The US Federal Reserve is sitting on significant paper losses on the real estate assets it acquired in the Bear Stearns rescue, with much of the red ink coming from debt used to back some of the most high-profile buy-out deals of the bubble years.
Among the debts weighing on the central bank’s portfolio are those used in financing the acquisitions of Hilton Hotels, which is being restructured, and hotel operator Extended Stay, which is in bankruptcy, people familiar with the matter say.
The Fed holds these and other real estate assets in a vehicle known as Maiden Lane I, which was set up to pave the way for JPMorgan Chase’s purchase of Bear. At the time the deal was struck in March 2008, JPMorgan feared that if it bought all of Bear’s assets it would be left with too much exposure to the real estate market. Bear, for example, originally had $5.4bn of Hilton debt, a huge concentration
The assets in Maiden Lane I – all of which came from Bear’s mortgage desk – were originally valued at $30bn when a final agreement on the portfolio was reached in June 2008 by the New York Fed, its advisers at asset managers BlackRock and JPMorgan. At the end of 2009 the Fed said the assets were worth $27.1bn (€20bn, £17.4bn).
People familiar with the portfolio said Maiden Lane I’s losses were concentrated in commercial real estate assets, which had a face value of $8.4bn and an estimated worth of $7.7bn when they were acquired by the Fed.
As of September they had been marked down to $4bn, filings show.
About two-thirds of the Maiden Lane I portfolio involved mortgage debt backed by government-created entities, people familiar with the matter said. Those people describe the debt as highly illiquid, a factor that has resulted in its failure to rally strongly as credit markets recovered and interest rates fell.
“It was the scrapings off the slaughterhouse floor,” said one person. “It started with the things that were not good enough to get securitised.”
The Fed has disclosed little detail on these or other assets in the Maiden Lane I portfolio, fearing such revelations could hurt sales efforts, a person familiar with the matter said. JPMorgan and the New York Fed declined to comment.
Maiden Lane I was funded with $28.8bn from the New York Fed and $1.15bn from JPMorgan, which agreed to absorb the first $1bn of any losses.
The struggles of the portfolio could stir the debate on Wall Street over whether the New York Fed, then run by Tim Geithner, who is now Treasury secretary, struck a particularly good deal for taxpayers in the Bear rescue.
In a typical restructuring, creditors are made whole before shareholders are paid. In the Bear case, shareholders received $10 a share while creditors – in this case, the Fed – may lose money.
Mr Geithner told Congress in 2008 that the central bank had three “risk mitigants” to protect its interests in the Bear deal: JPMorgan’s agreement to take the first $1bn in any losses; the Fed’s long-time horizon as an investor; and the fact that the central bank’s $28.8bn loan was backed by “a pool of professionally managed collateral”.
Testifying before Congress last month, Jamie Dimon, JPMorgan’s chief executive, said the New York Fed received “the less risky mortgage assets” on Bear’s books. He added: “It would have been irresponsible for us to take on the full risk of all those assets at the time.”