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

Summary

Odd Lots Podcast Summary: Jim Milstein on the Massive Risks of Any 'Mar-a-Lago Accord'

Release Date: March 24, 2025

Bloomberg's Odd Lots delves deep into the intricate web of finance, markets, and economics with host Joe Weisenthal and co-host Tracy Alloway. In this episode, they are joined by Jim Milstein, co-chair of Guggenheim Securities, to discuss the precarious state of U.S. debt and the potential ramifications of proposed debt restructuring initiatives, specifically the so-called "Mar-a-Lago Accord."

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1. Introduction to Debt and Resource Allocation

The conversation begins with Milstein framing federal spending as a competition for resource allocation. He emphasizes that persistent deficits are largely driven by expansive social safety nets like Social Security, Medicare, and Medicaid. When discussions arise about tackling the debt or deficit, they essentially pertain to reallocating resources—reducing consumption in certain sectors to free up resources elsewhere.

Jim Milstein [03:00]: “Any discussion of federal spending is about a competition for resource allocation.”

Milstein points out that efforts to reduce deficits often aim to curtail consumption in areas deemed less productive to allocate resources to more strategic sectors like reindustrialization.

2. The Mar-a-Lago Accord Proposal

Milstein introduces the concept of the "Mar-a-Lago Accord," a strategy attempting to address U.S. debt by restructuring it. This proposal involves exchanging short-term Treasury bonds for long-term "century bonds" with lower interest rates, thereby reducing the cost of servicing debt.

Milstein [05:37]: “A literal or metonynomic Mar-a-Lago accord… screams default.”

He discusses the underlying intention to weaken the dollar to make U.S. manufacturing more competitive globally, a move intertwined with broader strategies to reshore manufacturing and mitigate the reliance on critical imports from countries like China and Taiwan.

3. Challenges with Debt Restructuring

Despite the theoretical benefits, Milstein highlights significant challenges with the Mar-a-Lago Accord:

• Limited Impact on Foreign Debt Holders: Currently, only about 15% of U.S. debt is held offshore, and much of that is in the hands of foreign private investors rather than governments. This makes the proposed exchange offers less effective in significantly reducing overall debt.

  Tracy Alloway [25:27]: “Not more than 15% of it today is held offshore.”

• Domestically Concentrated Debt: The majority of U.S. debt is held domestically by entities such as government accounts, Social Security, Medicare trust funds, banks, insurance companies, and mutual funds. This concentration limits the efficacy of foreign-focused restructuring efforts.

• Economic Risks: Terming out debt at higher interest rates could exacerbate the annual interest burden, potentially increasing from the current average of 3.3% to over 4.3%, thereby worsening fiscal imbalances.

  Tracy Alloway [25:27]: “The 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.”

4. Sovereign Wealth Fund as an Alternative

As an alternative to the Mar-a-Lago Accord, Milstein and Alloway discuss the creation of a sovereign wealth fund. This fund would be capitalized by monetizing U.S. government assets, including:

• Natural Resources: A significant portion of land west of the Mississippi, mineral rights, and federal holdings in Alaska.

  Tracy Alloway [40:44]: “We own probably a third of the land west of the Mississippi… mineral rights on these lands…”

• Government Enterprises: Equity in commercial enterprises like the Tennessee Valley Authority (TVA), Fannie Mae, and Freddie Mac.

Milstein suggests that monetizing these assets could generate approximately $2 trillion to interfere in foreign exchange markets to weaken the dollar without relying on aggressive debt exchanges or geopolitical threats.

5. Privatization of Fannie and Freddie

A substantial portion of the discussion centers on the potential privatization of Fannie Mae and Freddie Mac. Milstein outlines the steps and benefits of restructuring these government-sponsored enterprises (GSEs):

• Capitalization: Fannie and Freddie have nearly reached their required capital levels, which could allow for their privatization without compromising their financial stability.

  Tracy Alloway [50:10]: “They have paid the treasury department back now $302 billion on that, characterized as dividends on that $192 billion par investment.”

