When the FDIC Sells Your Loan

Homeowners are not the only people having trouble with their loans. Many small businesses have also been hit and are now either facing default or foreclosure. According to the National Association for the Self-Employed, “These small business owners will be at-risk for “payment shock” and default as their monthly mortgage payments skyrocket during the “resets” that are scheduled to begin in 4th Quarter 2008 and continue through 2012,” said Prof. Samuel D. Bornstein of Bornstein & Song, CPAs and Consultants. “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.”

So, why are small businesses having this trouble? Many of them are being squeezed from both sides. On the income side, with the recession in full swing, it is getting harder to get paid. According to a survey by Intuit, 22 million of the nation’s smallest businesses are waiting for $1,500 in overdue payments each month, creating a collective $33 billion strain on their cash flow. As if that isn’t difficult enough, on the loan side, many of these loans have increased their loan payment as mentioned above. Throw in the rising number of bank failures that push these loans into foreclosure and you can see how this is a pretty toxic combination in the best of times—and these are hardly the best of times—and the results are fairly predictable:

1.      When your bank fails, the Federal Deposit Insurance Corporation (FDIC) will usually try to work out new terms with you.

2.      If they cannot, or will not, do this, they will then take your loan, pool it with similarly troubled loans and sell the pooled loans to investors for pennies on the dollar.

3.      Once the loans are sold, these investors then will come after you to collect.

That is what should happen. It is straightforward. You get to negotiate and, in theory, the FDIC will work with you—in theory. You have to realize that the FDIC is mandated to get as much as they can on the loan and if they think they can make a better deal selling the loan rather than working it out with you, that is probably what will happen. A recent New York Times article tells the story of Bob and Katherine Shoulders, owners of an athletic club in Fayetteville, Arkansas, and details how this can happen:

Mr. Shoulders and his wife, Katherine, who bought the Fayetteville Athletic Club 13 years ago, heard these same warnings [about settling their debts with the bank, which was about to fail]. They offered to pay $6 million immediately, and an additional $1 million upon the future sale of the gym, if the agency would agree to forgive their $10 million in debt.

FDIC officials, seeking to maximize their return for the insurance fund, said they proposed to reduce the loans’ interest rates instead; an offer Mr. Shoulders disputes was ever made. So the loans were bundled with others and auctioned off in late October.

The irony is that the offer made by the Shoulders was actually far more than the FDIC ultimately realized on the loan sale, a fact that irritates the couple. Once the investor, an ex-banker from Illinois named Williamson, bought their loan for far less, he then gave the hapless business owners 10 days to pay the full amount of their loan. When they could only come up with half—about $5 million—Williamson instituted a foreclosure lawsuit citing the value of the lavish property as the reason. He was determined to get it all. The case is now pending.

The FDIC tries not to foreclose on people’s homes, but they have no such scruple regarding business loans. From their point of view, and that of the debt investors, they are cleaning out the economic dead wood, forcing loans to be repaid and getting them off the books. In a way, they have a point. Part of what sent the economy crashing down was the debt load, so from that point of view these debt sales and collection actions are necessary. On the other hand, they presuppose that other businesses will open and replace those that are destroyed by this process. If we were in a robust and healthy economy, that might be a good supposition. But we are not, we are in a recession with record-setting unemployment and so we have to ask ourselves whether these loan sales and foreclosures are really the right things to do.

The Bottom Line

Small business is the engine of the American economy, creating almost all the new jobs and employing the majority of the people, yet it is big business that gets the deals and the bailouts. The small business sector, because it is so tied to individuals and because it lacks the lobbying and political payoff abilities of big businesses like GM, is lucky to get lip-service and loan guarantees, never mind actual bailouts. Big companies are “too big to fail,” while small Mom-and-Pop firms can drop like flies and that’s alright with the folks in Washington. True, there will be speeches and some hand-wringing, a congressional inquest or two, but what will be done? How will the problem be fixed?

Actions, after all, speak far louder than words and so far the action side of the balance sheet has been pretty pathetic. Where is all the concern, shown to those who bought far more house than they could have ever afforded, for small business owners who have been working hard to create jobs and stimulate the economy? What? Is that the chirping of crickets?

These are the people, the job creators, the economy engineers, who need the kind of protection being offered to overextended homeowners. They do not need cynical FDIC officials selling their loans at bargain basement prices, nor do they need to face predatory “investors” seeking to flip properties and liquidate assets.

Sometimes, creative destruction is necessary to clear the way to better times. That is one of the unfortunate truths about capitalism. The problem is that one group of debtors—homeowners—are protected from this while another—small business—is not. Instead of wasting trillions on pushing the nation into socialism, this Administration and this Congress should be putting that money to work in the one reliable economic engine this country has: Small business.

If you agree, contact your Congressmen and Senators and let them know how you feel. If the small business community stands together, then maybe our collected voices will truly be heard.