Unanswered Questions: Thinking For Ourselves
Presented by... http://www.unansweredquestions.org/
The Story of Edgewood Technology Services - (Part Three)
or… How I Lost $100 Million Discovering Who Makes Money Making Sure the Solari (Popsicle) Index Does Not Go Up
– My Scoop’s “ Real Deal ” Columnist
Also published Solari.com
Appeared in From The Wilderness, October 1999
For Earlier Parts See…
***********
On the face of it, one might think that insider trading profits on HUD real estate had nothing to do with insider
trading profits on Harken Energy stock. But it turns out what they both have in common is Harvard Endowment and Mike
Eisenson, the manager of Harvard's private equity portfolio. Indeed, the Edgewood story provides unique insight into the
philosophy that was behind George W. Bush and Harken Energy and Washington’s culture of insider dealings. As Mike
Eisenson complained to Fitts about her success in producing record savings for taxpayers, "I don't like this [Fitts's
use of Bell Labs optimization technology to auction HUD mortgages] because the only way we (Harvard) can win is by
paying more than our competitors. We prefer a bid process where we can win by 'gaming' it because we are 'smarter'."
***********
In Part One (August 1999), Catherine Austin Fitts described how, as an advisor for the Department of Housing and Urban
Development (HUD), she and her company Hamilton Securities had been charged with streamlining the HUD financial
portfolio for Secretary Henry Cisneros. Using her experience as a Wall Street investment banker she brought the
disciplines and creativity that had ensured her success on Wall Street into what was a decidedly political arena. It did
not take her long to realize that she was dealing with a different "operating system" powered by a different set of
values than the financial performance criteria dictated for government assets by law.
As she looked deeply into government operations and HUD programs and philosophies she saw obvious simple economies and
reforms that would have brought sizeable immediate benefit to taxpayers. But these reforms involved things like bringing
computer training to mothers in federally subsidized and financed housing projects. They involved things like upsetting
powerful vested interests and entrenched notions that poor people were "hopeless." And they involved training and the
creation of learning centers in HUD projects that would have made knowledge accessible to one and all about how the
money really works in America.
Just as Fitts was beginning to demonstrate how quickly the mothers of HUD's Edgewood Terrace project in Washington, D.C.
could master computer programs, data processing and software design she began to sense the approach of an oncoming
bulldozer. That bulldozer, set in motion when Hamilton used its own money to fund a data servicing company called
Edgewood Technology Services (ETS), would ruin her business and personal finances, endanger her life and [try to] stop
what was described to her as "computers for niggers."
In Part Two (October, 1999) we learned how HUD Section 8 projects were owned by "politically active" private firms that
had a vested interest in maintaining the secrecy that has always surrounded HUD financial operations. That secrecy has
benefited politicians who received recycled dollars in the form of campaign contributions. It has benefited government
bureaucracies and bureaucrats desirous of maintaining salaries, perks and empires or afraid of losing their jobs or
being forced to retrain themselves in a dangerous political environment. It has benefited drug dealers, criminals and
cheats who, like parasites, served the interests of the other entrenched groups. It has benefited covert operatives
linked to the CIA and other government agencies who have used HUD and HUD landlords and poor neighborhoods to "hide"
black ops. And it has served the interests of politicians who were able to dispense patronage via the HUD system to what
has become an infinite number of intermediaries who depend on communities being dependent on government largesse to
provide what amounts to guaranteed income streams. Notably, two groups who did not benefit from the HUD system were
people within communities who wanted to succeed in the marketplace and the taxpayers who continue to invest billions in
a HUD cancer that causes the health and well-being of our communities and financial system to deteriorate.
As the mothers and other residents who comprised ETS demonstrated prowess on computers, more prowess than that possessed
by some of the ambitious old school civil servants in the HUD enforcement operations, light began to shine into the
recesses of HUD program operations which, because people could see, started to reengineer for the benefit of taxpayers.
Catherine Austin Fitts had now offended the system twice: once by facilitating "computers for niggers" and again by
proposing to provide opportunities for resident moms to develop into responsible small business entrepreneurs. Fitts was
going to introduce poor people to the world of equity ownership in a way that made money for taxpayers.
She encountered sharp resistance from the wealthy owners of HUD section 8 buildings, some of whom, like the National
Housing Partnership (NHP), wanted to trade on Wall Street and were anxious to maximize profits, irrespective of the
effects on American taxpayers at large. As Fitts, her investment bank Hamilton Securities and ETS began to illuminate a
potentially hugely profitable community of interest among thousands of neighborhoods, taxpayers and the more
progressive, high-performance members of the business and investment communities, the storm clouds of an attacking swarm
began to materialize. If Fitts thought she had encountered resistance from the politicians and portions of the
enforcement bureaucracies that serve darker private special interests and from private property owners before, she had
seen nothing until she ran afoul of Harvard University and the "big" money that drives certain investments on "the
Street.
***********
… FOUR PART SERIES CONTINUES ...
Harvard Endowment Prefers "Gaming" to Market Competition
The Section 8 owner/manager organization most eager to cash out its investment position in the stock market was National
Housing Partnerships, now called NHP, Inc. NHP, originally formed as a pseudo-governmental entity to promote affordable
housing, had become a large, privately owned company that managed a complex web of private affordable housing real
estate tax shelter partnerships. These partnerships owned a portion of HUD's portfolio of Section 8 subsidized apartment
projects financed with HUD insured mortgages. NHP affiliated entities had made large profits and tax benefits under long
term often above-market-rate contracts for services like property and financial management services at taxpayer expense.
For various reasons, mortgages on some of the NHP owned and managed apartments had defaulted on government guaranteed
debt and were taken into the HUD-held mortgage portfolio. In some cases, NHP investors were forced to make advances to
keep the partnerships afloat, even as the tax shelter benefits were running out.
At the same time that Congress was exerting pressure on HUD to reduce its budget to support affordable housing, the
Chairman of NHP, Roderick H. Heller III, had been trying to take the company public. He and other stockholders wanted
the freedom to liquidate their positions in the company before the adverse affects of the inevitable budget changes that
come with deregulation could be reflected in share value. The largest investor in NHP, Harvard University's endowment
fund, represented on the board by Mike Eisenson who headed Harvard's private equity fund, very much wanted to liquidate
its investment, as did Herbert "Pug" Winokur of Capricorn Investors, another large investor in NHP. (Pug was also
Chairman and lead investor in DynCorp as well as member of the Harvard Management board and was later to be promoted to
the Harvard Corporation board, until his resignation was forced by his involvement in Enron. His company often invested
along side of Harvard, raising the question as to whether Harvard had seeded Capricorn and DynCorp as well.) The hope
was that NHP would go public, use its stock to do acquisitions, and then Mike and Pug could liquidate their stock over
time. Harvard could also sell its entire stake in the company in a large transaction if the stock price was high enough.
The key to maximizing capital gains, however, was to get the company public.
Rod had two problems. The first was that NHP's profits depended on HUD fees for property management that were above
market rates. As the HUD loan sales (of defaulted mortgages) proceeded, NHP was losing control of properties to
purchasers who would insist on market fees and performance, at best, and fire NHP at worst. Before Hamilton started
helping HUD with loan sales, HUD was recouping approximately 35 cents on the dollar on defaulted mortgages by doing
"workouts" with existing owners. With loan sales, HUD was recovering approximately 70-90 cents on the dollar. This
improvement translated into a $2.1 billion savings for taxpayers in the first three years of the program. A portion of
this savings also represented money that was no longer going to existing owners like NHP. Finding a way to destroy the
loan sales program and any use of disclosure and competitive investment principles was one way that NHP could ensure
it's success if it did not want to reengineer its operations to be competitive in the marketplace.
Two investors well positioned to be successful on any reengineering of HUD's Section 8 subsidized apartment portfolio
were Goldman Sachs and BlackRock Capital. In the early summer of 1996, Goldman Sachs was the high bidder at auction on a
large portfolio of HUD-held loans on partially Section 8 assisted housing projects, a transaction in which BlackRock
served on the financial advisory team. All told, Goldman sponsored bid teams---with and without BlackRock as a bid
partner-were high bidders on approximately $4.7 billion of HUD loans. The knowledge they gained from successfully
pricing and resolving HUD loans prepared them to outperform NHP and its investors if the Section 8 policies should
change, subjecting the remaining properties under NHP's control to open disclosure and competition in the marketplace
over time.
Harvard Endowment, which owned a majority of NHP's stock, had submitted bids on the early HUD loan sales, and had
complained to me at the time that our use of Internet accessible databases and Bell Labs optimization technology had
made the auctions much more open to lots of investors. Mike Eisenson, leading both the NHP investment and the bid for
Harvard on the first large HUD loan sale complained to me, "I don't like this [Hamilton's use of Bell Labs optimization
technology to auction HUD mortgages] because the only way we can win is by paying more than our competitors. We prefer a
bid process where we can win by 'gaming' it because we are 'smarter'." This Mike Eisenson-Harvard philosophy may explain
why Harvard gave up on the competitive process and turned to political "gaming" to make sure that Harvard could avoid
losing control to investor groups like those sponsored by Goldman Sachs and BlackRock. It would also explain why Rod and
Gene Ford, [who was lead partner of the company that developed the Edgewood project] got increasingly upset about
certain BlackRock activities. It may also explain latter disclosures about Mike's role backing George W. Bush as a lead
investor and board member of Harken Energy.
BlackRock was beginning to master this market, by bidding in loan sales, by taking on a financial advisory assignment on
a HUD loan sale, and by getting to know state housing finance agencies. Rod and Gene could tell that BlackRock could
profit from converting to the neighborhood investment model from the Soviet-inspired centralized command and control
system in which guaranteed subsidy and debt financing ruled the day. This would change from an old model that would "let
the human neighborhood be damned," to one in which local communities worked with investors in a joint venture equity
model where the knowledge and bounty was greater and was shared. To this end, BlackRock also was making efforts to learn
about grass-roots efforts like ETS and Neighborhood Networks. In other words, new investors with fresh ideas about value
in a knowledge-based society, capital and with networking and digital software applications tools were positioning
themselves to produce higher returns for taxpayers generally, neighborhood residents specifically, and themselves. This
is a powerful, win/win model that Rod and Gene knew could handily trump their closed system. The result would be
creation of increased neighborhood "equity" value, which would translate, ultimately, into higher real estate values and
a vast expansion in urban small business and employment prospects, at the expense of risk-averse, anti-competitive
subsidy and debt players.
Rod was very concerned about the impact of this "new" approach to the tax benefits both he and his investors enjoyed. At
a dinner of the National Multi-Housing Council in New Orleans in the spring of 1996, Rod was clear with me. Harvard
wanted capital gains on what was one of their largest real estate stock investments and to avoid taxes after the sale.
He (a former law partner of Wilmer, Cutler & Pickering; Lloyd Cutler served on NHP's board prior to joining the Clinton Administration in the White House Counsel
office after Vince Foster's death) and many other attorneys, accountants and professionals might be subject to
unanticipated tax bills if proposals supported by HUD, on the advice of Hamilton, were adopted. Big tax bills. Renewal
of expiring long term Section 8 subsidy contracts, made difficult by reforms in the federal budget process (since the
original contracts were authorized by Congress) were important to refinancing profits. Refinancing was also a good
business for NHP's newly acquired mortgage company, Washington Mortgage. Rod was adamant. The federal government was
morally obligated to subsidize him and other HUD landlords, regardless of the cost to taxpayers or performance for
communities relative to more economically sound options. Performance was irrelevant compared to the long term profits
owed to a certain "class" of Americans.
As Rod, Mike Eisenson and Pug Winokur grappled with the implications of having not reengineered their operations to be
competitive in the newly deregulated environment, they determined to fight back in the political one. A former NHP
senior executive and shareholder, Conrad Egan, had joined the staff at HUD at the beginning of the Clinton
Administration. Conrad was eager and happy to provide substantial inside information to help the industry subvert
government policy and the interests of taxpayers. The National Association of Homebuilders and other lobbying
associations agreed to help. In the meantime, Rod offered Gene Ford an opportunity to do a number of things with him in
business and, according to Gene, cemented Gene's support. By allying with a variety of private groups and state housing
agencies that also wanted to retain a highly subsidized, centrally controlled system fueled by Conrad's continual flow
of information from inside the Administration, Rod was able to build a coalition that would ensure that Congress
rejected HUD's performance based proposals and adopt a non-performance based one that ensured maximum profits for
Harvard, Mike, Pug, Rod and current investors without regard to performance or return on taxpayer investment.
Under serious stress to raise record amounts of campaign fundraising monies for the 1996 election, the appropriations
committees made their deals with the housing industry during the summer. Rumors flew that the HUD landlords were
promised whatever subsidies they needed to take their stocks public at an attractive price or keep their businesses
continuing without disclosure and competition. In addition to subsidies, there would also be lots of appropriations
support for new HUD mortgage financing on liberal terms so that the captive mortgage companies would generate more
profits. They would then help owners refinance and pull out equity and help make top dollar public offerings such that
future changes in value of the stock were entirely the expense of the taxpayer. The process was not unlike the way S were used during the 1980s to lock in inflated private real estate profits by leaving the taxpayer holding the bag. As
an incentive to go along, the HUD Office of Inspector General, whose job it is to prevent all of this, would get special
increases in funding for its law enforcement program Operation Safe Home. [It is my belief that "Operation Safe Home" is
part of an unspoken HUD role that provides a hiding place for covert operations in what many would think is an
out-of-the-way backwater.] Rumors flew that these Operation Safe Home funding increases were part of an agreement to
target Hamilton and take other enforcement actions that would help position politically adept HUD landlords and real
estate investors for gentrification during the remaining course of the deregulation process.
Cancellation of the loan sales would be a boon for the industry. Negotiated workouts with existing owners returning 35
cents on the dollar to HUD are more profitable to defaulting borrowers than purchase of the loans by third parties for
70 - 90 cents on the dollar. But this would hold true only so long as the White House Office of Management and Budget
(OMB) would go along with pretending that HUD was getting 70-90 cents in the budget assumptions to fund new insurance.
This is an important point to understand. In 1991, the Bush Administration had passed a law requiring that
appropriations were necessary to issue new insurance -- appropriations sufficient to pay for expected losses from that
insurance. This was part of an effort to prevent the kind of back-door giveaways that had marked the Iran-Contra years
at HUD. One of the reasons that HUD conducted the loan sales program was to ensure that it could lower insurance losses
so that Congress could afford the appropriations necessary under the new rules to issue the significant volume of new
insurance. New insurance would be popular with HUD developers because it meant more new projects could be developed. In
other words, if HUD expects to recover 70 - 90 cents on each dollar of defaulted loans, new insurance is cheaper for the
appropriators than if HUD expects to recover only 35 cents. That means HUD can issue far more insurance through
companies like NHP's mortgage subsidiary. It would be a fraud on the American taxpayers if new insurance were authorized
based upon overly optimistic loss assumptions, because taxpayers will have to fund additional losses. Nevertheless, OMB
has, in fact, agreed to this budget fiction of pretending HUD is doing loan sales when it is calculating the cost of new
insurance while in fact HUD is not doing loan sales. Instead, old-style negotiated workouts that feed the Congressional
fundraising coffers have returned. Everyone (except the taxpayer, whose interests are not represented) can profit, by
pretending the color of the sky is different depending on which part of the budget is at issue. Needless to say, the HUD
budget is full of these kinds of "multiple personality disorders."
With these "Soviet" subsidy policies in place, designed to ensure federal political control of HUD multifamily
investments in local neighborhoods, the opportunity to integrate on-line education and job opportunities on any
significant scale disappeared. This is because the plan for Goldman Sachs, BlackRock Capital and other capital market
and real estate investors to view information on the portfolio, to bid competitively on the remainder of the portfolio,
or to bid on "place based" trusts was lost. If such investors were able to bid for all HUD assets in a place, including,
for example, single family houses and apartment buildings, and the mortgages on them (what is referred to as a
"place-based" sale), they would have a real opportunity, through introduction of employment and educational programs and
other neighborhood-enhancing activities, to increase real estate values there. Hamilton believed that in such a
place-based sale investors would be willing to bid significantly higher than others whose plans for the properties did
not include neighborhood improvement, due to the huge profit potential. Instead, the portfolio now was to be managed so
that owners couldn't care less about education or jobs or neighborhoods and no broad range of investors have the
information that will cause them to convert these neighborhoods to make economies other than through gentrification.
Indeed, the big profit opportunities in HUD's scheme would be in moving current residents out or into more expensive
prisons or into assisted housing units for the elderly. They would also include bringing new, middle-income tenants in
via a process known as "gentrification." The gentrification phenomenon is happening all over the country today. While
gentrification can be highly profitable for private industry, done in this matter, it is often extremely expensive for
taxpayers.
For all of the enemies Hamilton and Edgewood made, there are approximately 250 Neighborhood Networks computer learning
centers in service around the country today. If HUD had proceeded with a performance based plan, that number would
probably have been closer to 2,500 and, more important, private equity would be replacing government subsidy and
guarantee financing in many communities at a much higher speed than is happening today. Unfortunately, we have evolved a
system in America where more people can make money from communities failing than from succeeding. This is perplexing,
because, unless communities succeed in creating fundamental wealth, there will be no new money and wealth created at
all. We are destroying the goose that lays the golden egg.
Learning Speed Heartburn:
"Oh, Senator, I Could Teach You How to Do This"
I have to say that of all the many challenges of prototyping outsourced data servicing with ETS, the problem that
drained the most energy was dealing with the Hamilton employees and the management that Hamilton had recruited to grow
and build ETS and other sites like it. The real estate, law enforcement and organized crime industries are not the only
ones opposed to performance-based access to knowledge and capital. Pogo was right, "The enemy is us." We experienced
these problems close to home, too. Our first challenge was in learning how to learn how to outsource as well as how to
teach investment bankers about the benefits of getting out of "expert" mode and into a "learning" model. This meant
creating tools and databases as they learned. We were grappling with being a network company. The nature of ETS and the
political risks attached to our project made that painful process even harder and more complicated.
The most important requirement for ETS to succeed was that a group of black women had to demonstrate high learning
speeds about how money works using the Internet and advanced software technology. They had to make that information
useful in their communities and provide services to small and large businesses in their area. There was no way that they
were going to do the actual data servicing work without understanding the implications of what the data told them. Their
comprehension of the substance of what we all were learning was part of what helped them see new opportunities and add
value. It was also what made them a bigger threat. Their performance came at the price of access to and understanding of
true knowledge.
Productivity at ETS was very much impacted by individual learning speeds within the ETS team itself. We had initially
hired a random sample of people -- we had not cherry-picked for performance indicators among applicants. As a result,
building a high performance team became difficult and expensive, both for the top performers at ETS and for the
investors. The lesson learned was that we needed to adhere to a strict discipline of hiring people who were committed to
leaning and creating value on a sustainable basis. But this did teach us what we needed to know for the prototype. The
cost of this approach was that sometimes ETS and Hamilton found it hard to get the day-to-day work done smoothly.
As time went by the top two or three members of the ETS team had skills and learning speeds about selected topics that
started to surpass those some of the employees at Hamilton. Some Hamilton employees were from real estate or mortgage
backgrounds and had trouble adapting to an Internet and software based learning environment. When an ETS employee
earning $20,000 a year starts to function on a trajectory that means he or she can be as productive or more productive
than someone earning $120,000 a year within a matter of years, tensions build. Such is the power of the Internet.
I really started to understand this when I went to China in 1997 to explore data servicing partnerships. What I
discovered was that it was more economic to send some of our $120,000 jobs to China and keep the $20,000 workforce in
the US, training them to perform up to a $30-60,000 level. The strictly "abstract" functions were much more mobile than
was the "concrete" function. Hence, if I could find an intelligent, reliable workforce locally that could do the
concrete task of raw data entry and document management while continuously adding software tools that continuously
reengineered the abstract functions as well, we could improve profitability greatly.
This had all sorts of irritating implications for traditional executives. The relationship with clients had to be
intimate and managed at the lowest day-to-day operations level possible. There was not time to send things back up a
chain of command. That meant senior management could not earn large salaries for managing "process" and marketing to
fellow executives who were equally divorced from day to day operations. Meantime, project managers at Hamilton had to
have enough understanding of technology and data servicing to be effective at anticipating what tools and databases were
needed and how to outsource this work. The learning network model was a shock to those used to chain of command and not
having to anticipate or explain.
Bridget McClarin was a case in point. Bridget was living on D.C. unemployment payments before joining the ETS computer
training class and learning the Microsoft Office Suite. After graduation she joined ETS and signed up to take classes at
Catholic University, which is near Edgewood. In one of her first courses, she studied relational database design and a
new technology called OLAP databases. Bridget was at Hamilton one day and was walking past a meeting in which our lead
database developer and several technologists were discussing a problem in applying OLAP software. Bridget overheard
them, walked in, helped them solve their debate and then walked out. The group was stunned. In 18 months Bridget had
moved from a person with no computer skills to someone who was reasonably literate on advanced database design issues.
The person whom Bridget probably surprised the most during those two years was Senator Kit Bond of Missouri. Senator
Bond chaired the Senate Small Business Committee. His counsel, who had been in the property management business and
involved with training programs in that capacity, was interested in what ETS was doing. Senator Bond had sponsored a
bill that, if passed, would have encouraged federal agencies to outsource work to businesses that located and generated
new employment in areas with high welfare and unemployment rates. The idea was that corporations did not have demand for
this work force, but there was plenty of outsourced work like data servicing that could be available. In addition, it
was much cheaper for the federal government to pay for data servicing work than to pay $35-55,000 per family for a woman
with children not to work. The goal was to improve skills and private income in a way that would save the government
money in an integrated federal budget.
Senator Bond invited a team of people from ETS to the Senate to testify.
Bridget's testimony included her description of how she became computer literate and walked the Senator by a large
monitor through a "money map" (these are maps that show how money works in a place) that we had posted on the Internet.
Bridget was now producing money maps for us at about 50-75% of the cost of what we had been paying for them before we
invested in ETS. She explained to the Senators her use and understanding of Geographic Information Systems (GIS) and
geocoding databases. Senator Bond asked her how she had learned GIS programming. Bridget explained that a GIS trainer
had come over to ETS, but that he was not competent, so she and her co-workers had gotten the training manual and taught
themselves. Senator Bond, with his mouth wide open, then said that he hoped Bridget understood that there were people
like him who found computers and technology intimidating. Bridget looked at him and said in the warmest and most
feminine of ways "Oh Senator, don't worry, you could do this, I could teach you." Senator Bond was speechless. He had
just realized the speed at which the presumed not-so-skilled could become skilled, and even more so.
Senator Bond's legislative efforts did not meet with success. Firms that benefit from minority set asides, 8A firms, saw
this effort as a threat. So a group of minority business leaders soon joined with prison companies, real estate
investors and construction interests seeking to profit on government subsidy and gentrification during the period of
deregulation. The number of private businesses that wanted to maintain lower learning speeds and preferred to survive by
"gaming" the process seemed endless. Worse still, it was clear that the leadership of the nation would do anything to
permit themselves and the status quo to survive the compelling pressures for change. During the summer of 1996, the
elites made a substantial commitment to grow "stupider and stupider." But it was far from just the elites. In 1996, it
looked like each group wanted a rigged deal for itself, and no one wanted to do what it would take to ensure that the
whole worked or grew.
(Keep watching Scoop for Part Four)
* - Catherine Austin Fitts is President of Solari, Inc. She is the former President of The Hamilton Securities Group,
Inc., Assistant Secretary of Housing in the Bush Administration and Managing Director and member of the Board of Dillon
of Read & Co. Inc. She can be reached at catherine@solari.com.