Houston-based Landry’s Restaurants Inc cut a deal with its main group of bondholders on Monday afternoon, resolving litigation that had consumed the company over the past month (prior posts here). Essentially, the bondholders gave Landry’s an 18 month window to refinance the $400 million in debt in return for Landry’s agreeing to bump the interest rate on the bonds from 7.5% to 9.5%.
Although the deal allows Landry’s to avoid refinancing the debt now at an even higher rate of interest, my sense is that the entire episode has been fairly disastrous for Landry’s. First, as noted here awhile back and as Loren Steffy recently pointed out, Landry’s has not been doing all that well in a brutally competitive restaurant market even before this dustup with its bondholders. A couple of weeks ago, Landry’s CEO Tilman Fertitta publicly claimed that refinancing of the bond debt “was no big deal,” but then testified during the injunction hearing this past Friday that forcing Landry’s to refinance the bond debt now would irreparably harm the company. That sounds like a pretty big deal to me. Meanwhile, Landry’s will now be looking to refinance a large chunk of junk debt in a shaky credit market that knows that the company just got done acrimoniously suing the holders of the debt. That approach generally does not induce favorable terms from debt refinanciers.
Landry’s looks as if it is heading for some very choppy waters.

The New York Times continues to do a reasonably thorough job of reporting on the downturn in the subprime mortgage business and its impact on the recent crunch in the credit markets (see here and here), although it’s not at all clear that the reporters and columnists understand how markets will adjust and resolve these problems. A case in point is this Paul Krugman column in which he decries the impact of securitization of mortages on the willingness of lenders to engage in workouts with financially-strapped borrowers:

In the past, as Gretchen Morgenson recently pointed out in The Times, the bank that made the loan would often have been willing to offer a workout, modifying the loanís terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.
Today, however, the mortgage broker who made the loan is usually, as Ms. Morgenson says, ìthe first link in a financial merry-go-round.î The mortgage was bundled with others and sold to investment banks . . .
My guess is that [the solution] would involve federal agencies buying mortgages ó not the securities conjured up from these mortgages, but the original loans ó at a steep discount, then renegotiating the terms. But Iím happy to listen to better ideas.

Here’s a better idea — how about allowing the parties that took the risk of the mortgages to endure the consequences of that risk-taking? Krugman is correct that one of the disadvantages of securitization (which is far outweighed by its many benefits) is that the rules for servicing the loans are established when the loans are pooled and cannot be changed without providing legal problems for the seller of the securitized mortgage pool. For example, if a pooled loan were sold at a discount, then the proceeds of the sale would be treated as a prepayment of the loan, which would benefit certain investors and disadvantage other investors. Inasmuch as the disadvantaged investors would seek damages from the seller of the securitized mortgage pool, that’s why the sellers of the security don’t allow the servicing terms of the mortgage to be changed after the loan is contributed to the pool.
Krugman’s proposal is essentially that borrowers should be allowed to remain in their houses on renegotiated terms and that the investors in the securitized pools should absorb the cost of such a modified arrangement. But borrowers can already file a bankruptcy case and attempt to extend the payment terms of the loan under either a chapter 11 or 13 plan so long as their income and the value of the collateral for the mortgage support such terms. However, if the borrower’s income or the value of the underlying asset will not support extension of the loan terms, it’s far better that the lenders be allowed to exercise their contractual right to conduct a foreclosure sale of the collateral for the loan. That way, the investors who bought the securitized mortgages absorb the losses, which is precisely the risk of investing in a securitized mortgage pool.
By the way, one of the Times articles linked above starts by passing along the following story, which is testimony to the creativity and resilience of American markets:

All through last year, Jim Melcher saw the signs of a rapidly deteriorating American housing market ó riskier mortgages, rising delinquencies and more homes falling into foreclosure. And with $100 million in assets at his hedge fund, Balestra Capital, he was in a position to do something about it.
So in October, as mortgage-backed bonds were still flying high, he bet $10 million that these bonds would plunge in value, using complex derivatives available to any institutional investor. As his gamble began to pay off in the first months of 2007, Mr. Melcher, a money manager based in New York, plowed the profits into ever bigger wagers that the mortgage crisis would worsen further, eventually risking some $60 million of the fundís money.
ìWe saw the opportunity of a lifetime, and since then events have unfolded on schedule,î he said. Mr. Melcherís flagship fund has since doubled in value, even as this summerís market turmoil cost other investors billions, forced the closing of several major hedge funds and pushed the stock market down 7 percent since mid-July. This week, Mr. Melcher is heading to Paris for a vacation with his wife.