Industry Vet Knows the Risks & Reward of the OZ

James Sanford

The Opportunity Zone Expo Podcast
Industry Vet Knows the Risks & Reward of the OZ


Jack: Welcome back everybody to the OZExpo Podcast. I'm your host, Jack Heald. And with me today is Jim Sanford who is now -- help me with your, your title, Jim -- you're the founder of Sag Harbor Advisors, is that right?

Jim: Founder and managing partner. I formed the firm called Sag Harbor Advisors that was an RIA and was a registered investment advisor created to manage money, as what we call liquid alternative. So it was a standard, you know, on shore in 1940 Act RIA. My custodian was a director of brokers that managed money for high net worth individuals that are performance fee basis. So similar to how a hedge fund's operated. I was engaged in that for about two or three years from 2013 until 2016 and I became less enamored of the publicly traded liquid markets given the valuation and how equities and how low interest rates were and how invasive quantitative easing had really made valuations in the liquid space that was available. The managers that are already focused on liquid instruments came in a little bit more enamored with the risk-return profile in the liquid alternative fixed income space, mainly real estate bridge lending.

And I started to shift my focus and my clients’ assets over to on alternative lending real estate fund in Connecticut, a commercial real estate bridge lending fund. When you look at the landscape of what was offered to a portfolio manager in the liquid space, you know with near zero interest rates, very tight spreads, high yield bonds, B rated trade with a five figuration trading, 5% or so. And when I looked at the liquid real estate bridge lending space, which kicked out returns after fees in the low double digits, 10 to 11%, which was first lien secure collateral on U.S. real estate or various asset classes, an average of 18 months duration of the loan, floating rate, mitigating it to say risk, it ws hard to not become enamored with that as a form of risk to put in front of my clients relative to fit.

Jack: I was reading that some of this stuff on your website, on Sag Harbor Advisor's website. And you were talking about these low double-digit returns. And I'll confess, I was like, yeah, right. But now as you begin explaining it, I get it. It makes sense. Okay. So, carry on. Now I'm really interested.

Jim: So, I started to raise capital for Connecticut where it was a good fit and I focused my client's exposure there. We're a smaller fund looking to grow. It didn't have internal core marketing assets. And I was excited to get involved and put that in front of prospective customers. And it also allowed me to start reaching out to much larger institutions, family offices, multifamily offices, pension funds and endowments.

And from that, I also started to advise and arrange or “broker” individual bridge loans on behalf of sponsors and developers, raising debt capital for them in the bridge lending space various commercial asset classes, commercial office, multifamily, industrial, retail, land, et cetera. A lot of my clients that I covered, back in my 20-year career in Wall Street, in the liquid credit space, were primarily hedge funds and alternative debt funds.

They've moved over into this space. So it was a natural progression for me to kind of pick up where I left off in 2012 and reengage a lot of those relationships. And I think I probably had a Rolodex of about 300 debt funds in the [Fixico] space over my 20-year life. So it was good to get back to doing what I was previously doing, but in a different product, arranging and advising on complex, fixed-income type securities and in this arena, illiquid. And then that led me to the QOZ space.

Jack: Yeah.

Jim: And while my commercial estate capital markets business originally focused on debt, one of my clients was starting a Qualified Opportunity Zone fund. We started talking about this in late fall of 2018 and they were an early mover in the space. They had capital to invest when a lot of people were talking about the space, they didn't really have the funds and capital to really put in front of sponsors and developers and this client of mine did and they had an early mover advantage.

And that was exciting because I had something very real this time and the equity part of the capital stack to put in front of developers. And you had something very real and interesting to show the QOZ fund because these were early deals that were conceived of and well-baked prior to the tax law. I think those are going to be the best deals that in and of themselves generate pretty strong IRRs and don't need the implication of the tax rule to make sense.

And a lot of the savvier guys with the early first mover advantage were able to scoop up and get these deals conceived back in early 2018, when, quite honestly, the real estate project woke up and realized it was in a QOZ and it was just an added bonus. Rather than they sought out a piece of property in the zone and conceived of a project after that.

Jack: Yeah. The very first guy I interviewed for this podcast woke up one morning and had four projects in an Opportunity Zone…

Jim: Mmmmm.

Jack: he'd already broken ground on. Many of them woke up one day and realized, oh my Lord, these are QOZ projects.

