Greed, Bankruptcy, and the Super Rich

A private ski resort created by a timber baron in the rugged mountains of Montana would hardly seem to be a global bellwether for anything, except perhaps the evolving preferences of the very rich.

Yet the dramatic bankruptcy of the Yellowstone Club, the events that precipitated it, and the way it has been resolved show with unusual clarity the good, bad, and ugly of our current economic predicament. And the club’s future will be a leading indicator of the economic zeitgeist in the age of Obama.

Let’s start with the bad. In 2005, investment bank Credit Suisse was aggressively peddling resort loans, offering developers the opportunity to line their own pockets with the proceeds and offering institutional investors high-yield loan products whose risks were vastly underestimated.

Tim Blixseth, founder and dominant shareholder of the Yellowstone Club, was among the many who found the money irresistible. First he was going to take $150 million. Take a little more, urged the investment bank. Hell, take a lot more. And he did, finally closing on a $375 million loan, and, as explicitly permitted in the loan agreement, immediately transferring $209 million of it to his personal accounts.

When he and Jeff Barcy, the lead Credit Suisse banker, couldn’t agree on the fee, they flipped a coin. (Blixseth won, and Barcy got 2 percent instead of 3 percent.) Appraisals? Cash-flow projections? The ability of the borrower to re-pay? Ah, not to worry, these small details didn’t require much attention, because Credit Suisse didn’t have any money at risk anyway. The loan would be packaged and sold as part of so-called collateralized loan obligations, putting possible future problems on the shoulders of institutional investors like hedge funds and pension funds.

Credit Suisse did more than half-a-dozen resort deals like this, totaling close to $3 billion. How many other loans of this nature were made between 2002 and 2006, by most of the biggest names in banking? (Answer: a lot.)

Now we get to the ugly: The club had minority shareholders, including cycling great Greg LeMond, who thought they should get a share of the windfall. They sued the club and Blixseth, who finally settled for $38 million (though the judgment was never fully paid).

Blixseth, always looking for ways to expand his reach, hatched a new plan to lure the über-rich. Yellowstone Club World would offer elaborate vacation timeshares at exotic overseas properties, including castles and private islands bought with the Credit Suisse loan proceeds. But that plan quickly disintegrated, leaving Blixweth with a pile of expensive (and soon all but unsellable) assets.

By 2007, the club was facing serious cash flow problems, stemming from the heavy debt service on the Credit Suisse loan, profligate spending, and erratic management. Blixseth decided to sell the property, but the deal fell through. Tim and Edra Blixseth, meanwhile, were getting a divorce. They fought it out in court even as they continued to spend lavishly—seemingly oblivious to that fact that their empire was on the brink of collapse. Edra got the club in the divorce, and with it the huge debt load.

When the real estate meltdown hit, bankruptcy was only a matter of time, and a Chapter 11 filing came last November.

Credit Suisse, still the agent for the outstanding $310 million on the loan, responded by calling the lawyers. The Yellowstone Club bankruptcy was an evil conspiracy, argued the men from Skadden Arps, a plot by Edra Blixseth and Sam Byrne (the private equity investor who had tried to buy the club in early 2008). And besides, they argued, we’re the first-lien holder! We have our rights! Don’t stand in our way or we will lawyer you to the death!

But then, surprisingly, came the good, mainly in the form of an unassuming Montana bankruptcy judge named Ralph Kirscher. When Credit Suisse floated an interim funding plan that would involve “mothballing” the club—and thus throwing hundreds out of work and diminishing the chances of the tradesmen getting paid—Kirscher rejected it.

When the club’s Unsecured Creditors Committee sued Credit Suisse for “fraudulent transfer” on the loan—a move most lawyers viewed as risky bordering on reckless—the judge all but dared the parties to take it to trial. Credit Suisse and Skadden took him up on it, and Tim Blixseth, an unnamed defendant in the original lawsuit, filed his own legal action against the creditors and the club.

The trial was quite a spectacle. Under Kirscher’s firm hand, the bankruptcy process compressed into weeks complex litigation that would normally take years. Kirscher, feeling pressure to make a decision and clear the way for an auction of the club, issued a partial ruling that minced no words about Credit Suisse’s behavior, blasting the bank for acting out of “naked greed” and making a “predatory” loan with total disregard for the consequences. He stripped Credit Suisse of its first lien position, a rare act in bankruptcy court.

Cleverly, though, Kirscher stopped short of voiding the loan entirely, and so Credit Suisse retained the right to use the outstanding debt as part of a bid for the club at auction. Sam Byrne and his firm, CrossHarbor Capital, already owned a lot of property at the club and had provided interim financing for the bankruptcy; they were the only other bidder. Finally, Credit Suisse agreed to settle (for an $80 million note and some other considerations), and Byrne will buy the Yellowstone Club for $115 million.

The settlement calls for Kirscher to take back all those mean things he said about the bank’s behavior. But the unsecured creditors will get their money. The big guys with the secured position lose almost almost everything, and the little guys get paid in full. How often does that happen in bankruptcy court?

Note to bankruptcy judges around the country: There can be rough justice in this tidal-wave of toxic asset workouts, even if you have to stretch the precedents a little.

The question now, though, for both the big guys (Sam Byrne and CrossHarbor Capital, and their operating partner Discovery Land Co.) and the little guys (the vendors and contractors and waitresses and lift operators of Big Sky) is whether there is a future in the ultra-high-end resort economy.

The rich will always be with us, for sure, but in what quantities? To what extent will the contraction of the financial services industry, and the more progressive tax policies of the Obama Administration, diminish the pool of people who are able or willing to spend $5 million on a ski house at the Yellowstone Club?

In short, does the financial crisis represent a mere steeper-than-usual turn of the business cycle or a more fundamental structural reset?

The answer to that question will soon be clearly visible in spectacular mountains of southwest Montana.