• Regulatory Oversight: Post-privatization, these GSEs would remain under the stringent supervision of the Federal Housing Finance Agency (FHFA), ensuring adherence to safe business practices and preventing a recurrence of pre-crisis risky behaviors.

• Market Stability: Enhanced capitalization and regulatory oversight would help maintain the credit ratings of mortgage-backed securities (MBS), ensuring their continued status as safe and liquid assets crucial for bank capital requirements.

  Tracy Alloway [57:24]: “They are the big factor in that conventional mortgage market… they buy mortgages…”

6. Implications for Financial Markets and Credit Ratings

The episode delves into the broader implications of debt restructuring strategies on financial markets:

• Credit Rating Stability: Privatizing Fannie and Freddie with robust capital backstops may preserve the high credit ratings of MBS, crucial for maintaining low borrowing costs across the economy.

  Tracy Alloway [59:03]: “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?”

• Investor Confidence: Maintaining high credit ratings and ensuring the reliability of MBS as safe assets underpin investor confidence in broader financial markets.

7. Conclusion and Final Thoughts

In wrapping up, Weisenthal and Alloway reflect on the interconnectedness of norms, economic growth, and debt management:

• Norms and Confidence: The U.S. has historically not defaulted on its debt, a norm that underpins global confidence in Treasury securities. Altering this norm through restructuring could have profound and possibly destabilizing effects.

  Jim Milstein [63:22]: “There are things in pieces of paper…?”

• Balance Between Private and Public Investment: Success has historically hinged on balancing private sector dynamism with essential public investments in infrastructure, education, and research.

  Tracy Alloway [35:44]: “The success of the United States is a demonstration of the balance between private and public investment.”

Milstein underscores the urgent need for a fiscal consolidation plan to stabilize the growing debt, emphasizing that without curbing deficit growth, the U.S. faces a growing debt overhang that could stifle economic dynamism.

Tracy Alloway [36:51]: “We have to get that fiscal imbalance corrected. We have to balance revenues and spending.”

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Notable Quotes:

• Jim Milstein [03:00]: “Any discussion of federal spending is about a competition for resource allocation.”
• Tracy Alloway [25:27]: “Not more than 15% of it today is held offshore.”
• Tracy Alloway [40:44]: “We own probably a third of the land west of the Mississippi… mineral rights on these lands…”
• Tracy Alloway [57:24]: “They are the big factor in that conventional mortgage market…”
• Tracy Alloway [59:03]: “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?”

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This episode of Odd Lots provides a comprehensive analysis of the complexities surrounding U.S. debt and the potential strategies for its management. Milstein's expertise offers listeners a nuanced understanding of the risks and realistic challenges associated with high-level debt restructuring proposals like the Mar-a-Lago Accord.

Transcript

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[Joe Weisenthal]

Please hold.

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[Tracy Alloway]

Bloomberg Audio Studios Podcasts Radio News.

[Jim Milstein]

Hello and welco. Welcome to another episode of the Odd Lots Podcast.

[Joe Weisenthal]

I'm Joe Weisenthal And I'm Tracy Alloway.

[Jim Milstein]

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 US Debt, the size of the US Deficit, et cetera. 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, et cetera. 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.

[Joe Weisenthal]

Are they.

[Jim Milstein]

Well, maybe they're not doing it.

[Joe Weisenthal]

I mean.

[Jim Milstein]

Yeah, I think so.

[Joe Weisenthal]

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?

[Jim Milstein]

Well, so, for example, Secretary Scott Bessant in some of his recent interviews talked about, you know, we want to re leverage the private sector, and so 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, etc. 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 reindustrialization.

[Joe Weisenthal]

Okay. Maybe what I would say, you know how I like to think about this.

[Jim Milstein]

Sure.

[Joe Weisenthal]

I like to ask, like, think about the big picture in bonds. And I always say bonds are built on norms, right?

[Jim Milstein]

Yeah.

[Joe Weisenthal]

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.

[Jim Milstein]

Yeah, well, you know, absolutely. And obviously, you know, we did that conversation with Jim Bianco about, you know, either a literal or a metonynomic Mar A Lago accord. And then we talked to Ray Dalio 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 re term 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.

[Joe Weisenthal]

But one man's default is another man's restructuring joke.

[Jim Milstein]

That's right. But I think if I were a Treasury holder, I would be very upset if the thing that I consider to be the most liquid safe asset in 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, it's this is five year bond and now a seven year bond and you're going to get the same money in the end. Like 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.

[Joe Weisenthal]

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 def. And also I guess address the sort of emotional sense that the US isn't getting compensated enough for its role in the global economy or global security, 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 Steven Miran put out last year that people started getting very interested in and talking about and that's why we're talking about it.

[Jim Milstein]

Well, I want to get to our guest in 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 US and we need to weaken the dollar and decentralize its role. And it's like these sort of like intellectualizing 5D chess. Meanwhile, Trump is like, no, I just want more money for terrorists. Like I don't know. He like there is 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 him on the show last year.

[Joe Weisenthal]

Someone who actually matters.

[Jim Milstein]

Sorry, my wife. Someone whose opinion. Someone whose opinion actually matters. All of our guests matter. All of our guests 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 Odd Lots.

[Tracy Alloway]

My pleasure.

[Jim Milstein]

We talked about your background when we had you on the show last year. What do you know about debt restructuring?

[Tracy Alloway]

Just a little.

[Jim Milstein]

What have you done? What have you done in that?

[Joe Weisenthal]

You've dabbled a bit.

[Tracy Alloway]

Yeah, it's my metier. So I had this awful job and a great title called Chief Restructuring Officer of the United States Department of the treasury during the financial crisis.

[Jim Milstein]

There you go.

[Joe Weisenthal]

That is quite a title.

[Tracy Alloway]

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 Citi and B of A and the rest of that crowd. But before that, I worked on the restructuring of Argentina. The Republic of Argentina is one of their many restructuring zones. You got to start debt in 2005. We did a big exchange offer for their international bond indebtedness. I worked on Puerto Rico's debt default and restructuring back in the aughts.

[Joe Weisenthal]

Wait, were you on the hedge fund side of Argentina or the country?

[Tracy Alloway]

I'm on the Republic side.

[Joe Weisenthal]

Oh, okay.

[Tracy Alloway]

Yeah. And then when I was a lawyer back in the 80s, my firm, Cleary Gotley, worked on all of the Brady bond restructuring across Latin America. So I've done a bunch of sovereign.

[Jim Milstein]

Okay, so you're the perfect guest.

[Tracy Alloway]

Yeah.

[Joe Weisenthal]

Okay. Shall I just jump into it and ask the obvious question or. One of the obvious questions, but where is the 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?

[Tracy Alloway]

So I think there's a clear. I mean, I don't want to engage in sane washing, which. Yes, you know, we. There's clearly an impetus by the President to impose tariffs. He's tariffman. And around him, through Besant 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. 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 the calculator industry and 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 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 now, going back in the 10 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, if you piece together what's some of the things that Besant 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 they're 35% of global manufacturing. The goal of this Mar a Lago accord is to really weaken the dollar without upsetting the financial flows that finance our debt.

[Joe Weisenthal]

And crucially, the manufacturing build out 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.

[Tracy Alloway]

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 raising a tariff wall, a high tariff wall, is a bet that private capital will invest behind it. Biden administration 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 and D policy to promote domestic industry. So you know, Trump has inherited the CHIPS act and it is making progress. It has spurred.

[Joe Weisenthal]

He says it's terrible.

[Tracy Alloway]

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 zero those out going forward. So going back though, 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 and D subsidies, of investment subsidies, and use procurement as a way to create demand pull for these new industries. Foreign.

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[Jim Milstein]

You use the word sanewashing, which is a good word because there's this sort of intellectual, as you said, architecture around Trump. It's not clear that Trump himself sees it this way, that this works, that you can sort of like re accelerate US 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?

[Tracy Alloway]

Okay, and this is all coming out of Morant's paper. As Tracy indicated at the beginning. I mean, he's put together the most kind of comprehensive strategy and he acknowledges there's 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 Dalio said in your podcast, debt crisis, and just let me maybe to frame that problem today, Federal debt to GDP is 1 to 1. Federal debt is equal to GDP. We're running deficits at 7% of GDP and the economy is kind of growing at 12 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.

[Joe Weisenthal]

Issuing bonds to pay off bonds.

[Tracy Alloway]

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, now some very tough allocation decisions need to be made with regard to federal spending because someone joked that the federal, when you look at the federal government, it's really a retirement program attached to an army. Yeah, right. We, I mean, the largest I've heard.

[Jim Milstein]

It called an insurance program, but it's the same thing.

[Tracy Alloway]

Yeah, it's 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, you know, Elon Musk is 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 supports education, transportation, housing, infrastructure. Right.

[Joe Weisenthal]

The wider economy, some people would argue.

[Tracy Alloway]

Stuff that 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 healthcare support. And so 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 Medicaid, transportation, housing and education. 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 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. They're not really attacking the deficit. So we're going to continue to need to sell a lot of debt.

[Joe Weisenthal]

So you've laid out the pickle problem very well. Perfectly laid out the Pickle problem Perfectly say that that's a good way. The idea here embedded in the Mar A Lago accord is that the US 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 US to actually pay back.

[Tracy Alloway]

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 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 doom and gloom. The two primary tactics here 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 say 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 hundred 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.

[Joe Weisenthal]

Terming out duration.

[Tracy Alloway]

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.

[Joe Weisenthal]

It's come down a lot.

[Tracy Alloway]

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, underwriting our money market funds. So the reality is to get this done, we're really doing it with ourselves. What we really need to do is term out our debt. And the problem we're facing right now is that the cost of debt the interest cost of our debt is relatively high. The 10 year is at 4.3. The 30 year put aside as what you'd 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. 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 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 as to improve the competitiveness of US Domestic manufacturing, there is another approach, and that you've also heard rumor of from the Trump administration, and that is the creation of a sovereign wealth fund to take assets that the US 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 current the foreign exchange markets to try and push the dollar down.

[Jim Milstein]

I see. It's interesting because historically, right. Sovereign wealth funds in resource rich countries are often about keeping the currency strong, et cetera, especially for countercyclical elements. And so the idea that we would use it to intervene in foreign exchanges. 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 US Government without immolating yourself.

[Tracy Alloway]

Yeah, I mean, you really want to see rates blow out. Have the federal government threaten to not pay its debts. That would be an event from which the financial markets might not recover.

[Joe Weisenthal]

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.

[Tracy Alloway]

Yeah, well, and 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, you know, potentially defend themselves without the benefit of the United States security umbrella. Poland's already done this. Their increase their defense spending. And basically the countries 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 Weisenthal]

Joe, you know what I was just thinking, say more. What if China exchanged its bills and treasuries for century bonds in exchange for NATO protection?

[Jim Milstein]

First of all, there's obviously that history of the fact that at one point in time China perceived its main adversary as the Soviet Union and did 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 giga plants 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. They always recover. But you know, like when you get into existential questions about the sort of safety and risk freeness of what do we talk about here?

[Tracy Alloway]

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 US Government debt is really a bet on the US 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. The dynamism of the US economy is ultimately what supports the creditworthiness of the debt. But as your debt, and this is what Dalio was talking about, 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 debt dynamism of the economy, you get to a point where 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 debts when due, we're in a world of hurt. I mean, I went to the speech of Besant gave at the Economic Club of New York and he talked a lot about unleashing the private sector, reducing regulation, freeing the banks to once again lend to the private sector and withdrawing the Biden stimuluses to 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, that's all fine and well, but the reality is that governments play an important part in promoting the growth of their domestic economies. 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 develop the investment in research and development and novel technologies that the private sector won't invest in because the commercial potential of them isn't obvious. Right. So the basic research that we do through NIH and the National Academy of.

[Joe Weisenthal]

Sciences, we've done an episode on this.

[Tracy Alloway]

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.

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[Joe Weisenthal]

I want to go back to the sovereign wealth fund idea, because when I hear that, it sounds like basically a shift from the US Issuing unsecured treasuries to secured 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. Encumbrance 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 US Is the biggest economy in the world. And probably if anyone's going to collateralize their debt, maybe it's the US but what exactly would they use to secure these things?

[Tracy Alloway]

Okay, so there's loan to value and then there's cash flow coverage. Right. So 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 north of 3,000. If you remarked the tons of gold at Fort Knox that we own to market, it's probably 800, $900 billion. That's against a $36 trillion debt balance. That's a drop in the bucket.

[Jim Milstein]

It's done nothing.

[Tracy Alloway]

But it's not nothing. It's not nothing. We own probably a third of the land west of the Mississippi. The western states complain about this all the time. That the federal government and the bureau of land management is a absent national park backed bonds. Is that where we're heading? Yeah. God forbid that Teddy Roosevelt's legacy, great legacy. Would be somehow undone. But put aside the national parks, 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 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 a variety of enterprises, commercial enterprises that we own equity in or own outright. 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 90 to 95% 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 $2 trillion of land values, mineral rights, ownership in commercial enterprises that could capitalize a sovereign wealth fund and some of those things cash flow. Or 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 $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 our debt and try to browbeat with security umbrellas and tariff walls foreign countries to help us in that endeavor.

[Joe Weisenthal]

It's still a big bet on economic growth though, right? Because the US 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.

[Tracy Alloway]

Yeah, no, I, you know, first of all, we never pay off the debt. We just outgrow it. That's the key here. The stock of debt is just refinanced and rolled over continuously. 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. 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 relative to the size of the economy, now denominated in much weaker currencies. You can try this kind of mar a lago exchange offer. And then of course, the worst of all outcomes is an outright default where you restructure the debt.

[Jim Milstein]

It seems to me, and I said in the beginning, I sort of conceptualize these things in terms of resource allocation and who gets what. And it seems to me, 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 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 then 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, the implicit guarantee of the government? Because you know, obviously like, you'd love to keep both. Right. You'd love to privatize the profits and keep that backstop. Is there any conceivable way to privatize them and actually not have that backstop in place anymore?

[Joe Weisenthal]

I think the expectation is they would implicitly keep the backstop. Like that's what investors.

[Jim Milstein]

How is that fair?

[Joe Weisenthal]

Well, this begs the question, why bother doing it at all? Right.

[Jim Milstein]

Is there a way to do it that's not just a giveaway?

[Tracy Alloway]

Yes, there is. Okay, so there's a lot of history here.

[Jim Milstein]

Yeah.

[Tracy Alloway]

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 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 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 a 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.

[Joe Weisenthal]

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.

[Tracy Alloway]

Yeah. So the, 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 one 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 CET1 capital levels. There are many of us who think that the capital rule that was created for them grossly oversolved for how much.

[Joe Weisenthal]

Capital they should carry right after the financial crisis. Everyone's nervous.

[Tracy Alloway]

Exactly. And so as with the big banks, the so called SIFIs, Fannie and Freddie have been subject to so called stress tests to see how they would fare in a severely adverse scenario where the financial markets decline by 20%, interest rates go up by 10%, unemployment skyrockets, 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 tests show would be negligible losses. Seems like pretty a waste of that capital, just grossly oversothing them. But I'll get off my horse on that. Leave them with those capital levels, 156 and 100 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, 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 treasury stand behind this $270 billion worth of capital with a commitment to buy 250 billion of capital should the need arise. So 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 the earnings would support a commitment fee. But that would give comfort to the markets that 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 instead of leaving them in conservatorship in perpetuity, is that the government owns 90 odd percent of the equity. They own the senior preferred stock. They have a Warrant to purchase 80% 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% 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 filled with lots of assumptions and you could quibble with some of them, but it's a dividend discount model which isn't unheard of in the valuation of financial institutions. And they suggested the total equity of which I think the government ends up with at least 90% when you recapitalize. And the total equities were somewhere between 300 and $500 billion.

[Joe Weisenthal]

That's a decent number.

[Tracy Alloway]

That's a decent number to put in your sovereign wealth fund or to pay down some of the deficit.

[Joe Weisenthal]

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?

