Businesses frequently must borrow in order to make major investments, especially as they are initially organized and begin operating. This entails risk for lenders, especially in cases where loans are requested by businesses that are untried and new. Nevertheless, the market can and regularly does provide this start-up capital. For example, venture capitalists often provide funds in exchange for ownership interests in companies. Cosigners can provide collateral for loans, as do second mortgages.
Despite these private methods of borrowing funds, state and federal governments, individually and in concert, often offer businesses, especially small businesses, guaranteed loans, on terms not unlike those offered to college students. For a lender, a government loan guarantee reduces risk, in some cases all the way to zero, because the government promises to repay the loan if the borrower defaults. From a big-picture perspective, guaranteed loans represent a very real subsidy to banks that participate, since these guarantees lower their costs of doing business.
Loan guarantees are also an obvious subsidy to the businesses who receive the loans. Since the loans are artificially made relatively low-risk to the lender, less interest is charged on the loan, benefiting the borrower. For that matter, the borrowing business might never even have gotten the loan but for the guarantee. Given the scarcity of loanable funds, businesses that participate in loan guarantee programs crowd out other potential business borrowers who do not participate in a guaranteed loan program. This gives a distinct competitive advantage to the businesses that participate.
The federal government is the largest provider of guaranteed loans through three major programs. The U.S. Department of Agriculture provides guaranteed loans through a program meant to support rural small businesses. The U.S. Treasury Department runs the State Small Business Credit Initiative, with another $1.5 billion in funding. This program uses state-level go-betweens in 47 states. Alaska, North Dakota and Wyoming do not participate. State participation in both of these programs is decidedly uneven. Wisconsin has received, by far, the largest amount of funding under the USDA program. California is the biggest recipient of Treasury’s program. Georgia gets more funding under both programs than Texas does, although Texas’ shares are significant. Less information is readily available regarding the U.S. Small Business Administration’s guaranteed loan program, referred to as the “7(a) Loan Program.” However, there is little doubt that participation is uneven, likely reflecting variation in the sophistication of various SBA state offices.
Some states have their own guaranteed loan programs, sometimes narrowly tailored to favor minority-owned businesses or agriculture. All are justified on the basis that they help to create jobs. And, no doubt, there are jobs associated with the businesses these programs have helped. On the other hand, loanable funds are scarce and funds going to these businesses are denied to others. It’s much harder to point to jobs that have not been created due to these programs, but this is, in fact, the case. Whether the net is positive or negative can be debated, but since market participants tend to scope out the best available productive alternatives for investing funds, and these programs interfere with that process, the result of these programs is likely an overall net negative to society as a whole.
States also go beyond loan guarantees and make direct loans to select companies. Select companies have received loans from Michigan’s Jobs for Michigan Investment Fund. State auditors note, “These are high-risk loans issued for the purpose of diversifying Michigan’s economy and helping to create jobs in competitive edge technologies.”