Washington tries to put more junk in the SBA’s trunk.

The pre-recession economy saw more than its fair share of credit alchemy as lenders ignored equity.  With bank loans to small firms dropping 5.6% to $670 billion from heights of $710 billion as recently as June of 2008, the Administration has become increasingly desperate to get credit into the hands of business.  The only problem?  The companies that need the credit can’t afford to accept it:

Bankers say the problem isn’t scarce credit, it’s lack of demand from creditworthy firms in a weak economy. The result may be more loans given to distressed firms and higher losses. While bank regulators don’t compile default rates, the biggest lenders have charge-offs of 4 percent to 14 percent tied to small businesses. Eliot Stark, managing director at Capital Insight Partners Inc., said their credit record resembles “junk.”

“The highest demand for loans is from the companies least qualified, the companies that have really struggled because of the economic downturn,” said Stark, a former Comerica Inc. executive whose Chicago-based investment bank helps community lenders raise capital. The way lawmakers see it, “everyone’s a good borrower, and that’s just not the case.”

Washington’s lending advice is currently as practical as a baseball coach telling his hitter he can swing away – but under no circumstances will he be allowed to get out. 

Worse is D.C.’s legislative panacea of having the Treasury Department make preferred stock investments in “small” banks (those with assets of $10 billion or less) in order to stimulate loans.  $30 billion in capital will be transferred to small banks in hopes that most of these lenders will leverage the funds to help create new small business loans – a figure that some in Washington estimate could be as high as $30 billion.  Despite assurances from Treasury that the program will earn $1.1 billion over 10 years for taxpayers, the legislation sounds like TARP for Hervé Villechaize-sized lenders.

Considering the bailout investment program targets largely community banks which account for most of the 240 banks that have failed since 2009, it becomes even harder not to see the effort as an attempt to inflate a TARP into yet another credit bubble.  Which may be precisely the point:

Small borrowers are higher risks because their size leaves less room for error, bankers say. Half fail within their first five years, according to the SBA, and the recession eroded the value of hard assets such as property and equipment to pledge as collateral, said Alfred Osborne, senior associate dean of the UCLA Anderson School of Management in Los Angeles.

“We can create lots of jobs making bad loans,” NFIB chief economist William Dunkelberg said. “We did that during the housing bubble.”