The Story of Edgewood Technology Services (Part 3)

Original Publication: July 2000

The Story of Edgewood Technology Services – (Part Three)

or… How I Lost $100 Million Discovering Who Makes Money Making Sure the Solari (Popsicle) Index Does Not Go Up

by Catherine Austin Fitts
For Earlier Parts See…
Real Deal: Edgewood Technology Services (Part One)
Real Deal: Edgewood Technology Services (Part Two)


On the face of it, one might think that insider trading profits on HUD real estate had nothing to do with insider trading profits on Harken Energy stock. But it turns out what they both have in common is Harvard Endowment and Mike Eisenson, the manager of Harvard’s private equity portfolio. Indeed, the Edgewood story provides unique insight into the philosophy that was behind George W. Bush and Harken Energy and Washington’s culture of insider dealings. As Mike Eisenson complained to Fitts about her success in producing record savings for taxpayers, “I don’t like this [Fitts’s use of Bell Labs optimization technology to auction HUD mortgages] because the only way we (Harvard) can win is by paying more than our competitors. We prefer a bid process where we can win by ‘gaming’ it because we are ‘smarter’.”


In Part One (August 1999), Catherine Austin Fitts described how, as an advisor for the Department of Housing and Urban Development (HUD), she and her company Hamilton Securities had been charged with streamlining the HUD financial portfolio for Secretary Henry Cisneros. Using her experience as a Wall Street investment banker she brought the disciplines and creativity that had ensured her success on Wall Street into what was a decidedly political arena. It did not take her long to realize that she was dealing with a different “operating system” powered by a different set of values than the financial performance criteria dictated for government assets by law.

As she looked deeply into government operations and HUD programs and philosophies she saw obvious simple economies and reforms that would have brought sizeable immediate benefit to taxpayers. But these reforms involved things like bringing computer training to mothers in federally subsidized and financed housing projects. They involved things like upsetting powerful vested interests and entrenched notions that poor people were “hopeless.” And they involved training and the creation of learning centers in HUD projects that would have made knowledge accessible to one and all about how the money really works in America.

Just as Fitts was beginning to demonstrate how quickly the mothers of HUD’s Edgewood Terrace project in Washington, D.C. could master computer programs, data processing and software design she began to sense the approach of an oncoming bulldozer. That bulldozer, set in motion when Hamilton used its own money to fund a data servicing company called Edgewood Technology Services (ETS), would ruin her business and personal finances, endanger her life and [try to] stop what was described to her as “computers for niggers.”

In Part Two (October, 1999) we learned how HUD Section 8 projects were owned by “politically active” private firms that had a vested interest in maintaining the secrecy that has always surrounded HUD financial operations. That secrecy has benefited politicians who received recycled dollars in the form of campaign contributions. It has benefited government bureaucracies and bureaucrats desirous of maintaining salaries, perks and empires or afraid of losing their jobs or being forced to retrain themselves in a dangerous political environment. It has benefited drug dealers, criminals and cheats who, like parasites, served the interests of the other entrenched groups. It has benefited covert operatives linked to the CIA and other government agencies who have used HUD and HUD landlords and poor neighborhoods to “hide” black ops. And it has served the interests of politicians who were able to dispense patronage via the HUD system to what has become an infinite number of intermediaries who depend on communities being dependent on government largesse to provide what amounts to guaranteed income streams. Notably, two groups who did not benefit from the HUD system were people within communities who wanted to succeed in the marketplace and the taxpayers who continue to invest billions in a HUD cancer that causes the health and well-being of our communities and financial system to deteriorate.

As the mothers and other residents who comprised ETS demonstrated prowess on computers, more prowess than that possessed by some of the ambitious old school civil servants in the HUD enforcement operations, light began to shine into the recesses of HUD program operations which, because people could see, started to reengineer for the benefit of taxpayers. Catherine Austin Fitts had now offended the system twice: once by facilitating “computers for niggers” and again by proposing to provide opportunities for resident moms to develop into responsible small business entrepreneurs. Fitts was going to introduce poor people to the world of equity ownership in a way that made money for taxpayers.

