Pod Insights a16z Podcast The PPP Omnibus: Eminent Domain, Fraud, and Fintech About this episode Special omnibus episode combining two previous episodes on the a16z Podcast network, discussing the relevance, considerations, and problems/ solutios of the Paycheck Protection Program (or PPP) from the Small Business Administration (and the role of government stimulus/ pandemic relief for the economy) and where tech comes in.
Transcript 11,262 words · 5 speakers
Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
0:01 Sonal? Hi, everyone. Welcome to the A6 and Z Podcast. This episode features not one, but two relevant episodes that we ran previously, both discussing the relevance of the Paycheck Protection Program, or PPP, from the Small Business Administration, and the role of government stimulus and pandemic relief for the economy, as well as where tech comes in. The topic is as relevant as ever, and this episode combines two separate episodes, beginning with one recorded much earlier this year on our show 16 Minutes, which outlines the analogy of eminent domain for government mandated shutdowns of certain businesses, and then is followed by an episode recorded later on preventing fraud and the role of fintech. Both episodes feature in common A6 and Z general partner in fintech,
0:46 Sonal? Alex Rampell, who also wrote about how small businesses depend on the stimulus package, and the stimulus package will depend on fintech, which you can find at a6andz.com/pandemicstimulus. Hi, everyone. Welcome to this week's episode of 16 Minutes. I'm Sonal. This week, we're covering the emergency move to stimulate the economy that's been very affected by this current coronavirus pandemic. Now, let me introduce our A6 and Z expert, Alex Rampell, general partner, who specializes in fintech. Alex, can you start by summarizing the news for me? And then I also want you to explain the measures and what they are, and what the Fed is doing as a way to help stimulate the economy during this time.
1:30 Speaker 01 Well, the Fed is doing lots of different things that all fall under this rubric of monetary policy. That can be everything from lowering interest rates to buying certain assets and making short-term loans. So they're doing lots and lots of different things. The news changes every day. I think they've now done seven or eight things to try to stabilize many markets. So they've slashed interest rates to zero. They've brought back quantitative easing. Which is you kind of create money and buy bonds. And I talked about this on another episode.
2:02 Sonal? Yeah, you talked about it previously on 16 Minutes.
2:05 Speaker 01 They've started buying commercial paper, which are short term business loans. They unveiled something called the money market mutual fund liquidity facility, which is actually something that came out in 2008, kind of guaranteeing and backstopping money market funds, which is basically saying, we're going to loan money or provide money to a money market fund so they don't have to potentially liquidate assets below par, which is how you break the buck. They've introduced swap lines with foreign banks to make sure that those countries have enough dollars. A swap line is not like, hey, we're going to give you free dollars. It's like you pledge collateral and then we give you dollars. They now let banks to now borrow money from the Fed at very, very low interest rates.
2:45 Speaker 01 And now they also have loans out to primary dealers of treasury bonds. Again, it's kind of pledging collateral to borrow money. There was a misunderstanding of some of these because, for example, the Fed rolled out a $1.5 trillion repo line. And some were like, if we can give 1.5 trillion to Wall Street, you know, why can't we provide Medicare for all or student loan forgiveness for this, that, or the other? That wasn't the Fed giving 1.5 trillion to anybody. What a repo line is, is it's a very, very short term lending facility. So it's saying, okay, you have lots of T bills or you have lots of agency bonds like Fannie and Freddie mortgages. So residential mortgages that are effectively backed by the, by the US government.
3:27 Speaker 01 And you've got a cash crunch because, you know, people want to withdraw money from you or you, you have to come up with liquidity. Who is going to give you money in this dire time? Well, the Fed is going to give you money, not as a handout, but just saying, okay, you go give me possession of your treasury bills or of your agency mortgages or of some kind of like very, very solid collateral and then I will give you cash. But then you got to give me back the cash later. It just prevents this problem of markets seizing up. And markets seizing up is a catastrophic thing in this period because it's like, okay, I need money. I don't trust the market. I want to sell everything, sell everything, sell everything.
4:09 Speaker 01 And having a stabilizing agent that can provide liquidity prevents the market from falling apart. But it doesn't mean that keeping markets liquid puts everybody back to work tomorrow. It's more of like if we didn't have liquid markets on top of every other catastrophe that we're going through right now, it would be like a mega, mega, mega catastrophe versus a mega, mega catastrophe.
4:29 Sonal? One of the concerns that's top of mind for people and for those of us who are in lockdown, like we are both remote on this podcast because where you live and I live, the cities have been, the declaration is to shelter at home to prevent the spread of coronavirus. So for instance, I can't go to a restaurant anymore. Some restaurants might be able to deliver, but they shut down all non-essential services. So the question I have for you is, how does this affect small and medium sized businesses? Because a lot of these moves at a macro scale sound very important for business.
4:59 Speaker 01 The Fed's job is to control the money supply. The Fed doesn't have tools to reach out to every small business and say like, here's money. And even if they did, if they have no demand, because the government doesn't allow customers to go to the restaurant for health reasons, and that doesn't really help anybody. This really goes into the realm of fiscal policy. And my, my personal take on this is that there's a notion that the government has eminent domain. Like you can own the land, but it's in the government's interest and ability to not seize that land, but to compensate you fairly and take back that land if necessary. So when-
5:35 Sonal? Right, like building a train.
5:36 Speaker 01 Yeah, like you build a train track. There's land in the way. We will compensate those people, but we will exercise our right of eminent domain. We as the democratically elected government has the right to take back this property. And my take on this situation, which I think is, it's dramatically different than 2008 and 2009, is it's almost an eminent domain of solvency and revenue, where the restaurant is not allowed to function.
6:00 Sonal? Right, they don't have supply of customers.
6:01 Speaker 01 Right, so giving every American who's now out of work money to go to the restaurant doesn't actually help the restaurant stay solvent. We collectively, in the name of public health, have eminent domain, a huge chunk of the economy, that doesn't have enough cash to weather all of their revenue going to zero. Many of these businesses operate on very, very small margins. It's going to be very hard for the airlines, where some of the most popular routes cannot be flown because the governments have shut this down. They've almost eminent domain that as well. And you could say, well, the airlines, they should have kept adequate cash on hand to really go forecast this. But you could say the same thing of the coffee shop, you could say the same thing of the yoga studio, you could say the same thing of the restaurant. Like, there are kind of two elements of fiscal policy that are being debated right now.