Jim: Well, it covers 12% of the topography of the United States. And they were chosen based on the 2010 census. And a lot of these regions has changed pretty dramatically in the eight to nine years since the 2010 census. There's some deals where you're scratching your head and you definitely ask yourself, you know, how did it get here? It really is based on the 2010 census and in a lot of sub markets, cities, neighborhoods, regions changed quite a bit. 

Jack Yeah, I live in the fastest-growing county in the country right now in Maricopa County, Arizona and there's a one-square-mile Opportunity Zone in my town that 10 years ago probably really was economically depressed, but it's just exploded here in the last several years.

Jim: Yeah. I'm about to hopefully get my third deal to work out in Arizona. And you know, as a New Yorker, you really forget the exciting growth stories that are happening in the rest of the country because there's not a lot of exciting growth in New York City Metro area. In fact, on the luxury side, the residential and office sector, there's an oversupply problem and prices you could argue are artificially inflated by non-commercial type investors out of China and Russia that pushed up prices that weren't really reflective of the real demographics here in New York City. And there's a lot of merit there to move and it's tough and we're a little bit of a funk in this population. It is flat to declining. And then I get involved in deals in Arizona, Austin, Texas, Denver, Colorado area where I'm seeing stuff in Nevada. And though the growth stories there are exciting, when you put those in front of investors, their eyes light up. They're looking for those type of previously non-primary markets. I've read in Austin, there are 200 new people moving to Austin buying homes per day in the Austin area. Exciting stuff. Florida, it goes without saying of course as well.

Jack: Well, I want to want to follow up on something that you hinted at there just around the edges of things. Subprime debt was the driver in the 2008 meltdown. I think you were involved with Credit Suisse, is that right?

Jim: I was at Credit Suisse, so it was on the fixed-income trading floor, trading credit derivatives and also getting involved a little bit in credit derivatives on a CDOs and something that was around at the time called the ABX, the subprime abs index. So it was a vehicle through which a lot of the smarter hedge fund shortage, the subprime mortgage market. So yeah, I was right there. Interesting time.

Jack: Although I don't want to chew up a lot of time talking about it while we're recording. I want us to jump forward here now 11 years. Are you still as part of an alternative investment alternative financing doing credit default swaps?

Jim: No, not at all. Okay. That’s a product that you have to be very large global banks. Part of the ISDA system. So, no, I don't broker or trade derivatives. My firm and my broker dealer are primarily engaged in the liquid alternative private debt space, whether it's real estate or direct lending, corporate debt. So, I have not been involved in that market since I left Credit Suisse.

Jack: Oh, okay. One of the other things I noticed from your website, as you talk about niche passive income strategies with little or no market correlation? Is that what you're talking about here? Like these bridge loans?

Jim: To a certain extent, yes. We've also been involved in amazing capital for funds devoted to other specialty winning categories. Whether they're buying trade receivables or something called FEMA receivables, disaster recovery receivables, where no one can say that any strategy is 100% uncorrelated. In a gap down market scenario, the extreme scenario like '08, we were all correlated to the extent that we were tethered to the banking system and using any form of leverage. But yeah, at Sag Harbor Advisors and under my broker dealer, we have raised some one o-f capital for funds and for trades in the perceivable space that are pretty interesting. They're considered niche strategies; niche alternative income strategies is how the allocators would categorize them.

Jack: FEMA receivables, that seems like that would be a pretty good business.

Jim: It's a new one. It's pretty interesting. It's very active in Puerto Rico. There's an interesting angle of risk. I would require a, you know, six months, a six hour podcasts.

Jack: I just interviewed Jerry Portela, the chief investment officer of Puerto Rico. Really cool conversation. Good guy. Have you guys crossed paths yet?

Jim: Wehave not. But you know, the municipalities down thereare very in favor of this business because it enables subcontractors to get liquid upfront. And sell the receivables and not wait for the payment chain coming from FEMA to the prime contractor to the municipality. And if these guys get too stretched in terms of their accounts receivable at the subcontractor level, they can't take on more work. So it helps lubricate the process and speed up the recovery. Their estimated recovery could be going on to 2025 and cost a total of $25 billion. So fairly large stories, you know, to discuss around that transaction.

Jack: Jerry said 97% of the island is an Opportunity Zone.

Jim: Yeah, that's correct.