[Tracy Alloway]

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, Ann Fannie and Freddie. 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. Just to do just a touch little more history. If you look back to 2003 through to 2008, 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, 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 principal and interest on those securities, they buy the mortgages out of the pools, restructure them and modify them.

[Joe Weisenthal]

Which is why agency MBS is treated as a very safe and liquid asset for bank capital purposes.

[Tracy Alloway]

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, what will back that guarantee is both the 2,280 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 will stand more than half a trillion dollars of capital. And so this is when I get into debates with people about people who were opposed to. Of 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? 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 at the end of the day, there'll be a conversation with Moody's and S and P and Fitch and they'll have to decide whether they remain near sovereign credit.

[Joe Weisenthal]

Oh, it's kind of funny that the credit rating agencies are like, still in control. Yeah, exactly. Okay, so we've talked a lot about creative ways for the US 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.

[Tracy Alloway]

Oh, no.

[Joe Weisenthal]

And that is the bonds owned by the U.S. issued by other countries. Really old ones. Oh, like Chinese imperial debt. Or did you know the UK owes the US a lot of money from, like, World War II loans?

[Tracy Alloway]

Oh, still.

[Jim Milstein]

I didn't know that.

[Tracy Alloway]

I didn't know that. No.

[Joe Weisenthal]

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.

[Tracy Alloway]

So, so these are. I don't know anything about this. These are bonds issued by predecessor governments in China. Yeah, There is some history of, I'm aware of some czarist Russia bonds.

[Joe Weisenthal]

Yeah, those are the famous ones.

[Tracy Alloway]

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 payout 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.

[Jim Milstein]

Well, we're in uncharted territory.

[Tracy Alloway]

We surely are.

[Jim Milstein]

Even this little, like, 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.

[Tracy Alloway]

Thanks.

[Jim Milstein]

We could just talk to you for hours.

[Joe Weisenthal]

Thank you so much.

[Jim Milstein]

But that was a fantastic, thorough conversation.

[Tracy Alloway]

I appreciate you coming back on all Enjoyed it though. Thanks.

[Jim Milstein]

Tracy. I love talking to Jim. He's so good.

[Joe Weisenthal]

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 US's biggest export.

[Jim Milstein]

Yeah.

[Joe Weisenthal]

And Trump is obsessed with exports.

[Jim Milstein]

I know, I know.

[Joe Weisenthal]

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.

[Jim Milstein]

I mean, look, I guess I'd rather US export real things that employ people than.

[Joe Weisenthal]

But he could just take the win, right?

[Jim Milstein]

Take the win. Yeah. We're a big, we're a big exporter of these pieces of paper. Not even pieces of paper anymore. No. I thought that 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, you know, some of these goals. It's like 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 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.

[Joe Weisenthal]

Well, this is the norms point, right?

[Jim Milstein]

Yes.

[Joe Weisenthal]

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.

[Jim Milstein]

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 debtor, etc. You're like go beyond norms and you actually like, you could trigger. Trigger formal things.

[Joe Weisenthal]

No, that's still a norm though, I guess. No, I mean, it's like historically has not defaulted on its debt.

[Jim Milstein]

No, but, but it's like there are things in pieces of paper right. That like, when you don't. When you like, try to change.

[Joe Weisenthal]

There are legalities, but frankly, legalities are being treated as norms now, right?

[Jim Milstein]

I suppose so, Yes. I suppose so.

[Joe Weisenthal]

Shall we leave it there?

[Jim Milstein]

Let's leave it there.

[Joe Weisenthal]

This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracee Alloway.

[Jim Milstein]

And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers Carmen Rodriguez at Carmen, Armando Bennett at dashbot, and Kalebrooks at Kalebrooks. For more Odd Lots content, go to bloomberg.com oddlots we have all of our episodes in a daily newsletter and you can chat about all of these things 24. 7 in our Discord with fellow listeners at Discord, GG Oddlauts.

[Joe Weisenthal]

And if you enjoy Odd Lots, if you like it when we talk about US Debt restructuring potential US Debt restructuring, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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[Jim Milstein]

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