Thursday, May 14, 2009

More Moral Hazard

All of us have heard the tale of woe from borrowers who find themselves underwater on loans that they probably shouldn't have qualified for in the first place. The rallying cry of libertarians is that they shouldn't have taken on obligations they couldn't handle. While there is truth to that its not that clear cut. Who among us has not said at some point, "well lets give it a shot and see what happens"? Sure its kool-aid, but that's why they make it taste so good.

Today we see a rather extreme example of the misplaced incentive to throw money down a hole. The Yellowstone Club is/was a playground of the ultrawealthy which came unraveled in the financial meltdown and is now in bankruptcy. In a very unusual ruling by the judge a secured loan made by Credit Suisse has been downgraded to true junk. The $375 million first lien loan has been put behind ALL other creditors, included unsecured.

The judges rationale is the utter haphazard lending practice and disregard for risk assessment. CS asked for NO financials or verifications. The judges ruling:

"The only plausible explanation for Credit Suisse's actions is that it was simply driven by the fees it was extracting from the loans it was selling, and letting the chips fall where they may. The only equitable remedy to compensate for Credit Suisse's overreaching and predatory lending practices in this instance is to subordinate Credit Suisse's first lien position to that of CrossHarbor's super-priority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors."

As long as they could slice and dice and sell the loan through securitization and pocket a nice $7.5 million fee go for it! The judge's ruling speaks volumes of the decreasing tolerance for such behaviour regardless of the contractual aspects. Could common sense be about to devour legal precedent?

John Barnyak