The United States' Cares Act aims to prop up the economy, but efforts to help small businesses have run into problems.

Steven Mnuchin

Under fire: secretary of the treasury Steven Mnuchin has been criticised over fair allocation of funds

When the $2200bn Coronavirus Aid, Relief and Economic Security Act (Cares Act) – the US rescue package targeting people and companies harmed most by lockdown measures – was enacted in March, it was understood there would be some imperfections because of the challenge of having to devise it so quickly.

But then a central initiative in the act, the Paycheque Protection Programme (PPP) created for small businesses, caused a public outcry, suffered umpteen technical glitches, frustrated those small business owners and led to lawsuits against some of the country’s biggest banks. The US government’s crisis response appeared to be even more widely challenged. So what went wrong?

Targeting small businesses 

The PPP promised small businesses – from cafes and restaurants to hairdressers, dentists and dry cleaners (about 30 million companies) – low-interest two-year loans of up to a maximum of $10m per company. These loans will be entirely forgiven if, at the end of the eight-week lockdown, business owners certify in a legally binding statement that 75% of the money had been used for payroll expenses and the remainder to pay utility bills, rent or a mortgage.

The programme’s aim is to blunt the expected spike in unemployment, which at the end of April reached an annual rate of 14.7% – the highest level on record since the Great Depression on the 1930s, according to the US Bureau of Labor Statistics. Saving small businesses from collapse would also shorten the US recession and speed up the recovery.

But the programme was underfunded relative to what it set out to achieve. The economists who had pushed for PPP to be included in the Cares Act – Michael Strain, director of economic policy at the Washington-based American Enterprise Institute, and Glen Hubbard, dean of New York’s Columbia Business School – insisted such an initiative would need at least $1200bn. US Congress, however, only authorised $350bn. Even when legislators subsequently approved a second tranche, after the first was depleted in 13 days, the total was only $660bn.

How to distribute limited resources that do not meet demand is a critical issue. Kathryn Judge, a senior professor at Columbia Law School, says that US secretary of the treasury Steven Mnuchin made an insufficient effort to ensure the limited funds available would be allocated fairly. She says that Mr Mnuchin not only has a crucial role in devising PPP guidelines but also a duty as a government official. 

Question of fairness

“A fundamental principle when you are setting up this type of programme is that you should want to ensure that businesses that are relatively similar are treated equally,” says Ms Judge. “[Two] businesses of a similar size and similar hardships, that are both making an equal effort to apply for a loan, should either both get it or both get denied.” Instead, the eligibility rule that the Department of the Treasury chose for small businesses to receive the assistance is on a ‘first-come, first-served’ basis.  

Members of Congress in the opposition Democratic Party and some economists agree that it is the arbitrariness of this rule that is egregious. Bruce Lee, president and chief executive of Heartland Financial USA – a holding company based in Iowa with 11 community banks in western and central US states – says: ”There is moral hazard. A slippery slope. There’s going to be inherent unfairness.”

The PPP adopts an existing definition of a small business, meaning a business with 500 employees or less. But this adds to the supply/demand imbalance as such size encompasses a variety of businesses that also include public companies, which naturally have other meaningful sources of financing.

French Hill, a Republican congressman from Arkansas and a member of the Congressional Oversight Commission for all of the Covid-19 response funds, says one reason why the programme’s implementation has been confusing is because public companies were not excluded from the aid. Another reason, he adds, is that while they are part of an industry severely hit by air travel and lockdown restrictions, some hotels and restaurants with up to 500 employees are allowed to receive PPP loans even they are an outlet of a much bigger franchise or chain. 

Spotlight on government

Bankers, commentators and economists say the flaws in the PPP's design have put a spotlight on weaknesses in the government’s crisis response capabilities to contain the economic fallout of the Covid-19 pandemic. When the virus started to spread in the US, the Treasury Department had seven out of 20 politically-appointed positions, including chief of staff and legislative director, unfilled – a number some observers consider to be disturbingly high.

Meanwhile, the Small Business Administration (SBA), which distributes PPP loans on its guaranteed network, has annual funding of less than $1bn. Bankers say that during the implementation of the programme, the agency’s system went down repeatedly – sometimes for almost whole days.

The issue of fairness has also cropped up in connection with US banks, the principal intermediaries in the programme, and especially regarding their role processing small business applications to see which qualify for the government aid. Processing applications on a first-come, first-served basis is likely to lead to different results from bank to bank, as processing times differ between institutions and depends on the technology used, among other factors.

