Lending Cap Is Unfair to Small Business

The recent viral video sensation “If I Wanted America to Fail” confirms that the regulatory state is a major focal point for the center-right movement, and indeed much of America. Produced by Free Market America, a project of Americans for Limited Government, the video garnered more than 1 million views in a span of just five days.

While mostly concerned with environmental regulation, the video voiced its objection to all types of mandates. Narrator Ryan Houck posits that if he wanted America to fail, he would “create countless new regulations and seldom cancel old ones.” He surmises correctly, “That way, small businesses with big ideas wouldn’t stand a chance — and I would never have to worry about another Thomas Edison, Henry Ford or Steve Jobs.”

It’s this very issue of access to capital for entrepreneurs who could be the next Jobs or Edison that has increased the focus by advocates of limited government on financial regulation. Frequently justified as needed to rein in Wall Street, these countless new and old regulations are having a pernicious effect on Main Street businesses, consumers, and investors.

The crushing accounting mandates in Sarbanes-Oxley Act of 2002 raise the cost of capital by making it extremely difficult for smaller companies to raise funds through the public equity markets. Even the Obama administration admitted Sarbox was chilling the entrepreneurial sector when it signed the JOBS Act last month granting limited but significant relief from the law for emerging growth firms.

Similarly, the Dodd-Frank so-called financial reform of 2010 greatly raises the cost of borrowing. The Durbin Amendment provision of that law, imposing price controls on what banks can charge retailers to process debit card transactions, has eliminated free checking and added fees to many consumers’ and entrepreneurs’ accounts at banks and credit unions.

Now, the center-right coalition is focusing on a rule that specifically burdens credit unions and the entrepreneurs among their members, from veterans to doctors. The cap on a credit union’s member business lending, enacted in 1998, has severely restricted the ability of credit unions to make small business loans to their members. And credit union regulators agree there is no safety or soundness justification for this rule, as business loans are not inherently more dangerous than car loans or — as we’ve seen during the financial crisis — mortgages.

So it should come as no surprise that leaders of 14 center-right groups — including the Competitive Enterprise Institute, Americans for Tax Reform, the Heartland Institute, the 60 Plus Association, American Commitment, Citizens Against Government Waste, and Campaign for Liberty — have signed on to a letter supporting S. 2231, a bipartisan bill that would substantially ease — but not eliminate — these restrictions on credit unions’ lending to the businesses of their members.

“The bottom line is this,” the letter states. “The bill is a sound, free-market, deregulatory action that will create jobs, help small business and assist veterans.” As to the latter point, the letter notes that “since two of the largest credit unions focus their efforts largely on military populations, veteran-owned businesses are also likely to reap particularly large benefits if this bill becomes law.” The two credit unions that serve military populations are Navy Federal Credit Union and Pentagon Federal Credit Union.

Given the legislation’s deregulatory approach and the fact that it helps veterans who are entrepreneurs, it should also come as no surprise that some of the most conservative and free-market minded members of Congress are co-sponsoring this bill and its companion House version, H.R. 1418. These include Rand Paul, R-Ky., in the Senate and his father, Ron Paul, R-Texas, in the House, as well as chief House sponsor Ed Royce, R-Calif., and Reps. Dana Rohrabacher, R-Calif., and Allen West, R-Fla.

But what might be surprising is that some of the House and Senate’s most liberal members are also co-sponsors. These would include Reps. John Conyers, D-Mich., Marcy Kaptur, D-Ohio, and Sen. Mark Udall, D-Colo., the lead Senate sponsor of the bill. Part of the reason for this strange bipartisan outbreak of common sense in viewing this regulation as outdated is that credit unions are so well received by their customers. A recent survey by the Temkin Group found credit unions to be among the businesses that “consumers are most likely to trust.”

What is also surprising is if not the opposition from banks — who compete with credit unions – the degree of it. It has been remarked that if banks’ opposition to the Durbin Amendment price controls from Dodd-Frank (which also hurts credit unions) were this intense, that provision would have been repealed.

In their intense lobbying campaign, with ads in Capitol Hill newspapers such as Politco and The Hill, bank trade associations have put forth two easily rebutted arguments. One is the aforementioned claim that business lending is somehow inherently dangerous for credit unions.

This was effectively refuted by Debbie Matz, President Obama’s chairman of the National Credit Union Administration, the federal agency that oversees credit unions.

Matz told the House Financial Services Committee last October business lending “did not have a major impact on the safety and soundness of the vast majority of credit unions” during the downturn.

Matz added further that an increase in “business lending is another way in which to prudently manage risk.” As she explained in her testimony, “An increase in the member business lending cap would allow credit unions to diversify the risk of their loan portfolio, with MBLs typically involving less interest-rate risk than long-term, fixed-rate mortgages. This change is particularly important given the present low interest rate environment.”

As to the “tax fairness” argument, in which the bank lobby sounds nothing so much like liberal supporters of the Buffett rule in its tax envy, a few points that I’ve made elsewhere. Yes, credit unions have an exemption from taxation at the corporate level because they are member-owned cooperatives that don’t have the many means that banks have to raise money such as the issuance of shares of stock.

Credit union members, however, are fully taxed on the dividends on their accounts, and are taxed at the “ordinary income” rate for interest and not the lower rate for dividends. Conservatives and libertarians have long argued that business income should only be taxed once, and credit unions provide a successful example of single taxation.

So it’s consistent to argue for expanding this structure, rather than for unduly restricting credit union activity simply because the tax system for all businesses hasn’t yet been reformed.

In fact, credit unions’ single taxation structure is similar to those of some community banks that are subchapter S corporations. There are some so-called tax reformers who want to kill or restrict S-corps and subject them to double taxation. This should be opposed as well, because both S-corps and credit unions are not “loopholes,” but way stations to a successful system of single taxation.

It’s unfortunate that some in the bank lobby find it — in the words of the Free Market America video — “more fashionable to resent success than to seek it.” Thankfully, 14 leaders of center-right groups have proven that they are pro-market — rather than just pro-business — and want America to succeed.