Odd Lots - Jim Millstein on the Massive Risks of Any 'Mar-a-Lago Accord'

Episode Date: March 24, 2025

President Trump wants higher tariffs, and he also wants more industrial production in the United States. This we know. In the meantime, a coterie of economists and pundits have tried to assemble a larger intellectual architecture to explain that strategy in a coherent way. The story they tell is one where America gets paid by its allies for national security and access to American markets, while the US brings down its debt and deficits, and weakens the dollar, so as to make US manufacturing more globally competitive. Whether Trump sees things this way himself, and whether it will actually work is an entirely separate question. On this episode of the podcast, we speak with Jim Millstein, co-chair of Guggenheim Securities, about what he sees as the massive risks underway with this line of thinking. During his time in government, he was closely involved with the conservatorship arrangement of the GSEs, so we also talk about the possibility of re-privatizing Fannie Mae and Freddie Mac. Read more: Dalio Warns of US Debt Crisis ‘Heart Attack’ Within Three YearsWishful Thinking Won’t Solve the US Debt CrisisOnly Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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Bloomberg's Surveillance, Essential Listening, each and every business. This day. Bloomberg Audio Studios. Podcasts Radio News. And welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway.

So Tracy, you know, there's obviously a lot of anxiety these days, really for a while, but going into the election post about the size of the U.S. debt, the size of the U.S. deficit, etc. And the way I like to think of these things is that any discussion of federal spending is about a competition for resource allocation, right? So we know that a huge component of what drives persistent deficits is the social safety nets, social security, Medicare, Medicaid, etc. And when we talk about the debt or the deficit in the abstract, and when people talk about tackling the debt or the deficit, what they're really talking about is freeing up resources somewhere, freeing up consumption somewhere and creating availability for consumption and

resources elsewhere in the economy. Are they? Well, maybe they're not saying. I mean, yeah, I think I would say so. It seems to me there's a desire to like pay down the debt and then not necessarily do anything else. Like what's the else here? Well, so for example, Secretary Scott Besson and some of his recent interviews talked

about, you know, we want to re-leverage the private sector. It's who we want to get rates down and therefore that makes investing more appealing for companies, et cetera. And so the idea of like, okay, we're going to like reduce demand, reduced consumption from various sectors of the economy that are perceived to be unproductive, such as retirees, et cetera. Okay, maybe. And then open up expansion. So then there's less consumption. And then that creates resource availability for other things, which are perceived to be more productive like reindustrial. Okay, maybe. What I would say, you know how I like to think about this? Sure. I like to ask, like, think about the big picture in bonds. And I always say bonds are built on norms, right? Yeah. So government spending is built on norms. So you lend money to me and I pay you back. It's basically a promise, which means it's a human construct. And there are all these values and norms and narratives that are embedded in those constructs.

in those promises. And that's what I find really fascinating, especially when those values start to change. And I think that's what's happening now. Yeah. Well, you know, absolutely. And obviously, you know, we did that conversation with Jim Bianco about, you know, either a literal or a metanomic Mara Lago accord. And then we talked to Radalio and he slipped it in there. And I thought it was like, kind of, he's like, well, maybe they'll restructure the debt in some way or return it out. And to me, that screams default. You know, I mean, that's just a, you know, it's a polite way of saying default. But one man's default is another man's restructuring, Joe. That's right.

But I think if I were a treasury holder, I would be very upset if the thing that I considered to be the most liquid, safe asset of the entire world that the entire finance system runs on, the one thing that's perceived to be genuinely risk-free from a credit standpoint suddenly gets like, oh, this is a five-year bond, is now a seven-year bond. And you're going to get the same money in the end. I think that would be very disruptive in a way that is not disruptive, say, like, you know, when a hospital chain has to restructure its debt. It is definitely the risk-free rate upon which, like, all the other markets are basically built on.

Should I do a reminder of what the Mar-a-Lago Accord maybe says about this point? So the way I think about it, it's an attempt to resolve some of the tensions embedded in the Trump administration's economic agenda. We spoke about it with Jim Bianco. And those tensions are primarily the desire to reshore manufacturing. and shrink the deficit and also, I guess, address the sort of emotional sense that the U.S. isn't getting compensated enough for its role in the global economy or global security. Excellent summary. All while paying down the debt, right?

So having your cake and eating it too. And I should just emphasize, this isn't a hardcore plan. This is based on a paper that Stephen Miran put out last year that people start. getting very interested in and talking about. And that's why we're talking about it. Well, I want to go to our guess at a second, but there is something very funny because there's all these academic papers that are going out. And it's like, oh, there's this big plan.

