Undwerwater Businesses

Last year we reported the tie between home equity lines and the financing of small businesses here. Even in good times financing was hard for small businesses to procure. So the norm became to use your property to fund your business. To this crowd HELOCs became a major source of funding. Not enough cash to make payroll, use your HELOC. Need to invest in new equipment, your home equity could cover it. It really was the lifeline for many start-ups. But between the innovative financings that were unsustainable and the ever falling amount of equity available many small businesses will be unable to endure.


How bad can things get - the Los Angeles Times article titled Some owners who used home to buoy finances are sinking - is predicting job losses of about 2.1 million due to the housing bust, and that is just for California. Just imagine the national toll that this will take. Let's take a look at how everything is so interconnected -

Even in the best of times, bank financing has not been easy to find for owners of start-ups, who instead typically rely on "the three Fs -- family, friends and fools," as Alton W. Do of the Oakland Business Development Corp. puts it.


No wonder, then, that using home equity credit lines and cash-out refinancings for business purposes was widespread during the good times. After all, 95% of small-business owners also own their own homes, according to a survey late last year by the National Federation of Independent Business.


To get cash for business expenses, one-third of California small-business owners took out exotic, high-risk products, such as those that required little proof of income or allowed borrowers to pay so little that their loan balances rose, said accounting Professor Samuel D. Bornstein of Kean University of Union, N.J.


Bornstein, who has studied the issue extensively, predicts the business owners, many now far underwater on their loans, could shed 2.1 million jobs in the state over the next four years, creating even more problems than the initial wave of subprime mortgages.

...

"Many of them came to us and said, 'We cannot do any more deliveries because every trip out we lose money.' Many of these people, when they bought a truck, used their home equity or an equity loan outright to buy the truck," Sokhom said. "Now when the business goes sour, they cannot pay the mortgage also."

...

The National Federation of Independent Business survey found that of the small-business operators who owned homes, 26% had mortgaged the residences to provide capital for the business. Answering a separate question, more than 10% said they had pledged their homes as collateral to buy other business assets.

If these numbers are even close to predictions we are in for a world of hurt. The housing bubble did more than just provide people with granite counters - it also funded numerous enterprises. With the loss of equity, businesses will go under making the owners and employees unable to make their mortgages. Which will cause more foreclosures. And the spiral downward can continue.


Meanwhile, we routinely hear about the second wave - will it come from job losses or Option ARMs. Perhaps the analogy of wave/tsunami is wrong. Perhaps it should be an earthquake. Ones where the aftershocks reach a much high magnitude than the original quake. They can destroy the whole foundation.


Being a Jersey girl I have never experienced an earthquake, but hearing from other East Coasters they are supposed to be one of the most disorienting events one can encounter. Seems a lot like the current economic crisis. One aftershock after another. Each one more debilitating than the last. Since the foundation was ruined from the earlier shock the devastation is even more severe as time progresses. And we have a group of people yelling that everything is over and things have returned to normal, only to be hit by another aftershock.