Jack: So, let's talk about Opportunity Zones, stuff that fits right into your wheelhouse. I'm guessing bridge loans is certainly a big part of it. The equity positions; talk about that.

Jim: Well, the QOZ investments in this space would be primarily equity investments in real estate. QOZ funds don't have to be totally comprised of real estate investments. By default, it seems like the bulk of the activity has gone that way, given the requirements of the minimum 10-year hold period. So my activity really revolves around equity investments in real estate projects. I raise capital, I present family office and QOZ Fund solutions to capital solutions to individual sponsors of developers at the individual project level. And at addition, what's pretty exciting is I'm also raising capital for QOZ funds, targeting REAs and wealth managers. So I'm becoming involved in both sides of the chain here. Pretty vertically involved.

Jack:  Yeah, I guess. So, when do you sleep? Is that the question that comes to mind?

Jim: The QOZ l has spiked a tremendous amount of activity, without a doubt. And I think we're going to find that a lot of the deals in a lot of the funds probably aren't the best choices things that spring up to meet an opportunity as opposed to there's probably going to be a small minority of really quality deals. You mentioned the subprime mortgage market earlier. So we have a situation with the 2017 tax rule where the amount of capital gains that could invest under this rule, you know, could dwarf the viable amount of investments by multiple, uh, anywhere between 10- or 50:1.

Jack: Yeah.

Jim: Just to give an example, I've heard total capital gains on the books of North County, that the Treasury put out a number that it was maybe $6 trillion in unrealized capital gains.

Jack: That's what I heard.

Jim: If you look at how many billions were raised by private equity managers for real estate in 2018 in general, I think number was about $110 billion total raised by private equity funds for real estate and admittedly that may not capture all the investment that's gone to real estate or all the very capable investment in 2019. But you're starting with two numbers that are pretty widely divergent and that's why it's going to be very important for people, for investors with capital gains to choose the right manager. Manager selection when you're choosing an alternative fund by default is always the main story and the main decision. But I think in the QOZ space, the manager selection process needs to be on steroids.
Jack: Sure.            
Jim: Really because of that mismatch in supply-demand. And I think it's going to be a great space that is going to be very advantageous for investors and advantageous for communities. And I hate to use the term win,-win, that’s cliché, but it will and can be, but we have to all be honest with ourselves that the disproportionate amount of noise that could invade the space in terms of suboptimal deal flow and suboptimal fund managers. We have to acknowledge that there could be a potential here given that supply-demand mismatch that we just mentioned.
So, people need to approach this investment the same way as any other investment: They need to make money. The tax rate on a 20% loss in a bad real estate deal is 20%.

The developer, not the IRS. I, on the one hand, urge generalists in the space to exercise some caution but also point out that there are great solutions out there. My involvement in the space is real estate focused.

It doesn't have to be the rule. There’s project finance deals that are happening in QOZ zones in the energy space. There also is direct lending and equity investing in private businesses that are domiciled within QOZ zones. I think real estate has dominated the discussion given the fact that we have that supply demand mismatch where there's a lot of money potentially looking at limited deal flow, and in real estate in and of itself. We're 10 years into a bull cycle here, over 10 years into a macro cycle with a quantitative easing behind us.

We're now in a quantitative tapering period. Europe hasn't even begun. You know, German tenures are still zero. They have yet to even start tightening over there. So, I think the Central Bank wind is against us more than for us. That being said, there is still major growth there is in the U.S., you know, and great deals to happen. And how do you solve that? If you're a generalist, like an REA wealth manager that normally doesn't embrace these alternative illiquid investments, it's really manager selection and that's even more important because of the type of real estate that is involved here. Because of the tax roll mandating, you have to spend 100% of the dollars on improvement of the asset you're purchasing. And I think for a vacant building, there's an exemption to that.

But with this investing, you can't buy stabilized buildings or assets in real estate have them be compliant with the rule. So when you're engaging in ground up construction, that segment of real estate, it's a logistically riskier type of real estate investing where you absolutely need to be investing with a manager who has solid, deep developer and general and GC expertise. So not just in choosing good investments, but really in the nuts and bolts, street level knowledge of the construction. You know, that's key. It’s a different and somewhat riskier angle of real estate, but it doesn't have to be when it's being run by the right people. So manager selection is even more important than it is by default when choosing an alternative under the regular tax scenario.

Jack:  Yes. I'm going to ask you to expand on that based on your background, specifically the risks that you're talking about. You and I have both lived through the S&L crisis, the Southeast Asia currency crisis, long-term capital debt, long term capital management. Um, let's see. We had the Internet meltdown in 2001 or 2000, I guess it was and we had 9/11. We had Enron, WorldCom and company and then we had 2008. 

So those of us who've been through this kind of stuff really  have been, I'm not sure what the word is, scarred by the series of financial risk events that were high impact in the same way that our grandparents were scarred by the Great Depression. Although you know, these were by and large, smaller, more contained events. It’s just the sheer number of them over the last 30 year that makes folks who've been through it very aware of risk. Whereas somebody like my kids -- I've got a son who's a financial adviser --he woke up in a post-2008 world so he doesn't know what we've been through.

Expand on your experience with actual risk events, what that really means at the, at the street level for the everyday person who's trying to make a little bit of money. Those kinds of things. Just talk about that.

Jim: No, I've certainly seen bubbles. And when you have a large amount of capital, a viable investment universe that is much smaller than the accessible capital, there is a tendency for bubbles to be created. But, you can't make a deal happen just to try to leverage the tax rule in investment. The deal has to make sense on its own.

And I think for a lot of people out there, they might not find that investment and the simple answer will be to do nothing. Your investing shouldn't happen. Investing should we based on what are the fundamentals of that particular deal or that fund, rather than use a tax rule to spur the investment. And a lot of people are already making these poor choices and 1031 exchanges of that happens a lot already, right?

They wanted to for taxes and maybe make a decision within a particular time window that they maybe should not have made. You know, in the end, the fund or the civic deal has to make money. You're not deferring taxes to lose money. You're just paying, then you’re just paying those taxes to somebody else. That being said, the limited type of investment choices within the QOZ rule are by their nature considered riskier investments. We can't go buy a portfolio of liquid stocks and bonds within a QOZ fund. We can't go buy publicly traded stocks, FANG stocks where the two year note fund, we have to engagein private equity and private debt type transactions that are by their nature considered riskier given their illiquidity they might be considered higher beta, higher correlation to the macro economy.

We are now 10 years into this bull economy, so the decision has to be made more carefully. But that being said, the textual creates incredible opportunities and within the United States there are still amazing growth stories. I myself am not convinced that the flatness of the treasury curve between fed funds with the tenure as indicative that we're about to slide into a recession. That's just my personal opinion. I'm not the macro economist from my broker dealer. There's a lot of technical at play in this world today, with German tenure at zero and Japan in negatives with the whole curve that may be contributing to that. They might break that correlation and that regression model, that recession indicator that we relied on the years past. So the manager selection is really key here and I think…

Jack: We’ll talk about that. I think you're absolutely right. So if you are advising someone how to select a manager, obviously you're talking your book a little bit, but you can't take all the lessons. How do you tell somebody, how do you advise somebody? How to vet a manager?

Jim: It really has to be a developer-heavy, developer-led QOZ Fund. You want the key principals in the fund to have multi-decade experience in developing and managing and being a construction manager of projects?

If you're a generalist to real estate, if you're an REA, a wealth manager or a high net worth individual, I think you really need to consider a diversified multi-asset fund that invests nationwide across all asset classes. Now, if you're a family office with a lot of expertise and real estate investing, you can face off I think against individual projects. It might be more efficient from a fee standpoint and also the ability to cherry pick what assets you want to invest in, family offices are doing that.

They're investing in interval individual projects and not funds, but they have a diverse portfolio of projects. So I absolutely would not advise an individual or a wealth manager RIA to really invest in individual projects. Do they have the expertise to face off against the developer sponsor in managing a ground up construction project? I don't think so. You're taking on idiosyncratic risks. You're putting a lot of eggs in one basket. You're taking risks by region. If you're investing in something in Hartford, Connecticut and United Technologies, the main employer there merges with Honeywell and they decide to move. You've got a major risk event that you didn't really model and that sort of type of risk could be solved when investing in a diverse multi-asset portfolio across the USA. A developer led-fund, if you're investing in real estate, I think that's very key, that is capable of underwriting nationwide that has a vast network of tentacles with other principals perhaps in the national real estate brokerage industry; that has assets that you can rely on to underwrite every asset class.. I think some of the bias that's willing to look away from primary gateway markets, you know, in New York and San Francisco, that basis is pretty high. You could argue there's been some artificial inflation, driven by foreign investors that don't have the same commercial objectives.

