Judge Strikes a Blow to SPE Game

| About: GGP, Inc. (GGP)

That which the lawmakers won't stop, that which the regulators won't stop, the judges just might:

The judge in General Growth Properties Inc.'s bankruptcy case rejected creditors' motions to dismiss several properties from the case, clearing the way for the mall owner to begin talks with its lenders about long-term debt extensions that would eventually allow it to exit bankruptcy court.

In a decision Tuesday, Judge Allan Gropper of the U.S. Bankruptcy Court in Manhattan ruled against the arguments of loan servicers ING Capital Loan Services LLC and Helios AMC LLC and lender Metropolitan Life Insurance Co. The three had separately argued that the General Growth malls they financed with mortgages are structured as individual "special purpose entities" that shouldn't be included in a broad corporate bankruptcy filing.

This entire "SPE" game has been a scam from the outset. Banks and others have used this scheme for years under the claim that the SPEs are "separate" entities.

But they're not - they are sponsored and controlled by the parent - just like any other subsidiary. The same thing holds true for banks that have stuffed somewhere around $2 trillion in tranched "assets" into these SPEs (e.g. credit card receivables, etc) and then have claimed that they should not have to count these as "assets" against their capitalization, thereby avoiding having to reserve against them as well as count them against capital ratios.

The Judge in this case said "NUTS!" and effectively destroyed this argument. All other Commercial Real Estate REITs now have to be considering whether they are also subject to this same treatment (the answer is "Yes!") and what that might mean for them and their investors.

Let me be clear: Off-balance sheet games are nearly always improper. In fact, I'll go so far as to say that they should simply never be allowed. I thought we learned this after ENRON, when the company used these "off balance sheet" games to hide transactions that were non-performing and in fact intended to be shoved under the rug where regulators and investors couldn't find them.

In fact we learned nothing. The banks and REITs ignored the ENRON debacle and regulators and law enforcement ignored it too, never mind that had ENRON been forced to consolidate all of its SPEs and SPVs everyone would have known that the firm was insolvent long before the lights went out.

The rule of law is supposed to protect investors and the general public against scams of various sorts, including attempts to hide losses and shield entities with actual and constructive control from being able to partition off certain pieces of themselves from a general bankruptcy. This is inherent in bankruptcy law and in the protection afforded to all creditors - if you have a subsidiary you have to ask for that subsidiary to be excluded from a bankruptcy, and you must demonstrate that you're not simply engaged in a shell game trying to keep creditors from obtaining their just recovery.

In this case the gambit failed, as, in my opinion, it should have.

It is ironic that more than a decade after ENRON we are forced to depend on Judges to do the job that regulators and lawmakers are charged with - protecting the public and investors from attempts to ramrod various loss-hiding schemes and games through the courts and up the rear ends of investors.

Unfortunately there is no evidence that we're going to see similar care paid to to the SPEs and SPVs that BANKS have put together, and which played prominently in the outrageously-loose extension of credit without reasonable defense throughout the decade from 2001-2007.

This commentator wants to know why not, and why it is that after nearly a decade has passed - plenty of time to force all this game-playing to stop and for these "assets" to be consolidated - we have instead seen banks and other entities expand their use of SPEs and SPVs instead of demanding that this sort of fraudulent accounting STOP.

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