And, you know, the exorbitant privilege of the dollar makes it so that, you know, it's hard to reshore manufacturing in the U.S. And we need to weaken the dollar and decentralize its role. And it's like they're sort of like intellectualizing 5D chess. Meanwhile, Trump is like, no, I just want more money from terrorists. Like, I don't know he, like, there's this intellectual infrastructure around it. I'm not sure that Trump himself buys into this. Anyway, we really do have the perfect guest because we're going to be speaking someone who knows about the intersection of finance and politics, someone who knows about debt and debt restructuring, someone who actually matters.

We've had them on the show last year. Someone who actually matters. Sorry. Someone whose opinion actually matters. All of our guests matter. all of our guess opinion matters. We're going to be speaking with Jim Milstein, co-chair of Guggenheim Securities.

Jim, thank you so much for coming back on Ovalds. My pleasure. We talked about your background when we had you on the show last year. What do you know about debt restructuring? Just a little. What have you done in that role? You've dabbled a bit?

Yeah, it's my metier. So I had this awful job in a great title called Chief Restructuring Officer of the United States Department of the Treasury during the financial crisis. There you go. That is quite a title. It is quite a title. It sounds like they might have been hiring me to restructure the federal government, but in fact, I was there to help restructure the TARP investments we made during the financial crisis in AIG and Ally Financial and City and B of A and the rest of that crowd. But before that, you know, I worked on the restructuring of Argentina.

the Republic of Argentina's one of their many restructuring. In 2005, we did a big exchange offer for their international bond and debt on Puerto Rico's debt default and restructuring back in the odds. Wait, were you on the hedge fund side of Argentina or the country? I was on the Republic side. Oh, okay. Yeah. And then when I was a lawyer back in the 80s, my firm, Cleary Gottlie worked on all of the Brady Bond restructurings across Latin America. So, you know, I've done a bunch of sovereign.

Okay. So you're a perfect guess. Yeah. Okay. Shall I just jump into it and ask the obvious question or one of the obvious questions, but where is this suggestion coming from? A debt restructuring as part of a potential Mar-a-Lago accord, and what is the problem we're trying to solve? So I think there's a clear, I mean, I don't want to engage in sanewashing, which, you know,

there's clearly an impetus by the president to impose tariffs. He's tariff man. And around him through Bessent and Moran, there is some intellectual architecture that suggests that's just a tactic towards an end. And the end is to bring manufacturing back to the United States. Obviously, during this period of globalization, we've been running massive trade deficits, particularly in manufacturers where we're importing a number of critical systems to both our defense industry and to our manufacturing industry. You know, we once dominated the semiconductor trade. We actually created that industry in the 1960s through a series of government policies, research and development grants to IBM and AT&T that created the semiconductor

technology, then a series of procurement policies at NASA and the Defense Department to commercialize that industry. And eventually we created, you know, the calculator industry. in the computer industry and the TV industry and all of that. But that was all a byproduct of a coordinated set of federal policies. Fast forward 40 years, 50 years later. And, you know, semiconductor manufacturing is mostly being done, particularly at the high end in a strategically vulnerable country across the Straits of China from China in Taiwan.

And that has created a sense, you know, now going back in the 10th, years in the defense establishment that we have a problem and not just in semiconductors, but in a number of advanced industries where we're really reliant as a country on the importation of critical technologies and critical intermediate inputs. Again, you know, if you piece together what some of the things that Bessent has said and some of the things that Moran has said, the goal of the tariff play, which is really just a tactic, is to bring, manufacturing back to the United States to hollow in or build out the communities that were hollowed out by the wave of globalization that occurred after China's admission to the WTO

in the early 2000s. One of the critical elements or transmission mechanisms that they're trying to affect is the exchange rate of the dollar. A high dollar means that our exports are more expensive and our imports are less expensive. So we have been the beneficiary with a strong dollar of very cheap imports, moderating the inflation that might otherwise occur from domestic manufacturing. But that said, we've lost manufacturing. We used 40 years ago, we represented 25% of the manufacturing industry. Now we're a mere 15% of global manufacturing.

China was nowhere to be seen. Now there are 35% of global manufacturing. goal of this Mara Lago Accord is to really weaken the dollar without upsetting the financial flows that finance our debt. And crucially, the manufacturing buildout is supposed to be done by private capital, to Joe's point earlier. It's not, you know, we've had efforts from the Biden administration, the Chips Act, to try to boost some of those industries. But the emphasis under Trump is really, we want to create a beneficial market environment so that private capital moves in. Yes. There's obviously a kind of traditionally Republican bias in favor of private capital

and scaling back the use of public investment to promote industrial development. But, you know, raising a tariff wall, a high tariff wall is a bet that private capital will invest behind it. Biden administration, you know, started something that I actually worked on as a graduate student back in the 70s called Industrial Policy. That is to use not only tariff barriers, but investment policy, tax policy, procurement policy, and R&D policy to promote domestic industry. So, you know, Trump has inherited the Chips Act and it is making progress. He says it's terrible. Yeah, I know he said it's terrible, but the reality is that there's all sorts of activity now, both under the Chips Act subsidies and through the Inflation Reduction Act,

