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Commentary by Samuel D. Bornstein

RISMEDIA, January 27, 2009-From 2002 to 2007, it was estimated that 80% of homeowners refinanced their homes. Booming home values and weak or non-existent mortgage underwriting standards provided the “perfect storm” where both lender and borrower were happy. Small business owners were drawn into these mortgages to quench their continuous need for capital and prompted easy access to cash.

Small business owners were attracted by the initially enticing “teaser rates” with low monthly mortgage payments but were unaware of the “payment shock” that would follow at “Reset.” They were especially targeted for these loans, which required little or no documentation of income which appealed to many small business owners who previously were unable to qualify. It was too good to be true.

Small Business Holds Approximately 3,709,800 of “Toxic” Mortgages

According to a survey conducted by the National Association for the Self-Employed (NASE) in coordination with Prof. Samuel D. Bornstein and Jung I. Song, CPA of Bornstein & Song, CPAs and Consultants, it is estimated that 3,709,800 small business owners hold Alt-A and “toxic” mortgages that are scheduled to “Reset” beginning in 4th Quarter 2008 and continue through 2012. These small business owners will be at-risk for “payment shock” and default as their monthly mortgage payments skyrocket.

This survey is one of the first to provide dramatic evidence of small business involvement in the “toxic” mortgage crisis. One key goal of this survey was to shed light on research completed by Prof. Bornstein that a significant number of small businesses are at risk of mortgage default, due to the fact that they have “toxic” mortgages such as Alt-A, Alt-A ARMs, Option ARMs, Interest-Only, etc. Whereas subprime mortgages were issued to borrowers with low credit scores, these “toxic” mortgages were targeted to small business owners who were prime and near-prime borrowers.

The results of this survey should highlight the fact that small business holds the key to mitigating the losses on the defaulting “Troubled Assets” in the TARP and Fannie Mae and Freddie Mac.

According to Inside Mortgage Finance, a trade publication in Bethesda, Maryland, approximately 3 million people hold toxic mortgages, totaling $1 trillion. The magnitude of this Alt-A and “toxic” mortgage crisis exceeds the subprime mortgage crisis which had $855 billion of subprime loans outstanding.

The resulting defaults will be the cause of the upcoming second “tsunami” wave of foreclosures that will dwarf the subprime crisis and will take many homeowners and small business owners.

“Toxic” Mortgages are the “Troubled Assets” in the TARP

These “toxic” mortgages are the underlying assets which are the basis for the mortgage backed securities and other derivative investments that are the “Troubled Assets” of the TARP and leveraged into investments valued in the trillions of dollars worldwide.

To date, Moody’s, S&P, Fitch, and other rating agencies have already downgraded Alt-A and other “toxic” mortgages which have resulted in hundreds of billions of dollars of losses. There is more to come. Many of these mortgages have already defaulted and losses are expected to surpass the levels of the subprime foreclosures.

“Toxic” Mortgages: Impact on Fannie Mae and Freddie Mac Losses

Since the US government is now covering the losses of Fannie Mae and Freddie Mac, the enormity of the impending losses of these “toxic” mortgages should draw attention to the fact that small business owners hold a significant portion of these mortgages that are expected to default.

Fannie and Freddie maintain investment portfolios that are burdened with these “toxic” mortgages. In November 2008, Fannie Mae and Freddie Mac released third quarter 2008 results which showed losses of $29 billion and $25 billion, respectively. According to Fannie Mae and Freddie Mac, the higher risk loan types, such as Alt-A, Option ARMs, Interest-Only, etc. were responsible.

Fannie Mae reported “toxic” mortgages, representing approximately 28% of the single-family mortgage portfolio accounted for approximately 72% of single-family mortgage losses.

Freddie Mac reported “toxic” mortgages representing approximately 10% of the single-family mortgage portfolio accounted for approximately 50% of single-family mortgage losses.

The Economic Impact of Small Business Mortgage Defaults on Job Losses

It is a tragedy when an individual borrower defaults on the mortgage and loses his/her home. The tragedy is magnified when the borrower is a small business owner, employing from 1 to 10 employees. The loss of jobs related to mortgage defaults and the resulting business failures will further weaken our economy and prolong the recession.

Job retention is as important as job creation. The small business owners are at great risk for their survival, as they must contend with personal and business debt, the recession, and the continuing forces of small business failure which have been exacerbated by the credit crunch and financial crisis.

In good times, small business operates under a cloud of risk for small business failure. According to Dun & Bradstreet, small businesses have only a 37% chance of surviving four years. The failure rate for new small businesses is approximately 70 to 80% in the first year, and only about half of those that survive the first year will remain in business the next five years. An economic downturn will dramatically increase the rate of small business failure and job losses.


Small business is the job creation engine of our economy. Proactive efforts must be taken to provide small business owners with immediate and specific financial guidance, combined with other measures, to avoid default on mortgages and other debts in this critical and challenging financial crisis.

Summary of Survey Results

This NASE survey was directed to its members who are self-employed small business owners. According to a report prepared for the Small Business Administration’s Office of Advocacy, the number of self-employed small business owners reached 16.2 million in 2007. It is useful to extrapolate the results of this survey using this number to determine the number of self-employed business owners who are at risk of default, foreclosure, and business disruption or failure.

“Toxic” Mortgages and Reset:

– 22.9 % (3,709,800* at risk) of all self-employed business owners used risky or “toxic” mortgages or refinancing that are scheduled to “Reset”.

Note: Although Fixed-rate mortgages are not “toxic” mortgages, they are at-risk of default due to the economic crisis and small business failure.

– 19.2 % (3,110,400* at risk) of all self-employed business owners are at-risk of “payment shock”. They do not know the monthly mortgage payment that they will be required to pay at “Reset”.

– 18.4 % (2,980,800* at risk) of all self-employed business owners are very worried about the monthly mortgage payment due at “Reset”.

– 7.9 % (1,279,800* Immediate Risk of Default) of all self-employed business owners have already missed one to three or more monthly mortgage payments at this date before the expected resets in 2009 to 2012.

Small Business Financing:

Each type of financing has inherent risks, which put the small business owner at risk of failure. In this financial meltdown, home equity financing and lines of credit have been frozen or withdrawn, while credit card debt has been subjected to extra fees and higher interest rates. These forms of financing may become unavailable or too expensive to maintain which will lead to small business failure. Credit card debt will be the next bubble to burst in the economic crisis.

– 33.9 % (5,491,800* at risk) of all self-employed business owners used their home for mortgage or refinancing to get cash for personal or business expenses.

– 49 % of all self-employed businesses used various forms of debt (mortgage, home equity, credit card, etc) to start their businesses. Credit Card Debt was 27.9 % of total debt.

– 66.9 % of all self-employed businesses used various forms of debt (mortgage, home equity, credit card, etc) for additional cash for their business operations. Credit Card Debt was 39.3 % of total debt.

* Based upon 16.2 million in 2007 according to a report prepared for the SBA Office of advocacy.

For more information, visit

Samuel D. Bornstein is Professor of Accounting and Taxation at Kean University’s School of Business in Union, NJ. For more information, call 732) 493-4799 or e-mail: