Are Predatory Business Loans the Next Credit Crisis? (Governing)

By Liz Farmer

Los Angeles restaurateur Jorge Rodriguez Assereto doesn’t need much sleep. He gets about five hours per night and the rest of his time is devoted to running Los Balcones, a successful Peruvian restaurant he opened in Hollywood in 2004 and recently shepherded through an expansion. The remodel was a major investment. Assereto spent more than $130,000 over two years just renting the vacant space next to him while he tried to find financing for his expansion. He even switched banks in an attempt to get a loan. It didn’t work.

When he finally got the money, he hired a local design firm to turn the interior into a hip and rustic open space. He added liquor to the bar, hired two experienced bartenders and sent them to Peru to devise a new cocktail menu. But as the planned reopening date neared in early 2014, Assereto was running out of cash. He needed about $30,000 to stock his new bar and to pay for other supplies to fill out his larger space. Rejected yet again by his primary bank, he began to get desperate. Sifting through his junk mail, he pulled out one of the many solicitations he’d received from alternative lending companies. He made a few calls. The annual interest rates he was quoted were painfully high -- as high as 60 percent -- but Assereto saw it as his only choice.

With the high-interest six-month loan he received, Assereto wound up paying the online lender $6,000 per month on top of his existing obligations. That turned out to be a major financial strain, and Assereto had no flexibility with the terms of the loan. But he actually considers himself lucky: The loan helped him expand when the banks frustratingly wouldn’t. Still, he knows plenty of other restaurateurs who have had to take on this kind of debt just to make ends meet. For them, these high-interest loans quickly become an insurmountable burden. “They think, ‘If I can just survive a few months, I’ll be OK,’” Assereto says. “And that never happens.”

Assereto and his fellow restaurateurs are part of a growing number of small business owners who have turned to alternative lenders to help them stay afloat. These lenders -- mostly online and almost completely unregulated -- may offer loans at exorbitantly high interest rates. But many small businesses, unable to get a loan from a traditional bank, say they have no other option.

If that all sounds a little familiar, that’s because it is. What’s happening right now with small business loans seems to be following a familiar pattern of lenders selling debt to borrowers who can’t afford it. A decade ago, unchecked mortgage lenders sold homeownership on unrealistic terms to people who didn’t qualify for traditional bank loans, contributing to the collapse of the housing market. Similarly, predatory payday lenders have made big business out of offering quick cash for consumers in exchange for triple-digit interest rates and myriad hidden fees. Both the mortgage lenders and payday loan outfits have attracted plenty of attention from government regulators, who have sought to put in place tougher protections to shield individual consumers against predatory lending practices.

But the issue of predatory small business loans is different. It’s only just now starting to show up on some regulators’ radar, and few places have started any conversation about how to get in front of the problem. As it stands today, small business entrepreneurs have essentially no protections against predatory lending. And that has many experts worried that these loans could represent a new looming crisis. “It’s not so long ago that this happened in the housing market,” says Mary Fran Riley, the vice president of external affairs for the Chicago office of Accion, a small business lender that is seeking greater regulation of the industry. “I was working in housing during the mortgage crisis, and this feels the same in the lack of transparency.”

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