which was another one of the Biden administration's policies to promote investment in the United States. The reality is that those investments have been made and are continuing to be made around the 50 states, most particularly in the red states. And so there will be political, pushback on the Trump administration to just, you know, zero those out going forward. So going back, though, you know, if we really want to restore American manufacturing dominance, particularly in critical industries, critical to our defense establishment, we're going to have to use a mix not only of high tariff barriers, but of R&D subsidies, of investment subsidies, and use

procurement as a way to create demand pull for these new industries. You use the word sanewashing, which is a good word, because there's the sort of intellectual, as they said, architecture around Trump. It's not clear that Trump himself sees it this way, that this works, that you can sort of like reaccelerate U.S. manufacturing simply via some sort of weakening of the dollar in a coordinated way or tariffs, what is the gap between what you see is actually going on and the sort of like the white papers that people put out on this? Okay. So, and this is all coming out of Moran's paper, as Tracy indicated at the beginning. I mean, he's put together the most kind of comprehensive

strategy. And he acknowledges this is a very narrow corridor within which this might work. And in some sense, the president has already gotten out ahead with his tariff tactics and also his threatening to withdraw the security umbrella from NATO. Because those are the two critical sticks that Moran advocated we use to induce foreign central banks and foreign investors to continue to buy treasuries at favorable rates so as to, continue to finance what is really a growing and potential, as Dahlia said in your podcast, debt crisis. And just let me say maybe to frame that problem. Today, federal debt to GDP is one to one. Federal debt is equal to GDP. We're running deficits at 7% of GDP. And the economy is kind of growing at one, two, little north of 2%. So the debt is growing faster as a result of the imbalance in the federal budget where deficits are growing at the rate of 7% of GDP, which means the debt's

growing at the rate of 7% of GDP, where our debt is growing now faster than GDP and is becoming an increasing overhang. To the extent that when you look at the federal budget, interest expense has become the second largest category of federal spending. Issuing bonds to pay off bonds. That's right. So we're now issuing bonds to pay the interest on our bonds. This is a classic recipe for disaster. We're not even treading water. We're now slowly sinking behind a huge, under a huge pile of debt.

So we have to get that fiscal imbalance corrected. And as you were saying at the beginning of the podcast, Joe, So, you know, now some very tough allocation decisions need to be made with regard to federal spending. Because someone joke that the federal, when you look at the federal government, it's really a retirement program attached to an army. Yeah. Right? I mean, the largest kind of... I've heard it called an insurance program.

Yeah, it's the same thing. Yeah, exactly. You have, you have, you know, income security in the form of social security for retirement, and you have medical security in the form of Medicare for retirement. But when you add it all up, the parts of the budget that Elon Musk and his merry band of pranksters are off trying to slash is a relatively small part of federal spending. But it is the stuff that actually, you know, supports education, transportation, housing, infrastructure, right? The wider economy, some people would argue. sort of stuff that, you know, is building human capital, building physical public capital, building housing structure. That part of the budget is a mere $700 billion out of a total

spending of $6.75 trillion. The rest of it is interest on the debt, retirement security, defense, and health care support. And so we're really, we're really in a pickle. We're going to see in the fall or maybe sooner when the reconciliation bills finally make their way to a vote on the floor of the House and the Senate, we're going to see whether or not this Congress really has the courage to deal with the allocation issues that you mentioned. Because in the framework for the House reconciliation bill, they call for 880 billion that's over 10 years. So it's really not a lot. It's really like about 100 billion of spending cuts annually in Medicare. Medicaid, transportation, housing, and education.

You know, out of that, Medicaid is about $600 billion a year, and the housing, transportation, education, that part of the budget is about $700 billion. So there's a, they're calling for a reduction of $100 billion a year against that $1.3 billion of Medicaid and the other social spending. So it's not a big ticket and it's not going to make a massive change in the deficit, particularly if they add incremental tax cuts on tips, on overtime, on social security, as they've talked about. You know, they're not really attacking the deficit.

So we're going to continue to need to sell a lot of debt. So you've laid out the pickle problem very well. perfectly. Laid out the pickle problem perfectly. Say that. That's a good way that. Yes. The idea here embedded in the Mar-a-Lago accord is that the U.S. could bring down its debt costs by getting foreign investors to swap some of their current treasuries into century bonds that would be less expensive for the U.S. to actually pay back. That's right. And so how do we induce them to engage in that exchange. So the two primary tactics that Moran lays out in his paper are sort of, you know, the way you do exchange offers in the private markets that I traffic in,

the way you do an exchange offer is with carrots and sticks. You offer a sweetener, and you threaten, you know, doom and gloom. So the two primary tactics here are that you foreign country are going to face, on the one hand, a high tariff wall unless you play ball, and on the other hand, the withdrawal of our security umbrella. So if you want the protection of the largest and most powerful military in the world to protect your borders against a Russian invasion, you're going to have to swap your debt that you currently hold, which is generally short-term bills into what they're calling century bonds, a, you know, 100-year bond at a low interest rate, which takes the refinancing risk of an indebted country away from it because we don't have to

touch that debt for 100 years. Terming out duration. Terming out duration, on the one hand, and reducing the interest burden of servicing that debt over time. So there are a couple of problems with this. one problem is that when you look at who holds U.S. government debt, not more than 15% of it today is held offshore. Yeah.

It's come down a lot. Yeah. It's come down a lot. And much of that 15% is not in the hands of government instrumentalities, but rather in foreign private investors. So inducing that crowd to come in to this exchange offer, even if you could succeed, you're touching a very small part of the debt. So where's the rest of it?

Where's the other 85% of our $36 trillion of outstanding debt? It's basically owned by us. Some of it's owned in government accounts and the Social Security and Medicare trust funds, but some of it is owned by banks and insurance companies, some of it's owned by endowments and wealthy individuals, some of it's in the bond in the mutual fund market, you know, underwriting our money market funds,

So the reality is to get this done, we're really doing it with ourselves. But what we really need to do is term out our debt. And the problem we're facing right now is that, you know, the cost of debt, the interest cost of our debt is relatively high. You know, the 10 years at 4.3, the 30 year, put aside what you pay for a century bond, 30 year is even higher. and the current average interest rate on our outstanding $36 trillion of debt is 3.3%. So to term it out in this market would take that $1.1 trillion of annual interest expense up.

You know, if we had to term it out at 4.3 or 4.6, we'd be talking about increasing the interest expense we're facing. So this intellectual architecture around the so-called Mar-a-Lago Accord has many flaws, not least among which is we're in targeting foreign holders of our debt, we're targeting a relatively small part of it. If the game plan here of that Mar-a-Lago Accord is to weaken the dollar, so is to improve the competitiveness of U.S. domestic manufacturing, there is another approach, and that you've also heard a rumor of from the Trump administration, and that is the creation of a sovereign wealth fund to take assets that the U.S. government currently

owns, dump them in a central fund managed by the Treasury Department, and allowing the Treasury Department then to intervene directly into the foreign exchange markets, to try and push the dollar down. I see. It's interesting because so, you know, historically, right, like sovereign wealth funds in resource rich countries are often about stable, keeping the currency strong, et cetera, especially for countercyclical elements. And so the idea that we would use it to intervene in foreign exchange is interesting twist.

You know, you said something about restructuring and you said there's carrots and sticks in a typical restructuring. And imagine the sticks are, look, if you don't want to go along with this restructuring plan, then you're going to end up with like some sort of asset and a bankrupt company and it's going to be pretty bad for you and you're going to get less money and it's going to take a long time. And so come on, go with the deal. It seems to me part of the problem like just conceptually with the carrot and sticks approach is like you can't really threaten a stick if you're the U.S. government without immolating yourself. Yeah. I mean, the last, you really want to see rates blow out, have the federal government threatened to not.

pay its debts. That would be an event from which the financial markets might not recover. Does the carrot hold any water here either? Because the carrot's supposed to be like, okay, maybe you don't get tariffs, maybe you get U.S. security. But that maybe is really important because what we've seen so far, it's only been two months. But we've seen Trump go back and forth, back and forth, back and forth, I think a lot of trust has been lost. Yeah. Well, and, you know, if you were going to use tariffs or the threat of tariffs and the threat of the loss of the security umbrella as the inducement to the exchange, he's already gotten out ahead of himself, right? I mean, he's on again, off again with the tariffs.

So the threat isn't imminent, it's extant. And as you say, the trust that he might change his mind the day after the exchange is consummated is real. And similarly, with regard to NATO, you know, it's not obvious if I were a NATO country that I can rely on the United States any longer. You saw what happened in Germany, you know, they've gotten rid of their debt limit, and are now going to massively increase defense spending in order to potentially defend themselves

without the benefit of the United States security umbrella. Poland's already done this. Their way, they increased their defense spending. And basically the country is on the border of Russia, the Baltics, Poland, have all increased their defense spending, recognizing that they may not be able to rely on us any longer. So as you say, Tracy,

he may have gotten out ahead of this to the point where this really can't be used as an inducement for an exchange of short-term to long-term debt. Joe, you know what I was just thinking? Say more. What have China exchanged its bills and treasuries for century bonds in exchange for NATO protection? First of all, you know, there's obviously that history of the fact that at one point in time, China perceived its main adversaries, the Soviet Union, and did, you know, try to have that protection with the United States. So there is not zero history for that. Maybe a slightly realistic version