6:46 Speaker 01 The two areas of focus are, there's one for business and there's one for individuals. Because people need to eat, they need to pay their rent, they need some kind of compensation. It's possible that unemployment could be 30% right now, which is just stunning. Because you're forcing everybody to stay home, and not everybody, you know, works in the knowledge economy where they can work from home. So you can give people two months of cash, and you say, okay, I'm going to come up with some mechanism to make it fair, I'm going to pay you this much to you, and then X dollars per dependent, and I'm sure they'll come up with all sorts of different clever ideas of doing that. It kind of matters not if they have no job to go back to in two months.
7:26 Sonal? Exactly.
7:27 Speaker 01 And if the government has to support 30, 40% of all people in the United States, in the name of public health, the employers that they used to work for will no longer exist. In the name of public health, like, the solvency of their employer has been eminent domain.
7:41 Sonal? Right.
7:42 Speaker 01 So you've got the individual response, and then you've got the business response. And my argument would be that the individual response, while very complicated, is a much simpler solve than the business response. A lot of what needs to be done is two things, it's adjudication and dispersment. It's how do we figure out who needs what? Adjudication means, like, who deserves this, who doesn't, how much do you need, how much do you not? And the thing that most small businesses need as a buffer, because they didn't plan for this, like, how could they, and even if they did, I would argue this is eminent domain, as opposed to their own failures as a small business owner. And a lot of what small businesses and even big businesses need help with is they need help with their fixed costs because variable costs like employees, you could
8:27 Speaker 01 say, I'm going to furlough them or like I'm a restaurant, I don't need to buy vegetables anymore. But what's a fixed cost is my rent, my utility bill, the machines that maybe I'm paying interest on because I'm renting them, like things like that where you can't just get out of it. And then on the dispersment side, the government already knows how to give money to people. You filed your taxes and you've already gotten money from the IRS. Like, great, the IRS can do that again. It's within their purview. Whereas small business, that's really, really complicated because a lot of small business, it's not like, oh, you have an LLC or a C corporation. Like, it's like, oh, no, it's like Jim the plumber.
9:04 Sonal? Mom and pop shops.
9:05 Speaker 01 It's mom and pop shops. This would be known as a sole proprietorship or a DBA, like doing business as, like, there's no corporation there. If you employ people legally, then you have what's called an FEIN, a federal employment identification number, which is kind of the business equivalent of an SSN. But how much money do we give to the plumber? How do we figure out what their fixed costs are? Because it's not as simple as we can look at your tax return last year. Like, there's no equivalent of that for a small business because they're not filing a corporate tax return. So the government actually has no idea what the P and L looks like for that business because Joe the plumber just keeps the profits or lack thereof and then pays personal income taxes on that. Like, that's
9:47 Speaker 01 how the owner compensates himself or herself. So, which again, makes this adjudication and dispersment very complicated because it's like, how do I know where the businesses are in America? And then how do I know where I help and who I help?
10:01 Sonal? So what I'm hearing you say, basically, is that adjudication and dispersment are hard. The government has certain existing tools in their toolkit for like solving things in the macro and for certain big businesses. But in this case, the small mom and pop, the people who aren't traditional LLCs, who are FEINs, you know, DBAs, these various other entities, they basically are businesses that are operating that the government does not have natural visibility into the way they might say with. The P and L because the company submits certain things.
10:29 Speaker 01 Exactly, yes. Like you might know that they have payroll, that's about it. You have some businesses by virtue of being what are called C corporations that file corporate tax returns and pay corporate income tax to the federal government. But even there, they're not showing line item detail of what they're spending money on. Well, at least the government knows that you generated $200,000 of profit. Whereas I'm Joe and all of my income comes from my business. I just file a tax return that says this is my income. Whereas every private lender, there are lots that make loans to small business. It's their job to understand like how much, how many widgets do you make? What are all your costs? How much do you pay in rent? Because they're giving you a loan and they want to make sure they're going to get paid back.
11:12 Speaker 01 So they really analyze the cash flow dynamics of the business. The government has no idea what that is. So I would argue that to adjudicate this fairly, you have to understand that. Because giving people a multiple of revenue, that doesn't make any sense. If you're giving people a multiple of payroll, which is what Denmark is trying to do right now. They're guaranteeing 75% of payroll, I believe, to employers to keep their employees employed. That might not matter either because like, what if you have five employees? And you have, you know, massive electrical bills because you've smelt aluminum or something. That's not going to work either.
11:41 Sonal? So your point basically is that where there isn't an obvious and easy solution, and it's always going to be quite complex. One area the government has zero visibility into, that's not machine readable, that's not really understandable for them to adjudicate or deal with, even if they wanted to, is actually partially addressable through technology solutions where these things are modeled and documented and analyzed. And so that could be one way to solve this.
12:06 Speaker 01 And the nice thing here is you get both adjudication and disbursement. Imagine that I use QuickBooks. I have my rent in there, everything is itemized. And you can see how much I have in terms of fixed costs versus variable costs and all of that. There could also be a button saying get government assistance. And you click on that button and then it looks at your financials and then boom, 24 hours later, you have money in your account. Whereas right now, there's something called the Small Business Administration, which guarantees loans to small businesses. SBA loans often have this kind of adverse selection mechanic to them because they just take way too long. An SBA loan typically takes 90 days to get. It's very, very complicated. Whereas if you go to like a private lender, that might take a day or even an hour.
12:50 Speaker 01 The default is the government's going to remain bureaucratic longer than you can remain solvent. That's the catastrophe where like every minute counts. Because if it takes like four months to go figure this out, then we have lost like 90% of small business in America.
13:05 Sonal? I mean, just concretely, like in my neighborhood alone, a number of restaurants have already laid off like workers and some of them are already shut down. And that's just a very specific example. And it's, those are people's livelihoods. It's not academic by any means. So now on this note of the difference between fiscal and monetary policy, what is the difference?
13:25 Speaker 01 Monetary policy is basically controlling the money supply, changing or backstopping certain financial instruments. Largely, it's everything around like how money works and how markets function. Fiscal policy is everything that the government can do to either stoke demand, lower taxes, increase taxes, buy lots of products, put people in work. Like the government during the Great Depression, there was something called the Works Progress Administration, the WPA. It's like, let's build bridges. It's things that the government does to increase GDP because one of the components of GDP is government spend.
