Fed Takes a Hit in Extended Stay Hotel Chain Bankruptcy

Chalk this bankruptcy filing up to yet another really leveraged commercial real estate deal crafted at the peak of the market, based on unrealistic expectations for future growth.  Extended Stay Hotels filed for bankruptcy on Monday.  Who were the crack real estate lenders who facilitated this transaction?  Why Bear Stearns and Wachovia.  Hmmm, those names sound sort of familiar.  Extended Stay Hotels is one of the many, many reasons why we don't hear the names Bear Stearns and Wachovia much anymore.  

Lightstone Group led the buyout, but only contributed $200 million in equity to the $8 billion deal, most of which was apparently borrowed.  Lightstone's Chief, Mr. Lichtenstein, has apparently learned a thing or two from past real estate meltdowns.  It's always best not to put too much skin in the game, just in case your overly ambitious growth assumptions turn out to be wide of the mark.  Apparently, investors didn't think Extended Stay would be able to file for bankruptcy because of a provision in the CMBS structure that would make Mr. Lichtenstein personally liable for $100 million if the company filed for bankruptcy.  Somehow Mr. Lichtenstein managed to weasel out of the $100 million personal liability by helping the secured lenders wrest control of the hotel chain.  So much for that theory.

The hotel chain is now valued at $3.3 billion, which isn't even 41% of the original buyout price and even lower than the amount of the first mortgage, $4.1 billion.  So clearly the junior lenders are getting wiped out, and the senior lenders will be taking it on the chin as well.  The really awesome part of this particular commercial real estate blow-out is that the Fed actually owns $744 million in face value of various junior classes of the debt on Extended Stay and also held $153 million of the senior debt that was packaged and sold as bonds.  That is courtesy of the Bear Stearns collateral that the Fed guaranteed so it could coerce JP Morgan into buying the now defunct broker dealer back in March of 2008, when "the worst was over."  Maybe those that believed that the hits the Fed had taken on that portfolio so far were just mark-t0-market losses but this one is for real.  We don't get to make it back on this one.  

Comercial real estate deals like these are one of the many reasons why I have never wanted the Fed involved in collateralized lending versus any collateral other than Treasuries.  Too many stupid deals crafted at the high that are going to go bust, one a a time.  Let the lenders and the equity investors eat the losses.  No bailouts for real estate developers and investors please.  I'm OK with Sheila Bair liquidating what she seizes from defunct institutions.  We can eat the losses then, last, like we're supposed to.