of that is swap out your debt and we'll let you build BYD plants. Then you get that technology transfer and you sort of do the whole classic thing where the high tech country brings in their manufacturing and teaches you how to build gigapplants and stuff. I would be into that. Jim, say more, though, about an event from which the markets may never recover. That's not a term you hear. You always recover. But, you know, like when you get into existing, substantial questions about the sort of safety and risk-freeness of U.S. debt. What do we talk about here? Yeah, I mean, once we went off the gold standard, once our currency and our debt was not convertible into gold, into a hard commodity, the reliability of the U.S. government debt is really a bet on the U.S. government economy,

that the economy is going to be so strong and generate the capacity to pay taxes to support the repayment of the debt. And so these two things now, it's a confidence game, and they're intricately linked. You know, the dynamism of the U.S. economy is ultimately what supports the credit worthiness of the debt. But, you know, as your debt, and this is what Dahlia was talking about, you know, as your debt levels increase to the point where your ability to service the debt is called into question, or your ability to service the debt is squeezing out the role that the government plays in buttressing, undergirding the dynamism of the economy, you get to a point where, you know, investors start to worry about the durability of the debt, the ability of the government

to pay the debt. And so the debt overhang itself becomes a retardant to economic growth. So if the dynamism of the economy is what undergirds people's confidence, in our ability to repay our deaths when due, we're in a world of hurt. I mean, I went to the speech of Bessonkev at the Economic Club of New York, and he talked a lot about, you know, unleashing the private sector, reducing regulation, freeing the banks to once again lend to the private sector and withdrawing the Biden stimulus to, you know, the various subsidies and procurement policies that were his attempt at reshoring to withdraw the heavy hand of government from overriding the economy, the private sector. You know, that's all fine and well. But the reality is

that, you know, governments play an important part in promoting the growth of their domestic economies as from as simple as, you know, connecting people and markets through roads and airports and railroads to ensuring that there is a healthy and educated workforce for private employers to be able to hire. You know, these are really essential functions of government, not least in, and including the investment and research and development and novel technologies that the private sector won't invest in because the commercial potential of them is an obvious, right? So the basic research that we do through NIH and the National Academy of Sciences. We've done an episode on this.

Yeah. This is a really essential function. So there's a balance, right? I mean, and the success of the United States is a demonstration of the balance between private and public investment. The risk that we are in now, given the massive amount of debt we've accumulated and more importantly, the continuous reliance on deficits, on debt to fund our spending is putting us in a place where really do need a fiscal consolidation plan. We have to balance revenues

and spending. It doesn't have to be one to one, but the deficit can't be growing faster than the economy, or we're just, you know, piling up debt that will become increasingly more difficult to sustain. I want to go back to the sovereign wealth fund idea because when I hear that, it sounds like basically a shift from the U.S. issuing unsecured treasuries to secure debt. And when I hear that, I think back to a term that I used to encounter a lot when I was covering European covered bonds. Incumbrance. Like there's a limited amount of collateral that you can put up into a bond and at some point you start to run out of it. How much collateral, I get that the U.S. is the biggest economy in the world and probably if anyone's going to collateralize their debt,

maybe it's the U.S. But what exactly would they use to secure these things? Okay. So, you know, there's loan to value and then there's cash flow coverage, right? And so we, the balance sheet of the United States has a variety of hidden assets that are not really marked to market. You've heard a lot of talk recently about our gold stocks, right, that are, I think, at $42 an ounce when the price of gold is, you know, north of $3,000. If you remarked the tons of gold at Fort Knox that we own to market, it's probably $9,900 billion. That's against a $36 trillion debt balance. That's a drop in the bucket. But it's not nothing.

It's not nothing. We own probably a third of the land west of the Mississippi. You know, the Western states complain about this all the time that the federal government and the Bureau of Land Management is an absent landlord. National Park-backed bonds. Is that where we're heading? Yeah, God forbid that Teddy Roselt's legacy, great legacy, would be somehow on done, but put aside the national parks.

It's all of Utah, Nevada. Yeah, I mean, Utah, Nevada, Wyoming, right? And then there's the vast expanse of Alaska, most of which is owned by the federal government. So there are those kinds of resources. Now, they don't cash flow today, but there are mineral rights on these lands that could be like, you know, many other countries in the world do with their mineral rights. that they give private developers the right to extract and they create cash flows for the government on whose lands they're doing the extraction. We have, you know, a variety of enterprises,

commercial enterprises that we own equity in or own outright. You know, the Tennessee Valley Authority is a huge electrical generation and distribution system in Appalachia. Fannie and Freddie, taken over during the financial crisis where the government owns, notwithstanding what Bill Ackman is asserting, where the government fundamentally owns, you know, 90 to 95 percent of the equity value in them. You know, there are those sorts of things that the government could try to monetize and capitalize a sovereign wealth fund with. Now, having done that, let's say there's a $2 trillion of land values, mineral rights, ownership in commercial enterprises that could be, that could capitalize a sovereign wealth fund. And some of those things, cash flow,

where you could design them to cash flow, so the sovereign wealth fund would actually have income. And some of those assets could actually be monetized, like the equity in Fannie and Freddie and the equity in the TVA. You could actually privatize them, sell them into the public markets and create actual cash in the sovereign wealth fund as opposed to just asset value. So there you would have, you know,