14:07 Speaker 01 So government can be demand and government can hire people. The government is effectively a business in this regard. Everything that Congress or your local legislature does, like that's very much in the realm of fiscal policy. Monetary policy, it's what the Fed does or what the Treasury Department might do in some cases. Largely speaking, that's the delineation.
14:27 Sonal? That's so helpful, Alex. Did you want to explain buyback versus dividend?
14:31 Speaker 01 Sure. I mean, this is a very, very complicated thing that I think goes back to adjudication. So there's been some populist uprising of like, oh, we shouldn't bail out XYZ company because they bought back their stock. And again, I'm not saying that we should bail out everybody, we should bail out nobody, but there's this misnomer that buybacks are bad and dividends are fine. And they're actually functionally the same thing. Interesting. What do you mean? Why? So if you are a company and you generated a million dollars of profit, and you have lots of shareholders, how much per share do I get? And that's what earnings per share means. So if you reduce the number of shares by buying back shares, then the shares that are left have higher earnings per share.
15:15 Speaker 01 Or if you pay out a dividend, then each shareholder gets a certain amount of money per share. They're mathematically equivalent. Like, there are papers on this. I mean, dividends are a sure thing versus like, I could buy back a lot of my stock, and then I tank the next quarter, and then like, the price goes down. But in terms of efficiency of returning money to shareholders, based on US tax policy, buybacks are actually more efficient than dividends. But most companies use a combination of both. And the reason why companies exist is to return money to their owners. And by the way, the coffee shop works the same way. There's no difference between a coffee shop and Boeing. The coffee shop owner makes a certain amount of money, and then withdraws some percentage of that money to pay himself or herself, and that would be called a dividend. The cogent argument would be like, this is their own fault.
15:59 Speaker 01 We should let them fail because they didn't keep enough money on their balance sheet for a rainy day. And it doesn't matter if they paid out dividends or buybacks. Again, I would liken this event more to eminent domain. But that is an ideologically sound argument. What is not an ideologically sound argument is like, okay, you paid dividends. Well, that's fine, because you just had to give money to your shareholders. You bought back your stock? That is the root of all evil. No money for you. Because, again, like, if we kind of take this back a step and think about adjudication, are we saying that, okay, the government has banned XYZ company from operating, and hell no, will they get a pass or some kind of bailout because they returned money to shareholders? Oh, but dividends would be fine, but buybacks were bad. Doesn't make any sense.
16:44 Sonal? Right. It's a fallacy because they're actually equivalent. So you shouldn't be judging people basically based on whether they did buy back.
16:49 Speaker 01 Yeah, they're functionally equivalent. And then you also say like the coffee shop and the yoga studio and everybody else. Well, like, you know, I guess it's their fault too, because why did the owner take out money? And they should have kept that money in the corporation. They should have said, okay, there might be a time when I am banned from operating for three months in the name of public health due to a virus. I'm going to hold on to four years of cash and not pay myself a cent. Like, they paid themselves dividends over the last four years. So I guess we should let them all fail too. And that means that 90% of businesses are going to fail. And then nobody will have jobs. So that that seems like a problem. I'm not saying that we need to bail out every company, but I would I would like to have a consistent
17:33 Speaker 01 adjudication and disbursement mechanism as opposed to kind of fall into populism, which is like, oh, buyback bad, big company bad, small company good. Oh, small company that does this good, but small company that does that bad.
17:47 Sonal? Right. You're basically arguing for a more systematic approach. So Alex, bottom line it for me, how should we think about this recent news about the government's moves primarily in monetary policy and also some of the fiscal strategies? It's an ongoing, developing story. It could be changing hourly as we speak. What's the takeaway?
18:04 Speaker 01 We have a very injured patient right now, and the patient is the US economy. The idea of monetary policy is keep the patient alive, keep the patient functioning. But it's like, if you just broke your leg and you're bleeding, like, the monetary policies are tools that we use to keep the markets functioning, but that's not going to make your leg better. That's just going to make sure that you don't run out of blood on your way to the hospital. You still have to learn how to walk again. You got to go through a physical therapy, and that's the fiscal policy. That's a lot more complicated. So it's not really clear exactly how to do that. We're fighting this actual virus, which if not addressed is going to cause catastrophic harm, but we also have to fight the economic virus because the way that economics works is that demand begets supply begets demand. So one person's revenue is another person's spending.
18:49 Speaker 01 Like, here you want not viral growth, but the same dollar gets recirculated many, many, many times. So, you know, we have a circulating virus, but no circulating money. And we need to kind of flip that.
19:01 Sonal? Thank you so much for joining this segment, Alex.
19:04 Speaker 02 Hi, and welcome to the A16Z Podcast. I'm Lauren Murrow. This episode is all about the potential for misuse and fraud among those applying for coronavirus relief and how fintech and software provide overlooked tools to stop it. On March 27th, the government enacted a $2.2 trillion stimulus package called the CARES Act, the largest aid measure in history. The act provides more than $500 billion for the Paycheck Protection Program, or PPP, a low-interest, forgivable loan program designed to help small businesses and self-employed individuals retain workers and stay afloat during the pandemic. Since March, the Small Business Administration has approved billions of dollars in PPP loans.
19:45 Speaker 02 But it is also estimated that US losses from coronavirus-related fraud and identity theft have reached almost $100 million. According to The New York Times, the SBA's fraud hotline has received 42,000 reports about coronavirus-related cheating and misuse. Last year, by comparison, it had less than 800. To date, the Department of Justice has charged more than 40 cases of PPP-related schemes, from claiming nonexistent employees or nonexistent businesses, to identity theft, kickback schemes, fake tax documents, and multistate fraud rings. Most of these cases have alleged fraud of more than $1 million. But what about the countless others that may be cheating the government out of smaller, but not insignificant, sums?
20:29 Speaker 02 How does the government decide who should get money and who shouldn't among millions of applications from businesses of all industries and sizes? And what role do the banks play? How does the program then distribute that money quickly and accurately, or not in many cases? And what are the tools at our disposal to catch those who cheat the system and ultimately build a more fair and efficient system in the future? In this episode, A16Z general partner Alex Rampal and I are joined by Bharat Ramamurthy, the original member of the Congressional Oversight Commission, which is tasked with evaluating the impact of coronavirus relief loans, and Neftali Harris, the CEO of Centalink, a software company that builds technology to detect synthetic fraud, which is something we'll get into further in the episode.
