Yesterday Lingling Wei and Mike Spector reported on a $4.4 billion dollar default in New York City:
A group led by Tishman Speyer Properties has decided to give up the sprawling Peter Cooper Village and Stuyvesant Town apartment complex in Manhattan to its creditors in the collapse of one of the most high-profile deals of the real-estate boom.
The decision comes after the venture between Tishman and BlackRock Inc. defaulted on the $4.4 billion debt used to help finance the deal. The venture acquired the 56-building, 11,000-unit property for $5.4 billion in 2006—the most ever paid for a single residential property in the U.S. The venture had been struggling for months to restructure the debt but capitulated facing a massive debt load and a weak New York City economy that has undercut rents and demand for high-priced apartments.
So does Tishman Speyer need to mail back the keys to survive?
The Stuyvesant Town deal is one of several Tishman Speyer did at the top of the market that the company is trying to save. But the company itself isn't threatened. It took advantage of easy credit and investors' eagerness to buy into real estate during the good times. As a result, it didn't put much of its own cash into deals.
Here's where I think the story gets funny. There has been a lot of controversy over the morality of "strategic default". Note how much nicer it sounds when a major company does it:
"It has become clear to us through this process that the only viable alternative to bankruptcy would be to transfer control and operation of the property, in an orderly manner, to the lenders and their representatives," the venture said in a statement to The Wall Street Journal. "We make this decision as we feel a battle over the property or a contested bankruptcy proceeding is not in the long-term interest of the property, its residents, our partnership or the city."
Are these guys selfless, or what?
MORE (John M): Big hat tip [oops! not "big hat", unless we start awarding prizes for tips -- which would just annoy Cass anyway 
] to Doomer arizonaslim for showing us that HuffyPo's on the same page1 with the Two-Tier Morality story
On Wall Street, it's okay to walk away from your mortgage.
"We basically walked away from it," said Clark McKinley, a spokesman for the California Public Employees' Retirement System [CalPERS], the nation's biggest municipal pension fund. CalPERS, one of several investors in the venture, wrote off its $500 million investment, McKinley said.
"It's underwater, anyway, so we've lost it," he added. "We took our medicine, and we're learning from it."
…So if Wall Street can do it, why can't homeowners?
Two and a half years ago super-bear investor Kyle Bass saw this coming and suggested leveling the playing field by treating Joe Sixpack more like Tishman and BlackRock. Doom covered that at the time in post "Personal Chapter 11 — The K-BASS Proposal" (Aug 25, '07), and my then-objections to the plan seem to have (**ahem**) largely evaporated since then
What little has emerged about Bass’ Personal Chapter 11 proposal leaves more questions than answers. How can the big GSEs possibly shoulder this burden with their huge, but still limited capitalization? Wouldn’t the present implicit guarantee on their senior debt need to be strengthened to full faith and credit? And would this further imply a closer relationship with the government, even up to F&F reverting back to the US agencies they once were? Housing Doom is waiting with anticipation for further details filling out the proposal, whether supplied in parts of the newsletter that haven’t yet come to light, or in further discussion by Mr. Bass.
AEI's banking analysts have been worried for years that the general public would discover and reject this two-tier morality. This concern is well documented in posts under Doom's Recourse Mortgages category. In Doom's Sub IV transcript you'll see where UBS' Tom Zimmerman is concerned about Augustine home sales, a particularly egregious practice where some home buyers were actually flipping out of their existing places into similar homes just down the street with (since the crash) lower prices. Tactically strategic default?
But the rubber really hit the road a half year later with this late question (by someone who I'm pretty sure is an Elizabeth Warren protegé) in Sub V, and especially Chris' reply.
…
Nick Smyth: … yes, so the question is about why you think that we can have bankruptcy for Chapter 11 for AIG, but you see it as an unfair breaking of a contract for a homeowner. I just … I don’t get why we should have bankruptcy for corporations, but not for individuals.
…Chris Whalen: If that legislation is passed, you will never have a securitization market in this country again. The other issue you have to understand is that most loans, you cannot legally get control of them so you can modify them.
I have a loan that was originated by Bank of New York. It was bought by Lehman Brothers. It was sold into a securitization. I know where it is. I know where it is. I can’t get to it, though.
Lehman cannot modify my loan. I’ve already asked them. They can’t. It’s legally impossible, so this is a — it’s an absolute illusion that comes out of a city where every day is Halloween … [laughter] … All right? That you can modify existing State Law contracts. You can refinance them, but remember you have an agency structure here. If you were the banker, and I was your borrower, and you were servicing the loan, then yes, we could do it. But not in a disaggregated agency.
… so the bottom line is that this is one awful mess. Before her untimely death from cancer, Calculated Risk's Tanta had a number of articles discussing how to modify securitized loans. However, I don't think even she made very much progress on the issue.
I couldn't help but think of this number from Man of La Mancha where Don Quixote's niece and housekeeper assure the priest that they are only thinking of him:
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[1]: "Don't Look Back: Major Players Continue To 'Walk Away' From Poor Mortgages", by Shahien Nasiripour, Huffington Post, January 26, 2010.
Looks like HuffyPo's also on this case:
http://www.huffingtonpost.com/2010/01/25/dont-look-back-major-play_n_435965.html
From the above story:
As Brent T. White, a law professor at the University of Arizona, notes, "there is in fact a huge financial upside to strategic default for seriously underwater homeowners — an upside that is routinely ignored by the media, credit counseling agencies, and other political and economic institutions in 'informing' homeowners about the consequences of default."
White argues that homeowners should act like corporations, or like Morgan Stanley and Tishman Speyer — maximize profits and minimize losses. Walking away from an underwater mortgage makes sense, White says.
But distressed homeowners are often guilted into paying their mortgages, White argues.
One must keep in mind that this particular commercial loan was a combination of bonds (since defaulted) and a non-recourse note on a leased fee estate. A little different than the typical mortgage. The ethics are the same though, to default, or not to default. That is the question.
The back story to this is the law firm that opined that the rent controls in Sty-town and Peter Cooper would expire upon sale and tenant turnover. They were wrong which threw the projected cash flows off by about 35% even without a property crash. Expect some serious litigation on that front.
Tobby-
You would think that with a project of this size that someone would have done their due diligence. I guess that's the story of the boom- buy now, ask if it makes financial sense later.