The Impact of the Consumer Financial Protection Agency on Small Business
Thomas A. Durkin
September 23, 2009
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The U.S. Department of the Treasury submitted draft legislation for the Consumer Financial Protection Agency Act of 2009 in July, shortly after the Department proposed this new agency as part of the Administration's overall plan to reform financial services regulation. The Consumer Financial Protection Agency (CFPA) would have significant powers to issue new regulations and toughen existing regulations of consumer financial products. It would also take over the responsibilities of enforcing existing consumer protection laws from federal regulators, including the Federal Reserve Board and the Federal Trade Commission. Under the Act, the CFPA's rules and regulations would function as a floor for individual states that could impose more stringent consumer protection regulations.
Although the CFPA Act of 2009 is focused on consumers, it would also affect millions of small businesses. Most of the 26.7 million businesses in the United States, including the selfemployed, rely on credit cards, home equity loans, auto title loans, and other sources of consumer lending to finance their business. They use these loans for everything from obtaining seed capital to start their business, to managing monthly cash flows, and providing working capital. Many of these businesses do not have access to a commercial line of credit, often because they are too small or too new. Many others use consumer loan products to supplement commercial credit.
Small businesses account for significant employment and job growth. According to the Small Business Administration, employer firms with fewer than 100 employees accounted for more than 35% of U.S. employment in 2006. Small businesses include many new firms that tend to grow quickly. These new firms account for a disproportionate share of the net new jobs that are added to the economy. Indeed, a Census Bureau study finds that new firms, most of which are small, accounted for most of the net additions to jobs in the United States between 1987 and 2005. Moreover, some of these startups grow into very large firms. Microsoft®, for example, operated as a small firm for several years before growing rapidly into one of the largest corporations in the world based on market capitalization. The well-being of small businesses is critical for the long-term performance of the economy, and the ability of small businesses to obtain credit is essential for their health.
In this economic analysis of the likely effect of the CFPA Act on small businesses, it is probable that if the U.S. Department of the Treasury's CFPA Act of 2009 were enacted, it would have a significantly adverse effect on small businesses by restricting their access to credit. Some would lose access to credit altogether. The businesses that would be most adversely affected would be the new businesses for which consumer loan products are a principal source of funding. As a result, the CFPA Act would inflict the greatest harm on those small businesses that account for a significant portion of the economy's net job growth. Fewer entrepreneurs would be able to start and expand their business. It does not go too far to suggest that the CFPA Act of 2009 could deny the credit that garage-based entrepreneurs need to create the next Apple® or Hewlett Packard®.
The following four specific conclusions have been reached:
- The CFPA would likely reduce an important source of credit to small businesses. This induced credit squeeze comes at a time when it is likely that small business credit will be already highly restricted as the lending industry digs out of the current financial crisis.
- The CFPA credit squeeze would likely result in business closures, fewer startups, and slower growth. Overall, this would cost a significant number of jobs that would either be lost or not created. It is not possible to give an exact accounting of the magnitude of this impact, since counterfactual conditions are never directly observable, but there certainly would be an effect similar to opportunity costs.
- The CFPA adopts a "one-size-fits all" approach to consumer protection that ignores the fact that small businesses use consumer financial products in different ways than the average consumer. Rules that are designed to protect ordinary consumers are likely to impose collateral damages on informed and sophisticated small business owners who depend on consumer loan products.
- Many suppliers of consumer financial services products are small firms such as community banks. The CFPA would harm these smaller suppliers because the new agency would impose fixed costs of compliance that weigh disproportionately on smaller firms, and because it would encourage product standardization that benefits larger firms. Also, only larger firms have the sophisticated legal staff to cope with waves of new regulations.
Section II of this paper describes the role of small businesses in the economy and, in particular, their role in generating new jobs. Sections III and IV summarize government data on how small businesses finance their operations and demonstrate their reliance on consumer loan products. Section V explains why the CFPA Act would likely reduce small business access to credit. Section VI presents conclusions.
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