The recent unemployment claims have made it urgent for President Barack Obama to take congressional action on legislation so as to cut taxes and ease credit flow. The legislation that Obama wants to promote would ease loan terms and provide up to $12 billion in tax breaks to small businesses. Banks with $10 billion in assets will also receive $30 billion so as to encourage lending to small businesses.

The legislation is opposed by Republicans like Senator Richard Shelby of Alabama as he says that it is a government rescue measure similar to the $700 billion bank bailout of 2008. Banks may have to grant risky loans. Obama, however, urged Republicans to stop blocking the measure and prodded lawmakers to consider the bill when they reconvene in September.

The economic index of the Federal Reserve Bank of Philadelphia fell to minus 7.7 this month from 5.1 in July. The below zero reading indicates contraction in places like Pennsylvania, southern New Jersey and Delaware. Obama says “Small businesses and community banks that loan to small businesses have been lagging behind.” He adds that the report of Labor Department “compels us to act.”

During the congressional and state elections in November, ‘economy’ is going to be a top issue for voters. Obama said, “There will be plenty of time between now and November to play politics. Let’s put aside the partisanship for a while and work together.”

Mr. Walt Minnick, the Idaho representative is considered the most conservative Democrat in congress. In 2008 presidential elections, he took his seat by just 2 points. He gained support from unlikely sources like the United States Chamber of Commerce and Tea Party Express. Minnick started his political career as a Nixon administration official. But he resigned after the Saturday Night Massacre in which Attorney General Elliot Richardson was assassinated.

In his early years, Walt Minnick remained a successful businessman. He did a job with Trus Joist, a $30 million Boise based forest product company. He served the company for 21 years -16 years as president and now the company’s revenue is $700 million. He says “I realize I liked Trus Joist a whole lot better when it was a $70 million company than when it is 10 times that size, and bureaucratic.” Following this, he started his own business that dealt with nurseries. He comments, “I learned it as boss, but I’d take orders from anybody, depending on what job I was doing. Now, that’s good training for being a congressman.”

While in congress, Minnick introduced a bill meant for resuscitating local banks and to address other small business issues. Minnick points out key issues related to the current recession.

No business, credit demand

Minnick comments that the current recovery is ragged and uneven. Some businesses are going gangbusters, some are seeing small improvements, and others are trying to hang on by cutting costs. So, only businesses that have a sound base to expand and are improving can ask for credit. The rest cannot ask for loans from community banks and other financial institutions and this is the reason why the recovery is faltering.

Corrupt Banking system

The market value of the commercial real estate does not support loan values that are outstanding. Under such a case, the borrowers are found not to possess the reserve equity that can downsize the borrowed loan. In many cases, borrowers are forced to default on loans. The banks then resell the property at distressed rates. The F.D.I.C. also wants a one-to one ratio and is asking banks not to renew loan terms but to get rid of them.

Federal Government’s Role

Federal Government should quit spending money that it does not possess and restore the banking system. Pump-priming should no longer continue. Minnick says “Quit throwing money at the problem. Balance its budget. Quit digging the deficit hole deeper.”

Possible solution

Minnick says that his bill encourages large financial institutions to buy small loans and compile them into market-sized packages. The bill will also have the provision to allow the treasury to give federal guarantee to investment packages like quality, performing loans, so that they can be sold in institutionalized markets.

We’ve heard how difficult it is for small businesses to secure bank loans, a new Fed report says that banks have been very willing to issue small business credit cards.

About 75 percent of applicants in 2009 were approved for small business credit cards, according to the report . Even among businesses considered high-risk, 72 percent were approved for a credit card.

In general, credit card loan terms are worse than regular loan terms. The average interest rate on a business credit card in 2009 was about 12 percent and cash advance interest rates 20 percent or more, says the report.

Credit card issuers can also change the terms of the loan or revoke credit card lines altogether. Business credit cards are not subject to the consumer protection afforded by the credit card reform bill passed last year.

While over 80 percent of small businesses use credit cards, only 12 percent borrow (carry over a balance from month to month) on credit cards.

If small business owners worry about borrowing on credit cards, they won’t invest in long-term businesses planning or growth, says CNN.com . And that means they won’t invest in hiring, the linchpin in reviving the economy.

Job seekers choosing to open their own businesses dropped to a record low, according to Challenger, Gray & Christmas, a Chicago outplacement firm.

Just 3.7 percent of high-level job seekers exiting the program were starting new businesses down from 7.6 percent in the first half of 2009 and 9.6 percent in the second half of last year, according to a survey conducted by the company on July 19.