21:12 Speaker 02 We discuss the issues with the design and rollout of PPP thus far, the myriad types of fraud that are slipping through the cracks, and how to catch it, and how tech might improve the process going forward as additional stimulus measures are likely. The first voice you'll hear after mine is Bharat, followed by Neftali, then Alex.
21:31 Speaker 02 So the potential for fraud was a concern from the beginning. All the way back on March 16th, before the CARES Act was signed, Attorney General Barr directed US Attorney's Offices to prioritize investigating and prosecuting PPP loan fraud cases. But I'm wondering, how prevalent is fraud in the program thus far?
21:52 Speaker 03 We're still trying to analyze that. And there's been some prosecutions on PPP. That's obviously not the full universe of fraud. I think one issue that's come up already is transparency. A good way of detecting fraud is to make sure that every single borrower through the PPP program is publicly disclosed. But the government is not doing that. They're only disclosing recipients of loans above $150,000. And something like 80% of recipients had loans under that amount. So at the moment, we only know 20% of the companies who got money through this program, which is a serious issue.
22:28 Speaker 04 Well, Bharat, I'll just say from our perspective, we appreciate the fact that you were able to get at least some of the loans publicized, because my firm has actually gone through some of them. And even with the very limited data that's available, found some pretty clear instances of fraud, which we've escalated to the banks that actually issued the loans. There's not too much you can do with the more limited information that's available.
22:51 Speaker 03 It's really important to track what these companies are doing with the money. And I think a big part of what the Oversight Commission should do and will be doing is scrutinizing the companies that get money through these programs to evaluate how that money is flowing thereafter.
23:05 Speaker 02 Alex, after the stimulus package passed back in March, you wrote this op-ed that argued, I'll quote, "The last mile of identifying, adjudicating, and dispersing assistance without a sea of fraud is a new challenge, one which the government is wholly unprepared for and for which technology is the needed answer." So it's now been nearly five months. Do you stand by that assessment?
23:31 Speaker 01 I do, unfortunately, in that, I mean, there's no time machine. If there was, I would do many things with my new piece of technology. The only way of explaining this whole process really is, is a very, very complex, worst way to do it, in my personal opinion, Rube Goldberg machine. And it took such a long time for many businesses to actually apply and figure all of this out, and like their bank couldn't do it. And, you know, of course, like somebody like some giant burger chain got the PPP loan and not like the 10 businesses that really needed it. A lot of businesses have failed, and I think it's terrible.
24:05 Speaker 02 So the Small Business Administration started accepting loan applications just a week after the CARES Act passed. And that pace, as you mentioned, raised some concerns. For one, to help quickly disburse those funds, which of course, speed was essential. The SBA allowed lenders to rely on borrower certifications to determine their eligibility. Was that a mistake?
24:27 Speaker 01 That's not how I would have done it. I think there was a little bit of a disconnect in terms of the people that set the policy, the speed at which the policy needed, in all fairness, to get rolled out. And then the level of technical understanding in terms of how the financial system works in 2020, with a lot of tools that have been developed, frankly, in the last five or 10 years. But just to walk through what I meant by that, what does identify mean? Well, if you're born in this country and you're a US citizen, you've got a social security number, and you might think that every business has a federal employer identification number, which would be the equivalent. But what about sole proprietorships? Or what about people that just use a legally fictitious name for their own quasi-business? There's not really a way of identifying them.
25:11 Speaker 01 There's not really a way of knowing what their income was before coronavirus and after coronavirus, how much of an impact it actually had. Like, you'll say that you're self-employed, but there's not really this knowledge that you had this business. So you're one of the 30 million small businesses in America, but it's just not really known as an entity to the government.
25:31 Speaker 04 The PPP really shined a light on how bad identity verification is in the United States. In addition to really not knowing who the people are or who the businesses are, if you look at the applications themselves and look at who's on payroll, really no good way of verifying that. And I think if the United States was able to know who citizens are and if there's a way of identifying them, this whole system would have been a lot easier to run.
25:56 Speaker 02 How could that improve?
25:57 Speaker 04 If you look at other countries like India or like Estonia, the government actually takes a very active role in identifying its citizens. In India, they have the Aadhaar system. In Estonia, they have government issued IDs, which even have public key cryptography on them. And so in the same way that you could give everyone a bank account, you could also give every citizen in the United States or every business, public and private key pairs, and actually allow them to verify their identities that way. If you did that, you could even prove that an individual actually was on payroll at a given company.
26:32 Speaker 01 I think the way to have done it is to say, let's get your banking information. And there's a way of doing that because there's a company called Plaid, where if you go sign up for a Mint account or if you go sign up for any kind of account online, it asks for your banking credentials from your current bank so that it can import all of the data. It's an API, an application programming interface. You go read that information from the bank. It really is effectively as close as you can get to a certified copy of the financials. It's much, much harder to somehow falsify information that is actually coming directly from your bank, coming directly from your credit card processor, coming directly from your payroll company. And the great thing about 2020
27:14 Speaker 01 is that there are APIs largely through companies like Plaid that allow that to happen. And I just feel like the PPP program, it was done in arguably the worst way possible because you go to the SBA website and it would say, okay, find a lender that can give you a PPP loan, enter your zip code. You'd enter in your zip code. No matter what zip code you entered, it would give you 56,000 results. As a small business, you'd go to Bank A and they'd say, sorry, we can't help you. So then you went to Bank C, Bank D, Bank E, Bank F. And then you actually applied 10 times, not out of fraud, but because you need the money so you don't have to lay off all of your employees and declare bankruptcy.
27:53 Speaker 02 Do you agree with that assessment?
27:55 Speaker 01 Yeah, I agree. And I think it goes back to the original policy choice that Congress made when this crisis hit. I like to point to Denmark, which took a different approach. Denmark said, regardless of how big your business is.
28:10 Speaker 03 If you are taking a hit from all these public health restrictions, we will step in and cover a significant percentage of your payroll costs. And you look at the result of that, in Denmark, the unemployment rate was about 4% before the crisis and it peaked at about 5%. In the US, it jumped from 4% to about 20% and it's still in double digits as of today. And as Alex said, a lot of companies have payroll processors that have this information handy and are to feed the money into the right places. The government could have partnered with those companies to make sure that the money was distributed. You could have done something through the IRS, which is an idea that Congress is currently looking at.
28:52 Speaker 01 I totally agree that other countries have done this better than we have on the how do they handle their economic woes? And if we just said, all right, here's what we're going to do. We're just going to support people on payroll, not for an arbitrary two and a half months, but we're going to support them for an indefinite period of time, provided that sales for the business are below some percentage of baseline. Like maybe that's a better way of doing it.
29:19 Speaker 03 I think that that original decision by Congress to treat companies of different sizes differently and send them money for different things created a lot of the complexity that we're seeing now.
29:29 Speaker 01 I largely agree with that. If you look at a company like Amazon that's grown into the pandemic, arguably they don't need any help supporting employment. But again, this is where you get information from the financial statements of the company, whether it's public or private. Because I totally agree with you, like there's a lot of this company shouldn't be getting a paycheck protection loan because they're rich. But it's like, yeah, but if their sales are down by 90% and they're going to fire 90% of their workers, how would you feel if you're a worker where you picked the wrong company to work at? And therefore that's why you're losing your job. So I think you actually could have threaded the needle on this, which is not based on employment, but based on were your sales impacted? Because basically there are companies that saw massive decreases in sales.
30:13 Speaker 01 And I think the most unfortunate thing about this entire situation is the government did end up picking winners and losers, where mom and pop retail just got eviscerated and Target just announced their best quarter ever. It's like this giant transfer of wealth from a lot of small businesses to large businesses. If more money is going into your bank account after COVID than before COVID, that's a pretty good hint that you probably shouldn't be getting any kind of assistance from the government.
30:40 Speaker 03 Alternatively, what you could have done at the beginning, when maybe you don't have a sense of which companies are going to benefit and which ones aren't, is that you just get the money out the door quickly to everybody and then you can recoup it on the back end on 2020 taxes, which are collected in 2021. But I think the larger point stands, which is that if you care about helping workers, then you shouldn't really care about whether that worker happens to work at a really big company or a really small company. And I think that the congressional response resulted in very different outcomes for different types of workers and different types of businesses is based on factors that I think aren't really relevant.
31:16 Speaker 02 And in addition to the application process, then, one aspect that seemed to pose a particular challenge was the dispersment. To give one example, the Treasury Inspector General for Tax Administration found that as of April 30th, nearly $1.4 billion had mistakenly gone to descendants, for example. So how might the dispersment piece have been done differently?
31:39 Speaker 01 The government has never had an organ where it's like, we need to send money to people. I think in a future world, if you were building a nation state from scratch, you'd probably just have your social security number also be a bank account, where if I, as the government, wanted to give everybody money, I could just push a button and then boom, it gets deposited into the government bank account, because you're already paying the government anyway. My idea would be every citizen should have some direct channel of actually both sending money to the government and receiving money from the government, which would ideally be some kind of quasi-government bank account.
32:12 Speaker 03 That is a proposal that is working its way through Congress. A number of Democrats support an idea called Fed Account, where every person and every business would automatically have an account at the Federal Reserve, like banks have now. It's a way of sending money out to individuals and businesses very quickly. But I think we've seen now that there are significant costs to not having that ability, both for businesses and individuals.
32:38 Speaker 01 The problem with the dispersment, in many cases, was you'd apply with 20 banks, not because you wanted to apply with 20 banks, not because you wanted to chief the government and get 20 loans, but you just had no idea if you were going to get your money in time. Because many big banks just don't do SBA loans. Before this happened, the largest bank by count of SBA loans per quarter was Wells Fargo, which did 692 loans in the quarter before COVID hit. And now we have 30 million small businesses in this country, many of which are going out of business. The SBA just isn't set up for this. And it was so complicated, partially because the government didn't want to be in the business of picking winners and losers in terms of this bank is competent. This bank is not competent. They just said, here's every bank. We're going to let the private market figure this out.
33:23 Speaker 01 My proposal would have been like every business now accepts credit cards. So the credit card processing company now has a pretty good idea of what your sales are. Most companies use electronic payroll systems. So they have a login for paychecks or ADP or Gusto. And most businesses also use QuickBooks or some kind of online accounting system. So to identify them, to adjudicate them and to disburse with much lower fraud, there are tools to do this, but the tool is not either a community bank or a Citibank. That was the worst organ for dispersal.
33:58 Speaker 03 I agree with a lot of that and had similar critiques of the PPP program as they were still trying to think through how to design it. Number one, because it operated through banks and the way that the bank regulations work, there is a significant incentive for banks to cater to their existing customers first, which meant that companies that had an existing small business relationship with a bank were put at the front of the line. But for a lot of small businesses who may not have that kind of existing relationship with a bank, they did not get the loan that they needed. A lot of minority owned small businesses are in that category. And that's why you've seen this highly disparate racial impact when it comes to small business closures.
34:39 Speaker 01 I would differ on this correlation of which people got the loans quickly versus not quickly. There was this just kind of like randomness around which bank you worked with. But a lot of it was just this crap shoot. If you happened to bank with a bank that knew what they were doing. And a lot of members of Congress were like, oh, see, it's the local and community banks that knew what they were doing. But actually, think about the old fashioned way of making a car where somebody would assemble it by hand. And the new fashioned way of doing it, which is an assembly line. These big banks are assembly lines and the small banks are effectively doing things by hand. And it turned out in the early weeks of this, the small banks were a lot more effective than the big banks. And that was really what kind of caused this disparity. It's like if you happened to be in an assembly line bank, you were screwed.
35:23 Speaker 01 And then you had to scramble to go find a local do it yourself handyman bank.
35:27 Speaker 03 Yes, on that last point, there's a lot of good PPP data by state and you'll notice that the state that was the most successful at getting PPP loans to businesses was North Dakota. And North Dakota is the only state in the country that has its own state-run bank. And so it's another data point in support of building out our public infrastructure in terms of delivering money to people and to businesses.
35:52 Speaker 04 Some organizations were very excited about this. This is free money from the government. Let's pass out as many of these PPP loans as we possibly can and collect some money that we have no risk in. And others were, I think, a lot more conservative and said, you know what, this is a new program. I'm not even sure we want to do this at all. And only based on significant pressure from their customers did they even do this. And so you ended up with a very sort of uneven patchwork approach and very uneven experiences for different small businesses.
