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Can Fixing the NID Save Homes?

The first speaker of the fourth panel from the 10/19/09 JEDE hearing was Professor Samuel Bornstein, Professor, Kean University, School of Business, Union, NJ. While most of the discussion surrounding the Enterprise Zone program has always focused on the hiring credit, Professor Bornstein has a focus on the NID component of the program. He has done research which has found that many small business owners have used their homes as collateral to obtain loans to fund their businesses. Many of these loans are the very same toxic loans which have played such a significant role in the country’s economic troubles over the last two years. Professor Bornstein has a proposal for modifying the NID benefit of the Enterprise Zone program to help these small business owners and help prevent many of them from losing their homes.

Here is a repeat of Professor Bornstein’s testimony to the panel:

JEDE Committee Hearing 10-19-09: Professor Bornstein from Max Shenker on Vimeo.

Professor Bornstein also provided me with the transcript of his remarks, as well as a much more detailed written version of the proposal. The following is the transcript as provided to me by the professor:

Introduction:

Good afternoon Chairman Perez, and Members of the Committee. Thank you for inviting me to discuss the California Enterprise Zone Program.

I would like to propose a Refinement of the Net Interest Deduction for Lenders that addresses the main concerns of California’s present economic crisis—to stimulate economic recovery, enhance small business survival, save and create jobs, and provide small business owners a means for effective loan modification which will prevent foreclosures.
My name is Samuel Bornstein. For the past 33 years, I have been a Professor of Accounting and Taxation, — as well as a CPA and Consultant in public practice.

Since 2000, I and my partner Jung Song, of Bornstein and Song CPAs & Consultants, have conducted small business research.

We discovered a Link between the Mortgage Crisis— and Small Business Owners. We found that small business owners often took out mortgages on their homes to get cash for their newly created or existing businesses, but the main problem was that they used toxic mortgages. In fact, small business owners were targeted by the lending community for these toxic mortgages.

Our research prompted an invitation to testify before Senator John Kerry’s U.S. Senate Committee on Small Business and Entrepreneurship on April 16, 2008. In my testimony, I presented our research that during the Subprime Era and Housing Boom, a significant number of small business owners fell prey to these toxic mortgages.

In order to confirm our research, we authored three Small Business Toxic Mortgage Surveys: The National survey in November 2008, the California survey in April 2009 and the California Hispanic survey in June 2009.

These surveys provide compelling evidence that a significant number of California, and especially California Hispanic small-business owners, fell prey to the toxic mortgages, such as Alt-A, Alt-A ARMs, Option ARMs, Interest-Only, and Subprime. These business owners are at-risk as their toxic mortgages reset and skyrocket to unexpected and unsustainable amounts. The resulting financial distress will lead to job loss. These resets will precipitate the 2nd Tsunami Wave of Foreclosures that will strike in 2009 and will continue to intensify through 2012. California leads the nation with 58 % of these toxic mortgages and will be hardest hit.

Most shocking is that 51.8% of California and 52.6% of California Hispanic small business owners used toxic mortgages. These findings clearly indicate that California’s small business usage of toxic mortgages far exceeds the National average of 31.9%.

Our, Bornstein & Song, California Hispanic Small Business Toxic Mortgage Survey in June 2009, provides further evidence for concern.…
1 out of every 2 ( 49.3% ) Are “very worried” about their monthly payment due at reset and 1 in 5 ( 21.1% ) Are already delinquent, having missed 1 to 3 or more monthly payments.

Our, Bornstein & Song, California Small Business Toxic Mortgage Survey in April 2009 found that— More than 1.5 million Californians are Now at Immediate Risk of Job Loss, and More than 2.1 million California Small Business Jobs may be Lost in the 2nd “Tsunami” Wave of Foreclosures in 2009 through 2012.

It is a tragedy– when an individual homeowner defaults on the mortgage and loses the home. The tragedy is magnified when the homeowner is also a small business owner employing from 1 to 21+ employees. The loss of jobs due to financial distress related to mortgage delinquency and default and the resulting possible business failure, will further weaken California’s economy.

Today’s hearing on California Enterprise Zones, is a natural outgrowth of my testimony before this Committee on May 5, 2009, wherein I sounded an alarm– that among California’s homeowners there are a significant number of small business owners who were drawn into these toxic mortgages. They are at-risk of failure, and their employees will lose their jobs.

Small businesses in California Enterprise Zones are the weakest link and are most vulnerable, especially Hispanic small businesses. Through This Hearing, it may be worthwhile for this Committee to explore– new and innovative programs.

I would like to suggest a Solution— A Refined Net Interest Deduction for Lenders —– (which I will refer to as an NID) — provides a solution to the toxic mortgage crisis— by preventing foreclosures — saving and creating jobs — reducing unemployment — enhancing small business lending — and saving California’s small businesses.
In its present form, the NID provides tax savings for Lenders, who make loans directly to Enterprise Zone businesses. This effectively gives the Lenders tax-free treatment on the interest income earned on these loans.

The current NID should be extended to include Lender loans made to small business owners, who took out mortgages on their homes, whether they were toxic or conventional fixed-rate mortgages, and invested the cash into their newly created or existing businesses, within Enterprise Zones. The tax savings, both current and retroactive, should be mandated to benefit these small business owners by lowering their monthly payments— and by principal reduction on their mortgages.

This Committee has a unique opportunity to target Enterprise Zone small business owners with toxic mortgages, and save them and their employees in the next 5 critical years as these mortgages reset.

