Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Odd Lots podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy Alloway.
Speaker 2: So, Tracy, something that we've touched on a few times
Speaker 2: is this sort of I guess I would say perverse
Speaker 2: situation by which you know, the FED is raising interest
Speaker 2: rates in an attempt to get inflation back to target,
Speaker 2: and you know, it seems like they're kind of having
Speaker 2: some success there and maybe we might begin a cutting cycle.
Speaker 2: But in the process of raising raids, you constrain supply
Speaker 2: of housing in particular, which is a you know, a
Speaker 2: big affordability crisis, one of the big long term upward
Speaker 2: sources of pressure on prices.
Speaker 3: Right, So higher rents and house prices are part of
Speaker 3: the higher inflation story. And one way of dealing with
Speaker 3: higher prices is to build out supply, right. But if
Speaker 3: you're raising rates to offset inflation, then building out that
Speaker 3: supply becomes more expensive and there's more uncertainty and people
Speaker 3: don't necessarily want to do it. And then just to
Speaker 3: add to that against that whole backdrop of inflation, I
Speaker 3: think it's funny how fast this kind of faded into
Speaker 3: the background, but we still had that mini banking drama
Speaker 3: crisis or whatever you want to call it from last year,
Speaker 3: which did kick off some credit tightening, particularly in commercial
Speaker 3: real estate, and commercial real estate, as we've mentioned a
Speaker 3: number of times on the podcast, includes multifamily residential.
Speaker 2: Right, So there's all this stress, and you know, in
Speaker 2: the short term, it seems like rate hikes have probably
Speaker 2: had some effect on cooling the economy, but there are
Speaker 2: long term costs associated with that. Everybody is aware of this,
Speaker 2: and it does seem to be according to many economists,
Speaker 2: the sort of deep structural housing shortage and the effort
Speaker 2: to fight inflation constraints that. So the question is, like,
Speaker 2: is there some solution here or do we just have
Speaker 2: to accept that this is the reality?
Speaker 3: Yeah, I guess the big question is how do you
Speaker 3: get people to build more?
Speaker 4: Yeah? Right?
Speaker 3: Especially yes, yes, especially at a time when like there
Speaker 3: are incentives out there that seem to be working against
Speaker 3: doing that. So you have the higher interest rates, so
Speaker 3: maybe now is not the time when you want to
Speaker 3: spend a bunch of capital to build something new. Maybe
Speaker 3: you want to wait for interest rates to go down.
Speaker 3: And then also, this is a controversial statement, but I
Speaker 3: saw you tweeting about it earlier today, Joe. But like
Speaker 3: I do wonder, you know, if you're a property development
Speaker 3: and you're building luxury apartments and there's all this question
Speaker 3: about like population density and zoning and things like that,
Speaker 3: maybe part of the incentive is you don't want to
Speaker 3: build that much because you could make money just by
Speaker 3: you know, constraining the supply and seeing prices go up.
Speaker 2: That's right, and there's certainly like you know, the way
Speaker 2: people talk about it is that if you're a developer
Speaker 2: and you own land, you have a real option and
Speaker 2: you don't have to build the moment you acquire the land,
Speaker 2: and you can wait until a stronger conditions. So it's
Speaker 2: actually like getting the policy mix right.
Speaker 1: You know.
Speaker 2: People focus on zoning, and I'm sure that's an aspect,
Speaker 2: and then the housing supply chain and labor and all
Speaker 2: this stuff. It's a multifaceted challenge to do it. But
Speaker 2: you know, we need some ideas here about how we're
Speaker 2: actually going to produce more housing units in this country.
Speaker 3: Yes, and you mentioned multifaceted. We have the perfect guests
Speaker 3: to talk about this very multifaceted and nuanced issue of
Speaker 3: how do you build more multifamily in the US.
Speaker 2: That's right. We have truly the perfect guest, because he
Speaker 2: might even I think he's even going to give us
Speaker 2: a solution, or at least a partial solution to this challenge.
Speaker 2: We're going to be speaking with Jim Milstein. He is
Speaker 2: the co chair currently of Guggenheim Securities. Previously, he was
Speaker 2: the Chief Restructuring Officer at the Treasury from two thousand
Speaker 2: and nine through twenty eleven. So I was dealing with
Speaker 2: a lot of aig stuff at the time, right in
Speaker 2: the wake or in the sort of immediate time of
Speaker 2: the Great Financial Crisis. Previously to that, he was at Lazard.
Speaker 2: He's also done work on Fanny and Freddy or attempted
Speaker 2: to look into the challenge of restructuring these big housing
Speaker 2: banks that we have in this country, and maybe he
Speaker 2: can shed some light on possible situations to at least
Speaker 2: alleviate some of the financing strains of the housing problem. So, Jim,
Speaker 2: thank you so much for coming on odd Lots.
Speaker 4: Well, thanks for having me.
Speaker 2: Why do you give us the sort of you went
Speaker 2: to Treasury and Tim Geitner called you up and said,
Speaker 2: come help us fix this gigantic mess that we have.
Speaker 2: Why do we start there? What did you do when
Speaker 2: you're at Treasure.
Speaker 4: I came in right at the beginning of the new administration,
Speaker 4: and you know, we were in the middle. The financial
Speaker 4: crisis was in full blue. Yeah, at that point right started.
Speaker 4: Really the seeds were planted in two thousand and seven
Speaker 4: and six from the whole subprime mortgage crisis and where
Speaker 4: all of that credit risk resided in various banks and
Speaker 4: other financial institutions, including AIG. And so I was asked
Speaker 4: to get my hands around AIG first and foremost we
Speaker 4: had put by the.
Speaker 3: Wait, can I just ask? I always wondered this, but like,
Speaker 3: how does the ask? What form does the ask? Actually
Speaker 3: just get a phone call one day and it's like,
Speaker 3: can you sort out what was it? Billions, if not
Speaker 3: trillions worth of AIG monoline insurance?
Speaker 4: Yeah, I mean desically, there was a meeting in the
Speaker 4: Secretary's office with the team that he had assembled, a
Speaker 4: bunch of you know, financial experts that he had brought in.
Speaker 4: There were some longtime Treasury officials, but mostly a bunch
Speaker 4: of outsiders came in and he built himself a little
Speaker 4: investment bank inside the Treasury Department to deal with all
Speaker 4: of these institutions that were, you know, that were wobbling.
Speaker 4: And so by the time I got there, the federal government,
Speaker 4: between the FED and the Treasury Department's Start program, had
Speaker 4: put one hundred and thirty billion dollars into AIG and
Speaker 4: most of that was to shore up the capital of
Speaker 4: the various insurance companies, but the bulk of it and
Speaker 4: the immediate need went to AIGFP, which had written a
Speaker 4: series of credit default insurance swaps and had relied on
Speaker 4: AIG's credit rating, which had been double A, as a
Speaker 4: substitute for cash collateral on those trades. And when the
Speaker 4: rating agencies, in their infinite wisdom, downgraded AIG credit rating
Speaker 4: from double A to single A, it required a massive
Speaker 4: cash collateralization in order to keep those trades in place.
Speaker 4: So within six weeks, AIG was into the FED for
Speaker 4: about one hundred billion dollars and all of that went
Speaker 4: right into AIGFB to cash collateralize their trades, so they
Speaker 4: didn't default on Goldman Sacks, on SoC Gen, on BNP,
Speaker 4: on Bank of America, on the various insurance they had
Speaker 4: written in their favor, on various structured finance products. And
Speaker 4: it was a black hole. And one of the real
Speaker 4: problems with AIG was that it was not regulated by
Speaker 4: the Fed, by the Treasury Department, by anyone at the federal.
Speaker 2: Level of insurance is like fifty state regulators.
Speaker 4: And AIG was expert at regulatory arbitrage. So there was
Speaker 4: a insurance regulator I think it was either in Delaware
Speaker 4: or Maryland that was the primary regulator of this worldwide.
Speaker 4: The largest insurance company in the world, it was also
Speaker 4: the largest aircraft leasing company in the world, one of
Speaker 4: the largest consumer finance companies in the world, and one
Speaker 4: of the largest participants in the credit default insurance market.
Speaker 4: So how do you end up getting settled with AIG?
Speaker 4: So he called into his office the team and said
Speaker 4: somebody's got to take charge of it, and basically everybody
Speaker 4: else in the room took a giant step back.
Speaker 3: That left me into the hedge exact style.
Speaker 4: Oh thank you, Jim for volunteering. So I spent a
Speaker 4: ton of time up at Wilton, which is where AGFP
Speaker 4: was located, talking to the guys who ran the twenty
Speaker 4: two desks, which were twenty two different trades that they
Speaker 4: had put on. And I got to tell you, I
Speaker 4: think of myself as a I was worked as a
Speaker 4: lawyer for eighteen years and then as a banker for
Speaker 4: ten years before this, and I think of myself as
Speaker 4: a reasonably smart guy who can figure things out. It
Speaker 4: took me two weeks to really just understand what they
Speaker 4: had done and what they were doing, and to whom
Speaker 4: they owed their insurance and the impacts then what we
Speaker 4: call the interconnectedness and potential contagion effects of their failing
Speaker 4: to make good on their insurance.