36:20 Speaker 03 There's always this rule in anything where you're allowing transactions, which is the best way of stopping all fraud is to stop all transactions. And when you need to move quickly to stop businesses from failing, which was the debacle that we were in and unfortunately still are in, you're going to let more erroneous or fraudulent transactions through. It's inevitable.
36:38 Speaker 02 Right. And to that point, there are many different means of fraud. So some who have been charged have claimed non-existent employees or misrepresented the number of employees. Others claim non-existent businesses. Some submit forged bank statements or use fake tax documents. There was a software engineer who created fake tech companies to obtain over a million dollars in funds. We've had several instances of kickback schemes. And there was a pretty well-publicized PPP fraud ring in which five people from three different states were paying each other for services that were never rendered. So Nifatali, in a program of this scale, what methods of fraud are you most concerned about here?
37:20 Speaker 02 And what are the tools at our disposal to catch these bad actors?
37:25 Speaker 04 I've been thinking about this as three different categories of fraud or more mildly misuse of funds. The worst for sure is creating totally fictitious businesses and fake employees and just using it to steal money from all of the citizens. That's one category. I think another category is someone that does have a business. They actually are employing people, but they're misusing the funds that are coming to them to using it to pay themselves a better salary or take money from the loans that they shouldn't be doing. Lastly, it's about who should really be getting this and is this business really one that was at risk of going out of business? I think the ones that I'm most concerned about are really the ones in that first category because that's where you're really, really ripping off the government and taxpayers.
38:10 Speaker 02 Your company, Sentalink, aims to detect synthetic fraud, which is, as you mentioned, creating a fake person or a fake identity from the ground up. Typically, my understanding is that kind of fraud is coming from more organized crime rings. Is that a concern here?
38:28 Speaker 04 Absolutely. And we've seen quite a lot of that in the PPP because it's very helpful in this case to be able to have a bunch of fake people that are on payroll or to have a fake person that you can list as the owner of a business so that nothing will tie back to the fraudster themselves. It's actually relatively simple to create a synthetic identity. And so for the PPP, we've also seen a lot of lone wolves attacking it, people like that software engineer, for instance. I'd also say for the payroll stuff in particular, since there's very little verification of, if any, of the people that are supposed to be on the payroll itself, that's a case where it's even easier. You know, there was even
39:08 Speaker 04 an indictment we saw where the identities that were used as employees on payroll were actually literally generated online in one of those fictitious name generators. So for a program like this, you really need to have a strong ability to audit it at the backend and prosecute in cases where the government and all of the citizens have been ripped off.
39:29 Speaker 02 Right. The DOJ has filed, I think, between 30 and 40 fraud cases. Most of them are for more than a million dollars.
39:37 Speaker 04 Personal favorite's the guy with the Lamborghini.
39:40 Speaker 02 Describe.
39:41 Speaker 04 Oh, it's a really great indictment, but essentially some guy has this lame business. He claims that there's a bunch. He has like 107. People that are employed, which is patently not true. He gets the money, immediately uses it for, I think, a Lamborghini and like a diamond watch and a whole bunch of crazy stuff. But my favorite part of this whole indictment is at the end of it, the indictment ends with, "These are not approved purposes for PPP loans." Very understated.
40:09 Speaker 02 Yes. I mean, so while those individual headlines are sensational, so far, we've only heard about a very minuscule percentage of those funds that have been fraudulent versus the funds that are going to help small businesses. We don't know yet.
40:23 Speaker 01 Well, but that's part of the problem is that fraud is not black or white. I mean, in most cases, people think of there are good guys, there are bad guys, the good guys chase the bad guys. But I mean, as an example, what if you didn't buy a Lamborghini, but what if you paid yourself a slightly higher salary than you used to as the business owner? There's also something that you certify on the PPP loan application, which is, "These funds are absolutely necessary for the continued operation of my business." And that one's a little bit more subjective, but I think there's a whole spectrum of, "I didn't even need this thing, but I applied for it anyway because why not? Free money from the government, never hurt anybody."
41:04 Speaker 01 Like, there's all of these different gradations of, perhaps we shouldn't throw people in prison kind of fraud, like we should the Lamborghini guy, but this is not being used as was intended. It certainly didn't meet the spirit of the law, and it certainly didn't meet the letter of the law. And how much of that is going on? Or, "I wanted to try to hire back all of these employees, but I can't."
41:25 Speaker 02 Right. And more than 85% of the loans issued were for under $150,000. So arguably, the speed and the scale of the PPP program means we're likely dealing with much more fraud than usual, but it's not necessarily the usual fraudsters, right? It could be, according to the cases thus far, it's a woman with an Etsy store, or a guy who runs an auto body shop, or someone who just takes the money and spends it at a casino. So are we missing the smaller schemes because of the need to actually get this money out quickly? Does it matter?
41:56 Speaker 04 You know, I'll tell you, we've been helping some of the organizations process some of the smaller loans, not for every PPP lender out there, but for a subset of them. And we've certainly seen a lot of fraud in that sort of smaller dollar range. To your point, you know, it's around $100,000 or so, not so huge that it would be triggering huge alarm bells, but also not so small that it's not really worth their time. And you know, the number of fraud attempts that we're seeing there has actually been pretty significant.
42:23 Speaker 01 We're not going to know for a while because you have to kind of play the game theory here, which is right now, these are loans and there's now an application to apply for forgiveness of the loan. Now, if you're a criminal and you already like bought a private jet with all your PPP proceeds and put your Lamborghinis on the jet and fled to like some country that doesn't expedite to the US, would you apply for forgiveness for all the loans? No, of course not. So ironically, the companies that plan on surviving that apply for forgiveness, I would argue are going to be that second tier of fraud. The actual abject criminals that created fake businesses that don't exist, that already got the money and ran off with it, they're not going to apply for forgiveness for anything.
43:07 Speaker 01 And the SBA is going to be on the hook to reimburse the banks when the banks try to collect on that money. So I think you're going to know once the applications for forgiveness start coming through and the announcements by the bank to go claim money from the SBA from businesses that defaulted and by the way, that have been completely non-responsive to any kind of collections effort.
