urges 
Congress to remain vigilant of any unintended consequences 
arising from the enactment of credit card reform. There is a 
provision in a recent bill before Congress that would make it 
detrimental for small businesses to use credit cards in an 
attempt to protect the consumer. While the provision may make 
sense when applied to seniors or other consumers, it would 
wreak havoc on the 44 percent of entrepreneurs in this country 
that rely on credit cards to finance their business.
    NSBA appreciates the recent efforts to boost the nation's 
sagging economy. America's small business owners are convinced, 
however, that the effort to ward off financial ruin on Wall 
Street should be equal to the effort to stave off the economic 
disaster on Main Street.
    We thank you for your time to address that and we welcome 
your questions.
    [The prepared statement of Ms. Landis follows:]

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

    Chairman Kerry. Well, thank you all very, very much. It is 
a pretty stark picture you all draw in the conglomerate. It is 
very important testimony and very helpful testimony.
    Can I just ask you a question. I mean, you are a business 
president and owner. Did you know that that rate could go up to 
27 percent?
    Ms. Landis. No. One of the most difficult parts--obviously, 
working as a CFO, I counsel my clients on the wise use of 
credit or no credit at all is better. You don't want to be 
over-leveraged with your business. I spent 30 years as a 
banker. I understand the credit risks. One of the most 
difficult parts about credit card debt is that you are subject 
to the volatility of the terms and conditions of payment and 
interest rate change.
    Chairman Kerry. But they reserve the right to essentially 
raise it whenever they want.
    Ms. Landis. Correct.
    Chairman Kerry. Without an understanding of what that might 
be or terms, correct?
    Ms. Landis. Correct, and what was significant, particularly 
with the credit line decrease, I got the letter announcing an 
increase to $11,400 on the seventh of January and the decrease 
on the eighth of January.
    Chairman Kerry. Mr. Mitchell, what do you do in this 
situation? You are sort of the prisoner, in a sense, of forces 
over which you don't have control that we were talking about 
earlier with the Governor of the Fed. Do your lenders sit with 
you and kind of give you a sense that they are willing to hang 
in there with you or are they putting pressure on you in this 
circumstance?
    Mr. Mitchell. Senator, I have been through four of these 
downturns and I learned a long time ago in making my way 
through them that you go to your lender as soon as you realize 
that conditions are such that they could worsen or you could be 
in trouble. And so that has been going on for a number of 
months. And I will tell you that I think the lenders with whom 
we are dealing today have been really as cooperative as they 
could and they are trying to work with us.
    However, as I pointed out, this downturn has been going on 
for such a lengthy period--we are over 30 months in the 
downturn that started in 2005--that interest reserves are 
running out and the term of the loans are running out, and if 
they go back to renew their loan then the appraisers are 
saying, well, the property values are going down and they are 
asking for equity to meet the regulator's standard.
    So it is a difficult situation and you only have but so 
much capital and my objective is to pay them all in time, which 
is the solution, but also to keep my business, which as I said 
has been going on for 33 years.
    Chairman Kerry. It has been going on for 33, but it sounds 
like if you are laying off 40 percent of your employees, and 
what was the other figure? Forty percent of your employees 
and----
    Mr. Mitchell. I am not sure there was another. Well, I said 
I have tapped my personal resources. I am putting capital back 
in the company.
    Chairman Kerry. How long can you do that?
    Mr. Mitchell. It is questionable, but my suggestion is that 
we have probably got anywhere from six to nine months before we 
would be in dire straits.
    Chairman Kerry. Secretary O'Connell, you said in your 
testimony the community banks are suffering a crisis of 
confidence and they are afraid to make a long-term loan. You 
have been through this a lot under various incarnations, but 
how do you break that at this point? Can public policy--is 
there something that we can do that kind of gives them, okay, 
it is okay to go out and do this now, or is it going to have to 
happen because the market has kind of bottomed out, people know 
it, and they suddenly see the demand for housing growing so 
fast because there is a lot on the market and it is cheap and 
all of a sudden the psychology turns? Which is which? Is there 
a chicken and egg situation?
    Mr. O'Connell. I think the actions you have taken, Senator, 
on the foreclosure issue are a step forward in easing that 
crisis. We need to see what happens in the House now and how 
the eventual----
    Chairman Kerry. You are talking about the mortgage revenue 
bonds and put cash out there so people can actually make the 
loans and so forth.
    Mr. O'Connell. Yes, sir. I think the feeling is that that 
will help to find the real pricing, which is what needs to 
happen for that confidence to be restored, and I think these 
smaller and community banks, fairly small staffs. I was talking 
to one. Five members of the total banking staff, two of whom do 
nothing but Federal and State paperwork. It is a tough time and 
they are worried about increased regulatory oversight and 
making mistakes that would cause them to endanger their 
institutions.
    So bringing back a level of support, signs like the 
legislation you have proposed involving simplifying some of 
that paperwork, dealing with some of the fee issues, providing 
more capital to back up their efforts, all of that will help to 
ease the crisis, I believe.
    Chairman Kerry. At the State level, have you convened 
groups of or all of these lenders at some point in time and 
kind of had a discussion with them where you try to do some of 
this and restore that?
    Mr. O'Connell. One of the things I have found, and I am 
sure you do it already, Senator, is that Massachusetts is not 
one economy, it is a series of regional economies--the South 
Coast, the Western part of the State, the older mill cities. 
And the solutions--one size does not fit all in our State. So 
what we have tried to do, the Governor and I both, is reach out 
and meet with roundtables and banking and business groups in 
the various regions. It is something you have done in the past 
that you have suggested in the foreclosure are. And we are 
finding that that is the most effective way to deal with really 
our local concerns and issues, which vary around the State.
    Chairman Kerry. I know you also mentioned in your testimony 
the tightening that you have perceived with respect to student 
loans among these. Since we have about 140 colleges and 
universities, that is a big base for us. To what degree is that 
really being experienced or felt out there?
    Mr. O'Connell. We are deeply concerned. It is our second-
biggest industry in Massachusetts after health care, education. 
It is a key to the economy. It is one industry where we have 
been growing jobs over the last year, last 15 months. And if 
student loan availability tightens as we think it will--it is 
just beginning to happen--MEFA, Massachusetts Education Finance 
Authority, announced yesterday that they will no longer be 
doing federally-guaranteed loan activity because the secondary 
market for those loans has dried up--it could be a crisis in 
one of our key industries if drop-off of five percent of the 
students who thought they would be there in the fall but can't 
put the loan package together to meet the needs.
    Chairman Kerry. You also mentioned the CAP program, the 
Massachusetts Small Business Capital Access Program. Would you 
liken that to the SBA's 7(a) or do you draw distinctions?
    Mr. O'Connell. No, I think it is quite similar. It has been 
a great leveraging opportunity. We have seen----
    Chairman Kerry. And what kind of fees do you charge in 
comparison with what the SBA does?
    Mr. O'Connell. I think the fees average about a third of 
what the SBA does. CAP's fees to the borrower average 
approximately 3 percent of the loan amount, which is slightly 
less than the SBA's for loans in the $150,000 to $700,000 
range. However, CAP's fee is one time and paid at the loan 
closing. For loans that exceed $700,000, the SBA's fees 
increase; they also charge a servicing fee for each year the 
loan is open, so over the life of the loan, their cumulative 
fees to the borrower can be significantly higher than those of 
CAP.
    Chairman Kerry. A third of the SBA.
    Mr. O'Connell. Of course, we have had to recapitalize that 
program and both the legislative houses in Massachusetts have 
approved a $5 million recapitalization of the program.
