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Study: Bank bailout didn't boost small business lending

November 14, 2012: 12:17 PM ET

Not sure we needed it, but here's another sign the great bank bailout of 2008/2009 didn't work as promised.

FORTUNE --  A new study by the Small Business Administration found that the money the banks got from the government in the wake of the financial crisis didn't encourage small business lending. In fact, it may have done just the opposite.

The study, which was done by Rebel Cole, a professor at DePaul University, looked at banks that got money from the government in 2008 and 2009 through the Troubled Asset Relief Program, and banks that did not. What Cole found is that the banks that got TARP not only didn't use the money to boost lending, they actually cut their lending, at least when it came to small businesses, and that drop was larger than at banks that didn't get TARP.

This is of course distressing for the SBA and small businesses in general. But alone it isn't really a sign that the bailouts didn't work. Nor is it all that surprising. Nonetheless, the study does bring up a good point.

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The bit that the bank bailout was going to boost lending to small businesses or anyone else was always a bit of a misdirect and cover for TARP, which law makers knew was going to be unpopular for what it was, which was a large bailout of Wall Street. We know how to encourage lending. The government has to guarantee loans. That's how it works in the housing market. And, indeed, in the small business market. At no other time does the government hand over money to banks to boost lending. So it's not surprising that you can debunk this.

What's more, in measuring the bailout's effect on lending there is a lot of noise in the data. The bulk of the bailout funds went to large banks. Small business lending is never all that important to the big banks. So it's no surprise that they, the TARP banks, would pull back on that part of their business when they ran into trouble, more than small banks, to which small business lending is their bread and butter.

There is a lot of other stuff in the report that is obvious as well. Matt Levine at Dealbreaker does a nice job of summing this all up when he writes, "There you were hoping that giving money to banks was somehow equivalent to giving money to small businesses, but it turns out that giving money to banks looks more like giving money to banks."

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And Cole seems to misinterpret some of his results as well. The study finds that better capitalized banks do more lending. (They have more capital after all.) So Cole argues that the big bank CEO are wrong to say that higher capital requirements will hurt lending. But I don't think that's what they are saying. What they are saying is higher capital requirements will hurt lending because we have to hold onto more of our cash in order to get there.

As for TARP, No big bank failed after the government started giving out cash. That's why many can argue, rightly so, that the bailouts worked. But as I have said before I think that's a very low bar.

In that sense, I think the Cole and SBA study gets at an interesting point, even if they are looking at the wrong metrics. The important point is not whether TARP banks boosted their lending right after the bailout. The real indictment of the big bank bailout of 2008/2009 is that banks four years later are still lending at much lower rates than they historically have. And the lending weakness does appear to be worse at the largest banks - the ones that got the most assistance from the government. Whatever pick up has happened in lending had mostly happened from mid-sized banks. Smaller banks are struggling as well, but that might be a different story.

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A well structured bailout would have done something not just to save the banks, but to clean them up so that our banking system was healthier than before the bailout, and not the limping along mess it has become. That's the real sign that the bailout perhaps not failed but certainly could have been much, much better.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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