Co-Investing before the 2008 Crisis… Part I of II
You are 66 years old, your home is paid off, you have few bills, and no car loans. You feel good because both you and your wife had contributed the maximum amount in your 401(k) plan for 20 years, and the payoff is near…Life is good! Then one day a Sheriff’s deputy knocks on your door and tells you to vacate your home within 24 hours. He hands you an eviction notice and walks away.
You stand stunned in your doorway. “But this is OUR home, you tearfully tell your wife”… there has to be a mistake. A letter is attached to the eviction notice with Principal Life Insurance Company’s letterhead. The letter states that to protect all of their existing mortgages from default, they are taking possession of all past and present properties that are, or had been mortgaged through Principal Life Insurance Company. All past and present home owners are to vacate their homes immediately! “But we don’t have a mortgage with Principal anymore”, you tell your wife. “It was paid off years ago. Someone with Principal really screwed up, and this has to be fixed!”
Within minutes, you are on the phone with a Principal Life representative….. the young lady on the phone with you informs you that there was no mistake. The original mortgage had a clause in it, giving Principal the right to freeze all residential properties that had past or existing mortgages with Principal, regardless of whether or not the mortgage was paid in full. The law gave them the right to do this to protect all past and present home-owners from default. The sale of your home will help pay off mortgages defaulted by other borrowers!
You are aghast… you call your State Attorney General’s office, and tell him your story. He agrees that what Principal did not sound right, or legal, and he would open an investigation immediately. Months pass, and the State Attorney General’s office has finished investigating several related activities involving Principal, and decided that what Principal did was wrong and illegal…. They had even signed Loan Purchase Agreements with other lending institutions, using your home as collateral. Other dwelling properties that had no mortgage were sold so defaulted loans where Principal was the mortgagee could be paid off!
Unfortunately, your Attorney General decides to actually charge Principal executives with a crime would be disastrous for thousands of
Principal employees, and concluded there will be no charges filed. Even worse, Principal would not be required to return the properties to their rightful owners. You are simply the victim of the financial crisis, and must accept the fact that you lost your home do to circumstances beyond your control. The Attorney General advises you to “move on” with your life, because Principal was “too big to jail!”
You and your wife now find yourselves homeless. You have just enough left in savings to buy a house, in a not so nice neighborhood, but it was cheap. The home is small, next door to a used car lot, and behind an apartment complex, with a trailer park nearby. Of course, your savings account balance is now is zero, and you will have only social security as your only income.
This story sounds like a fiction, and it is… you think this could never happen, but you would be wrong. Thousands of 401(k) investors woke up one morning to find their 401(k) Principal U.S. Property Separate Account, was frozen at midnight the night before. There was no notice, as required by law, some investors lost $250,000 or more, the value of a nice home, and the money was never returned. The account funds were used in part to pay off defaulted debt Principal had loaned to their investment partners, or to honor loan purchase agreements to buy the defaulted loans.
Many of these loans were never intended to be paid by the developers. and Principal was a party to this fraud as well. In other cases, the investment plan failed and the developers decided to default the loan rather than pay off the incurred debt. But exactly who were these developers? For the most part, they had partnered with Principal Real Estate Investors to develop new properties on vacant land. The typical co-partnership arrangement was for Principal to provide the equity capital through bank loans guaranteed by the 401(k) account. Never mind that the account was not even a legal entity, the developer would represent the borrower and develop the property. Of course, if all went smoothly, the developers, including Principal, would sell the developed property at a handsome profit, and move on to another project.
If things didn’t go as smoothly as planned, Principal and their co-developer could always “sell” the developed property at an inflated price, a “fair value” as determined by Principal, to the U.S. Property Separate account, including the defaulted mortgage. The developers would pocket all the inflated sales proceeds, and the account would buy the property and assume the existing mortgage, effectively paying twice it’s inflated value for the commercial property. This was a sweet deal for Principal as well as their co-conspirators, but everything crashed in 2008.
By then, the Principal U.S. Property Separate Account was a Ponzi Scheme, with little or no equity value left in the account. On the credit side of their ledger were thousands of 401(k) investors, all holding “units” of value in an account that had no value. On the debit side, there was no cash to pay creditors. Principal had been promoting the account for months while driving more cash into their fraudulent investments, keeping the PUSPSA drained of cash. The PUSPSA had been the most active investment option for most of the plans, holding far more in asset value when compared to the overall allotment.
Principal had to freeze the PUSPSA account, or their fraud would have been soon discovered by federal authorities. They had no choice. A clause existed in which they could withhold withdrawal requests for up to three years. In 2008, the PUSPSA was the only Principal investment containing that narrative. Today, all separate accounts offered by Principal include a similar clause, so if need be, they can freeze their entire 401(k) investment portfolio if necessary.
In part II of this blog post, we will discuss in detail who the co-investors really were, the “comrade in arms” in Principal’s commercial property portfolio, prior to and during the financial crisis of 2008/2009. Stay tuned.