43:27 Speaker 02 Yes, I do want to talk about that question of loan forgiveness. So in order to get paycheck protection forgiven, meaning you don't ever pay the money, small business owners have to show proof that at least 60% of the money was used for payroll. They have to hire or retain workers at the same salary levels. So there's currently a proposal in Congress for automatic forgiveness of loans that are $150,000 and under. Basically that require the borrower to say, yep, I used it like I was supposed to. So some critics say that there's not enough information available yet to say whether the program is actually working to save jobs and that by easing forgiveness requirements, you could potentially heighten the risk of fraud. Bharat, what's your perspective?
44:08 Speaker 03 Yes, I share the concerns that you mentioned about that. As I noted before,
44:13 Speaker 01 They're not disclosing the names of companies that got under $150,000. And what is the level under which you get automatic forgiveness is $150,000. So that seems to be a troubling overlap. I think at a minimum, you should be publicly disclosing the names of all these companies before you do blanket forgiveness for that set of companies. Second of all, I'm in favor of figuring out ways to minimize the paperwork responsibilities for companies to get loan forgiveness. But there's an important public policy issue here, which is that the money was supposed to go to support payroll and keeping people employed. And if companies ended up not using the money for that purpose, then I don't think that they should be getting their loans forgiven.
44:55 Speaker 01 And so I think it's important to verify that that actually happened. And the only way to do that, I think, is to require them to jump through at least some hoops before the loans are forgiven.
45:06 Speaker 02 I'd like to talk about how we might potentially improve this as additional stimulus measures are passed and extended. One issue in detecting and preventing fraud was also the issue of faulty data. SBA data showed that many companies claimed to have retained more workers than they actually had, in some cases, not by the fault of the business owner. The analysis also showed that for more than 875,000 borrowers, zero jobs were supported or no information was listed. Bloomberg reported data that at least a quarter of a million dollars may have listed the wrong location for the borrowers. How can we improve the data to better assess the success or the shortcomings of this program?
45:47 Speaker 01 Well, I think there are two things here. So my favorite article just took apart the data dump that was provided by Treasury on like every single person above $150,000. In Pennsylvania, the state was spelled like 155 different ways. Because the E-Trans system for processing these loans was just not very good, business owners did not have access to it directly. So they filled out a PDF, sent it to the bank, and then it got transcribed. And then all the information was wrong, but as long as you got an E-Trans number on the other side, then the bank would disburse the money, knowing that if the business failed, then they'd be made whole. So I'd say two things. If you're a restaurant and you took a PPP loan and your sales went down by 70%, and
46:32 Speaker 01 they're still down by 70%, it does not make sense to employ any people. Like, that's kind of part of the problem, is that that would not be a case of fraud. The thing that's missing from that data, my point? Is what the sales have been, but we just don't have the data on how the businesses have performed, except in aggregate.
46:50 Speaker 03 Just a slightly different point. One of the things that I found in government is that simplicity is probably the biggest virtue. When we're trying to figure out how to design a program, I would say that the simpler the program, the easier it is for businesses to comply with it, the easier it is to get good data on it, the easier it is to monitor compliance, the easier it is to enforce whatever the rules are of that program. And my other rule would be, when in doubt, make sure you're being over inclusive rather than under inclusive. Okay, so maybe some businesses get money that you don't think should get money at the margins. To me, that is a small price to pay for, number one, getting money out quickly, and
47:35 Speaker 03 number two, making sure that companies that do need the money are getting it. And so I think that on those two metrics, the congressional response so far has been fairly shaky in that if the goal is to make sure that businesses get money in order to keep people employed, there are about 10 different ways of doing that more directly than the one that Congress chose. And the result is that we're going to have to collect a lot more data, and there's just a lot more opportunities for people to slip through the cracks and for fraud to occur because we created all these intermediaries and we created all these different hoops you have to jump through. And so as a result, you create all sorts of weird incentives and outcomes for companies where there may not be a way of getting people to come back, right?
48:18 Speaker 03 Like, what if all of their employees have childcare problems and they can't work right now because they can't leave the home? And so when you have a country of 300 million plus people and how many other businesses, there's always going to be edge cases that opponents of the program are going to seize on to say, this was a bad idea. But at the end of the day, the goal is to, I think, get the most help to the most people as quickly as possible. And I think doing things as simply as possible is the key. And I think learning from this experience to develop basic infrastructure so that you can deliver relief more effectively in the future is also really important.
48:55 Speaker 02 Well, and to your point, we're talking about potential improvements here. But the current administration says that 51 million jobs have been quote unquote "supported" by the Paycheck Protection Program. The program has been credited with driving down the unemployment rate. Is it cynical to focus on fraud, which, as we've discussed, may be limited, when in fact we should be celebrating the program's success thus far?
49:20 Speaker 01 I mean, look, if a business has had sales go down by 50% and they got a loan that was basically handling two and a half months of payroll, and we're in month five of this, it just seems like a very hard-to-believe claim. So I think actually the claim itself should be investigated and not just taken at face value.
49:40 Speaker 03 You know, I would say on PPP, I'm deeply skeptical of the number that came out of the administration. David Autor, who's a professor at MIT, did an independent analysis of PPP. He found that there was a pretty wide range when it came to what is the cost per job saved through this program, but the median amount or sort of the middle of his range was about $200,000 per job, which frankly, isn't that great. And I think speaks to both flaws in the design of the program and inefficiency in delivering the money to the companies that really needed it. And of course, that also doesn't account for the cost of potentially allowing tens
50:23 Speaker 03 of thousands of businesses that could have qualified for PPP to fail because we were unable to locate them and provide them with money in time.
50:30 Speaker 04 One thing that I've made it a point to do is when I take out or go to a small business, I'll ask, "Hey, did you apply for the PPP?" And more often than not, they'll say, "No, I didn't. I don't want to have a loan like that, or I didn't know how to complete it." And that's a huge shame, and I just hope that the next time that we do this, if we have to do it, we'll be able to serve those deserving businesses. I think if you look at the spectrum between let's lock down this money as well as possible and make sure it only goes to the most deserving businesses as opposed to fraud. The program was skewed towards the let's give out money more quickly. And I think that was the right thing to do.
51:10 Speaker 04 But on the flip side, it's taxpayer dollars that all Americans have worked hard for and given to the government. And the fact is that I don't think limiting fraud or finding the fraudsters is all that challenging or all that expensive to do. And so even if the amount of fraud that's limited, I still think that from a matter of morality, we as a society should go after the people that have stolen money from deserving businesses.