    The Capital Access Program is designed to help small 
businesses with less than $5 million in revenues throughout 
Massachusetts obtain loans from participating banks. Using cash 
collateral guarantees from a loan loss reserve fund, this 
program enables banks to make loans they might otherwise be 
unable to grant. The Business Development Company administers 
the CAP program on behalf of the Commonwealth of Massachusetts.
    Accessing the CAP program is very simple and requires no 
extra work on the part of the borrower; there is no application 
form to fill out. When a business applies to a participating 
bank for a commercial loan, the bank will determine whether the 
loan requires credit enhancement and then it is the bank which 
submits an enrollment form to CAP. The enrollment form is less 
than a page in length and the bank negotiates all loan terms 
with the borrower directly, including pricing and the level of 
guaranty premiums required. It is also the bank that commits 
and funds the loan, following its own procedures within its 
timeframe. The borrower only has to deal with his/her bank, 
thus making the process very simple and easy.
    Chairman Kerry. Ms. Landis, I meant to ask you, in terms of 
the tightening of the credit impacting your business, what have 
you not been able to do as a consequence of that?
    Ms. Landis. I haven't been able to expand. I have----
    Chairman Kerry. You were planning to? You were about to?
    Ms. Landis. I was planning to expand into Michigan. I am 
actively expanding into New England. I have had inquiries for 
my business here in the D.C. area and up in Michigan. I am just 
unable to invest in the additional people, computers, and 
travel to do that.
    Chairman Kerry. And why will an SBA loan not fill that gap? 
If you are able to do that, why won't that work?
    Ms. Landis. An SBA loan would perhaps fill that gap if I 
felt I had a confident way to repay that and I planned it 
carefully. However, I don't have any equity in my home. I had a 
fire and I used the equity in my home to rebuild my home, so I 
have no equity to use to borrow against, so that option is not 
out there for me.
    Chairman Kerry. I see. I see. So you have got to get the 
capital just through your revenue stream and go report back in, 
or find some kind of investment----
    Ms. Landis. Well, the other thing that has hurt me, as I 
mentioned with the credit card increase, when I am increasing 
travel to New England, the client pays for my travel. So that 
is not necessarily an expense of my business. Those credit card 
balances that have been growing are repaid monthly as my client 
pays me for my invoices. So it is simply the growth of my 
business and the cash flow of that business that has caused me 
to be impacted with my one credit card being cut and the other 
one the rate being increased. The economic model that is out 
there was looking at a credit score based on use, not the 
underlying business principle that was causing my business to 
have more revenue, more profit, and more opportunity.
    Chairman Kerry. What would make the greatest difference to 
you now? What would change this playing field as you are 
currently on it?
    Ms. Landis. An opportunity to have the community bankers 
and other bankers have access to the business plan that I have, 
the cash flow that I have, the underwriting that I have, 
instead of relying on a credit score model that offered me an 
unsecured loan only based on credit scoring.
    Chairman Kerry. So if you had a different way of judging 
your creditworthiness, you believe you could meet a viable 
standard by which they would be repaid and they could make a 
loan?
    Ms. Landis. Thirty years ago, I was with a commercial 
lender for 30 years, and I know there are also a lot of loans 
that should not have been made because the credit scores look 
good and the underlying business plan and the opportunity to 
repay that with cash flow from the business wasn't there.
    Chairman Kerry. Now, Ms. Blankenship, sort of picking up on 
that, in your testimony, you say that lenders, community 
lenders are ready to lend, but you say the bank regulators are 
going to insist on a tightening of that standard, not looking 
perhaps to a different standard like Ms. Landis is talking 
about, right in the middle of the economic slowdown. Are you 
seeing that tightening?
    Ms. Blankenship. I believe that our community banks are 
seeing that tightening.
    Chairman Kerry. The regulatory tightening?
    Ms. Blankenship. The regulatory tightening----
    Chairman Kerry. Is that not wise for them? I mean, don't 
they have a responsibility to take a look and say, whoa, we may 
not get repaid here. We can't have another S&L crisis.