Speaker 3: I realized, we're supposed to talk about building additional housing supply.
Speaker 4: We'll get there. We'll get there.
Speaker 3: I have so many questions just about this particular period
Speaker 3: of time, But when you say it took two weeks
Speaker 3: to figure out just what was going on and what
Speaker 3: the network of who owed what to whom actually looked like.
Speaker 3: What was the system like back then? Was it just
Speaker 3: like actual hard copy contracts or was there an Excel
Speaker 3: spreadsheet somewhere retangle it?
Speaker 4: They were reasonably sophisticated in terms of their digitization of
Speaker 4: their records. But the truth is is that you know
Speaker 4: these were bespoke trades, and so without probing each of
Speaker 4: the managers of each of the desks on you know
Speaker 4: how it came to be that you had, you know,
Speaker 4: six hundred billion dollars worth of exposure on internal securitizations
Speaker 4: that European banks had done on their credit portfolios, where
Speaker 4: AIG what do they call this the capital structure arbitrage desk,
Speaker 4: where banks would basically create an internal securitization, create a
Speaker 4: senior and subordinated trnch in their loan books, and AIG
Speaker 4: would write credit insurance credit to fault protection against the
Speaker 4: senior trench and thereby transform a book that would otherwise
Speaker 4: have had a credit rating of overall on average double
Speaker 4: B and turn the senior tranch into double A, which
Speaker 4: was where their credit rating was at the time AIG's
Speaker 4: credit rating was at the time, with the result that
Speaker 4: the bank's capital charges on that loan book would be reduced. Yeah. Right,
Speaker 4: And AIG was paid handsomely for the privilege of helping
Speaker 4: the banks do this, and mostly it was European banks.
Speaker 3: So this reminds me of something else that I want
Speaker 3: to ask you, But the decision to recapitalize AIGs so
Speaker 3: it could make good on some of these guarantees, and
Speaker 3: maybe this will be relevant to our conversation later about housing.
Speaker 3: But how much discussion was there at the time about
Speaker 3: moral hazard because I do remember the headlines about how
Speaker 3: bailing out AIG was in effect a bailout of big banks,
Speaker 3: including there was a big controversy at the time about
Speaker 3: Goldman Sachs and how much it benefited from the AIG bailout.
Speaker 3: But what was that aspect of the conversation, like.
Speaker 4: Yeah, so this let's just go back in time, Well, have.
Speaker 3: Our producers add in a little sound effect like do
Speaker 3: dig so?
Speaker 4: On September eighth, Secretary Paulson and the newly created regulator
Speaker 4: over Fanny and Freddy, the FAHFA, the Federal Housing Finance Authority,
Speaker 4: which had succeeded something called the FAO, which had done
Speaker 4: a miserable job of regulating Fanny and Freddy, put Fanny
Speaker 4: and Freddy into conservatorship on September eight, two thousand and eight. Okay,
Speaker 4: On September fifteenth, AIG's credit rating was downgraded and as
Speaker 4: a result, the massive cash collateral call was required on
Speaker 4: their derivatives book, cash they didn't have, and on September fifteenth,
Speaker 4: at midnight, Lehman Brothers filed for Chapter eleven, creating really
Speaker 4: the beginning of the widespread panic in all financial markets
Speaker 4: because of the size of Lehman brother's own derivative book,
Speaker 4: mostly the repo book right where they were both a
Speaker 4: lender and a borrower in the short term overnight repo markets.
Speaker 4: So that destabilized the financial system. And I think as
Speaker 4: a result of the impact of the Lehman filing, the
Speaker 4: New York Fed decided that to throw the largest insurance
Speaker 4: company into a receivership or rehabilitation proceeding under state law,
Speaker 4: which is where it would occur, would just creater the
Speaker 4: financial markets and accelerate the panic that occurred with Lehman.
Speaker 4: And so the New York Fed wrote the largest loan
Speaker 4: and recorded human history in favor of AIG. Seventy five
Speaker 4: billion dollars was extended to AIG in order to make
Speaker 4: sure that it did not fail right then and there.
Speaker 3: Imagine the junior lawyer whose tasked was like getting that
Speaker 3: loan signed by both parties.
Speaker 4: So AIG went through that loan within six weeks, just
Speaker 4: drew the whole thing down. And on top of that,
Speaker 4: the Fed then separately extended basically a broker dealer loan.
Speaker 4: They did clateralize lending to AIG in order to give
Speaker 4: it incremental liquidity. In October, the TARP legislation would finally passed,
Speaker 4: and that gave the Treasury Department seven hundred and fifty
Speaker 4: billion dollars of firepower to do something with. Initially, Secretary
Speaker 4: Paulson thought, and that's what he sold Congress on, that
Speaker 4: he was going to buy troubled assets off of bank
Speaker 4: balance sheets in order to create liquidity for the banks.
Speaker 4: The problem with that was the price at which you
Speaker 4: could buy those trouble assets if you were protecting the taxpayers,
Speaker 4: would reveal the deep insolvency of many of these banks
Speaker 4: if they were forced to sell their assets at highly
Speaker 4: discounted prices. So he very quickly changed course and decided
Speaker 4: to recapitalize the entire industry by buying preferred stock. And
Speaker 4: so the one hundred and thirty five billion that I
Speaker 4: talked about the Fed being into AIG for under their
Speaker 4: Emergency Lending authority under Section thirteen to three. There was
Speaker 4: a first recapitalization of that one hundred and thirty five
Speaker 4: billion dollars done in November and December of two thousand
Speaker 4: and eight after TARP passed, where fifty billion dollars of
Speaker 4: tart money was brought in to refinance out fifty billion
Speaker 4: dollars of the Fed's lending to AIG. So at that point,
Speaker 4: the FED was into AIG for call it seventy five
Speaker 4: billion dollars of senior secured loan at the parent level,
Speaker 4: and the Treasury Department owned fifty billion dollars worth of
Speaker 4: preferred stock at the parent level.
Speaker 2: I love talking about this stuff because you know, this
Speaker 2: is like where we start our career, so this is like,
Speaker 2: you know, it could go on this forever, but AIG
Speaker 2: did get cleaned up.
Speaker 4: It's fun.
Speaker 2: I always get a kick out of looking at the
Speaker 2: stock of AIG because if you just look at like
Speaker 2: a ten year chart, it looks like a normal thing,
Speaker 2: you know, like a normal stock price because it's still trades,
Speaker 2: but like on a split adjusted basis, So it's like
Speaker 2: a seventy six dollars stock right now, but because of
Speaker 2: the just gigantic dilution and the split, it was like
Speaker 2: a fourteen hundred dollars stock equivalent back then. So it's
Speaker 2: just you know, it was saved, but the equity was
Speaker 2: truly a visceery.
Speaker 4: Yeah, so I'll just take you to the end of
Speaker 4: that stock. Okay, in order to pay back the FED
Speaker 4: Yeah and pay back the Treasury, we had to downsize
Speaker 4: and de risk the company. So we did a series
Speaker 4: of asset sales over eighteen months. We sold off one
Speaker 4: of the largest consumer finance companies in the United States.
Speaker 4: We sold off the aircraft leasing business. We sold the
Speaker 4: Asian life insurance businesses. They were the largest life insurance
Speaker 4: provider in Asia, including China.
Speaker 2: They had one of the only really founded in China right.
Speaker 4: Well, they founded, but they had one of the first
Speaker 4: licenses and only persisting licenses to provide insurance by a
Speaker 4: foreign entity in China. We sold off the Middle East
Speaker 4: Life insurance operations. We sold off the European life insurance operations,
Speaker 4: and then having generated all of those asset sale proceeds,
Speaker 4: had could pay off the FED Alan and that left
Speaker 4: the Churchury preferred stock in place, and we then had
Speaker 4: to do a complete recapitalization, and as you noted, we
Speaker 4: converted the preferred into ninety two percent of the fully
Speaker 4: deluded common equity, diluting the existing common down from one
Speaker 4: hundred percent ownership to eight percent. And over the next
Speaker 4: two years and twenty twelve twenty thirteen, the Teratury Department
Speaker 4: sold off that ninety two percent of the common equity.
Speaker 4: The net result of that was all in between interest
Speaker 4: dividends and asset sale proceeds and stock sale proceeds. The
Speaker 4: Government of the United States made twenty two billion dollars
Speaker 4: on its one hundred and fifty billion dollar investment in EIG.
Speaker 2: So AIG was just one of there were many troubled
Speaker 2: institutions that floated to the surface of that time all
Speaker 2: of their troubles. AIG was a huge one, and there
Speaker 2: were those ones that went bankrupt, and then there was
Speaker 2: also Fanny and Freddy, which still exists and which still
Speaker 2: also have some sort of weird equity that I don't understand.
Speaker 2: And there was for the last fifteen or so years.
Speaker 2: There's always talking about reform, and you know, there's all
Speaker 2: these lawsuits and stuff like that. So Geitner asked you
Speaker 2: to try to figure out something with Fan what happened
Speaker 2: with that after so AIG cleaned it up, and yeah,
Speaker 2: solved that, I guess.
Speaker 4: Yeah, And by you know, the time we got the
Speaker 4: AIG recapitalization agreed and consummated in January of twenty eleven. Yeah,
Speaker 4: all that needed left to be done on that was
Speaker 4: to sell the stock we had converted the pervert into
Speaker 4: and you know, any monkey could do that. They didn't
Speaker 4: need me for that. So I went into the secretary
Speaker 4: and suggested that it was time for me to leave,
Speaker 4: having done what I came to do and was asked
Speaker 4: to do. And I had worked on a bunch of
Speaker 4: other things along the way. They've sort of all hands
Speaker 4: on deck kind of situation for the first two years. Sure,
Speaker 4: And he said, well, you know what about Fanny and Freddy?
Speaker 4: And I said, what about it? And he said, well,
Speaker 4: why did you take a look?
Speaker 3: Why don't you solve another one of our Thornias financial problems.
Speaker 4: Yeah, and there had been an ongoing interagency study group
Speaker 4: to try to figure out what to do with them,
Speaker 4: And so I looked at their twenty five volumes of
Speaker 4: work product and then came back with something not dissimilar
Speaker 4: to that which we had done with AIG. So at
Speaker 4: that time, just to sort of situate this, by twenty eleven,
Speaker 4: between Fanny and Freddy, the Treasury Department had purchased one
Speaker 4: hundred and ninety two billion dollars worth of preferred stock
Speaker 4: in the two of them, sort of one hundred and
Speaker 4: twenty and Fanny and seventy and Freddy. But so maybe
Speaker 4: it's important to the full story here is to understand
Speaker 4: how that rescue occurred, similar to the way the TAR
Speaker 4: program was ultimately deployed, where they purchase a preferred stock
Speaker 4: in effect, and if you think of what the purchase
Speaker 4: of preferred stock does for third party investors in large
Speaker 4: financial institutions, it's basically the government of the United States
Speaker 4: saying your entire liability structure, you J. P. Morgan, you,
Speaker 4: Fanny and Freddy, you b of A, you're good. Anybody
Speaker 4: who has a debt claim or a contract claim against
Speaker 4: a large financial institution that has a significant preferred stock
Speaker 4: investment from the federal government. The federal government is basically saying,
Speaker 4: you guys are money good because we're junior to you
Speaker 4: in the capital structure.
Speaker 3: This was back in the time when there was still
Speaker 3: debate about whether or not Fannie May and Freddie Mack
Speaker 3: their guarantees were the same as a government guarantee.
Speaker 4: Yeah. So, so yeah, we'll step back even further.
Speaker 2: So we're doing this episode in reverse, getting further and
Speaker 2: further back away from the time.
Speaker 4: Yeah, so Fanny and Freddie are so called government chartered.
Speaker 4: They have charters that derive from the Congress of the
Speaker 4: United States Financial Institutions, unlike JP Morgan, which is organized
Speaker 4: under state law I think in Delaware or maybe New York,
Speaker 4: because it's like an amalgamation of a series of New
Speaker 4: York banks and regulated by the FED and the FDIC
Speaker 4: who provides insurance to them. Fanny and Freddy were chartered
Speaker 4: by the federal government. Fanny actually derives back from the
Speaker 4: Great Depression. They were the first troubled asset purchase program.
Speaker 4: They were organized to purchase defaulted debt mortgage loans off
Speaker 4: the balance sheets of failing banks in the nineteen thirties,
Speaker 4: and when they purchased them, they then restructured them. They
Speaker 4: actually created the first long term mortgages in the United States.
Speaker 4: Most mortgages were of five year storation back in the
Speaker 4: nineteen thirties, and once purchased by Fanny, the way they
Speaker 4: worked out those troubled loans was to extend the maturities
Speaker 4: out first ten then eventually fifteen years in order to
Speaker 4: give the barers time to get through the depression and
Speaker 4: actually get current on their loans. So Fanny was then privatized.
Speaker 4: It was government owned corporation throughout the thirties, forties, fifties, sixties,
Speaker 4: and as the United States entered the Great Society Programs
Speaker 4: and the Vietnam War and the deficits started to blow out.
Speaker 4: With Fanny having all of that mortgage debt on the
Speaker 4: balance sheet of the United States, they needed to get
Speaker 4: it off balance sheet, so it was privatized, I think
Speaker 4: in nineteen sixty eight, so its debts were no longer
Speaker 4: consolidated with the debts of the United States federal government.
Speaker 4: And then Freddy was formed in nineteen seventy because the
Speaker 4: savings and loan industry thought, you know, they needed access
Speaker 4: to the securitization market, just as the big banks who
Speaker 4: were basically the customers of Vennie May. So you had
Speaker 4: now two entities in effect buying mortgages, creating a secondary
Speaker 4: market for mortgage credit that banks originated. So JP Morgan
Speaker 4: would originate alone. As long as it met Fanny or
Speaker 4: Freddy's criteria that the loan was at least had twenty
Speaker 4: percent equity, that it didn't exceed a certain principal amount,
Speaker 4: JPM could sell it to Fanny or Freddy. So they
Speaker 4: were secondary market purchasers and ultimately in the nineteen eighties
Speaker 4: when the securitization market was first developed, and that there
Speaker 4: was a lot I was actually a lawyer at a
Speaker 4: law firm that pioneered the securitisation market at that time.
Speaker 4: There are a lot of legal issues that had to
Speaker 4: be solved to create a trust into which mortgages could
Speaker 4: be dumped and securities issued against the cash flows of
Speaker 4: that pool of mortgages, and that market really was pioneered
Speaker 4: and developed in the nineteen eighties. Then Fanny and Freddy,
Speaker 4: as the owner of large amounts of mortgages, thereby could
Speaker 4: create liquidity for themselves by selling mortgage securities mortgage backed
Speaker 4: securities mbs and actually are mbs residential mortgage backed securities
Speaker 4: to institutional investors and thereby do it all over again
Speaker 4: provide incremental liquidity to the banking industry for the mortgages
Speaker 4: they were originating.
Speaker 3: Just to be clear, those bonds came with a guarantee
Speaker 3: from Fanny and Freddy that they guaranteed principal and interest payments.
Speaker 4: Of principle and interest on those bonds, okay.
Speaker 3: And there was a debate pre two thousand and eight
Speaker 3: about whether or not that guarantee was like effectively the
Speaker 3: same as the US government guarantee those bonds.
Speaker 4: So how did the market infer that it was as
Speaker 4: good as treasuries that the bonds guaranteed by Fanny and Freddie.
Speaker 4: So there were two essential elements of the quote implied guarantee.
Speaker 4: One was they were federally chartered. Right, they were originally
Speaker 4: instruments of the United States government, agencies of the United
Speaker 4: States government federally charted, so in a sense they were
Speaker 4: children of the federal government, even though they were privatized
Speaker 4: and owned by you know, private equity investors. Because they
Speaker 4: were federally chartered, the bond market thought, well, the government
Speaker 4: of the United States, you know, has ownership of these
Speaker 4: one way or another. Separately, in their charters, they had
Speaker 4: authorization to borrow two and a half billion dollars from
Speaker 4: the Treasury Department in a pinch. Now, just to size
Speaker 4: that up a little bit. By the time I'm of
Speaker 4: the financial crisis, Fanny had probably three trillion dollars of
Speaker 4: outstanding mortgage security guarantees and Freddie probably two trillion of outstanding,
Speaker 4: So each of them could borrow for their liquidity needs
Speaker 4: two and a half billion dollars from the federal government.
Speaker 4: So that was a drop in the bucket in terms
Speaker 4: of what their liquidity needs might be compared to the
Speaker 4: outstanding liabilities they had. But nonetheless, investors believe that that
Speaker 4: meant between the Federal Charter and the right to borrow
Speaker 4: from the Treasury Department two and a half billion dollars,
Speaker 4: that somehow there was a guarantee by the federal government
Speaker 4: of these securities.
Speaker 2: This is so useful because I've always sort of known this, like, oh,
Speaker 2: there was an implied guarantee, but I didn't actually know
Speaker 2: that there were two specific underpinnings of where this implication
Speaker 2: came from.
Speaker 4: That's where it came from.
Speaker 2: So then it actually has some sort of real bank.
Speaker 4: So we're now in two thousand and eight. In the
Speaker 4: summer of two thousand and eight, the Congress in the
Speaker 4: United States passed the Housing and Economic Recovery Act of
Speaker 4: two thousand and eight, which was basically a complete redo
Speaker 4: of the regulatory arrangements around Fanny and Freddy. A new
Speaker 4: regulator was created, the Federal Housing Finance Authority, that succeeded
Speaker 4: the former regulator, which had proven to be weak, and
Speaker 4: its authorities were buttressed it was given authority to place
Speaker 4: Fanny and Freddie into receivership or into conservatorship, receivership being
Speaker 4: a liquidation preceding conservatorship being a conservatorship to conserve its
Speaker 4: operations and assets, and the Treasury Department, under HERA and
Speaker 4: the Housing and Economic Recovery Act of two thousand and eight,
Speaker 4: was given authority to purchase preferred stock in order to
Speaker 4: ensure the solveignty of Fanny and Freddy.
Speaker 2: So the implication became real or the yeah, that was
Speaker 2: the moment that it was no longer ambiguous exactly.
Speaker 4: And when Paulson went to the Congress to ask for
Speaker 4: this authority, he said, look, if I have a howitzer,
Speaker 4: I won't have to use it. But shortly thereafter he
Speaker 4: had to use it, and September eighth of two thousand
Speaker 4: and eighty the conservatorships were created, and very quickly, by
Speaker 4: the first quarter of two thousand and nine, the preferred
Speaker 4: stock authority the Treasury had was deployed and the first
Speaker 4: big draws on that, and ultimately by the end of
Speaker 4: twenty ten, one hundred and ninety two billion dollars of
Speaker 4: preferred stock had been put into the two entities. Now
Speaker 4: the markets were covered. Right in twenty eleven, the equity
Speaker 4: market took off, and you know, May of two thousand
Speaker 4: and nine after the stress tests were announced and the
Speaker 4: interbank market sort of recovered. By the end of two
Speaker 4: thousand and nine, they were the banks started to trust
Speaker 4: each other again and lend to each other overnight.
Speaker 3: You still didn't have private label mbs, right.
Speaker 4: And you still don't know that market is almost completely dead.
Speaker 3: I have to say my expertise in housing finance ends
Speaker 3: in twenty fifteen when I left the FT and I
Speaker 3: came to Bloomberg. However, as far as I can tell,
Speaker 3: not much has changed since twenty fifteen, So the gsees
Speaker 3: are still under conservatorship. You still don't have much private
Speaker 3: label mbs. There used to be proposals for sorting out
Speaker 3: housing finance, but I don't even see those that much anymore.
Speaker 4: Yeah, So let me give you the macroh because it
Speaker 4: goes to the housing supply issues. So if you took
Speaker 4: the aggregate market capitalization of the public equity markets in
Speaker 4: the United States, that's about fifty trillion dollars. If you
Speaker 4: took the aggregate value of the housing stock, the residential
Speaker 4: housing stock in the United States is about fifty trillion dollars.
Speaker 4: That's the house value. There's twelve trillion dollars of mortgage
Speaker 4: debt outstanding against that fifty trillion dollars of house value.
Speaker 4: And of that twelve trillion dollars, seven is on the
Speaker 4: balance sheet of Fanny and Freddy Is guarantees of mortgage
Speaker 4: backed securities. Those are mortgages. Seven trillion of that twelve
Speaker 4: has been securitized by Fannie May and FREDDIEMAC and guaranteed
Speaker 4: by them. Another two trillion is on the balance sheet
Speaker 4: of another government sponsored entity called Ginny May, which is
Speaker 4: controlled by the federal government, and it securitizes faj and
Speaker 4: Veterans Authority Administration loans. So there's about two trillion there.
Speaker 4: So when you add it up, of the twelve trillion
Speaker 4: dollars of mortgage credit risk that is out there against
Speaker 4: the housing stock of the United States, nine trillion is
Speaker 4: on Fannie MAE, FREDDIEMAC, and Ginny May's balance sheets. So
Speaker 4: the government basically is the biggest player in the mortgage
Speaker 4: finance market. None of these entities originate mortgages. That's all
Speaker 4: done by non banks and banks, but most of the
Speaker 4: mortgage credit risks resides on the balance sheets of one
Speaker 4: of these three entities.
Speaker 2: So we have to get to the present tense. Although
Speaker 2: again you talk about this for three hours, but before
Speaker 2: we just do because this is I think the last
Speaker 2: step in understanding how we got to this point. Just
Speaker 2: describe real quickly the current institutional and economic arrangement of
Speaker 2: Fanny and Freddy. Because there is this like little stub
Speaker 2: equity that trade. I think all the profits that they
Speaker 2: may go to the government. There's all kinds of lawsuits.
Speaker 2: But what is the form that they exist as today?
Speaker 4: Okay, so the good news is the two entities have
Speaker 4: been substantially reformed during this sixteen year conservatorship. One of
Speaker 4: the biggest problems that they faced in two thousand and
Speaker 4: eight was that they had become a huge buyer. Not
Speaker 4: only they have this guarantee business where they guarantee mortgage
Speaker 4: backed securities that are securitized out to institutional investors, but
Speaker 4: they also had a huge portfolio investments where they borrowed
Speaker 4: money at basically a slight premium to treasuries, so they
Speaker 4: could fund a portfolio very cheaply, and they went out
Speaker 4: and bought not so much the subprime private label securities,
Speaker 4: but they bought all day, which was the sort of
Speaker 4: next step, right exactly, So they bought a lot of
Speaker 4: all day and they made it was a huge carry trade.
Speaker 4: They were making a huge spread on those portfolios. Their
Speaker 4: portfolios exceeded a trillion dollars combined between the two of them,
Speaker 4: and that's how they were juicing their earnings in two
Speaker 4: thousand and four, five, six, and seven, as the subprime
Speaker 4: securitization market was taking market share away from the prime
Speaker 4: or conventional securitization market that they ran. So during the
Speaker 4: course of the conservative ships, the portfolios have been wound
Speaker 4: down to the point where they're really now just transaction
Speaker 4: portfolios where they borrow money to buy mortgages off bank
Speaker 4: balance sheets before they can securitize them and repay that borrowing.
Speaker 4: So the portfolios are down to, you know, one hundred
Speaker 4: and fifty billion, you know, or two hundred billion at
Speaker 4: most between the two of them, from the trillion dollars
Speaker 4: they were coming at the beginning of the financial crisis.
Speaker 4: So that's a major reform that's gone on. They've also
Speaker 4: new capital standards have been imposed by their regulator and conservator.
Speaker 4: The SHFA, and they are slowly through retained earnings recapitalizing
Speaker 4: and building capital. So today I Fannie MAE has eighty
Speaker 4: billion dollars of capital on its balance sheet and Freddy
Speaker 4: probably has fifty billion. But they're still from a regulatory
Speaker 4: capital point of view, under capitalized. They need more capital
Speaker 4: based on the capital rule that was created to govern
Speaker 4: them during the concern readership. So how did they even
Speaker 4: get to the point where they could and conservership have
Speaker 4: that much capital as they have today in twenty twelve,
Speaker 4: I believe it was after I was gone from the
Speaker 4: Treasury Department. The Treasury Department changed the deal and instead
Speaker 4: of a fixed dividend on that one hundred and ninety
Speaker 4: two billion dollars worth of preferred stock, it became a
Speaker 4: so called profit sweep, so whatever profits they made went
Speaker 4: to the Treasury Department. And by twenty nineteen, seven years later,
Speaker 4: after the profit sweep was instituted and over which there's
Speaker 4: much litigation pending by existing shareholders, then existing shareholders. By
Speaker 4: twenty nineteen, when the profit sweep was suspended, the Governor
Speaker 4: of the United States received three hundred and two billion
Speaker 4: dollars worth of dividends so they made one hundred and
Speaker 4: ninety two billion dollar investment. The Treasury Department's already received
Speaker 4: three hundred and two billion backs. They've made more than
Speaker 4: one hundred billion. They've way out done my AIG profits.
Speaker 4: But it was suspended. So the Secretary Manuchin, President Trump's
Speaker 4: former President Trump's Secretary of the Treasury, determined he was
Speaker 4: going to try to recapitalize them and actually end the conservatorship,
Speaker 4: and towards the end of that goal, he suspended the
Speaker 4: profit sweep so they could build capital. And these two
Speaker 4: entities have become fabulously profitable. Fanny makes you know, on average,
Speaker 4: over the last four or five years, has been making
Speaker 4: net after tax, net after a special charge that was
Speaker 4: created as a pay for for an offset of one
Speaker 4: of the Trump tax cuts. After all of that special
Speaker 4: assessment against their income and after tax, they're making sort
Speaker 4: of fifteen billion dollars a year, and Freddy's making about
Speaker 4: eight or nine bi million a year.