$2 trillion fund that could intervene in the foreign exchange markets to try to intentionally weaken the dollar without having to engage in this exchange offer and term out on debt and try to, you know, browbeat with security umbrellas and tariff walls, foreign countries to help us in that endeavor. It's still a big bet on economic growth, though, right? Because the U.S. has to grow enough to pay off

what it owes. And if it doesn't, then at some point you have to hand back the collateral. And I think people would be sad slash annoyed if they were handing over all the gold or national parks. probably not national parks, but land and things like that. Yeah, no. I, you know, first of all, we never pay off the debt, right? We just outgrow it. That's the key here. The stock of debt is just refinanced and rolled over continuously.

You know, it'd be great to pay it down one day, but we actually don't have to do it. We just have to outgrow it. And there are a couple of different ways that countries have done this, some of which are more dangerous than others, right? You can inflate your way out of the debt. You just devalue your currency over time, and the debt stock shrinks relative to the then current value of your productive enterprises, because you've devalued your currency. And so the debt stock, which is fixed in amount, shrinks as relative to the size of the economy now denominated in much weaker currencies. you can try this kind of Mara Lago, you know, exchange offer.

And then, of course, the worst of all outcomes is an outright default where you restructure the debt. You know, it seems to me, and I said in the beginning, I sort of conceptualized these things in terms of resource allocation and who gets what. And it seems to me, you know, yeah, you could revalue the gold in Fort Knox and probably people are sitting here thinking like, why wouldn't you do that? if it's $3,000 and we have it at 40 or whatever, of course. No, just do it. But that doesn't produce more doctors. It doesn't produce more beds for hospitals. It doesn't produce more food for senior citizens. You know, like when we're talking about these resource constraints, which is how I sort of think about it, it's an accounting trick, right? Because it doesn't ultimately, it doesn't create any new factories. It does not do any of that. Anyway, let's talk a little bit more. You know a lot about

Fannie and Freddie, and you've made a reference there to Bill Ackman. And the thing that I'm trying, you know, there's obviously big profits being generated by these government-owned enterprises, and private investors would like access to those profits so that they don't just get to the Treasury. But to me, there's the question of like, can you do that in a way to avoid the problem, which is that investors get access to those cash flows or access to those profits without the implicit guarantee of government because, you know, obviously, like, you'd love to keep both, right? You'd love to privatize the profit and keep that backstop. Is there any conceivable way to privatize them and actually not have that backstop in place anymore? I think the expectation is they would

implicitly keep the backstop. Like, that's what investors want. How is that fair? Well, this begs the question, why bother doing it at all, right? Is there a way to do it that's not just a giveaway? Yes, there is. Okay. So, um, There's a lot of history here. Yeah. So before the financial crisis, these government-sponsored, government-chartered entities had a special charter that enabled them to borrow from the Treasury Department. And that was the source of their being viewed as ultimately backed by the Treasury Department,

even though what they could get from the Treasury Department was a mere fraction of their. balance sheet size. But the fact that they had that entitlement gave investors the confidence that in a pinch, the government would step in and take them over. And we had a pinch in 2008, and the government did, in fact, step in and put them into a conservatorship. The conservatorship was structured to make that implicit backstop explicit. And the Treasury Department entered into a preferred stock purchase agreement with each of the entities under conservatorship, pursuant to which the government actually purchased $192 billion of preferred stock in the two entities, infusing $192 billion worth of the cash of Treasury Department cash, authorized by Congress

under the Housing and Economic Recovery Act of 2008 into the enterprises. In exchange for equity as well, right? They got preferred stock back, right? a senior preferred stock. That senior preferred stock carried a fixed dividend, which was converted into a variable dividend in 2012 in order to keep them from having just to borrow more preferred to pay off the dividend. And so they were only then required to pay a dividend to the extent that they were profitable out of their net profits. And were they profitable? They have paid the Treasury Department back now, $302 billion on that, characterized as dividends on that $192 billion par investment.

Yet, not only are they profitable. They've also, as I understand it, kind of restructured their business and increased their capital, basically like gotten ready for a sale while generating a profit, which is pretty impressive. Yeah. So the dividend stream to Treasury, which generated $302 billion, was turned off in 2018 to allow them to build capital in anticipation in Trump administration won that they would be privatized. And so they allowed them to build capital. And so the Treasury Department hasn't received any dividends since 2018, so seven years ago. And during that seven-year period, Fannie and Freddie have built between the two of them almost $200 billion of capital.

