Exactly three months ago, I told you to expect bankruptcy in the record Stuyvesant Town real estate deal. Today, this is exactly what we got:
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.
This is the corporate version of you walk away – strategic default, if you will. And just as the household version is often a result of excessive leverage and debt, this too is a product of the Ponzi financing we witnessed during the real estate bubble. The financiers who bought the property paid $5.4 billion in 2006. Now, the property is worth one-third of that price, $1.8 billion. Tishman Speyer and BlackRock paid too much. It’s as simple as that.
How is this any different than a couple buying a home in an inflated market to find that its value has been cut in half three or four years later? In the case of the homeowner, there are many voices which have condemned people who have taken out contracts, only to renege on them a few years later because they realize the terms of the contract will never be favorable. Mark Thoma outlined the moral dilemma two days ago:
If you were underwater and lost your job and had to move to get a new job, that was one thing, there was little choice but to default and use the protection embedded in non-recourse. But simply walking away when you were still employed and could still afford the mortgage was another. That wasn’t the option embedded in the implicit contract. Following this implicit rule lowers costs for everyone, that’s the sense in which, contrary to claims above, there’s a financial incentive to follow this norm — should I pay more for my loan so that you can speculate and then walk away from a bad bet (there are unrecoverable costs each time a default is socialized)? That’s different than using non-recourse as a form of social insurance against contingencies beyond a household’s control, and paying extra closing costs for that insurance.
The change in norm will occur when people begin to believe that they weren’t just unlucky, but instead were duped or treated unfairly in some other way. If it wasn’t just a bad bet, the kind you reluctantly pay when you lose, but was instead caused by some unfair factor that only becomes evident ex-post, then the norm begins to change as people begin to realize what really happened to them. They don’t want to believe or admit to themselves that they were fooled into a loss rather than the victim of a fair bet, but that changes as the losses and resentment mount, and as the evidence that things weren’t what they seemed comes into focus. And that does seem to be happening.
There are a few problems that I don’t think can be solved:
- How do we discern between those who can legitimately claim ex-post that their ex-ante decisions were based on fraud and those who were merely speculators? And how do you make public policy to divide these groups fairly as a remedy for this problem? I don’t think you can.
- Aren’t Tishman Speyer and BlackRock engaging in the same strategic default behavior that we claim is morally repugnant for individuals? Why should we hold these corporations to one standard and individuals to another?
- How do we differentiate between mortgage fraud perpetrated by unscrupulous lenders and mortgage brokers and greed and fraud perpetrated by mortgage debtors? Isn’t this a major issue in the moral dimension of the you-walk-away debate?
As Thoma’s post indicates, the norms have definitely shifted. Walking away is seen as a legitimate option regardless of the conditions that prevailed when the mortgage was originally contracted. Many who walk away will do so for reasons connected to mortgage fraud and economic necessity. Others will do so for strategic considerations. Knowing who’s who is going to be pretty difficult.
Looking at Stuyvesant Town and the jingle mail it has sent its own creditors, it would seem a double standard to point the finger at someone and say, “you’re not living up to your moral obligation.”
Update: Richard Thaler has a good piece in the New York Times talking about this double standard as well. See Underwater, but Will They Leave the Pool?
Tishman Venture Gives Up Stuyvesant Project – NYTimes.com
"Underwater, But Will They Leave the Pool?" – Mark Thoma