    Ms. Blankenship. I think that it is a reaction from the 
subprime, basically the subprime meltdown.
    Chairman Kerry. Does it, in your judgment, have a 
relationship, a nexus to the realities of the economy and the 
creditworthiness?
    Ms. Blankenship. Yes, I believe it does, and that is why I 
think it is so important for the SBA program to be more 
friendly for the community banks to use, because right now in 
this downturn of economic time, we live by our small business 
customers. Community banks survive by small business. They are 
partners in the community and we have to have the tools to be 
able to provide more capital. And the fact is that we can't 
make the terms on some of the loans that we could under the SBA 
guidelines, the extended terms, and that is when the small 
businesses need those terms are in times of economic downturn. 
And it also provides us, by using SBA, the ability if we desire 
to sell the guaranteed portion, obtain more liquidity, 
therefore we have more funds to turn around and loan back to 
other small businesses.
    Chairman Kerry. If the fees were reduced, say by half, or 
you put a moratorium on the fees for six months or so, would 
that be an incentive, in your opinion?
    Ms. Blankenship. I believe it would be a huge incentive for 
both the banks and the----
    Chairman Kerry. Is SBA here?
    Ms. Kirk [continuing]. Small business.
    Chairman Kerry. You believe it would be?
    Ms. Blankenship. I believe it would certainly.
    Chairman Kerry. Do you believe this discussion we had with 
the Administrator is legitimate with respect to fee impact?
    Ms. Blankenship. I certainly do. I had a similar 
conversation with him before the hearing began, because we have 
been an SBA preferred lender since the late 1980s, but we have 
seen a decrease in our program just because of the fees and the 
paperwork. We are a small community bank. We are committed to 
the program. But if we can't make it work, other community 
banks can't make it work.
    Chairman Kerry. Secretary O'Connell, do you agree with 
that?
    Mr. O'Connell. I fully agree. The evidence I have heard as 
I have traveled round the State suggests that the fee impact is 
significant and the paperwork impact, as well. The Low-Doc 
program that was talked about, a return to that kind of 
program, I think, would have an immediate upturn----
    Chairman Kerry. I helped start that program when I was on 
the Banking Committee. We started the Low-Doc program and I saw 
the impacts of that immediately. It was terrific, a simple way 
to get the credit to move.
    Why is your bank still doing this, given that? I mean, we 
have had all these banks drop out. You haven't.
    Ms. Blankenship. The reason that our bank still uses SBA is 
because it is a viable answer for small businesses and we have 
even----
    Chairman Kerry. You believe in it?
    Ms. Blankenship. I believe in it, and it affords us the 
ability and opportunity to provide capital that fits that small 
business--their model, their business model, when they need 
long-term financing for cash flow and inventory, which we 
couldn't necessarily do because under regulator guidelines, we 
would fall under certain criticism.
    Chairman Kerry. Mayor Kirk, I know this is affecting 
property values, and therefore it affects your revenues, and 
therefore that can affect your choices with respect to school 
and infrastructure and police and fire. Those are your options. 
But my question to you is, in what ways is it affecting the 
city's cash flow itself, other than that? Is the credit crunch 
directly impacting your ability to do some of the things that 
you have laid out in your budget?
    Ms. Kirk. The tax policy in Massachusetts, as you know, is 
a cap on property value, and the rest of the budget is driven 
through growth, housing and commercial development. So what we 
have in my city is a structural deficit where revenues are 
flat, or just increase on a very slow glide, and the expenses 
are far outpacing. So we are in this constant cycle of cutting 
budgets. We closed an elementary school last year. We have 
closed fire stations. We have--the skyrocketing water and sewer 
rates impact small business who have to pay that bill, as well.
    So the credit crunch is prohibiting these small businesses 
from doing the improvements to their property or expanding 
their commercial base, if they are in that mode, which has a 
direct impact on the bottom line, because the balance of the 
revenues for the city is either off what we can capture in the 
property tax increase, which is only two-and-a-half percent 
under our tax policy, and all the rest is from new growth. So 
we have a very dismal economic picture in my city in 
Massachusetts.
