Many believe that job loss is driving foreclosures. I believe that there is an overlooked factor that is impacting foreclosures. It’s coming from small businesses that are cutting costs in order to survive in this sluggish economy. The result is cost-cutting which is leading to job loss for their employees, which is leading to more foreclosures.
A Bornstein & Song Small Business Toxic Mortgage Surveys (National, 11/08; California, 4/09; California Hispanic, 6/09), provides compelling evidence that during the Housing Bubble from 2004 to 2007, a significant number of small business owners refinanced their home mortgages to access cash for their small businesses. In fact, they were targeted by banks for these mortgages by the ease in which they could access cash with low teaser rates and little or no proof of income. These Surveys showed that 95% of small business owners had homes, while 85% had mortgages on their homes. Among these small business owners, 60% took out mortgages on their homes during this housing boom and refinanced to access the increased equity.
Refinancing to cash-out the equity in their homes was the easiest way to meet the small businesses’ cash-flow needs, instead of the traditional sources of funding provided by the SBA, commercial banks or other financing sources that required cumbersome paper work such as financial statements, income documentation and credit history. These small business owners are now among the prime borrowers who are defaulting on their mortgages in record numbers.
The Bornstein & Song Small Business Toxic Mortgage Surveys discovered that many small business owners fell prey to the most toxic of these mortgages such as the Alt-A and Option ARMs. These risky and toxic mortgages were the most popular, but there would be a nasty surprise when these mortgages reset after the initial five years and the monthly payments skyrocket to unsustainable amounts. These resets may be blamed for the second Tsunami wave of foreclosures which has begun and will intensify through 2012.
For small business owners, the scheduled resets during 2009 through 2012 and the spike in the monthly mortgage payments will cause additional financial distress and cost-cutting which will be a contributing factor for unemployment and mortgage failure. The financial distress and the resulting job loss will be the catalyst for additional foreclosures for these homeowners as well as their unemployed former employees.
So here we have a Self-Perpetuating Cycle. The credit crunch and economic downturn is driving weak consumer spending which is jeopardizing the survival of many small businesses… Small business owners are having trouble paying their bills and are defaulting in record numbers on their home mortgages… A significant number of small business owners holding toxic mortgages are in “payment shock” as their monthly mortgage payments skyrocket… Small business owners are struggling to avoid mortgage default… Small business owners are suffering financial distress and losing their homes to foreclosure… Small businesses are cutting-costs and laying-off their employees…The resulting job loss is driving more foreclosures!!!
The small business owner is keenly aware of the importance of a good credit rating. The prospect of default will prompt cost-cutting measures that will mean job loss and closed shops and offices, in turn causing a loss of rental income for commercial real estate owners who have loans originated with small Community banks.
We, Bornstein & Song, discovered a link between small business owners and the mortgage crisis. We tested our theory by authoring three Small Business Toxic Mortgage Surveys which provide compelling evidence that a significant number of small business owners fell prey to these toxic mortgages and were at-risk of failure. In fact, all small business owners who took out mortgages to fund their businesses were at-risk, even if they held fixed-rate or other conventional mortgages, due to the weak economy and diminished consumer spending. The studies were an outgrowth of the small business research which I had been conducting with my partner Jung I. Song, CPA since 2000.
The National survey was completed in November 2008, the California survey in April 2009, and the California Hispanic survey in June 2009.
The three Bornstein & Song Small Business Toxic Mortgage Surveys found that among small business owners:
- Nationally, more than one-third (33.9%) cashed-out the equity in their homes during the 2004-to-2007 Housing Bubble.
- Respondents have Toxic Mortgages: U.S. 31.9%; California 51.8%; California Hispanic 52.6%.
- Respondents are expecting resets between 2009 and 2012: U.S. 22.9%; California 34.9%; California Hispanic 44.7%.
- Respondents are “very worried” about their monthly mortgage payment at reset: U.S. 18.4%; California 29.9%; California Hispanic 49.3%.
The link, that our Bornstein & Song studies discovered, between the financial distress of small business owners and resetting toxic mortgages, may have contributed to the 81% increase in small business bankruptcy filings in June 2009 versus June 2008, as reported by Equifax. The sharp increase in delinquencies, notices of default, and foreclosures especially in California, Nevada, Arizona and Florida, were consistent with our findings because the Housing Bubble was centered in these states where 75% of Alt-A and Option ARMs were issued from 2004 to 2007.
It is not coincidental that California, Nevada, Arizona, and Florida lead the U.S. in unemployment and foreclosures. Our studies indicate that there is a link between small business owners, toxic mortgages, and the financial distress and mortgage defaults which precipitate job loss, unemployment, and accelerate the pace of foreclosures which will jeopardize our economic recovery.
Samuel Bornstein is a Professor of Accounting and Taxation at Kean University, School of Business in Union, N.J., and a partner at Bornstein & Song, CPAs & Consultants in Oakhurst, N.J.