Speaker 2: Fanny the equity is worth eight billion dollars total. So
Speaker 2: you could see why private investors would love some legal
Speaker 2: ruling that gives them access to these profits.
Speaker 4: Yeah, well, let's talk. It's not that's a little misleading. Okay, sorry,
Speaker 4: So what is the Treasury Department own It owns one
Speaker 4: hundred and ninety two billion. It's actually more because of
Speaker 4: the way it accretes. But they own a one hundred
Speaker 4: and ninety two billion dollars for their one hundred and
Speaker 4: ninety two billion dollars an investment of senior preferred stock.
Speaker 4: Under that is about thirty two billion of junior preferred
Speaker 4: stock that third party investors own.
Speaker 2: Okay.
Speaker 4: And these are most of the guys who were litigating,
Speaker 4: funding the lawsuits against the various actions that were taken
Speaker 4: both to start the conservatorship and during the conservativeship, like
Speaker 4: the profit sweep, and under that is the common stock,
Speaker 4: but the common stock that trades only represents twenty percent
Speaker 4: of the fully deluded equity because on top of the
Speaker 4: senior preferred stock, the Treasury Department has a penny warrant
Speaker 4: that can be exercised for one penny to buy seventy
Speaker 4: nine percent of the stock of each entity. Okay, And
Speaker 4: this is very similar actually to the way AIG was
Speaker 4: set up. The tart money went in as senior preferred,
Speaker 4: but we also had a warrant entitled the Treasury Department
Speaker 4: to seventy nine percent of the stock. So today the
Speaker 4: stock that trades really represents only twenty percent of the
Speaker 4: total captainization.
Speaker 1: Got it.
Speaker 4: But still the equity account is teeny because why is
Speaker 4: it teeny? Because you have that huge senior preferred stock
Speaker 4: that sits above all of the junior preferred and the
Speaker 4: senior preferred and the common Okay.
Speaker 3: I'm going to resist the temptation to ask more questions
Speaker 3: about the design of like the capital stack of some
Speaker 3: of these things. But let's go back to the beginning
Speaker 3: of this conversation about how do we increase housing supply
Speaker 3: in the US. So we are already in a situation
Speaker 3: where as you mentioned, nine of the twelve trillion I
Speaker 3: think it was, mortgages outstanding in the US effectively reside
Speaker 3: on the balance sheet of government sponsored entities. So what
Speaker 3: more can these agencies do to support the housing market?
Speaker 3: What more would you ask of them?
Speaker 4: Yes? Well, all right, so let's begin with the limitation
Speaker 4: under which they operate. So, in order to protect the
Speaker 4: banking industry's franchise to make mortgages, to originate mortgages, these
Speaker 4: entities are barred from being in the primary market. They
Speaker 4: couldn't go out and start lending to developers directly. But
Speaker 4: just as they do in the residential mortgage market and
Speaker 4: as they do in the multifamily mortgage market, they could
Speaker 4: create a secondary market for construction loans and thereby increase
Speaker 4: liquidity in the construction finance market. And if you look
Speaker 4: today at the real constraints on supply as a result
Speaker 4: of the inflation problems we've had over the last couple
Speaker 4: of years, and they fed interest rate hiking, the construction
Speaker 4: finance has become incredibly expensive. But not only. The other
Speaker 4: impact of high interest rates is that cap rates for
Speaker 4: once a project is completed, because the financing costs are
Speaker 4: so much more expensive, the projects have less value to
Speaker 4: the equity owners, and so that market is almost frozen.
Speaker 4: There's been a surge of multi family constructions post pandemic,
Speaker 4: so in cities like Austin, rents are actually starting to
Speaker 4: come down because there were so many people moving to
Speaker 4: Austin and like communities that multifamily developers went in before
Speaker 4: the interest rate hikes and started projects, And the supply
Speaker 4: constraints in some markets are being eased by a surge
Speaker 4: of multifamily construction. But that's not true in all markets.
Speaker 4: There is real supply demand and balance, and the only
Speaker 4: way depends on who you talk to, but there's a
Speaker 4: shortage of supply of somewhere between a million to five
Speaker 4: million units is the best estimates I've seen nationwide. So
Speaker 4: you know that on the margin, right, when supply and
Speaker 4: demand are out of balance like that, you get the
Speaker 4: enormous house price and rent price increases. And that's what
Speaker 4: we've seen over the last post pandemic period. There's been
Speaker 4: a huge surge in house prices and huge surge and
Speaker 4: rents because there's just more demand than there is supply
Speaker 4: to meet it. So going back to what these entities
Speaker 4: could do again, I want to just take one further
Speaker 4: step back. Sure, what does a federal government do today
Speaker 4: to try to augment the supply of housing. Well, they
Speaker 4: have a bunch of demand side programs, which you would
Speaker 4: say today are counterproductive. We've got more demand than we
Speaker 4: can handle. But the government subsidizes demand in a variety
Speaker 4: of ways, in part by making cheap mortgage credit widely
Speaker 4: available through the government sponsored entities, and through programs for veterans,
Speaker 4: and through programs for first time home buyers and lower
Speaker 4: middle income persons. Through the FAJA and through a rental
Speaker 4: voucher program administered by HUD. They also on the supply
Speaker 4: side provide. There's a tax credit program, the Low Income
Speaker 4: Housing Tax Credit Program, which is subject to annual appropriations
Speaker 4: by Congress and is one of the most incredibly cumbersome
Speaker 4: bureaucredit processes. To get your hands on these tax credits,
Speaker 4: they get allocated by HUD to the state finance agencies.
Speaker 4: The state finance agencies set up programs to qualify for
Speaker 4: those tax credits for new projects. But if you have
Speaker 4: the patients and the lawyers to do the paperwork, and
Speaker 4: you can go through the competitive bidding process, you can
Speaker 4: get a tax credit that can basically foot the bill
Speaker 4: of new construction. About somewhere between twenty five to fifty
Speaker 4: percent of the cost of new construction is basically being
Speaker 4: subsidized through the tax code of the United States the
Speaker 4: sale of tax credits. So a developer can build a project,
Speaker 4: all the tax credits to somebody who needs them, and
Speaker 4: offload about twenty to fifty percent of the construction costs.
Speaker 4: But that's it. That's what the federal government does today.
Speaker 4: I think a much more efficient way would be to
Speaker 4: create a new finance program somewhere in the federal government
Speaker 4: to provide mezzanine financing. Then how could we do this
Speaker 4: and why mezzanine financing? Right, So, if you want to
Speaker 4: build a new apartment building, or you want to build
Speaker 4: a house, if you put up forty percent, you as
Speaker 4: the builder or developer, put up forty percent of the
Speaker 4: construction cost. You can get a loan for sixty percent
Speaker 4: of the construction costs from a bank, so your equity
Speaker 4: is levered one and a half to one sixty forty.
Speaker 4: If the government were to provide twenty percent of the
Speaker 4: construction cost and a mezzanine financing, so you could still
Speaker 4: get sixty percent senior debt because the mezzanine would be
Speaker 4: expressly subordinated. It's the equivalent of equity from a senior
Speaker 4: lenders born in view. But now the equity holder, the developer,
Speaker 4: only has to put up twenty percent. It's like a
Speaker 4: conventional mortgage. Right, you put twenty percent down, you get
Speaker 4: an eighty percent loan. So here the government could actually
Speaker 4: expand financing for new construction and thereby lever the equity
Speaker 4: of the developer for to one rather than traditionally one
Speaker 4: and a half to one, and if the government were
Speaker 4: to pass on its own relatively cheap borrowing costs as
Speaker 4: opposed to what the market would charge for mezzanine financing,
Speaker 4: the developers and we've done this math, could build affordable housing,
Speaker 4: you know what qualifies as affordable housing and still earn
Speaker 4: the same kinds of return on equity that they earn
Speaker 4: from market rate housing. So it would create a massive
Speaker 4: incentive to build new supply for where it's really needed.
Speaker 2: Let's hear the math both in terms of why affordable
Speaker 2: housing be comes more profitable under this, and then also
Speaker 2: the math of like how many units we're talking about
Speaker 2: potentially this could unlock.
Speaker 4: Yeah, so this is you know, private equity guys who
Speaker 4: listen to you will understand. Gals will understand this. Right,
Speaker 4: So if you're levering your equity four times, yeah, you
Speaker 4: can effectively earn the same rate of return building lower
Speaker 4: priced units.
Speaker 2: It makes sense.