That's still short of the capital rule, the capital regulation that was created for them during the conservatorship, but they're pretty damn close, probably two years away from meeting their minimum capital, their so-called CET-1 capital levels. You know, there are many of us who think

that the capital rule that was created for them grossly oversolved for their, how much capital they should carry. Right after the financial crisis, everyone's nervous. Exactly. And so, you know, as with the big banks, the so-called Siffies, Fannie and Freddie have been subject to so-called stress tests to see how they would fare in a severely adverse scenario where, you know, the financial markets decline by 20%,

the interest rates go up by 10%, unemployment skyrocks, housing prices collapse, blah, blah, blah, they've been subjected to stress tests over the last couple of years, and those stress tests show that basically their losses would be less than like $10 billion. And so to have them carrying around, in Fannie's case, 156 billion of capital, and in Freddie's case, $120 billion of capital against what the stress test show would be negligible. losses seems like a waste of that capital, just

grossly oversolving them. But I'll get off my hours on that question. On that, leave them with those capital levels, $156 and $120 billion respectively. They would need another four years of retained earnings to

reach that. So if you were really, if you weren't prepared to let them out of conservatorship, until they were fully capitalized. You'd wait four years. And then they'd be fully capitalized under that rule. And then the question goes to the backstop.

You know, why privatize them and can they be privatized without an explicit government guarantee? Well, there's no reason in law or fact that would prohibit them from carrying that preferred stock purchase agreement, that equity backstop out of conservatorship and having the tax. Treasury stand behind this $270 billion worth of capital with a commitment to buy $250 billion of capital should the need arise. So, you know, if, if in my view, Fannie carrying $160 and Freddie carrying $120 billion is already overcapitalized, well, we're going to almost double that with the Treasury backstop. And Treasury should be paid for the privilege of standing behind them, a commitment fee, and could the earnings would support a commitment fee, but that would give

comfort to the markets that, you know, there's enough capital behind them to ensure the prompt payment of principal and interest on the underlying mortgages that they guarantee. The benefit to the government of doing this, of instead of leaving them in conservatorship in perpetuity, is that the government. government owns 90-odd percent of the equity. They own the senior preferred stock. They have a warrant to purchase 80 percent of the stock for a penny. You do a classic recapitalization, turn the preferred stock into common, diluting the existing common and the Treasury Department's warrant. And Fannie, the Treasury Department will end up owning 90 to 94 percent of the total

common stock of cleanly capitalized companies. What's that worth? The CBO did a recent analysis and said, well, this is the Congressional Budget Office, did a recent analysis, and it's, you know, filled with lots of assumptions and you could quibble with some of them, but it's a dividend discount model, which isn't, you know, unheard of in the valuation of financial institutions. And, you know, they suggested the equity, the total equity, of which I think the government ends up with at least 90% when you recapitalize. total equities were somewhere between $300 and $500 billion. That's a decent number. That's a decent number to put in your sovereign wealth fund or to pay down some of the deficit. The one question I have is, okay, if the GSEs are privatized, the government gets a payout of an unknown amount, but it could be pretty decent, as we said.

Is there anything that Fannie and Freddie actually start doing differently once they're privatized? So they get an influx of private capital. What do they do with it? Okay. So this is a critical question of whether they're going to be allowed to go back and do the kinds of crazy things they did prior to the financial crisis that got them into hot water. One of the great innovations, along with Dodd-Frank, coming out of the financial crisis, was a new statute governing both the federal home loan banks and Fennie and Frank. It's this Housing and Economic Recovery Act of 2008, which created a new stronger regulator called the Federal Housing Finance Agency.

This is the agency to which Bill Pulte has just been confirmed as the director. But that agency has significant supervisory and regulatory powers to constrain the business model that Fannie and Freddie can pursue. So, I mean, just to do with just a touch a little more history, if you look back to 2003 through 2008, you know, what really got Fannie and Freddie into trouble is they were running hedge funds. They were a government-sponsored hedge fund beyond the basic business of securitizing so-called conforming mortgages, you know, 80 LTV or less, safe mortgages besides packaging them and securitizing them. and guaranteeing the prompt payment of principal and interest on those mortgage-backed securities, of which there are now $7.5 trillion outstanding. So they are the big factor in that conventional mortgage market.

In the run-up to the crisis, they also expanded their balance sheets. They borrowed money at near government rates, levered themselves up, and bought all-day subprime, no-doc private label securities in order to goose their earnings. and they did it on a highly levered basis. One of the great reforms that has occurred during the conservatorships is those portfolios have been completely wound down. And so today, the only balance sheet that they have is to facilitate a securitization business they're in.

So they buy mortgages that have been originated by someone else. They pool them, and then they securitize them. And with the proceeds of the securitization, they repay the debt that they incurred to buy the mortgages in the first place. And similarly, when mortgages go bad in the MBS and the securitizations, in order to fulfill their guarantee of prompt payment of principle and interest on those securities, they buy the mortgages out of the pools, restructure them, and modify them. Which is why agency MBS is treated as a very safe,

and liquid asset for bank capital purposes. Exactly, because Fannie and Freddie are there to guarantee the prompt payment of principal and interest. And now if we go back to the privatization, right, what will back that guarantee is both the 280 billion of capital directly on their balance sheets, as well as the preferred stock purchase agreement with 250 billion of unused capacity.