Those investors will be looking at Denver, Austin, Arizona, certain parts of Florida or Nevada and that might be good. The cost basis is lower in those other regions I just mentioned. And the growth is higher. So those two are the growth in population, the growth and companies moving to those areas. So, a nationwide diverse fund that's looking at all different asset classes within real estate.

Within all different regions I think is key. And the principals have to be pretty prominent names in real estate because there's no central repository for deal flow. Like an exchange.

Jack: Yeah.

Jim: It's really your reputation and your network that gets you access to seeing the premium deal flow. There's no fintech solution here yet. So, the better-known, quality folks with MultiTech could experience, are going to see better flow. And that's the Alpha generation and real estate that separates them from other managers. And lastly, I think early mover advantage is key here. And there's a few funds and you know; I'm definitely talking my own book. I like met a few funds that have been able to invest starting last November before they've actually closed the fund. And they have warehouse wines from banks that will underwrite their collateral, their equity investments in real estate.
And then when they close the fund, they'll buy down the warehouse line with the fund assets. So they've been able to cherry pick these early deals that were well-baked prior to this tax law because there's no doubt nine months down the road from now, we're going to see a lot of noise in the space, deals created to fit the tax rule where you're kind of trying to jam a square peg in a circle hole.

Those deals won't work because professional real estate managers in the end, it all comes down to the proforma and that's the excel model from which we derive current and future evaluation for this asset. And the good real estate mentors use that proforma based on real data from the local economy with real supply-demand data where existing rents, vacancy rates and they're going to be able to vet out the west suboptimal deals very quickly. So I am working with a fund that has been able to leverage the warehouse line model and scoop up deals that were conceived prior to when anyone was aware of the tax rule and what QOZs were. Um, you know, they are around. Again, I'm talking my own book there.

Jack: Yeah. It's your show. I'm letting you do it.

Jim: Those being five points, developer led-prominent principles. I can see the primary deal flow, a nationally diverse fund. Forth, they ‘ve got the resources to underwrite nationally. Their principals have a vast number. Five, that they’re capable of mover advantage in scooping up having early capital, which I really do think is correlated with better deals, with higher IRRs.

Jack: Right. I've got one more technical question for you and then we're going to dive into a little bit more of the, who is Jim Sanford? You asked a question on LinkedIn. That is a question I've had as well, and I don't know that you found an answer to it. You ask about, I think you called it the two at bats at the plate within the 10-year rule. Have you gotten an answer to that question? If you get an exit from a refined, a permanent financing exit and then start over again within the teen years, did you get an answer?

Jim: Yeah. Admittedly, I'm not an accountant and being FINRA-regulated, they look askance at us all pining on accounting and legal matters. I'll tell you this, people are excited about the latest regs that came out without a doubt. I have not received a definitive answer, yet on whether one can invest in the ground up real estate project and exit once it has stabilized and you refinance in a perm financing and then we invest those proceeds into a second project.
From what I've heard out there, in the coming world, is it as beneficial as one thinks? Would it increase your basis in the first investment? I'd like to pass it off to some of the expert accountants out there to opine on in the end. I think most people would believe the ball rolled our way into the investor category and everyone's pretty happy with that aspect of the regulations.

In terms of the specifics and implications, not sure yet, but what I can say is in a ground up real estate project, the bulk of your IRR are generated in the first five years when you can complete construction. We set up, stabilize and then refi or constructional loan at a permanent financing and that creates a major distribution to the equity investors. When you stretch that IRR up 10 years, it can get diluted. If you look at it over five years, it can be, 50 to 100% higher returns in that shorter durations.

So naturally, real estate folks, if they're allowed to exit a project and then reinvest the proceeds, and get maybe two deals within the whole period window, that would be very create that much higher IRR assumptions. Then when we started talking about this, so I think you know the specifics of which I would admittedly defer to the accounting world.

Jack: I'm going to call a couple of the accounting gurus that I've talked to. I'm going to lay that in front of them specifically the way you ask it. I liked the way you asked the question. Alright, so let's dive into who Jim Sanford is. What are the qualities that you either innately possess because you were born with it or, maybe recognized and developed early that have allowed you to succeed in this business?