Speaker 4: I mean, the math is pretty straightforward. And I tested
Speaker 4: this out with a variety of multifamily developers directly and
Speaker 4: just said, hey, you know, if the government had a
Speaker 4: mezzanine financing program, could you build to eighty percent ami
Speaker 4: average median income? What's affordable in government parlance, is someone
Speaker 4: earning eighty percent of area median income if their rent
Speaker 4: cost is only thirty percent or less of that, right, AMI,
Speaker 4: that's affordable. And so we tested this with a series
Speaker 4: of the large multi family developers, and you know that
Speaker 4: they're if they could lever their equity four to one
Speaker 4: with cheap mezzanine financing, they could build to those metrics.
Speaker 4: I want to give you some more numbers, system.
Speaker 2: No, I love it. We're here for numbers.
Speaker 4: Yeah, yeah, just to impress upon you how small. The
Speaker 4: federal government's role in housing other than through the mortgage
Speaker 4: markets is HUD, the Housing and Urban Development Agency, which
Speaker 4: was created in nineteen seventy four to deal with urban
Speaker 4: renewal because the inner cities were falling down in the
Speaker 4: nineteen sixties. It's total budget today for new housing, for playgrounds,
Speaker 4: for urban renewal. Its total budgets is about four billion dollars.
Speaker 4: The military budget, just by contrast, is eight hundred billion dollars.
Speaker 4: So we're investing eight hundred billion dollars in our national
Speaker 4: defense and four billion dollars in housing an urban renewal.
Speaker 4: And now we are also have the tax credit program,
Speaker 4: and the tax credit program is responsible for building about
Speaker 4: one hundred and ten thousand new units a year, which
Speaker 4: is big. But if we have a five million unit shortfall,
Speaker 4: if that alone is not going to fill that shortfall,
Speaker 4: to take you fifty years to fill that shortfall at
Speaker 4: that level of subsidy, a mezzanine financing program put aside
Speaker 4: for the moment where we would do that. Who could
Speaker 4: do it? A mezzanine financing program, which would be basically
Speaker 4: a revolving loan program, right, because we're talking about construction finance,
Speaker 4: that would be taken out the way construction is done. Right,
Speaker 4: get you finance the construction. As soon as the construction's done,
Speaker 4: the buildings leased up, you get takeout financing because you
Speaker 4: now have a stable set of cash flows from rent
Speaker 4: payments coming in on the property. And therefore a different
Speaker 4: set of lenders will give you longer term financing, including
Speaker 4: Fanny and Freddy who do take out financing for new construction.
Speaker 4: So if there were a mezzanine lending program at the
Speaker 4: federal level, generally it's three to five years from permitting
Speaker 4: to completion on a new apartment development of any size,
Speaker 4: so that mezzanine loan would get taken out and could
Speaker 4: go right back and do it again. It'd be a
Speaker 4: revolving loan program. So it's a it's not a one off,
Speaker 4: it's not a one off, and it's also not a
Speaker 4: continuing hit to the federal budget. So from a deficit
Speaker 4: point of view, this is a one time capitalization and
Speaker 4: you've done, and now you have a program, depending on
Speaker 4: its size, that can make a major impact on new
Speaker 4: supply of new housing. So just to size it, if
Speaker 4: there were one hundred billion dollars of mezzanine lending authority,
Speaker 4: and so twenty billion dollars a year, because it takes
Speaker 4: five years from permitting to construction, so we'd put out
Speaker 4: twenty billion a year in effect in a revolving So
Speaker 4: in year six you get the year one loan paid back.
Speaker 4: You put it back to work in year six, so
Speaker 4: twenty billion a year, and that twenty billion is twenty
Speaker 4: percent of the total construction cost. So you're now facilitating
Speaker 4: or turbot charging one hundred billion dollars of new construction
Speaker 4: a year. One hundred billion dollars of new construction a
Speaker 4: year would get you two hundred and fifty to four
Speaker 4: hundred thousand new units a year, which means that one
Speaker 4: to five million dollar housing shortfall unit shortfall could be
Speaker 4: filled over the five year period.
Speaker 3: So just on this point, I'm sold. Okay, wait, I'm
Speaker 3: going to ask all the Devil's advocate questions then, So
Speaker 3: I understand the role of leverage in this. However, given
Speaker 3: the history of two thousand and eight, I think people
Speaker 3: here leverage in the housing market and maybe start to
Speaker 3: get a little bit nervous. How risky are those construction
Speaker 3: loans because I assume, you know, in twenty twenty three,
Speaker 3: I think there was a drop of like forty percent
Speaker 3: in construction financing. I assume there's a reason for that,
Speaker 3: and it's either, you know, banks being reticent to extend
Speaker 3: this type of credit, or maybe they're constrained by higher
Speaker 3: capital charges around this particular issue, or maybe it's simply
Speaker 3: that with the interest rate uncertainty, the numbers don't pencil out,
Speaker 3: and so it's not that the loans themselves are inherently risky.
Speaker 3: It's the idea that the US government could effectively hold
Speaker 3: them through the cycle of interest rates. But can you
Speaker 3: talk a little bit more about what risk the US
Speaker 3: government would be taking on its balance sheet if we
Speaker 3: were to do this.
Speaker 4: Yeah. So the way I look at this is, if
Speaker 4: the standards that Fanny and Freddy now operate under for
Speaker 4: their mortgage purchases, right, they buy mortgages from banks, Those
Speaker 4: mortgages have to meet certain basic criteria both in terms
Speaker 4: of the DTIs of the borrower, the debt service to
Speaker 4: total income of the borrower that the mortgage represents, and
Speaker 4: the loan to value. So Fanny and Freddy can't buy
Speaker 4: a mortgage that has a loan to value higher than
Speaker 4: eighty percent, Right, So you've got to put as a
Speaker 4: new home buyer, you got to put twenty percent down
Speaker 4: in order to get a mortgage that ultimately ends up
Speaker 4: on Fanny and Freddy's books. Now there's some exceptions to that,
Speaker 4: but ninety five percent of the mortgage credit that's on
Speaker 4: their books is on that basis of twenty percent equity
Speaker 4: eighty percent down. Their history over their lives on those
Speaker 4: kinds of mortgages, in terms of credit, losses are negligible.
Speaker 4: Obviously in the cycle, you know, in a massive downturn
Speaker 4: like we had in two thousand and eight, you're going
Speaker 4: to have you know, a higher rate of delinquency and default.
Speaker 3: But no, I think even in two thousand and eight, multifamily.
Speaker 4: Yeah, the multi family books was fine, was fine. So generally,
Speaker 4: as long as we have a growing population, you're going
Speaker 4: to have increased demand for housing, right, I mean, if
Speaker 4: the population started to strengthen, the holder of a construction
Speaker 4: loan on the other end of that five year construction
Speaker 4: period might face a market that's very soft. But we
Speaker 4: have a growing population. Even though you know, we're only
Speaker 4: adding half a million people a year by way of birth,
Speaker 4: We're you know, adding a couple of million people a
Speaker 4: year by way of immigration, legal and illegal. But nonetheless
Speaker 4: we have a growing population, and therefore you could expect
Speaker 4: the housing market it'll have ups and downs based on
Speaker 4: you know, interest rates and the like. And location. Location,
Speaker 4: location is important for housing always. But I think with
Speaker 4: twenty percent equity underneath the government, the risk of you know,
Speaker 4: a mezzanine lending program are very manageable.
Speaker 3: Why don't banks do more construction loans?
Speaker 4: They do, but they do it only up to sixty percent.
Speaker 4: There is a mezzanine market, but the mezzanine market is
Speaker 4: expensive and liquidity constrained. And get another five percent of
Speaker 4: your construction costs, but that's going to cost you twelve
Speaker 4: to eighteen percent, and that's eating into the equity holder's
Speaker 4: rates of return.
Speaker 2: So we already know that there are all kinds of
Speaker 2: legal fights going on with the Fanny and Freddy already,
Speaker 2: and you're sort of introducing a new market for them
Speaker 2: or your idea that has never existed. So there are
Speaker 2: sort of two things. One, you mentioned that in residential mortgages,
Speaker 2: you know, they don't go out and extend alone. They
Speaker 2: buy a loan from a bank. Yeah, and so it
Speaker 2: sounds like that in this case. So a they're entering
Speaker 2: a new space, or they would be entering a new
Speaker 2: space mezzanine lending for multifamily, and it sounds like there
Speaker 2: would be a direct interface.
Speaker 4: No, they're charters, those federal charters that created the implied guarantee.
Speaker 4: Those federal charters prohibit them from so they would be entering. Okay,
Speaker 4: so it have to be a secondary market, got it right.
Speaker 4: But if I'm JP Morgan, Yeah, and I know I
Speaker 4: can dump this mezzanine loan that I wrote to Fanny
Speaker 4: May as long as it meets Fanny May's criteria. I
Speaker 4: can sell it immediately to Fanny may delf Spread Dell
Speaker 4: write that loan.
Speaker 2: I have to imagine there are other legal questions, and
Speaker 2: you mentioned your lawyer, but you know you can always
Speaker 2: get multiple opinions from multiple lawyers. So when you are
Speaker 2: talking about these ideas, are there any concerns about is
Speaker 2: this actually allowed?