Experts suggest that an improving job market and the difficulty getting small business loans may be steering people away from entrepreneurship, said Business Week.

Federal Reserve Chairman Ben Bernanke said last week that small businesses, and especially startups, are crucial to job growth and economic recovery. Bernanke once again called on banks to loosen credit to small businesses.

Some see the lower startup rate as a sign that the economy is improving. The unemployment rate is still high, but the private sector added 593,000 jobs in the first half of 2010, according the Bureau of Labor Statistics.

Startup activity typically increases as the economy improves, Challenger CEO John Challenger said in a statement.

Obtaining a loan is no easy task. Banks check many aspects of a borrower’s history, such as previous bankruptcy filings, liens, or judgments. Previously, obtaining a $150,000 business loan just required a 700 FICO score and a one page application. The process of lending used to be transacted in the same amount of time required to buy a cheeseburger in a drive-through as well as only relying on borrowers’ personal credit scores. The unsecured nature of loans gave little recourse to lenders apart from the personal commitments and principles of borrowers. The personal guarantees become void when principles are broken. This is the reason why Kenneth Lewis, former chairman BOA, in 2008, commented on the banks’ deteriorating credit quality as “a dam disaster”.

Banks of today are still compensating for the blunders of such loans. This has made the process of obtaining a loan much stricter than before. The underwriting processes that work these days can be summarized as follows:

1. An assessment of character through personal credit report.
2. Borrowers’ basic character can be questioned with a skipped or missed student loan or child support payment.
3. Late payments of mandatory payments like mortgage, car, and credit-card payments are taken into consideration by lenders. Even one late payment is considered an indication of a possible beginning of risk.
4. The qualitative sections receive more attention. This includes payment history and public records data.

Importance of Credit Scores

The personal credit score of a borrower is analyzed to find out if the person fits into the general risk profile of the bank. It is assumed that there is a strong correlation between personal credit and the capability of businesses to pay back loans. Scores are also found in the business credit reports, but with the reliability of such as being more questionable than personal credit scores. The reason being that such scores are less reliable as they are made with the cooperation of business partners and often exclude information about prior bankruptcies, payment history and outstanding liens.

Personal credit scores do not affect one’s application but it determines the borrowing costs. Credit agencies like FICO, FICO II, or Beacon have their own methods of calculating credit scores and so it may vary up-to 50 points. Cost of capital increases if the score is below 700.

Income Proof Required

Borrowers wanting to obtain $50,000 in loans, have to verify their income first and provide details of three years of business and personal tax returns. Banks want the guarantee of the borrower’s personal resources in addition to financial pro formas and other personal guarantees. The size of the bank also determines the depth of investigation. A regional bank has a smaller buffer to overcome losses and so they have made deposit certificates compulsory. In case of nationalized banks, the protectionist stand may be far less.

Small businesses are still facing a tough time to acquire loans for their expansion, said the chairman of Federal Reserve, Ben S. Bernanke. In a Fed hosted conference in Washington, Bernanke disclosed that credit-worthy firms with strong cash flows are refused loans just because their collateral values have declined. Receiving of loans by small businesses is much required to help in speedy recovery of the US economy.

In last two years, bank loans to small businesses fell from $710 billion to $670 billion. Bernanke is imposing pressure on lenders to increase credit so as to boost growth and employment. “Making credit accessible to sound small businesses is crucial to our economic recovery and so should be front and center among our current policy challenges.  Our message is clear: Consistent with maintaining appropriately prudent standards, lenders should do all they can to meet the needs of creditworthy borrowers.” said the Fed chief.

Consumer spending is crippled by “tight credit” The Fed policy makers pledged to help keep interest rates close to zero for an extended period of time. A resolution of the House of representative to pass a $30 billion plan bill to enable community banks find incentives on granting loans to small companies has been opposed by three Republicans.

Confidence Major Issue
The bill “would be very helpful” and a “good boost to the economy,” said Jack Hopkins, director, Independent Community Bankers of America. He thinks it is a confidence issue and so comments “We need to get confidence back into the markets, and that’s difficult when we’re hovering around 10 percent unemployment.”

A difficult situation
The US commercial and industrial loans have reduced from $1.6 trillion at the end of 2008 to $1.24 trillion. Recently many owners had to borrow loans based on credit cards and retirement accounts. “The formation and growth of small businesses depend critically on access to credit. Unfortunately, those businesses report that credit conditions remain very difficult,” commented Bernanke in a conference at Fed headquarters today. Bankers who were present in the conference said that they were willing to extend credit and asked business proprietors to meet their community lenders.

It is critical to find better information about potential borrowers. Banks do not find requisite information and so it is tough to make decisions says Denise Pickett, executive vice president at American Express Co. Also, Kevin Watters, officer in JP Morgan Chase & Co, opines that the problem faced by banks is “healthy borrowers not wanting to borrow.”

At a Federal Reserve conference in Washington this week, Fed Chairman Ben Bernanke called upon banks to increase their lending to small businesses.

“Making credit accessible to sound small businesses is crucial to our economic recovery,” said Bernanke, a vocal proponent of loosening credit for smaller companies.

While many big firms are flush with cash and are expected to report strong profits during earnings season, smaller businesses have struggled to secure the loans they need to expand and hire. Economists point to this disparity as a reason that the recovery has not been as robust as was hoped.

Small businesses generally spur job creation during recoveries and employ roughly half of all Americans.
Unless these borrowers are able to get loans to expand operations and make new hires, experts fear that the economic rebound will slow in the second half of 2010. Business owners, who identified credit lines and working capital as key financial needs, point to the declining value of real estate and other collateral used securing loans has been part of the challenge in securing funding.

In May, the Obama administration sent Congress a proposal to create a $30 billion stimulus program designed to encourage small and mid-sized banks to loosen credit for the nation’s small businesses. The legislation has not yet passed in the Senate.

The rules of Wall Street are being amended to better regulate the US financial System. Congress provided a rewrite of the rules that was submitted to President Obama on July 4th. After a 20 hour session of the House and Senate negotiators, a bill has been approved that envisages a ban on the bank’s proprietary trading and provides more oversight to the US financial market. The House and Senate are all set to vote on this measure and congressmen have conveyed that no further amendments will be added to the bill. Some of the major provisions that law makers in Washington agreed to in the Wall Street rules include the following:

Volcker Rule

Named after Paul Volcker, former Chairman of The Federal Reserve, the rule bans banks from proprietary trading. Banks can invest in private equity and hedge funds but are capped at 3% of the fund’s capital. For Tier 1 capital, the investment can be more than 3%. This is an amended provision from the bill introduced in May, when banks were completely barred from investing in hedge funds and private equities. This change was made in response to the Massachusetts Republican, Senator Scott Brown, whose concerns were that the ban would torment Boston-based State Street Corp. Brown along with three other republicans was the first to vote for the Senate bill, breaking party ranks. Proprietary trading is now defined as a principle for trading account of banks and financial institutions that are supervised by the Fed for purchase, sale or any other transactions. Any bans on proprietary trading actually reduce profits. Goldman Sachs says that 10 percent of its annual revenue comes from proprietary trading.

Derivatives

In a last minute deal, lawmakers for the first time introduced a regulatory structure for $615 trillion in the counter derivatives market. This provision will push banks to use some of their swap trading into subsidiaries. This will reduce the taxpayers’ risk by barring their trades from institutions that receive federal benefits. Senator Blanche Lincoln, chairman of the Senate Agriculture Committee actually introduced the original proposal to ban all swaps-trading by commercial banks. But, later there were negotiations among all parties, secretaries and directors whereby it was agreed that banks can maintain their trading operations until and unless they are used to trade interest rates or hedge risk or foreign exchange swaps. Now, federally insured banks will get two years time to clear un-cleared default swaps to separate capitalized subsidiary.

Consumer Bureau

A protection bureau at the Federal Reserve to police banks and financial services against abuse from credit-card and mortgage-lending, will be created. This plan is in opposition to the opinion of Republicans and financial industries. Obama proposed a stand-alone consumer agency to prevent financial crisis. Travis Plunkett, the Director at the Consumer Federation of America, said “It’s an agency with considerable authority to protect consumers from abusive financial practices, which is a landmark achievement.”

This bureau will be an independent authority though it will be housed at the Fed. It will be responsible to write consumer protection rules for banks and firms that offer financial services and will be headed by a director appointed by the president. It will enforce rules for firms with more than $10 billion in assets.

Credit, Debit cards

The Federal Reserve will have the authority to limit swipe fees during debit card transactions. Now retailers can refuse credit cards for less than $10 purchases. U.S. merchants pay interchange fees in Visa and MasterCard debit cards. Last year, the fees amounted to $19.7 billion and accounted to 1.63 percent on an average for each sale.