Jim: I think quite honestly, transparency really works. And being honest and transparent about the product you're putting in front of somebody about the risk factors out there. It’s not only the right thing to do with whether it is or not it's -- I'll put it to you this way, Jack-- in irrational, selfish interest to operate that way. And you know, in the end, none of us are going to convince anybody Santa Claus exists and there is a lot of great institutional quality business to do out there. I'm pretty excited about the QOZ rule and I, I think that would be one feature of how I operate that way that I'd stand out there.

Jack: But where did that come from? A lot of people will, will say that, but I've read some of the stuff that you've written and one of the first thoughts I have, I'll back up. I always approach guys who are lifelong in the finance, particularly on Wall Street, with a certain amount of skepticism. So, I was skeptical when I started researching you and then I started reading some of this stuff that you read, and it completely changed my opinion. I saw what I think is, is frankly that attitude of transparency, not just exercising it, but calling for it as well. And I really appreciate it and it made me doubly excited to talk to you, to tell you the truth, but the question then becomes: Well, where did that come from? Why are you that way when, when dissembling and shading the truth seems to come so easy in this business?

Jim: Yeah. You know what, I'll tell you at the beginning, I've been working on Wall Street since 1991 when they started the American Stock Exchange, and I'll be honest with you, I've seen a heck of a lot of nonsense out there.

Jack: Yeah.

Jim: Within finance and I think the industry operates in and I think I'm not calling out those type of sales practices or businesses or products that don't mean to make it seem to make sense. It tends to dilute the industry that I work in and I just don't like that feeling. And secondly, you know, I've sold complex products to complex people for a long time and I find one of the most effective selling tactics is just to believe in what you have in hand. If you really believe in what you're marketing and the product that you're operating in, you become such a more effective operator and happier employee and better salesperson if you absolutely believe it.

I couldn't sell annuities, Jack, if you put a gun to my head, I don't believe in the product. You're probably referring to one of the articles I wrote when I was an RIA about the topic. I couldn't do it. I think in the end and I said before none of us have convinced anyone Santa Claus exists, I think transparency is going to catch up on everybody. Not only is it the right thing to do, but in terms of the general way about how you feel about yourself in this industry.

It's a lot more creative to operate in a transparent and honest manner, so we all feel much better at the end of the day. I don't think some of these nonsense products are viable in the long run. And nothing that I wouldn't invest in or embrace myself would I have the capability of presenting to a potential client.

I just don't have the talent base to be able to do that. There is plenty of opportunity and lucrative outcomes within the industry operating within an honest, transparent framework. We have good products that makes sense, that have very appropriate fee structures attached to them. That are beneficial to all people. Plenty of business to do there.

Jack: Sure.

Jim: I think on the end, on the institutional grade side, I really think that those of us in the institutional sector of this industry really need to call out the BS and the nonsense rather than just avoid operating and we really need to call it out. If not for it's the right thing to do, it'll make our industry stronger and it's an irrational, selfish interest to do that, in addition to being the right thing to do.

Jack: Well and isn't it funny that that money is the wrong word, but ironic perhaps that when you engage in that rational self-interest that it actually creates a stronger, more resilient economy for all of us. The environment just is strengthened by that kind of rational self-interest. It amazes me. I want to ask, I want to just because this is a personal interest of mine. I want to think back to, I remember the spring of 2007 was when I first learned about credit default swaps and they sounded dodgy to me, but I wasn't  deep enough in the industry to really understand what was going on. Did you realize back then when you were with credit a Credit Suisse what we were dealing with credit default swaps and what was going on in the industry with buying fire insurance on your neighbor's house? 

Jim: I think toward the final year or two before 2008, I started to realize that credit default swaps their derivative, they enabled certain institutions to take an incredible amount of risk without putting a lot of money down. For instance, dawning on me that AIG and GE had, you know, financing units where they were just selling, they could protection collecting premium because they were AAA entities. They didn't have to put any collateral down. So at the product itself, I have no beef with, I think CDS was created to hedge risks. It's very important and essential, but the leverage one was able to take on risk via that product.

Jack: Oh yeah.

