The Corruption of the Timeshare Industry

Larry and Sarah Palmer of Dayton, Ohio are empty-nesters, who had recently returned home from vacationing in Las Vegas. But Sarah was scratching her head over coffee one morning, trying to makes sense of a bill she’d just received in the mail from the resort where the couple had stayed.

On checking into their hotel, the Palmers had been directed to visit the concierge, who presented them with an ‘itinerary’, including free show tickets, complimentary cocktails, and a hundred-dollar casino credit. First, however, they would have to sit through a presentation addressing ‘investment’ opportunities of some kind.

Feeling beholden to the resort developer for its largesse, the Palmers weren’t about to spurn the hospitality and had quickly acquiesced to the investment proposals, which included a vacation ‘ownership’ package with ‘points’ of access to the resort network that would increase in value as time passed and could easily be resold at a premium. In the meantime, they would have liberal access to the affiliation of resorts so extensive and opulent that their lives would become a veritable Shangri La.

But now Sarah was struggling to reconcile the numbers in the account statement with what they had been promised. Indeed, these numbers looked so inflated that she called her adult daughter, who suggested that her parents contact an attorney. It soon came to light that for far less money the couple could stay at many of the same resorts by booking publicly online, rather than paying the exorbitant ‘investment membership’ costs. Worse yet, Sarah learned that the ‘points’ of access could not be sold as an investment – indeed, they could not be sold at all. In fact, many such points packages were being advertised on Ebay for nothing. The final insult: The Palmers were stuck with this suffocating contractual arrangement – thousands of dollars in debt. The resort developer would not take back their points – not even for free.

 What the Palmers experienced didn’t happen in a vacuum. Millions of Americans routinely encounter deceptive sales and trade practices courtesy of the billion-dollar timeshare industry. But where there’s money to be made, even the mainstream hoteliers  – brands that have spent decades cultivating good will in their tradenames – have capitulated to the profit-pressure – at the risk of sullying that good will. How could it have come to this?

Flashback thirty-odd years to a financial crisis of the late 1980s and early 90s, when a Wall Street firm called Drexel Burnham Lambert had seemingly caught lightening in a bottle. Specifically, a crusading young financier there named Michael Milken refined an investment vehicle known as the ‘junk bond’ that he and Drexel extensively touted as a means to acquire controlling, hostile equity interests in publicly traded corporations. Drexel would issue the bonds serially to finance these takeovers, known as leveraged buyouts. The Machiavellian bond investors, often with very little exposure, could then effectively wreck the stability of otherwise sound companies by forcing existing owners and directors out of power. Typically, however, these unscrupulous ‘investors’ were merely looking to drive up the price of the stock and then dump it all at a premium, to the detriment of everyone else involved. Often the beleaguered ownership was forced to pay green mail to the junk bondholders simply to go quietly away, relinquishing the securities in a windfall for the junkmen.

Ultimately Milken was convicted of racketeering and tax evasion, while Drexel itself filed bankruptcy following charges of securities fraud. Notably, among Drexel’s money managers at the time was Leon Black, a figure who now plays prominently in the timeshare industry.

By the early 2000s, Milken’s former colleagues were looking for other ways to make a quick buck. Traditionally, mortgage lending, though staid, was still a staple of conservative investment portfolios based on tried and true lending practices. The conservative lender, typically a bank or mortgage company, dealt only with those creditworthy enough to warrant its trust, and then generally retained the mortgage.

Impatience with this successful but deliberate approach led to the practice of securitization.  In a financial epiphany, it occurred to investors like Michel Vranos[1] and others that this process could be dramatically accelerated and extended by: 1. Separating the mortgage loan origination function from the actual ownership of the asset(s); 2. Allowing investment in these assets by non-traditional investors, particularly private equity; and 3. Loosening credit-related standards to allow for sub-prime lending. To achieve the third step, the financial sector lobbied Washington unremittingly to relax traditional lending requirements. [2]

In this fashion, banks and lenders became mere originators of mortgage loans, who would almost invariably assign the paper to a third-party investor, typically a private equity firm, that holds the mortgage collectively with others, bundles them into a mortgaged-backed security (MBS), and issues bonds or other denominated security instruments from them.[3]

Of critical importance, just as much as the relaxation of credit-related lending standards, it was the separation of the mortgage origination function from actual ownership of the mortgage that lead to the feeding-frenzy of lending to sub-prime candidates. In this fashion, the banks and mortgage companies had little or no financial incentive to insure the long-term viability of the mortgage loan – but rather were impelled to initiate as many loans as possible, regardless of the risk of default.