She encountered sharp resistance from the wealthy owners of HUD section 8 buildings, some of whom, like the National Housing Partnership (NHP), wanted to trade on Wall Street and were anxious to maximize profits, irrespective of the effects on American taxpayers at large. As Fitts, her investment bank Hamilton Securities and ETS began to illuminate a potentially hugely profitable community of interest among thousands of neighborhoods, taxpayers and the more progressive, high-performance members of the business and investment communities, the storm clouds of an attacking swarm began to materialize. If Fitts thought she had encountered resistance from the politicians and portions of the enforcement bureaucracies that serve darker private special interests and from private property owners before, she had seen nothing until she ran afoul of Harvard University and the “big” money that drives certain investments on “the Street.



Harvard Endowment Prefers “Gaming” to Market Competition

The Section 8 owner/manager organization most eager to cash out its investment position in the stock market was National Housing Partnerships, now called NHP, Inc. NHP, originally formed as a pseudo-governmental entity to promote affordable housing, had become a large, privately owned company that managed a complex web of private affordable housing real estate tax shelter partnerships. These partnerships owned a portion of HUD’s portfolio of Section 8 subsidized apartment projects financed with HUD insured mortgages. NHP affiliated entities had made large profits and tax benefits under long term often above-market-rate contracts for services like property and financial management services at taxpayer expense. For various reasons, mortgages on some of the NHP owned and managed apartments had defaulted on government guaranteed debt and were taken into the HUD-held mortgage portfolio. In some cases, NHP investors were forced to make advances to keep the partnerships afloat, even as the tax shelter benefits were running out.

At the same time that Congress was exerting pressure on HUD to reduce its budget to support affordable housing, the Chairman of NHP, Roderick H. Heller III, had been trying to take the company public. He and other stockholders wanted the freedom to liquidate their positions in the company before the adverse affects of the inevitable budget changes that come with deregulation could be reflected in share value. The largest investor in NHP, Harvard University’s endowment fund, represented on the board by Mike Eisenson who headed Harvard’s private equity fund, very much wanted to liquidate its investment, as did Herbert “Pug” Winokur of Capricorn Investors, another large investor in NHP. (Pug was also Chairman and lead investor in DynCorp as well as member of the Harvard Management board and was later to be promoted to the Harvard Corporation board, until his resignation was forced by his involvement in Enron. His company often invested along side of Harvard, raising the question as to whether Harvard had seeded Capricorn and DynCorp as well.) The hope was that NHP would go public, use its stock to do acquisitions, and then Mike and Pug could liquidate their stock over time. Harvard could also sell its entire stake in the company in a large transaction if the stock price was high enough. The key to maximizing capital gains, however, was to get the company public.

Rod had two problems. The first was that NHP’s profits depended on HUD fees for property management that were above market rates. As the HUD loan sales (of defaulted mortgages) proceeded, NHP was losing control of properties to purchasers who would insist on market fees and performance, at best, and fire NHP at worst. Before Hamilton started helping HUD with loan sales, HUD was recouping approximately 35 cents on the dollar on defaulted mortgages by doing “workouts” with existing owners. With loan sales, HUD was recovering approximately 70-90 cents on the dollar. This improvement translated into a $2.1 billion savings for taxpayers in the first three years of the program. A portion of this savings also represented money that was no longer going to existing owners like NHP. Finding a way to destroy the loan sales program and any use of disclosure and competitive investment principles was one way that NHP could ensure it’s success if it did not want to reengineer its operations to be competitive in the marketplace.

Two investors well positioned to be successful on any reengineering of HUD’s Section 8 subsidized apartment portfolio were Goldman Sachs and BlackRock Capital. In the early summer of 1996, Goldman Sachs was the high bidder at auction on a large portfolio of HUD-held loans on partially Section 8 assisted housing projects, a transaction in which BlackRock served on the financial advisory team. All told, Goldman sponsored bid teams—with and without BlackRock as a bid partner-were high bidders on approximately $4.7 billion of HUD loans. The knowledge they gained from successfully pricing and resolving HUD loans prepared them to outperform NHP and its investors if the Section 8 policies should change, subjecting the remaining properties under NHP’s control to open disclosure and competition in the marketplace over time.