Jim: That wasn't this price and this allocated. So I started to realize that the leverage in the system was way off. And you know, the Muni bond insurers were writing credit default swaps on media insurance in cities and this came up and in Puerto Rico and then the second lien, of home mortgage insurers did they have the right amount of capital versus just portfolio of risk where they were kind of guaranteeing writing default insurance out of secondly mortgage, you know, the home mortgage insurance market. Itdefinitely started to realize around 2007 that the amount of risk you could take with little capital from the product, not only those entities but within the synthetic CDO market.

Jack: The CDO squared stuff you talking about?

Jim: I had some smart hedge funds that were buying CDS on CDOS and the market was created by those that wanted to sell it. They wanted to take long risk on this portfolio and they needed someone to bet against it. And it fell right into the short sellers. But you know, it's comes back to the supply-demand mismatch.

Jack: Right.

Jim: And really happened at the end 2000 you know, the Clinton-era had a surplus. So, they limited it as 30-year bond. So at the same time you had the agencies, Fannie and Freddie's swelling up massive amounts of mortgages and crowding out the private market. And because of the lack of a 30-year bond, foreigners that wanted to own U.S. dollar government-guaranteed assets started to really look at the agency mortgage market as a way to buy government bonds for an extra spread.

You know? Okay. So I have to tolerate this prepayment derivative to the behavior of the U.S. homeowner. No problem. I just want the U.S. dollar risk period. And you know, there's no more 30-year bond issuance. Then you had synthetic CDO enter the mix with their own demand for ABS because it added “diversity” to the pool and got you a better rating. So you had a lot of demand for mortgages. And what happens when you have demand outstripping supply? Someone creates a new product to meet demand.

And voila, the subprime mortgages your product that didn't exist prior to 2000. Really it was created to meet the massive demand for mortgage risk from people that looked at it quantitatively. And there were some of the smartest people in the room and they didn't really look outside the box and say, “You know, the model, has historically never involved this type of home buyer. Well how can I model it?” They used historical data to analyze what home price loss assumptions could be in the United States because we've got a new home buyer at a new mortgage borrower that never existed before. And I think I was a critical mistake that was made. A lot of the demand came from overseas. Absolutely.

Jack: Are we seeing the same thing today? Demand from overseas because of…

Jim: You know what, I'll tell you what I'm seeing today. You know who has replaced those third party, subprime mortgage lenders? To a huge extent. It's been the Sha and they've continually loosened lending standards and they've decreased the down payment required. You can get a three and a half percent down payment mortgage. In my personal opinion, just Jim Sanford, that shouldn't happen, when you lend money to people to buy a home and they can't afford it. By default, you're going to create a crisis.

Jack: Isn't that crazy? He was doing that today. I've learned this lesson we did this 10 years ago. Come on, people.
Jim: I don't think about the agency's role in the problem then and today, Fannie and Freddie, we do not have a free market capitalist market in the home mortgage market. I don't even think Sweden and Norway have a, a government entity that's swelling up. You know, how much is it now? It was at 90% of all home mortgages outstanding out there. I forget the number. Maybe that was a number post-crisis. So sorry if I digressed there…

Jack: But oh well I'm in violent agreement with you. So, hey, I want to ask you a question because this may be the field that you play in. I think it is. Why are municipal bonds outperforming taxable bonds?

Jim: In terms of less interest rate sensitivity or in terms of higher yield or higher spread?

Jack: Yeah, specifically a higher yield, higher spread.

Jim: I don't know. It's not a market I follow that closely. I think we made it in my own personal portfolio. They can be that these little bonds have a lot of interest rate risk. And they tend to have a 10-year duration. Me personally, I'm speaking for no one else, I'd rather not have 10-year duration risk right here when we're pretty flat to the 30-day bill. I'd rather just own 30-day bills, take the tax consequences.

And then you've got some municipalities and states that are a little bit underwater. It went away mainly, you know, we found out the hard way with Puerto Rico. So you know, the fiscal scenario for me as a private investor, I am just speaking for myself, hasn't made that asset class look attractive enough even given its tax optimality.

Jack: Yeah. Alright, so time for my time for my favorite question. Put on your imagination cap here. You're going to get to be king of the world for one day, actual king of the whole world, but it's just one day and you get to solve one problem and one problem only. What problem are you going to solve as king of the world?