Oversight Council

It is meant to establish financial stability. The ‘Oversight Council’ will monitor large Wall Street firms and other real players and would respond to system risks. It will be headed by the treasury department. With 2/3 of the vote, the council can leverage capital requirements on lenders and bring hedge funds and broker dealers under the Fed’s authority. It will also have the power to force companies to divest their holdings if they become a threat for the financial stability of the country.

Bank Capital Rules

Introduced by Senator Susan Collins, the bill will force some banks to show their capital. It is going to show its impact on ‘Trust Preferred Securities’ (TruPS). Banks with $15 billion in assets will find 5 years time to replace TruPS with common stock and other securities. It is found that smaller lenders sold $45 billion in TruPS out of the $150 billion issued by US banks. According to Richard Bove, analyst at Rochdale Securities, smaller banks like McLean, Capital One Financial Corp. & Buffalo and M&T Bank Corp would be hurt the most as they heavily rely on TruPS.

The Federal Reserve

The Federal Reserve will possess a broad supervisory scope and will bring transparency to its 96 year history. Headed by Chairman Ben S. Bernanke, a new Financial Stability Oversight Council will be created that will deputize the Fed to implement tough standards for disclosure, capital and liquidity. The rules will be the same for all financial companies and banks that pose a financial system risk. The Fed’s bank supervision was earlier curtailed but now the bill would allow the Fed to keep supervising banks like Goldman Sachs, Bank of America and Central Virginia Bank shares Inc, which have assets around $471 million.

There are also other provisions under this bill that enforces amendments in segments such as Credit Raters, Private Equity, Failed Firms, Risk Retention, Fiduciary Duty and the Insurance Industry. The changes have helped to regulate discrepancies in the US financial system with concessions granted to taxpayers and banks.

The conviction that the ‘trade creditor’ would come to the rescue and fund businesses may no longer be the case. Trade creditors are now scrutinizing their credit applicants. While banks just make up about 20% of the short term credit for small businesses, the other suppliers make up the rest (surveyed by Credit Research Foundation, a trade group in Columbia, MD). But with banks showing more friction towards lending, small companies have their eyes fixed on private creditors for loans. They are also pressing vendors for more time to make their bill payments and also asking for loans so that they can keep afloat until they receive payments from their clients.

“Small businesses have been forced to reach out to trade creditors and begin to utilize them as bankers,” says Lyle P. Wallis, vice-president, Credit Research Foundation. But the real difficulty arises with trade creditors slashing their loan amounts to borrowers. A microscopic analysis of creditors is being done by vendors before lending out loans to their customers. Gray Desilets, who runs a $2 million construction business witnessed a slash of credit line from $200,000 to $20,000 from the company that sells him building materials and $20,000 to $8,000 from Home Depot. Trade-creditors have increased their use of scoring tools as well. Products like ‘Dun & Bradstreet’s’ credit reports and ‘Experian’s Predictive Metrics’ have seen client inquiries triple in the last three years.

Earlier, it was possible for small business owners to work out a deal with suppliers that enabled them to clear their debts slowly. But now such negotiations are long gone, as trade creditors are taking steps to cut off customers who are less likely to pay bills. Trade creditors do however fear that by doing so, they might completely lose their customers. As Rob Olsen, chief risk officer at WXS, says “Trade creditors have to step in or they lose the sale.”

Credit unions are lobbying Washington to lift the cap on lending rules that have been in effect for 12 years. Currently, credit-union lending is limited to 12.25% of a credit union’s total assets. The Credit Union National Association is pushing to raise that limit to 25% of total assets.

The vast majority of credit-union loans go to small businesses. CUNA estimates that a change in the law would enable them to extend up to $10 billion in additional business loans.

Banking lobby groups oppose the legislation, saying that an increased cap would create a distorted competitive environment detrimental to community banks, also big lenders to small businesses, according to an article in the Wall Street Journal.

Credit unions were created to provide financial services to people of modest means, and members pay a small fee to join. They are member-based organizations with non-profit tax status – another bone of contention for the banking lobby. Credit-union lending to small businesses increased in 2009, while lending by community banks decreased, according to the WSJ.com article.

Banks contend that there is not enough oversight on credit-union loans, so customers are more likely to default on their loans.

Small business owners who were approved for credit-union loans after being turned down by banks said they faced a rigorous application process at the credit unions.

Matthew Rembe, owner of Los Poblanos Inn and Cultural Center in Albequerque, received a $3 million loan from a credit union to expand his business after a year of getting turned down at banks.

“There was major due diligence,” Rembe told the WSJ.com. “In the past we’d gotten easy money, so it was not what we were used to at that point.”