There should be no difference, between a loan which was made directly to a business within an EZ, and a loan that was made to a small business owner, who mortgaged the home to fund the business, within the EZ. This should apply regardless of whether the small business owner’s home is located within or outside of an EZ.

The normal Lender-to-Small Business type of financing is not the only means by which businesses access cash for their business operations. Studies show that small business owners often got mortgages on their homes to fund their newly created or existing businesses. Bankers estimated that at least 90% of first-time small business owners used their homes as collateral, and 54.2% used their home as collateral for the business’s subsequent cash flow needs.

The results of these studies are not so surprising if you consider that a new business often does not have a track record nor sufficient assets to serve as collateral to get a business loan. Any subsequent financing requires cumbersome paperwork, including financial statements, income documentation, and an established credit history. Refinancing the home is the easiest way to meet the small business cash flow needs.

The Refined NID will provide tax savings for Lenders, which should be mandated to help small business owners, to reduce the current and future monthly mortgage payments to affordable amounts.

The retroactive application to prior years, will provide a windfall of tax refunds for Lenders through amended tax returns for the past 4 years. This tax refund windfall should be used for mortgage principal reduction. By reducing Principal, the equity in the home will increase and provide an opportunity for the small business owner to acquire additional cash for the business through refinancing.

Since California leads the nation with in excess of 1.9 million underwater borrowers, who are in negative equity, this principal reduction will mitigate the negative equity problem for these small business owners by increasing their equity in their homes.

The Principal pay-down will stimulate small business lending. The tax refund windfall will provide an inflow of cash to the Lender which can be used to make more loans to small businesses. Today, banks are not lending to small businesses due to the Lender’s lack of liquidity which is restricting economic growth.

This is a win-win for small business owners and Lenders. Small business owners will benefit by lower monthly mortgage payments, avoid the expected spike at the resetting of their toxic mortgages, and additional Home Equity for refinancing. This will benefit all small business owners, including those with conventional, fixed-rate mortgages. The reduction in financing costs on these mortgages will improve the small business chances of survival in this economic downturn.

Lenders will benefit by providing loan modifications to comply with the Obama Administration’s push for loan modifications to prevent foreclosures. The tax savings will lower the small business owner’s monthly mortgage payment and will not cost the Lender a dime as other loan modifications require Lenders to recognize a loss on the reduced monthly payment.

The lender will benefit in another way. Since the foreclosure rate in California is among the highest in the nation, these loan modifications will prevent foreclosures and save lenders,- as the average cost of a foreclosure is as much as $50,000.

The Net Cost to California Should Be Zero. The cost of the Refined NID program should not only be borne by the State of California alone. The Obama Administration may view the Refined NID as a complementary program to Treasury’s “Making Home Affordable” (MHA) program to enhance loan modifications and foreclosure prevention. President Obama has allotted $75 Billion from the TARP for this purpose, but it has fallen short of its goals. MHA was intended to save 8 to 9 million foreclosures, but instead only 487,000 are in the trial period, and a few thousand have succeeded in converting their trial modifications into longer term modifications.

The MHA program is failing !!! According to the Congressional Oversight Panel’s October 9, 2009 report, the MHA program must be reworked to address the most important aspects of the foreclosure crisis, which is the Resetting of toxic mortgages, Principle Reduction, and Negative Equity. The Refined NID can be part of that rework. MHA’s efforts which ignore these factors will doom the success of the loan modification program.

The good news, is that the Refined NID will mandate Principal Reduction, which is a cure for Underwater small business owners with Negative Equity.

It can be suggested that both the Refined NID and MHA program can be coordinated to enhance loan modifications for foreclosure prevention. California may be entitled to reimbursement from Washington. Another approach would be to suggest reimbursement under the Federal Government Economic Stimulus program.

For California, employee layoffs and furloughs now appear to be among the main causes of foreclosures. With rising unemployment leading to higher rates of mortgage defaults, California will be locked-into a Self-Perpetuating Cycle. As the toxic mortgages reset in 2009 through 2012 and spark the 2nd Tsunami Wave of Foreclosures, small business owners will suffer financial distress, —-lose their homes to foreclosure, —and precipitate employee unemployment —which will lead to more foreclosures !!!.

In Conclusion

My Proposed Refined NID for Lenders will target California Enterprise Zone small business owners, with toxic or conventional fixed-rate mortgages, and save them and their employees.

A Refined NID for Lenders will address the major concerns for California’s economic recovery:

• Preventing Foreclosures
• Saving Jobs and Reducing Unemployment
• Enhancing Small Business Lending
• Providing additional Home Equity for Small Business Owners and
• Saving Small Business from failure and bankruptcy.

California has the highest rate of business bankruptcies, according to an Equifax Report, with 10 Metropolitan Areas among the 15 areas with the most commercial bankruptcy filings during June, 2009.

Toxic mortgages are beginning to take their toll on California’s economy !!!

On October 10, 2009, H.D. Palmer, the Governor’s budget spokesman, announced that there was a 5.3 percent drop in the budgeted income tax receipts for the 3 months ended Sept.30, 2009. This can be blamed on the drop in Estimated Quarterly Personal Income Tax Payments.

These personal estimated tax payments are made by small business owners to pay their taxes, on a quarterly basis, for their personal income tax returns. This may be a sign that the toxic mortgages, held by small business owners, are taking their toll as these toxic mortgages are beginning to reset in 2009 and will continue to intensify through 2012.

I and my partner, Jung Song, of Bornstein and Song CPAs & Consultants, would be happy to work with the Committee to develop the Refinement of the Net Interest Deduction for Lenders.

I welcome any questions that you may have.

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