Jim: Oh yeah, I think a lot about that, and I wish our politicians would talk a lot more about it. We have a pension and social security time bomb problem and I'll tell ya, FDR in the 1930s deemed to the retirement age to be 65 and life expectancy was 68 and the retirement age is still 65, you have life expectancy is somewhere between 78 and 81. And the problem we have is I don't think the concept of pensions and social security were designed to fund a 20-year retirement.

And I sound like I'm being a Grinch here, but let's just speak from simple math. You have a declining birth rate, a declining amount of workers and you can't make people start working at 12 to help pay into the social security system. And you have an ever-increasing number of retirees.

You've got a time bomb problem that's just not going to work. And it's not working on the state level with pensions and places. I go away in Chicago and the math, just what would I do? We have to raise the retirement age gradually and acknowledge that since the ‘30s, when the concept was introduced, it wasn't designed to fund retirement this long. We have to make younger people work harder and harder and be taxed more and more to fund longer and longer pensions and social security benefits. It's going to blow up either with or without us. So, we, we've got to raise the age and I think in the pension fund front at the state level, states really have to start raising the age of eligibility.
You know, in some states it's 55 once you put with firefighters and policemen, different story, you know, you maybe we look at them like veterans, they're putting themselves in harm's way. Can I do that for 40 years? Probably not. But let's talk about other civil, government workers and public sector unions. I solve that problem. It's going to sound like we can solve it.

Jack: That's a great answer because as king of the world for one day, you actually could do that. You could just by decree that the retirement age is now 75 and probably,

Jim: Maybe you start at 68 years solely a creep higher.

Jack: Well you've only got a day. So yeah.

Jim: Well, and I think the federal government could mandate that states start doing this as well and not fund certain state programs unless they start doing this. The worker class, the younger class under 55, there's not enough income generated to pay this ever-increasing benefits stack.

And, I think if you prepare people 55 and under like myself and you give them time to plan and you say, “Okay, this won't apply to anyone 56 or older,” so that we want to give people 10 to 20 years to plan for this. You're giving people a lot of runway to plan. I honestly don't think I'm going to stop working at 65, Jack. I've worked in the private sector. I have no pension. It's a 401k, you know, IRA plan and savings. So a lot of us were already there and we're prepared for it.

The problem will solve itself. They'll blow up on his own or we can solve it slowly ,you know, ourselves and I think it can be politically deliverable if we apply it, the changes to anyone 55 and under, so that we leave a lot of run late for it. You can't just spring on somebody, you're 64, by the way, got to cancel your plans next year because we're changing the age. You've got to provide a lot of runway. But I think that's a problem that's going to lead to major potential the fall where the retirees won't get the benefits.

The existing retirees won't get them. If it had happened to people in Detroit and certain cities in California and in Rhode Island, but they did lose benefits and we don't want that to happen. We don't want the lead to a chapter nine bankruptcy, close to where Puerto Rico is dealing with. Yeah. So there are altruistic motives there. I'd seen that way. We also have to think of the present working class under 55 rather than continually ask our population to be taxed more and more and work longer and harder to fund benefits that probably they aren't going to see at 65.

Jack: Yeah, exactly. Right. That's a great answer. I love that answer. I'm going to make sure that everybody in my family under the age of 45 of listens to at, at the very least, this part of it. Cause that was good stuff. Well, Jim, this has been a fabulous conversation. I've really enjoyed it. You got any closing words for us before we sign off?

Jim: I'm looking forward to the convention in Vegas on May 9th and 10th. I went to the first one in L.A.. It was incredibly lucrative from a social and business networking standpoint and, I appreciate the opportunity to speak again at the Vegas one. You guys have been great. You know, there's a lot of folks looking to get everybody engaged in the QOZ space, and you guys have done a fantastic job. So thanks for the time letting me be on the show.

Jack: Absolutely. It's been a great conversation. If folks want to get ahold of you or Sag Harbor Advisors, what's the best way to do that?

Jim: My website It's got my email and phone number there. I’d love to have a sit down conversation with folks. It is all one word.

Jack: Alright, and I will remind our listeners this information is also going to be available on the podcast website. Well, thank you Jim. I appreciate you being with us today. On behalf of Jim Sanford of Sag Harbor Advisors, I am Jack Heald for the OZExpo Podcast. Thank you for listening. Be sure to subscribe for future additions and we will talk to you next time. 

Announcer: This podcast is for informational purposes only and does not constitute legal tax or investment advice. For specific recommendations, please consult with your financial, legal, or tax professional.

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