Also, because banks need to comply with anti-money laundering rules, there is a strong incentive to serve only existing customers that the bank already knows, which inevitably means that other worthy small businesses may be left out. 

There is also the risk of fraud. In early May, the SBA and the Department of Justice both announced they would investigate potentially illegitimate transactions within the PPP.

Community bank contribution

The upshot, according to Paul Merski, executive vice-president of the Independent Community Bankers of America (ICBA), is that during the first PPP round in early April, small community banks “really stepped up and punched above their weight in getting this money out to small businesses quickly, as was intended, saving them from going under”. The ICBA covers about 5000 institutions that account for half of all US small business lending.

Take Peach State Bank and Trust, in Gainesville, Georgia, a $300m asset bank. It processed about 200 loans with a total value of $32.5m in nine days as the programme launched, says chief executive, Ron Quinn. This is more than a third of all the lending the bank did in 2019. Furthermore, 20% of those loans were extended to new customers, including not-for-profit organisations.

A similar number and value of loans was processed by Stephenson National Bank and Trust, based in Marinette, Wisconsin, in 10 days – equivalent to what the bank usually lends in a year. The loans went to service companies, realtors, contractors and a small helicopter assembly company among others, says chief executive Daniel Peterson. “It’s hard to think of a business we didn’t help,” he adds.

By contrast, some of the biggest US banks were criticised for processing a comparatively low number of loans. Usually the biggest US banks provide about one third of all the loans for US small businesses. But, according to its own data, Bank of America (BofA) processed only about 15,000 loans in the programme’s first round. On May 1, JPMorgan said its Chase Business Bank subsidiary had only got 27,000 loans through in the first round but it was nonetheless the biggest individual bank participant in this round in terms of the total value of its loans, which amounted to $14bn, or 4% of the total $350bn pool.

Causing lawsuits

This touched on another snag in the PPP relating to fairness: it is not so much the number of loans made that is necessarily an issue, but rather the size of some of the loans and how much of the available funds they consume. 

The issue of fairness has also featured in lawsuits brought by small businesses against some of the largest US banks. In one, law firm Rifkin Weiner Livingston, representing small business plaintiffs, alleged that on April 3, when the first round of the programme was launched, “Bank of America established gating restrictions that prioritised access to the PPP loans to its lending clients and denied access to certain depository clients and other small businesses,” according to a statement. 

However, on April 10, the examining magistrate, Stephanie Gallagher, while recognising in her ruling that “Bank of America’s rigid criteria have undoubtedly made it materially harder for some businesses to access the PPP,” dismissed the case because, among other things, there is nothing in the text of the Cares Act that allows private businesses to sue lenders.

Additionally, there is nothing in the text of the Cares Act that prohibits banks “considering other information when deciding from whom to accept applications, or in what order to process applications,” the document of her ruling said. 

Columbia Law School's Ms Judge raises another issue: “One of the challenges is that even though many of the banks were effective as intermediaries in getting money out quickly, they have their relationships and their infrastructure, with their apps and their credit cards. We can’t expect them to make loans equitably when they already have strong economic incentives not to do this.”

More loans distributed

A backlash was not long in coming. After analysis by the Wall Street Journal revealed that an estimated 200 public companies obtained large PPP loans, other US media outlets published the names of some of the companies and a few decided to return the money. 

There have been some improvements in the second round of the programme, with more loans of smaller amounts, being distributed. After media criticism of their allegedly meagre participation in the first round, BofA and Wells Fargo significantly increased the number of PPP loans they processed in round two, and also announced that they would donate all the SBA fees that they earn for originating the loans to small businesses and charities. BofA said on May 4, after just one week of the second round of the programme, that it had processed 250,000 small business applications, most from businesses with fewer than 100 employees and most for loans of less than $350,000. 

Economists and academics argue that banks played a role in the PPP's fairness issues. But the fundamental flaw in the programme’s design made banks the face of the problem and shoulder blame that was not entirely theirs. “One of the issues that I think Covid-19 lays bare is that the overall resilience of the economy depends in part on the capacity of the government to help the system to heal,” says Ms Judge. 

That means, she adds, not only the ability of Congress to act quickly but also asks: “Do the bureaucrats have the knowledge and skills to implement [such programmes] effectively? That is something that we have undervalued and that needs to be heard.”


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