Speaker 4: Yeah, so let's talk about the necessary steps. Okay, Right today,
Speaker 4: they don't do construction lending, so the capital rule that
Speaker 4: was developed for them during conservatorship does not address what
Speaker 4: the capital charge for a construction loan would be, particularly
Speaker 4: a mezzanine construction loan, So that would have to be
Speaker 4: developed and promulgated and passed by the regulator. It'll take
Speaker 4: a little time, but it's not rocket science because banks
Speaker 4: do construction lending, and there's a bank capital rule for
Speaker 4: construction lending that the regulator for Fanny and Freddy could
Speaker 4: borrow from and use as a model and a precedent,
Speaker 4: but nonetheless a capital rule would have to be created.
Speaker 4: I think there's very little question whether Fanny could create
Speaker 4: a secondary market and construction loans, because in fact, they
Speaker 4: did some of that back in the nineteen eighties. So
Speaker 4: there's actual precedent for them in construction loans. In the
Speaker 4: case of Freddie, there's probably a better argument that you know,
Speaker 4: a more conservative lawyer than me who's really being an
Speaker 4: advocate on this, might say that Freddie might be constrained
Speaker 4: and doing construction lending on a secondary market basis. But
Speaker 4: the truth is that, you know, the Congress of the
Speaker 4: United States recognizes it broadly. There's bipartisan recognition that we
Speaker 4: got a housing supply problem in the United States. So
Speaker 4: even if you don't use Fanny and Freddie's vehicles, you know,
Speaker 4: the hardest thing in America to do today is get
Speaker 4: a piece of legislation pass. So I'm not you know
Speaker 4: of some wild eyed optimist about the ability to create
Speaker 4: a new federal financing bank to do this. But the
Speaker 4: problem on housing is so great, and it's so widespread
Speaker 4: across red states and blue states and purple states alike,
Speaker 4: rural communities and cities alike, that I actually think if
Speaker 4: you went to the Congress and said, hey, guys, let's
Speaker 4: start small and see if it works. Let's start fifty
Speaker 4: billion and against a seven trillion dollar budget, could they
Speaker 4: not find fifty billion dollars to augment housing supply in America.
Speaker 4: I think they're probably could I think.
Speaker 3: You possibly anticipated my next question with the wild eyed
Speaker 3: optimist comment just then, But why do we have to
Speaker 3: make it so complicated? So there are restrictions on the
Speaker 3: gsees doing direct flending into the mortgage market, but what
Speaker 3: they're effectively doing is using their balance sheet and their
Speaker 3: credit rating, and their association with the US government and
Speaker 3: their subsequent cheap capital costs to subsidize these mortgages effectively.
Speaker 3: So why not just go whole and have them extend
Speaker 3: the finance.
Speaker 4: Tracy, I'm with you. I'll bring you to the next
Speaker 4: meeting down with Dacy.
Speaker 3: It's just politically infeasible.
Speaker 4: No, no, it's not. I think it's well. First of all,
Speaker 4: this idea is getting traction at the state level, right
Speaker 4: the number of the state housing finance agencies are starting
Speaker 4: to do this, recognizing the constraints on developers.
Speaker 2: We did an episode about the Montgomery County.
Speaker 4: Exactly, and the Massachusetts Housing Finance Agency is now gotten
Speaker 4: authority from the Massachusetts legislature to do some of this
Speaker 4: lending as well. So this is catching on. I mean, people,
Speaker 4: this isn't you know, I didn't invent this. There are
Speaker 4: a variety of people who have thought this mezzany lending
Speaker 4: by state or federal agencies could help lever developer equity
Speaker 4: and augment the supply or turbertize the supply of new housing.
Speaker 4: But I think even at the federal level this is
Speaker 4: getting some interest. The problem is we're an election season, right,
Speaker 4: and try as we might get new initiatives passed by
Speaker 4: an existing administration. You know, they're a little diverted on
Speaker 4: getting re elected.
Speaker 2: Hey, have all this stuff going on. So, just to
Speaker 2: be clear than on this, right, there are theoretically multiple
Speaker 2: ways that the US government could use its borrowing authority
Speaker 2: or its lending capacity to facilitate this. It doesn't necessarily
Speaker 2: have to be through Fanny and Freddy. But if it
Speaker 2: were through Fanny and Freddy, would that require legislation or
Speaker 2: who so, why don't you walk us through that component?
Speaker 4: Yeah?
Speaker 2: So would have to make a decision, And how would
Speaker 2: they go about making the decision where these existing banks,
Speaker 2: under their existing rules now enter a new market.
Speaker 4: Yeah? So in conservatorship, Yeah, Fanny and Freddy are effectively
Speaker 4: there's joint control over them by their conservator, the Federal
Speaker 4: Housing Finance Agency for the person of the executive director
Speaker 4: of that agency and by the Treasury Department, because the
Speaker 4: Treasury Department has one hundred and ninety two billion dollars
Speaker 4: into them and a senior preferred stock that has a
Speaker 4: series of covenants. So both the Treasury Department and the
Speaker 4: FHFA would have to authorize this. The FHFA would have
Speaker 4: to create a capital rule for construction lending, and the
Speaker 4: Treasury Department would have to consent to the use of
Speaker 4: their borrowing capacity, their ability to create a portfolio of loans.
Speaker 4: Would have to consent to them building a portfolio of
Speaker 4: mezzanine construction loans. But the Congress has nothing to say.
Speaker 4: I mean, they could intervene if they thought this was
Speaker 4: a stupid idea or they wanted to do it separately
Speaker 4: away from Fanny and Freddy. But as I said, but
Speaker 4: they are not necessary, they are not for this. Yeah,
Speaker 4: So this is so. When HERA was passed in two
Speaker 4: thousand and eight, it created authority to create the conservatorships
Speaker 4: and end the conservatorships. You know, the purpose of the
Speaker 4: conservator ships was to restore the safety and soundness of
Speaker 4: the entities, and the safety and soundness of these entities
Speaker 4: has been restored. They need more capital to meet the
Speaker 4: needs of their capital rule. But they could raise that
Speaker 4: capital as they were doing now by retaining their earnings
Speaker 4: which are substantial, and building more capital. They could raise
Speaker 4: that capital by accessing the public markets and doing reipos
Speaker 4: if they were released from conservatorship. Congress is an unnecessary party.
Speaker 4: The Congress has already authorized the release from conservatorship, subject
Speaker 4: to meeting the standards that Congress laid out in two
Speaker 4: thousand and eight, and with regard to the creation of
Speaker 4: a new product, which is what this would be for
Speaker 4: the two entities to create a secondary market in mezzanine lending.
Speaker 4: That doesn't require Congress. That requires the authorization of the
Speaker 4: Treasury Department to permit their portfolio to be used for
Speaker 4: this purpose, and the FHFA as conservator and as regulator.
Speaker 4: So this is something that could be done by so
Speaker 4: called administrative action.
Speaker 2: We don't know who's going to win in November, and
Speaker 2: you mentioned that when Trump was the president, before Minuchin
Speaker 2: had started to make some steps, including ending the SWEEP
Speaker 2: to recapitalize it and essentially make it a properly for
Speaker 2: profit entity. Again, if that were to happen at some
Speaker 2: point under a theoretical second Trump administration, would that preclude
Speaker 2: this avenue or there would be no constraint this under
Speaker 2: a different Yeah, it doesn't have to be under conservatorship
Speaker 2: for this to happen.
Speaker 4: This could be done under conservatorship by administrative action and
Speaker 4: the cooperation between Treasuring and the FHIFA. It could also
Speaker 4: be done post conservatorship. If the capital rule permits it,
Speaker 4: the regulator then not the conservator were to permit it, okay.
Speaker 4: And you know, it seems based on what I've heard
Speaker 4: about what the second Trump administration would do, I think
Speaker 4: ending the Conservative ships is something that a new Trump
Speaker 4: administration would pursue. Trump actually submitted after in one of
Speaker 4: the litigations, he submitted an affidavit saying I would have
Speaker 4: done this had I, you know, not run out of time.
Speaker 4: And you know, the Biden administration, We've had sixteen years
Speaker 4: of conservatorships, twelve of them have been under democratic administrations.
Speaker 4: The Democrats haven't shown a real appetite to end the conservatorships.
Speaker 4: That seems to me the policy crowd around the Democrats
Speaker 4: seem to, you know, like having these as direct instruments
Speaker 4: of policy and under the thumb of the Executive Director
Speaker 4: and the Treasury Department. But I think even the group
Speaker 4: of policy advisors around the Democrats and the housing finance
Speaker 4: policy complex, I think even they're coming to recognize that
Speaker 4: a permanent conservatorship, which is kind of a limbo state,
Speaker 4: is really not ideal, and that I think there's a
Speaker 4: growing momentum to figure out how to end the conservatorships
Speaker 4: and that these companies recapitalize and have, you know, more
Speaker 4: normal corporate governance and a more normal relationship as a
Speaker 4: regulated entity with a regulator, a regulator who's not also
Speaker 4: the effectively the owner.