51:41 Speaker 03 I totally agree with that. I think that it's totally reasonable to focus on fraud. I would just argue that there are other important factors for the government to consider when developing these types of stimulus or relief programs. And that in some cases, there are trade offs where you make choices that could potentially open the door to more fraud, but they have upsides, either in terms of speed or inclusiveness or whatever the case may be, that make it worth it. Honestly, I was frustrated after PPP came out and so much of the focus was on a handful of big companies that got money that were essentially shamed into returning it. You know, if they weren't eligible under the rules of the program, that's one thing. And certainly they should be required to return the money in that case.
52:26 Speaker 03 But there was far more focus on that issue than on the fact that tens of thousands of companies that were eligible weren't getting the money and that disproportionate number of them were owned by black or Hispanic owners because they lacked traditional banking relationships or there weren't banks participating in the program in their area. That to me is a much bigger tragedy than a couple burger chains getting money they shouldn't have.
52:50 Speaker 02 Yeah. So you're effectively saying some fraud is a price we have to pay for getting people the aid that they need in a short period of time.
52:59 Speaker 03 Yeah, I would say that there is a trade off between efficiency, inclusiveness and potential fraud. Now, you can solve the fraud on the back end by identifying cases of it and bringing enforcement actions to cut down on that or to hold people accountable. And I'm all for that. But I find that what happens more often than not in government is that this idea that the most important thing is making sure that people who don't deserve the money don't get it. Leads to all sorts of terrible policy designs and outcomes that have much greater harm than, you know, some small group of people getting money that we think aren't deserving.
53:41 Speaker 02 Iftali, you mentioned it's not that challenging to catch this type of fraud, particularly in the first category, which was people who are claiming nonexistent employees or misrepresenting their number of employees. How can we do this better?
53:56 Speaker 04 Well, I think we should have, in addition to private banks or other lenders checking for fraud, a uniform checks that's done by the SBA themselves. There are lots of products in the space to detect various different kinds of fraud and including a uniform check that the beneficial owners are actually real people and who they say they are, that the people listed on payroll actually exist as well, so that we're not just as the least common denominator of whichever lender wanted to issue the most money as fast as possible.
54:30 Speaker 02 So we talked about how the stimulus is unprecedented. Alex, do you have a perspective on how potentially tech could help detect fraud as additional measures are passed?
54:40 Speaker 01 Well, it can only do it in the constraints that are provided by the bill that is or is not in existence. There's a lot of stuff that you can change to better adjudicate what is fraud and what isn't. I mean, I 100% agree with Rod that focusing on this kind of envy capitalism or whatever would be like, oh, this person got money, they didn't deserve it, and we should have really made it a one-year process before anybody got money so that not a single cent was wasted. That itself is so penny wise and sound foolish that it could just topple over the economy. So that doesn't make sense. But I think the main thing is get data from companies and use that as an automatic adjudication mechanism.
55:22 Speaker 01 And then ideally, just have a dispersment mechanism that comes from not banks, but from the government directly, rather than paying banks $15 billion to give away the government's own money, which is the people's own money.
55:35 Speaker 02 Bharat, from your perspective on the Oversight Commission, do you get the sense that in future stimulus measures, they're looking to standardize the process into something that would improve some of these issues?
55:47 Speaker 03 So I think step one is strengthening the authorities that we have. So for example, we don't have direct oversight authority of PPP. We don't have subpoena power to force people to testify before us or to get documents from other agencies. So strengthening those oversight authorities would go a long way towards ensuring that there's robust, independent, and bipartisan oversight. I think that we have learned from the experience of PPP or Congress has learned, and I think is pushing towards different approaches. So using the tax code to provide direct support to companies without having to go through banks, that's included in the HEROES Act, which is the bill that the Democrats in the House passed in May,
56:31 Speaker 03 and that's been sitting in the Senate ever since. And I think that there's been a lot of discussion recently about what data is necessary for full transparency and accountability for these programs. So the PPP discussion has led to follow-on legislation about mandating that every single loan recipient is disclosed, even if they got under 150,000. Mandating, and I think this is critically important, certain demographic data about the nature of recipients so that we can get harder data about Black and Hispanic borrowers, for example, systematically being excluded from this program, either because of purposeful discrimination or because of things like access to traditional banking services. And if so, is there something additional we should be doing to target those communities?
57:16 Speaker 03 So I think there's been a lot of congressional interest in strengthening oversight authority and improving the quality of the data that's being collected and in tweaking these programs so that the money is delivered more efficiently.
57:28 Speaker 02 Alex, if you were to write your op ed again today, what would you adjust based on what you've learned over the past five months since the rollout of the CARES Act?
57:39 Speaker 01 Honestly, I wouldn't adjust that much, except the duration. So I still think everything that I wrote is still standing behind me. That's the right way to do it going forward. However, what if this goes on for a year? What's happened to businesses where there's still this demand, there's still this supply, but the government has said you can't go there, which has helped Amazon. That's why you're having this transfer of wealth from, in some cases, mom and pop businesses to big corporations that are able to kind of meet their COVID requirements. Like, I need to buy Plexiglas to have an ordering station as a small Mexican restaurant. I can't do that, but Chipotle can. There are all sorts of winners and losers being created here, which is really fundamentally unfair.
58:20 Speaker 01 If this is going to go on for a long time, it's actually healthy in capitalism to have weak businesses fail. The airlines, should they have gotten bailed out? Maybe, maybe not, but if nobody wants to fly anymore, the answer is no. If the government stops you from flying, the answer is probably yes. A little bit more nuanced than that. So I think the real question is, if this goes on for a very, very long time and it's not just a blip, does it make sense for the government to say, everybody's a winner and we're going to protect businesses that weren't doing a good job before? Because if you look at the restaurant space, a lot of restaurants go bankrupt on their own. So if this plays out for years, should we be on the hook as taxpayers for bailing out everybody if we provide a bad service to customers?
59:02 Speaker 01 I don't think anybody would say the answer to that is yes, even if workers will be impacted. But where do you draw the line? And since this has been going on for a much, much longer time now than when I wrote that in March, it was like a stopgap measure. It's very hard to have a one-year stopgap measure.
59:18 Speaker 02 Well, thank you all so much for joining us on the A16Z Podcast.
59:22 Speaker 01 Thank you. Thank you.
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