Sunday, May 3, 2009

Lehman's real estate fix

From the NY Times:

As Mr. Visone remembers it, Mr. Walsh would wave his hand dismissively and would argue just as emphatically that the best way to make office buildings spew cash was through the magic of financial engineering. Typically, Mr. Visone gave in...

But even among Mr. Walsh’s supporters, a nagging question remains: How could a real estate wizard who built a thriving business by creating new ways of managing risk by sweeping loans off Lehman’s balance sheet end up doing deals that contradicted everything he seemed to stand for — and contribute to the collapse of one of Wall Street’s most venerable firms?

..During the late ’90s, Mr. Walsh forged close ties with many of the most prominent developers in New York. He bankrolled Tishman Speyer in its purchase of the Chrysler Building in 1997. He backed Steven C. Witkoff in his purchase of the Woolworth Building in 1998. And he financed the acquisitions by the German real estate developers Aby Rosen and Michael Fuchs of the landmark Lever House and Seagram Building...

Mr. Walsh was also skilled at making all that debt vanish from Lehman’s balance sheet before the firm choked on it. On the eve of the financial crisis brought by the near collapse of Long Term Capital Management in 1998, Lehman flushed $3.6 billion in commercial real estate loans through its securitization machine, avoiding some of the losses that crippled other firms, including Nomura and Credit Suisse.

But the funds’ structure created perverse incentives within Mr. Walsh’s group, according to two former members of his team who requested anonymity because of confidentiality agreements they had signed with Lehman.

Lehman owned 20 percent of the funds. Institutions and wealthy investors controlled the rest. Mr. Walsh, in order to raise money, promised to give the outsiders a first peek at deals.

If institutional investors and others passed, Mr. Walsh’s bankers were free to make the same investments with the firm’s money — which was just fine with his troops: they received bigger bonuses on the riskier deals because Lehman didn’t have to share the profits.

But it also meant that more deals that could go wrong ended up on Lehman’s balance sheet. And this is exactly what happened with a set of deals known as “bridge equity” financings.

As real estate went into overdrive in 2003, Mr. Walsh, in order to help clients pump up their offers in heated bidding wars, started frequently putting Lehman’s own cash into deals — alongside the debt they raised. With its cash on the line, Lehman would be dangerously exposed in any downturn, so, once a deal closed, the firm would try to sell its equity stake as quickly as possible.

Lehman made ripe 4 percent fees for its equity investments — twice the going rate for loan securitization. As long as the market was rising, Mr. Walsh’s group was fine. But if the bank couldn’t sell the bridge equity and if real estate prices fell, it could end up with nothing....

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