Small-Business Sector Is Hit with Double Whammy

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Byline: Kate Berry

The tepid demand for credit from small businesses may be more directly related to the mortgage boom and bust than it appears.

Obviously, the continued slump in the housing market is one reason for a weak economic recovery that has sapped overall demand for goods and services, and hence growth prospects for small businesses.

But many business owners took out toxic mortgages on their homes during the bubble years. Now in default or foreclosure, they cannot access credit just as their firms' sales are tanking.

"Small-business owners have a large amount of real estate, and they leveraged it," says William Dennis, Jr., a senior research fellow at the National Federation of Independent Business in Nashville.

"The value of small businesses' collateral has gone down, often by substantial amounts," Dennis says. "You add to that weak sales, and it's dampened their enthusiasm to hire or expand."

Samuel D. Bornstein, an accounting professor at Kean University School of Business, has conducted surveys suggesting that over half of alternative-A mortgages in California alone went to small-business owners.

Such high exposure to bad home loans could delay the recovery of small-business hiring - and of the rest of the economy - for years.

"There's an unrecognized link between small businesses, toxic mortgages and the housing crisis," says Bornstein, who has been studying small-business failures since 2000.

"Small-business owners are always looking to quench their need for cash and the mortgage companies were targeting them, letting them refinance into risky loans."

In 2008 and 2009, Bornstein conducted three surveys of small business owners. He found they were eager to use the equity in their homes to fund their operations, but then struggled when home prices dropped and access to credit shriveled.

According to Bornstein's surveys, 75% of toxic mortgages for small-business owners were issued in the states with high levels of foreclosure: California, Florida, Nevada and Arizona. In California alone, 52% of bad home loans went to small-business owners.

Historically, small businesses that employ one to 20 people have been first to recover from economic downturns, but that hasn't happened this time around. …