    Chairman Kerry. So leaving aside the direct Federal grants 
for water treatment and/or some of these specialized programs 
that we passed that you benefit from, i.e., some of the 
education money and some of the other areas, transportation and 
whatever it is--leaving those aside, what do you think at this 
point the Federal Government might do or could do that would 
have the most impact on your ability to maintain the quality of 
life and meet your responsibilities?
    Ms. Kirk. I think the direct grant piece on the 
infrastructure is very, very important.
    Chairman Kerry. I agree, but leaving that aside, is there 
something else you see? I mean, obviously, whatever earmark we 
could get within the appropriations process that is authorized 
and appropriate----
    Ms. Kirk. Right. Well, I mean, this gets to be a very local 
scenario where we are a port city and we have a number of 
infrastructure assets and we have an open harbor and we have a 
lot of demands placed on us through Homeland Security and we 
are cast in a region that is suburban and we really should be 
considered as an urban port. And so we don't have the capacity 
to really take on the protection of the harbor and the assets 
that we have in our city as an urban center through proper 
staffing of public safety. I mean, we are really severely 
depleted in those areas. So----
    Chairman Kerry. I just want you to know, I have sent a 
letter to the Secretary of Homeland Security, Secretary 
Chertoff, on that subject based on a conversation we had 
previously, so we are trying to see if there is some leeway 
there.
    Ms. Kirk. Yes. So I am a big believer in earmarks, because 
that kind of an earmark would absolutely help Gloucester 
specifically.
    The other things are just to look at the unfunded mandates, 
because again, when you talk about education, we divert funding 
away from things that enhance the quality and bring joy, 
basically, to education to the mandated programs and to keep 
those other programs in our schools, we turn to the community. 
We fundraise. We have auctions. And that is all small business. 
We have 800 small businesses in our Chamber of Commerce and 
they are bombarded with the public schools and different 
organizations who have their hand out. It is just not 
sustainable. We are trying to patch together some solutions.
    So I think unfunded mandates have an impact on the overall 
picture, and that is why I say in my testimony to, when you 
look at the credit crunch, really evaluate all of the fiscal 
impacts, because any one of them, a resilient small business 
could overcome, but because they are stacking up, it leads to 
that sort of downward spiral.
    Chairman Kerry. Well, thank you. That is helpful. I know it 
is a bleak picture. It is a tough picture, but it certainly 
underscores and helps to bring home here the interrelatedness 
of all of this.
    We are going to have to wrap up in a couple of minutes 
because I have a meeting with Senator Levin and Senator Boxer, 
but let me just, Dr. Bornstein, come back to you for one 
second. Very interesting observations about valuation and the 
home equity piece, which I think is really important, and we 
have heard it hear from Ms. Landis and others. The New York 
Times had the very interesting article over the weekend about 
this issue of home valuation, et cetera, and we see a whole 
bunch of small businesses that are facing a shrinking of their 
credit line even where the value of the home has not declined, 
or even where the value of the homes around the home have gone 
up. What can we do about that? How do we--is there a solution 
that can help get these banks to not treat this thing in a 
broad-based swath?
    Mr. Bornstein. Actually, based on the six years of research 
that I have done, I have come to various conclusions, again, 
related to small business failure and related to personal 
financial literacy. There is a lack of confidence in the 
American consumer and the small business community because of 
the small business failure rates, which many people recognize 
and we see through the documentation. If we can somehow make a 
dent and indicate to the banking community and the small 
business community that we have an opportunity here to make you 
operate smarter, that will increase confidence. I have spoken 
to a subprime conference in September 2007 and I basically told 
them that in the securitization industry, risk has drawn the 
value of all the securities down.
    If we can somehow show that small business and individuals 
can be made smarter through financial literacy education to 
avoid making the wrong moves and stay on the right track, that 
will generate a greater confidence, I think, in the small 
business person's ability to succeed, and the individual's 
ability to meet those payments and avoid foreclosure. Those 
resets are going to be on for the next two, two-and-a-half 
years. We still have a chance to help these small business 
owners and, by the way, they are also individuals, because we 
see them in bankruptcy, a lot of those supposedly personal 
bankruptcies were actually small business owners who were part 
of the bankruptcy problem.
    So, what I am suggesting is that we have this opportunity 
to basically turn it all around, but the problem is, 
unfortunately, we have been giving financial literacy education 
which I view as almost like a vitamin supplement to a cancer 
patient. It has to be specific, effective financial literacy 
education. The research that I have done basically was three-
fold. It was a discovery process. It was a discovery of content 
and also delivery. How can we deliver financial literacy 
education?
    So in answer to the question, I think a gaining of 
confidence by the banking community and the individual and the 
small business community that they will be able to stay on 
track and be able to make those payments, that, I think, will 
go a long way. Again, it is all about confidence, isn't it?
    Chairman Kerry. Well, it is, I think. A lot of it is 
confidence, anyway. Some of it is sort of the practical steps 
you can take to instill that confidence, but it is.
    Do you survey your folks about the bankruptcies, Ms. 
Landis? Do you survey or not?
    Ms. Landis. I don't know that we have done that recently 
within our survey. It was not in the results I looked at this 
morning. It is something we could look at, and if we have it, 
we will get it to you.
    Chairman Kerry. Well, let me just say to all of you, boy, 
this is crunch time in every respect, and I am so concerned and 
disturbed to see a kind of double-talk going on. On the one 
hand, the White House and the administration and other people 
in public life bemoan the lack of confidence and the impact and 
sort of acknowledge there are effects here of psychology. On 
the other hand, they don't do anything to break the cycle or to 
adequately intervene.
    I was not enormously enamored by the stimulus package that 
we passed here, which gave people sort of a quick hit cash 
inflow but did very little to create jobs, and I argued 
vehemently that anything we did then should have dealt with the 
housing crisis. We won that in the Finance Committee, got it 
onto the floor, and it was lost on the floor due to some of the 
partisanship that got wrapped up, and ideology, in the Social 
Security/LIHEAP and other things, and I understand some of the 
restraints people felt about the breadth. But the bottom line 
is, none of the underlying factors were really addressed and we 
are still struggling now.
    We have got a housing bill that has passed here, the 
Foreclosure Act, as it is called. It has got too many goodies 
in it for some of the folks who created the problems and 
hopefully we can work that out. But this has got to get out to 
you. I mean, it has got to get out there fast and I don't sense 
that urgency somehow in the response.
    I know it has got to be frustrating for you, particularly, 
Mr. Mitchell, somebody like you, or Ms. Landis, where you are 
sitting there and it is your hide and your bank account and 
your home and your family and your workers that are on the line 
in a very real way. So I am very sympathetic. Or, Mayor, your 
small businesses, the 800-plus that you are struggling with.
    So we have got to somehow move this. I think your testimony 
here has been helpful. I know there are some folks from the SBA 
sitting here. I am confident--I hope they will report to the 
Administrator, and I look forward to following up with him 
personally on not just the legislation we have that Senator 
Snowe and I have talked about, but also on how we might sort of 
proactively try to address some of these things in a 
coordinated way. This shouldn't be partisan and it shouldn't be 
lost in any politics. So I hope we can do that.
    So thank you for taking the time to be here. Thanks for 
caring. Thanks for fighting back. Hopefully, we can join you in 
that effort and get the job done. I appreciate it.
    We stand adjourned.
    [Whereupon, at 4:55 p.m., the committee was adjourned.]
                      APPENDIX MATERIAL SUBMITTED

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


                        COMMENTS FOR THE RECORD

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]