The Coming Small Business Loan Bubble: A Thought Experiment

For a while now, I have speculated that a speculative market is forming somewhere. I have hypothesized this because the Fed Funds Rate was lowered to .75% and kept there for about a year and a half and this lead directly to the current mortgage crisis caused by a speculative bubble in sub prime and eventually real estate altogether. Now, the Fed Funds Rate is at zero and will likely be there even longer than Greenspan kept it at .75%. Beyond this, the Fed is flooding the market with new money by buying U.S. Treasury bonds at an alarming rate. All of this hasn't been felt yet because the velocity of money is rather low right now. (because everyone is afraid to spend) Yet, as soon as the economy picks up, so will the velocity of money. Once that happens, the full effect of all this monetary stimulus will be felt.

At the same time, the Obama administration is likely to create all sorts of new regulations through their "new regulatory framework". The thing about regulations is that it's much easier to predict and eliminate the previous crisis than it is the predict the next one. You can bet that there will be onerous regulations to mortgages, credit default swaps, hedge funds, and anything else identified with the current crisis.

This brings us to small business loans. Today, President Obama is announcing plans to encourage more small business loan lending.

The new measures taking effect Monday focus on opening up small-business lending, seen as critical to cities' growth. While the SBA typically guarantees $20 billion in loans annually, new lending this year is on track to fall below $10 billion, according to the administration.

Under the two-month-old administration's new initiative, the government will step in to buy these loans to help unlock the frozen credit market, using money from the recently passed bailout package in the range of between $10 billion to $20 billion, one official briefed on the plan said.

The other measures are part of Geithner's financial stability plan announced last month. They involve temporarily eliminating upfront fees of up to 3.75 percent and some processing charges on certain SBA loans that lenders typically pass along to borrowers. It also increases the government guarantees on certain loans to 90 percent, up from 85 percent for loans below $150,000 and 75 percent for larger loans.

Small businesses have become a sort of third rail. Not only are they seen as an engine for job growth, but more than that, they are sympathetic. No one is going to stand in the way of their ability to grow. As such, it is very unlikely that small business loans will be part of any push by the Obama administration to regulate.

Instead, the Obama administration will do everything in its power to expand lending. This is only the first step. Now, the SBA will guarantee loans for a higher percentage of the loan's value. That's the best way to flood the small business loan market. Furthermore, when onerous regulations make it difficult to conduct any other lending, small business loans will become a beacon. It will become the one product that won't face a new stiff set of regulations. As such, banks will flood the market with new loans. With new loans will come competition, and that will eventually lead to irresponsible lending. Then, we will be in a full blown speculative bubble.