Leon Black’s company, Apollo Global Management, also became heavily involved in this securitization of mortgages, a practice which, in conjunction with the general loosening of credit-related standards, had cataclysmic results. By 2008, as defaults mounted, the unsustainability of the process became obvious, and the mortgage market bubble burst, sending shock waves reverberating throughout the economy. Ultimately, the collective net worth of US households declined by 13 trillion dollars[4], the stock market fell to half its pre-crisis peak[5], gross domestic product dropped to forty percent (40%) of its previous high[6], and subjectively, untold human angst occurred.

In retrospect, there is a thread common to the foregoing crises, which tends to characterize financial practices that place a premium on rapid optimization at the expense of long-term viability, i.e., the separation of effective control from vested ownership. That is to say, in each instance, control over the allocation of money was divested from those most concerned for its prudent expenditure.

In the case of the junk bond crisis, of course, those with very little or no stake in the sound operation of the publicly traded ‘target’ corporation were allowed to gain control, or threaten control of its operations, essentially by artifice. These unscrupulous ‘investors’ and their enablers, i.e., the junk bondsmen, were leveraging acquisition of corporate control with very little financial outlay relative to the vested owners and directors, much less the rank and file employees whose livelihoods hung in the balance.

Likewise, during the events presaging the mortgage meltdown of 2008, control was essentially in the hands of the loan originators, i.e., banks and mortgage companies, not the long-term investors at risk of default. And again, all of this was accomplished through the brokers facilitating and enabling the transactions, with little or no interest in safeguarding the integrity of the process, but with ample financial incentives to do the deals, regardless.

Now, history seems to be repeating itself, but through increasingly nuanced and subtle ways. In the timeshare industry, unregulated ‘securitization’[7] of lending has made a roaring comeback. Also, there is very little effective regulation of credit-related standards for acquisition financing. Indeed, closing protocols are so lax and interest rates are so high that every loan issued could be deemed ‘subprime’.

But there is an even subtler and, with reflection, alarming aspect to financial and legal practices prevalent in the timeshare industry. That is, the typical timeshare resort developer does not ‘own’ the resort at all. In point of fact, the timeshare developer merely acquires the right to manage the resort facilities and business-related activities. Indeed, the developer has already purported to sell the ownership interests to the members, like the Palmers and countless others.

Legally, these management related functions should inure to the benefit of those ‘owners’ who have bought points or deeds in the resorts’ network. At the very least, the timeshare developer, as a manager, should operate the resorts as a fiduciary of the members.[8]

But there are practical means and some quasi-legal sophistry commonly employed by timeshare developers so as to maintain effective control over resort facilities and management, and thus, the flow of money. These include: 1. Under the guise of ‘privacy’ rights, the policy of preventing owners from communicating with one another so as to galvanize opposition; 2. The practice of installing themselves, ostensibly through puppet ‘owners’ who are complicit in this process, as the resort management company, exclusively, and without competitive bidding; and 3. The illegal maintenance of perpetual control over resort management.[9]

Thus, the financial and legal stratagems employed by those who gave us the junk bond crisis and the mortgage meltdown have culminated in the ultimate slight of hand – the ability to exercise full beneficial control over a vast and growing industry with little or no vested ownership. It’s a recipe for financial disaster, of course, but the timeshare developers have little or no exposure to it because they have no little or no actual ownership. And that will not keep the Palmers from having to retain a law firm.

[1] Morgenson, Gretchen (2007-07-22). Mr. Vranos Has a Deal for You,. The New York Times Company. Retrieved 2007-12-10.

[2] Lender Lobbying Blitz Abetted Mortgage Mess, Wall Street Journal, December 31, 2007

[3] Lemke, Lins and Picard, Mortgage-Backed Securities, Chapters 4 and 5 (Thomson West, 2013 ed.).

[4] Households and Nonprofit Organizations; Net Worth, Level. 7 June 2018.

[5] S&P 500. 3 July 2018.

[6] Johnson, Simon (Sep 26, 2013). Three Unlearned Lessons From the Financial Crisis.. Bloomberg. Retrieved 17 November 2013.

[7] “Securitization” in this context is touted by its proponents, but illusory, as ‘points’ of access are not real estate, and thus cannot collateralize a mortgage.

[8] See, e.g., Fla Stat. s. 721.13(2)(a)

[9] See e.g. Nevada Stat. 119A.522