Does job Loss Lead to Foreclosure, or Does Foreclosure Lead to Job Loss?

Posted on 29 July 2011

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By Samuel Bornstein

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.

The states you identify have higher numers of hispanics and also larger populations - stands to reason that they would also have more small business owners.

About 75% of all mortgages refi'd during the "boom" were cash out. Does this figure hold for the four states identified? If they had NOT refinanced to the cheapest means possible they would have been negligent in failing to identified the highest possible NVP and/or IRR for their investment at the time given opportunity costs in the market were low. They were, in fact, penalized for doing what they were supposed to do.

I sense some skewed logic and hand picking figures for the sake of pulishing.

The driving force for our research was the attractiveness of these toxic mortgages which enabled easy access to cash with no or little proof of income and low teaser rates. One cannot blame the self-employed and small business owners for taking advantage of this unique opportunity. We have data published by the NY Fed which illustrates how pervasive these toxic mortgages were throughout the U.S. There is much blame to go around on this issue. But, it would be foolish to criticise the borrowers or lenders for their actions because both acted in their best interests. Borrowers saw the opportunity and lenders did as well. We discovered that these mortgages were marketed to the self-employed and small business owners were targeted for these mortgages. In truth, these mortgages can be an effective means by which to fund a business.

There is always risk in any economic decision. The key concern right now is what actions will help us recover from this crisis. We suggest that the solution may be found by considering the results of our Bornstein & Song Small Business Toxic Mortgage Surveys. Since this is a real estate driven recession, our research indicates that these small business owners are the homeowners who hold the key to a recovery. Hopefully, the policy makers will see this to be true and proactively address a solution.

I would also like to suggest that Banks can modify these mortgages through various means which will not conflict with the "moral hazard" issues. My last point is that the 75% figure that you refer to is not the amount of "cash-out" refis. In my article is was referring to..."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."

There is sufficient documented data to prove that 75% of these toxic mortgages were centered in these 4 States... CA 58%, FL 10%, NV 3%, AZ 3%. Our research centered around California.."The Mother of All Toxic Mortgages." How we address these mortgages which originated in California will determine how quickly we escape the grip of the economic downturn.

As a small business owner, and owning a mortgage company for nearly 20 years, the information in your findings, for the most part, agrees with my experience.

Having only provided two Option ARM loans to customers, because they made sense for their short term needs, the Alt-A market is what I can speak about. There is a legitimate market for these loans, and before the boom, they served well.

Being a small business owner, and having many customers that also were business owners, using non-traditional sources to approve an individual for a loan is a must. Even my own mortgage was a stated income, stated asset, no doc loan, one of the many offered by GreenPoint Mortgage at that time. It served me well. I paid 9.25% interest rate and after having the loan for two years I refinanced into a new loan at 7% interest rate, the going rate at the time.

These loans are not a problem, and never were. In fact, a business owner needs this kind of loan product. The problem occurred by the ease of the availability of these loans, and the Option ARM to the general public. The secondary market made a profit on these products before the boom and saw a way to exploit them during the boom. When they became toxic, the market hid the facts from investors by having the rating agencies with their "look-the-other-way" reporting and committing fraud.

In July of 2006 when my sub-prime and Alt A lenders started to implode, a large portion of my business collapsed, as well as a legitimate market for useful products for consumers. As I saw it, the CRA and the corruption with rating agencies, as well as Credit Default Swaps completely destroyed our economy.