So behind that guarantee, guarantee will stand more than half a trillion dollars of capital. And so that this is, you know, when I get into debates with people about people who were opposed to the privatizations about whether or not the privatization would create instability in the MBS market because would they suffer a ratings decline and therefore attract higher capital for anyone who owned them. and therefore higher rates on the mortgage-backed securities, which translate into higher rates on the mortgages themselves,

you know, that is the big question, is half a trillion dollars of capital standing behind the guarantees enough to keep the credit ratings on the MBS stable and in place? I think it is, but, you know, at the end of the day, there'll be a conversation with Moody's and S&P and FIT, and they'll have to decide whether they remain near sovereign credit. Oh, it's kind of funny that the credit rating agencies are like the... Still in control.

Yeah, exactly. Okay, so we've talked a lot about creative ways for the U.S. government to raise money and pay off its debt. There's one we haven't talked about, which is one of my favorite financial topics of all time. Oh, no. And that is the bonds owned by the U.S. issued by other countries, really old ones, like Chinese imperial debt. Or did you know the U.K. owes the U.S. a lot of money from like World War II loans? Oh, still. I didn't know that. I didn't know that, no. And as an intellectual curiosity, I find it really interesting to think about the question of what would

happen if Trump decided to go after those as a way of raising money. And this actually came up. in the first Trump administration, the Treasury was looking at ways to get a payout on the Chinese bonds. And funnily enough, it was doing that at the same time that the SEC was prosecuting someone for selling those bonds to investors and promising a payout. That's fun. That could be fun. So these are, I don't know anything about this. So these are bonds issued by predecessor governments in China. Yeah. You know, there is some history of, I'm aware of some Tsarist Russia bonds that are out there. Yeah, those are the famous ones. Yeah, that are out there. Shortly after the collapse of the Soviet Union,

the French government and the British government representing French and British bondholders got the Russian Federation to acknowledge those bonds and make a pad on them because the Russian Federation was desirous of having access to the capital markets in Europe. And the quid pro quo was to pay off the debts of Tsarist Russia. Well, we're in uncharted territory. We surely are. So even this little intellectual exercise at the end of the conversation may one day not just be an intellectual curiosity. Jim Milstein, so great to have you back. Thanks, guys.

We could just talk to you for hours and hours. Thank you so much, yeah. But that was a fantastic thorough conversation. I appreciate you coming back on Lothland. Enjoyed it. That's great. Tracy, I love talking to Jim. He's so good.

He's great. And he lays everything out so clearly, which is very useful when we're talking about a hypothetical like this. The one thing, well, there are a lot of things that I think are funny or ironic in some of this discussion. But one of the big ironies I think about is treasuries are kind of the U.S. his biggest export. Yeah.

And Trump is obsessed with exports. I know, I know. But he doesn't want to export those particular things, even though you could make an argument that debt helps to grow the private economy, as Jim was discussing. It is funny. I mean, look, I guess I'd rather us export real things that employ people than... But he could just take the win, right? You take the win.

Yeah, we're a big exporter of these pieces of paper, not even pieces of paper anymore. No, I thought there was like a great conversation. And look, the way I see it is some of this stuff could be playing with fire. Like we really don't know how some of the, you know, some of these goals is like, all right, we're going like, you know, we're, the fact that Germany itself is rearming and that for decades and decades and decades, this sort of entire premise of sort of Western geopolitics was preventing Germany from rearming. That was in itself this sort of like this like massive pivot in. world history feels like for me and, you know, who knows? Decades from now, you know, we don't, we might not know how the consequences of the ways geopolitics have been reshaped by that decision. Well, this is the norms point, right? Yes. Like norms, it turns out, are actually pretty important and there's a risk of what happens once they're gone or they start to change. Yeah, I would say two points. I mean, one is, yes, norms themselves, I think, are pretty important. And then you get into things that are sort of beyond norms questions, like once you bring in the conversation

about, and again, I don't know how serious it, but like restructuring debt or et cetera, you're like go beyond norms and you actually like you could trigger, trigger formal things. No, that's still a norm though. I guess the U.S. like historically has not defaulted on its debt. No, but it's like there are things in pieces of paper, right, that like when you don't, when you like try to change paper. There are legalities, but frankly, legalities are. being treated as norms now, right? I suppose so. Yes, I suppose so.

Shall we leave it there? Let's leave it there. This has been another episode of the Oddlots podcast. I'm Tracy Allaway. You can follow me at Tracy Allaway. And I'm Joe Wisenthal. You can follow me at the stalwart. Follow our producers, Carmen Rodriguez,

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