Fed becomes reluctant landlord

October 7, 2009

The Federal Reserve’s ballooning balance sheet is turning into something of a legal morass.

Some of the $29 billion in troubled securities and loans the Fed took on from Bear Stearns as part of last year’s rescue is starting to give rise to lawsuits. These are cases where the Fed is either suing to collect on a multi-billion commercial real estate debt or is trying to fend off claims from rival creditors.

The lawsuits are a fee bonanza for the high-priced law firms that the Fed is paying to litigate these cases on behalf of Maiden Lane LLC — the entity set up by the New York Fed to hold the Bear assets.

But this mushrooming litigation is drawing the Fed into conflicts with commercial developers or into uneasy partnerships with some of the banks it regulates.

It even means that Fed Chairman Ben Bernanke has become a reluctant landlord — forced to rely on BlackRock, which manages Maiden Lane for the central bank, to collect the rent from some of its commercial tenants.

In February, for instance, lawyers for the Fed foreclosed on the Crossroads Mall in Oklahoma City, after the shopping center’s operators defaulted on a $76 million commercial mortgage. The Fed subsequently took title to the property after paying $11.2 million for the half-empty retail space.

The Fed has put the 941,745-square foot mall back on the market with an asking price of $24 million. Now the Fed is in federal court in New York, seeking to recoup its losses by going after three of the mall’s former owners who, the Fed contends, signed a personal guarantee on the loan with Bear. This is not what the Fed bargained for when it assumed some of Bear’s worst assets to induce JPMorgan Chase to buy the teetering Wall Street bank. But it’s the inevitable outcome of taking on a distressed portfolio that includes $8.5 billion in commercial mortgages — hotel chains and office complexes, assets that the Fed had marked down in value by about half last summer.

The litigation over the floundering mall in Oklahoma is nothing compared with the starring role the Fed is playing in the bankruptcy of Extended Stay Hotel. The South Carolina-based operator of more than 600 mid-priced hotels received $900 million in financing from Bear as part of a complex $4.1 billion loan package.

The Fed is now in the middle of two lawsuits arising from the Extended Stay bankruptcy. The Fed also stands to incur substantial losses as a result of the bankruptcy.

In one lawsuit, the Fed has joined with Bank of America and Wachovia, now part of Wells Fargo, in suing Extended Stay’s owner, David Lichtenstein, on a $100 million loan guaranty. The litigation is similar to the one the Fed has brought against the former owners of the Crossroads Mall.

In the other case, the Fed, Bank of America and Wachovia are all trying to defeat a claim for damages brought by one of Extended Stay’s more junior lenders.

A subsidiary of the Carlton Group, a New York-based real estate investment firm, is suing the Fed and the two banks, claiming the more senior lenders “colluded” and “conspired” against the interest of the junior lenders in the weeks leading up to the bankruptcy filing.

The Fed has declined to comment on any of the litigation. But in court papers, the Fed denies Carlton’s allegations and has moved to dismiss the case.

The danger for the Fed isn’t losing any single court case. It’s the problem of getting bogged down in litigation — something that is better suited for a bank creditor, not monetary policy makers.

Yet the longer the Fed holds onto these wasting commercial real estate assets, the greater the likelihood becomes of additional litigation to protect the Fed’s dwindling economic interest.

Maybe this why the Fed, according to The Wall Street Journal, is worried that banks haven’t moved fast enough to recognize losses on commercial real estate mortgages and related securities. The Fed knows from its own experience just how much more pain there is to come from commercial real estate. So here’s a suggestion: Maybe it’s time to strike a deal with JPMorgan to take the Maiden Lane portfolio off the Fed’s hands and let it assume the litigation risk. Or the Fed can have BlackRock go out and try to sell off some of these distressed assets.

The Fed appears to be looking at significant losses on some of Bear’s commercial real estate deals. The last thing we need is for Bernanke to become a landlord of struggling strip malls across America.


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Posted by ETF FOOL | Report as abusive

It is very obvious that Bernanke and FED do not see the gap between what they have and what they ought to have.

Posted by Drazen | Report as abusive

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Posted by Business Headlines For October 8, 2009 | Cronkite | Report as abusive

Over a year has passed since the Fed’s take over of the investment holdings of Bear Stearns, which was designed to maximize their value and minimize disruptions in the financial markets. What was a desperate maneuver then to maintain liquidity is now proving a drag on the financial system due to bad assets. The real story is the underlying problem of huge losses from bad lending practices. Have lending practices changed in a market that is so complex and still very non-transparent, or is it still business as usual, with the Fed playing the safety net once the debt load becomes critical.

Posted by Realness | Report as abusive

[…] Reuters Columns Blog Archive Fed becomes reluctant landlord | Blogs | __________________ Float Like a Butterfly Sting Like a Bee […]

Posted by BUND, TBOND and the middle of the guado (VM 69) – Pagina 184 – I Forum di Investireoggi | Report as abusive

It is important for Policy makers to recognize that Commercial Real Estate and Real Estate of all forms is a classical illiquid asset class. That simple forecasting measures, that Blackrock could have, should have provided could have avoided the Fed taking this the balance sheet.

Bad work by blackrock, fire them.

Posted by James Reginald Harris, jr | Report as abusive

I honestly think there was a conflict of interest related to BlackRock engagement by FED and Maiden Lane. Now taxpayers pay the price!

Posted by Drazen | Report as abusive

Law suits and Lawyers will not solve these problems. The Fed is ill equipped to handle upside down loans and upside down properties. The people who are sueing to get their money back would have more luck hollaring out the window than paying lawyers. These properties must be liquidated and if in an overbuilt situation may have to be used for homeless shelters, a school campus, or to replace old government buildings. The retail market is changing and some of the empty malls may never open again.

Posted by f belz | Report as abusive