The Regulation Chasm:
Middle Market vs. Government

Mick Rich Contractors has been in business in Albuquerque, New Mexico since 1988. Rich is a familiar face to government officials and business owners across the Southwest. But his business has fallen from a peak of 100 people to a third as many over the past few years. The reason? Rich, like many small and middle size business owners across the country, blames state and federal regulation – mainly Dodd-Frank — for negatively impacting his business.

While the financial downturn of 2008 hit small and regional business hard, the stricter bank regulations as a result of Dodd-Frank has prevented middle market businesses from bouncing back. Prior to the Act, banks based credit decisions on a number of factors, Rich said, including relationships and history in the community. Now, with the new regulatory pressures faced by banks as a result of Dodd-Frank, banks are forced to make much more complex credit decisions about what they put on their books. In other words, reduced lending is a symptom of increased regulation.

Regulation plays a significant role in the prosperity of small and middle market business, and today’s companies face two major challenges: Increased regulations on banks (e.g. higher capital levels, stronger liquidity ratios, more stringent underwriting standards) have led to decreased credit availability for all but the strongest of companies, and financial institutions have less flexibility and less ability to be creative because of these new regulations.

For example, take Rich’s experience in the last year, in this new lending environment, to demonstrate how these stricter standards are preventing him from bringing in new revenue.

“[The banks] tell me that if you’re going to use and occupy this building yourself, sure we have a loan for you,” he said, “but if you’re going to construct a building so that you can lease out the space, we’re not in the position to give you a loan for that.”

Rich isn’t alone in his frustrations. According to new research by CIT and The Washington Post, new data shows how middle market business influencers and federal government employees differently view the impact of regulation on the economy and middle market businesses.

The survey found that employees of government agencies tend to believe that regulation has a particularly positive impact on the economy and overall job growth.  Business influencers, conversely, believe that regulation has an overall net negative impact on their businesses.

However, the difference in perspective crystalizes when it comes to how each view financial regulations: 27 percent of federal government employees view regulation as a negative to the economy; 50 percent view it as a positive; and 23 percent view it as neither positive nor negative.

Business influencers see things through a different lens: 50 percent said they view financial regulation as having a negative impact on their business; 26 percent view it as a positive; and 24 percent see it as neither positive nor negative.

One thing to note: when it comes to the perception of regulation, the government takes a forest perspective, looking at how regulation impacts the broader economy; whereas those middle market business influencers are staring at the trees, in this case, their particular business.

Many economic experts believe that regulatory compliance costs and bank lending restrictions are related, and that small and middle market businesses are stymied by the financial industry’s inability to lend money due to rigorous oversight and rules from the government about the kinds of lending they can do.

According to Professor John James, Chairman Emeritus of the Center for Global Governance, Reporting, and Regulation at Pace University, the stress test and the rigid rules on asset backing for loans means that it becomes harder to loan money. This is unsustainable, he said.

Easing of the severe standards of Dodd-Frank would allow banks to lend money more freely and reduce the cost of compliance in terms of consultants, staffing or process, said Professor James.

“If you really want to solve Dodd-Frank then pause, go back and evaluate objectively,” he said. “Have congressmen, business, and regulators examine what has been the cost-benefit impact of each of the particular implementations. Look at what can be modified and what can be repealed.”

The dichotomy of views between federal employees and the business community stems, in part, from the differences in perspective between the two bodies. Federal employees tend to have a positive outlook on the impact of regulation on the economy, but acknowledge that politics adds uncertainty to the mix. Several government employees indicated that while local representatives have a lot of power to help stabilize the market, national politicians are frequently out of touch.

“Unless Congressmen go out and visit small places, they wouldn’t know what goes on,” said a federal employee. “I’m really not sure Congress knows about the specific challenges that confront small business.”

Mick Rich believes that government officials ultimately want the best for the economy and for businesses as well. He continues to work with business owners and government officials across the Southwest. Banks are learning to work with regulators and are beginning to increase the amount they are lending. Rich’s clients are optimistic and so is he.

The current problems with access to lending and capital are exasperated by legislation that is broadly applied, rather than tuned for specific problems, according to Rich. Fixing Dodd-Frank would go a long way to relieving burdens placed on middle market business.

“If I was going to write the legislation again I would separate the large, regional and small banks, and develop a set of regulation tailored for each type,” said Rich, when asked what changes would have the greatest impact on regional businesses like his. He stressed the need for small business to communicate and find compromise with lending partners and with the government.

Rich and many business owners like him support smart regulation. “We all heard about ‘too big to fail’ and we passed Dodd-Frank for a reason,” he said.

But the resulting regulations from the Dodd-Frank Act paint with too broad of a brush. Examining and tuning particular components of the Act would ease the pressure on banks and give them more flexibility to work with middle size and small businesses to help them to come back even stronger from the most recent economic recession.