Speaker 3: If someone from the administration were to tap you on
Speaker 3: the shoulder again and say, hey, do you want to
Speaker 3: sort out the conservatorship issues and maybe implement a secondary
Speaker 3: market for construction loans, would you be interested?
Speaker 4: You know, I didn't think I was coming here to advertise. Yeah, no,
Speaker 4: I've been, like, I've been thinking about this for a
Speaker 4: long time and working on it in various different guys.
Speaker 4: Is so I know a little bit about it? Yeah, yeah,
Speaker 4: I love a little bit. And you know, I do
Speaker 4: think that one of the major problems the country faces
Speaker 4: in terms of the stability of our civil society is
Speaker 4: providing adequate housing for our citizens, and I think it's
Speaker 4: really one of the great sources of tension. It's one
Speaker 4: of the great sources of inflation, which is one of
Speaker 4: the great sources of tension and in our economy. And
Speaker 4: so you know, using these things that successfully reformed as
Speaker 4: instruments to address this fundamental need would be something that
Speaker 4: should be done. And whether I do it or you know,
Speaker 4: they take the work I've done and somebody else does it,
Speaker 4: it should be done.
Speaker 2: Jim Milston, fantastic conversation, learned so much, so much fun.
Speaker 2: That was so much fun, fantastic. Hopefully it sounds like,
Speaker 2: you know, I have no opinions, but it sounds like
Speaker 2: a very promising idea. Maybe someone listening to this will
Speaker 2: pick up the ball in some ways. Thank you so
Speaker 2: much for coming out, Thanks for having me.
Speaker 4: I really appreciate it. Yeah, that was fantastic, great.
Speaker 2: Tracy. That was amazing. So, like we'll talk about the
Speaker 2: housing element, but just like the history and the number
Speaker 2: of like light bulb moments in that conversation, lingering things
Speaker 2: that I didn't really understand where the source of that
Speaker 2: implicit guarantee for Fanny and Freddy came from the arrangements
Speaker 2: of you know, I sort of got the preferred stock
Speaker 2: a bit, but that was just that was fantastic.
Speaker 3: I had forgotten the juicing earnings, like using your cheap
Speaker 3: funding to buy alt A in Yeah, pre two thousand
Speaker 3: and eight, I totally forgotten about that.
Speaker 4: The other thing that I.
Speaker 3: Was thinking, just hearing the war stories of the financial
Speaker 3: crisis was how much letting Lehman Brothers go really did
Speaker 3: crush financial markets? Oh, in many ways, like so much
Speaker 3: so that a few days or even weeks later, like
Speaker 3: the conversations about whether or not to bail out other
Speaker 3: things seemed to have like it was just, yeah, let's
Speaker 3: do what we can because we let this one entity
Speaker 3: go and it's caused so many problems. Yeah, that seems
Speaker 3: like an obvious statement to say in hindsight, but I
Speaker 3: remember in two thousand and eight, two thousand and nine,
Speaker 3: there was a vibrant and heated discussion about, you know,
Speaker 3: whether letting Leman fail was the right thing to do.
Speaker 2: I know, no, it's incredible, And then you think about, like,
Speaker 2: you know, what if, like you know, just the sheer
Speaker 2: scale of AIG's role in this, and you like understand
Speaker 2: why like they felt that they had to, you know,
Speaker 2: inject one hundred billion dollars because of just the sheer
Speaker 2: number of financial instruments all over the world. Some of
Speaker 2: the US, a lot in Europe would have like gone
Speaker 2: belly up without that.
Speaker 3: Yeah. The other thing I was thinking about again sort
Speaker 3: of big picture realization, but how much of us, like
Speaker 3: social programs, I guess for lack of a better word,
Speaker 3: are wrapped up in like tax credits. Yeah, I know,
Speaker 3: incentives versus direct fund So we.
Speaker 2: Got to do more, you know, one episode that we
Speaker 2: should do and it's kind of in the context of
Speaker 2: the Inflation Reduction Act, but that market I'm aware for
Speaker 2: tax credits because if you don't if you let's say
Speaker 2: you have some tax credit, but if you don't pay
Speaker 2: taxes because of your money losing entity, which many again
Speaker 2: this is in the irate context. Many of them are
Speaker 2: because their startups so they don't get any value out
Speaker 2: of that, or they're sort of new companies, you know,
Speaker 2: making batteries. But with this secondary market that's emerged for
Speaker 2: tax credit so that they can sell and Jim talked
Speaker 2: about this a little bit, that you could sell that
Speaker 2: text credit to someone who does want to reduce their bill,
Speaker 2: Like that market is booming, and so we should do
Speaker 2: an episode on that.
Speaker 3: Yeah, I would be totally up for that, but we
Speaker 3: have to have Jim back On's to talk more totally
Speaker 3: well the Treasury experience and all of that.
Speaker 2: Yeah, he would be a good one for a live episode. So,
Speaker 2: like there's something like about you know, the history of whatever,
Speaker 2: So we should keep that in mind. Idea on the
Speaker 2: topic at hand. You know, it certainly seems there are
Speaker 2: many constraints to housing. Clearly, finance is clearly a big one.
Speaker 2: And if you're able to really expand that market, and
Speaker 2: it's pretty clear it makes sense that if you have
Speaker 2: the backstopping authority that then the commercial banks like a
Speaker 2: JP Morgan would be more than happy to step into
Speaker 2: that market and flip it for a small premium to
Speaker 2: Fanyer or Freddy. But it does seem as though if
Speaker 2: you could solve that problem, like there is serious numbers,
Speaker 2: a few hundred thousand extra units per year in the math,
Speaker 2: and it sounded like it made sense to me you
Speaker 2: might actually be able to put a dent in this stuff.
Speaker 3: I mean, here's one thing I will say, we do
Speaker 3: so many episodes here on all thoughts where we identify
Speaker 3: a problem and we ask what the solution is, and
Speaker 3: we effectively get no solution, no solution, or just crickets.
Speaker 3: It was very nice to talk about a problem that
Speaker 3: we have discussed previously on the show, the lack of housing,
Speaker 3: and actually be able to talk about a potential solution.
Speaker 2: Yeah, and so two things on that that I had
Speaker 2: thoughts about. So one is it's very powerful that we
Speaker 2: have the vehicles already to do this in theory and
Speaker 2: imagined that different lawyers might have different opinions. But like,
Speaker 2: at least in theory, you know, there's a lot of
Speaker 2: stuff that we could do with legislation, but nothing it's
Speaker 2: so hard to get anything passed, right, So if you
Speaker 2: have a way of doing something within an existing financing vehicle,
Speaker 2: then that automatically, you know, among pie and the sky
Speaker 2: dreams like that makes it a little less pie in
Speaker 2: the sky. But it's also interesting to me just politically
Speaker 2: that there is so much public anxiety about the cost
Speaker 2: of housing and the housing shortage and all this stuff,
Speaker 2: and people feel very stressed about their ability to come
Speaker 2: up with a down payment or how much. And yet
Speaker 2: like at the national political level, like it never really
Speaker 2: comes up.
Speaker 3: Yeah, and it's just crazy concrete proposals. You certainly don't
Speaker 3: hear Fanny or Freddy mentioned on like the debate stage.
Speaker 2: No, not ever, right, or you don't hear any like
Speaker 2: I'm not going to say that Joe Biden or Trump
Speaker 2: have no policies because I'm sure I know, like you know,
Speaker 2: in Biden's budget there's something like I know, but it
Speaker 2: is not something that given the amount of public anxiety
Speaker 2: there is about the cost of housing relative to the
Speaker 2: amount that politicians talk about ideas to solve the cost
Speaker 2: of housing, it's like there's incredible disconnect to me.
Speaker 3: Well, also to Jim's point early on, this is one
Speaker 3: of the few areas where there's seems to be some
Speaker 3: bipartisan agreement, at least in the sense of identifying the
Speaker 3: problem that housing is expensive, there is a structural shortage,
Speaker 3: and maybe we should do something about that. Well, shall
Speaker 3: we leave it there?
Speaker 2: Let's leave it there.
Speaker 3: This has been another episode of the Odd Lots podcast.
Speaker 3: I'm Tracy Alloway. You can follow me at Tracy.
Speaker 2: Alloway and I'm Joe Wisenthal. You can follow me at
Speaker 2: The Stalwart. Follow our producers Carmen Rodriguez at Carman Ermann
Speaker 2: Dashel Bennett at Dashbot and Kelbrooks at Kelbrooks. Thank you
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