Washington Is Missing the Point on Pandemic Relief Fraud

Not all of the SBA's bad loans are fraudulent.

The SBA and Congress are back to fighting about the $200 billion in Covid loans that may have gone bad.

By Ami Kassar

All of the headlines scream: fraud, fraud, fraud!

The issue at hand is a new report by the Inspector General of the Small Business Administration warning Congress that as much as $200 billion of the Covid relief funds that went to small businesses were taken fraudulently. The report estimates that $64 billion of the Paycheck Protection Program loans and $136 billion of the Covid-19 Economic Injury Disaster Loans loans were fraudulent.

Obviously, it would have been impossible to distribute that much money without some fraud in the program. During the pandemic, the SBA, an agency that typically oversees about $40 billion of loans annually, was charged with administering about $1.2 trillion of relief funds in short order. Even if the agency had done everything perfectly, which it did not, some fraud would have been inevitable. The mission was to distribute the money as quickly as possible, save as many businesses and jobs as possible, and then sort out the fraud later. Under the circumstances, that was probably the right approach.

But let’s break the fraud down by program. The SBA approved about $800 billion of PPP loans nationwide through banks and some non-bank lenders. The inspector general’s report estimates that the PPP fraud will be $64 billion, or about 8 percent of all PPP loans. While $64 billion is a lot of money, and while we should pursue the bad actors and learn from our mistakes, an 8 percent fraud rate should not surprise anybody considering the speed and breadth of the program.

On the other hand, the EIDL data is much more concerning. These were low-interest, 30-year loans with payments deferred for two years. The SBA lent over $400 billion to about 4 million small businesses, and the inspector general estimates that this program will have a staggering $136 billion of fraud. That is a 34 percent fraud rate.

But is that even possible? Without a doubt, many schemes by bad actors should be chased down and prosecuted. But it’s almost impossible to imagine a scenario where more than a third of the EIDL loans were fraudulent. It is more likely that a very high percentage of those loans are going to default for reasons that do not involve fraud. 

Many EIDL loans were obtained by borrowers who got more money than they needed or knew how to manage. Already today, about 1.6 million Covid EIDL loans, representing 54 percent of all active loans in that portfolio, are past due, delinquent, or in liquidation, amounting to $114.2 billion.

To understand what went wrong, you have to look at the origins of the EIDL program and how the government tried to adapt it to cope with the pandemic. Long before Covid, the EIDL program was designed to assist businesses in a relatively small geographical area when a specific disaster damaged them, such as a hurricane or tornado. The government would step in to offer long-term, low-rate loans to help the companies rebuild.  And while insurance might cover the physical losses, if a business really wants to rebuild, that takes time, investment, and working capital.

The EIDL loans issued during the pandemic were handed out without demanding proof of economic injury. Yes, some businesses that got the loans were genuinely decimated by Covid and needed every penny. But many companies thrived during Covid and jumped on these loans out of FOMO (fear of missing out). Who could imagine a business getting another opportunity to borrow a large amount of money with a fixed rate and a long payoff?  It felt too good to be true—and this situation was exacerbated near the end of the pandemic by nonstop promotions from the SBA that encouraged borrowers to take the biggest loan they could get before the money ran out.

I have heard some crazy stories about how the money was used, including buying jets, paying off divorce settlements, and investing in cryptocurrency. And there were plenty of companies that were in terrible financial shape before Covid and saw these loans as an opportunity to refinance debt, stretch out terms, and take another shot at solving long-existing issues. And for many of these companies, the money is starting to run out, the problems remain, and now they don’t know what to do.

One entrepreneur I know, whose business was genuinely decimated by Covid, received $2 million of EIDL money. And while some of the money was used for working capital and to catch up on payables—as it should have been—some also went to replace and repair equipment that should have been replaced long before Covid. But the company didn’t have the money back then, and now his bank is considering not renewing his line of credit and wants to know where all of the EIDL money went. Cash is low, and it’s a tough situation for everyone.

In another instance, a contractor I know did not have good financial controls in place to run his business.  Before the Pandemic, he took a large deposit from a client, and the project got stuck in permitting and never got off the ground.  When the client demanded the money back, he didn’t have it.  His saving grace was an EIDL loan.

Another entrepreneur received two EIDL loans for two different operating companies.  He used the money to ramp up his staff and operations and grow his business.  Things got messy, though, when he needed a bigger line of credit to handle the receivables growth.  The government had a lien and wasn’t in the mood to subordinate it to a new lender who insisted on being in the first position.

There are almost certainly hundreds of thousands of stories like the three I have shared above—way more than government auditors will be able to catch up on. Yes, borrowers need to take responsibility here, but so does the SBA. I completely understand how early on in the pandemic, the agency released EIDL loans in tranches of $150,000. I do not understand its decision to release larger tranches of EIDL money later in the pandemic when many businesses had recovered and stabilized. The agency did this without any consideration of the business’s financial situation at the time.  

Lending money to businesses requires assessing their ability to pay it back.  And borrowers need to understand their loan terms in big print, such as the liens and personal guarantees (in the case of an EIDL, any loan over $200,000 requires a personal guarantee). Time and again, in our conversations with business owners about their EIDL loans, we realize they did not understand what they signed up for. In short, handing out money quickly can have negative consequences—both for the borrower and the lender, which in this case was the U.S. government.

What’s the biggest lesson here? The SBA should slow down and create checks and balances when it lends money.  Here’s hoping we never see another crisis like Covid in our lifetimes.  But if we do—and if we need to distribute money quickly, we should consider partnering up with banks to get the money out as we did with the PPP instead of having the government lend the money directly. That’s the unmistakable message of the disparity between the 8-percent potential fraud rate in PPP lending versus the 34-percent rate with the EIDL program.

Fortunately, the Covid crisis has passed. Sadly though, it doesn’t seem as if the SBA has learned the right lessons from this experience. If anything, it is adjusting its normal, day-to-day lending to be more like the flawed emergency lending of the pandemic. The agency is changing the longstanding 7a program rules to dramatically simplify the process of obtaining loans. That is highly likely to produce more bad loans.

The SBA should put the brakes on the current changes to the flagship 7a program. The agency should first make sure it understands what went wrong with the EIDL program. Most important, it needs to understand that not all of the bad EIDL loans were the result of fraud. It’s more complicated than that. Many of the defaults have been and will continue to be the result of poor credit procedures and decisions. Both in good times and in bad, we can do a better job of getting capital to businesses.

Ami Kassar is CEO of MultiFunding.

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