Harvard Endowment, which owned a majority of NHP’s stock, had submitted bids on the early HUD loan sales, and had complained to me at the time that our use of Internet accessible databases and Bell Labs optimization technology had made the auctions much more open to lots of investors. Mike Eisenson, leading both the NHP investment and the bid for Harvard on the first large HUD loan sale complained to me, “I don’t like this [Hamilton’s use of Bell Labs optimization technology to auction HUD mortgages] because the only way we can win is by paying more than our competitors. We prefer a bid process where we can win by ‘gaming’ it because we are ‘smarter’.” This Mike Eisenson-Harvard philosophy may explain why Harvard gave up on the competitive process and turned to political “gaming” to make sure that Harvard could avoid losing control to investor groups like those sponsored by Goldman Sachs and BlackRock. It would also explain why Rod and Gene Ford, [who was lead partner of the company that developed the Edgewood project] got increasingly upset about certain BlackRock activities. It may also explain latter disclosures about Mike’s role backing George W. Bush as a lead investor and board member of Harken Energy.

BlackRock was beginning to master this market, by bidding in loan sales, by taking on a financial advisory assignment on a HUD loan sale, and by getting to know state housing finance agencies. Rod and Gene could tell that BlackRock could profit from converting to the neighborhood investment model from the Soviet-inspired centralized command and control system in which guaranteed subsidy and debt financing ruled the day. This would change from an old model that would “let the human neighborhood be damned,” to one in which local communities worked with investors in a joint venture equity model where the knowledge and bounty was greater and was shared. To this end, BlackRock also was making efforts to learn about grass-roots efforts like ETS and Neighborhood Networks. In other words, new investors with fresh ideas about value in a knowledge-based society, capital and with networking and digital software applications tools were positioning themselves to produce higher returns for taxpayers generally, neighborhood residents specifically, and themselves. This is a powerful, win/win model that Rod and Gene knew could handily trump their closed system. The result would be creation of increased neighborhood “equity” value, which would translate, ultimately, into higher real estate values and a vast expansion in urban small business and employment prospects, at the expense of risk-averse, anti-competitive subsidy and debt players.

Rod was very concerned about the impact of this “new” approach to the tax benefits both he and his investors enjoyed. At a dinner of the National Multi-Housing Council in New Orleans in the spring of 1996, Rod was clear with me. Harvard wanted capital gains on what was one of their largest real estate stock investments and to avoid taxes after the sale. He (a former law partner of Wilmer, Cutler & Pickering; Lloyd Cutler served on NHP’s board prior to joining the Clinton Administration in the White House Counsel office after Vince Foster’s death) and many other attorneys, accountants and professionals might be subject to unanticipated tax bills if proposals supported by HUD, on the advice of Hamilton, were adopted. Big tax bills. Renewal of expiring long term Section 8 subsidy contracts, made difficult by reforms in the federal budget process (since the original contracts were authorized by Congress) were important to refinancing profits. Refinancing was also a good business for NHP’s newly acquired mortgage company, Washington Mortgage. Rod was adamant. The federal government was morally obligated to subsidize him and other HUD landlords, regardless of the cost to taxpayers or performance for communities relative to more economically sound options. Performance was irrelevant compared to the long term profits owed to a certain “class” of Americans.

As Rod, Mike Eisenson and Pug Winokur grappled with the implications of having not reengineered their operations to be competitive in the newly deregulated environment, they determined to fight back in the political one. A former NHP senior executive and shareholder, Conrad Egan, had joined the staff at HUD at the beginning of the Clinton Administration. Conrad was eager and happy to provide substantial inside information to help the industry subvert government policy and the interests of taxpayers. The National Association of Homebuilders and other lobbying associations agreed to help. In the meantime, Rod offered Gene Ford an opportunity to do a number of things with him in business and, according to Gene, cemented Gene’s support. By allying with a variety of private groups and state housing agencies that also wanted to retain a highly subsidized, centrally controlled system fueled by Conrad’s continual flow of information from inside the Administration, Rod was able to build a coalition that would ensure that Congress rejected HUD’s performance based proposals and adopt a non-performance based one that ensured maximum profits for Harvard, Mike, Pug, Rod and current investors without regard to performance or return on taxpayer investment.

Under serious stress to raise record amounts of campaign fundraising monies for the 1996 election, the appropriations committees made their deals with the housing industry during the summer. Rumors flew that the HUD landlords were promised whatever subsidies they needed to take their stocks public at an attractive price or keep their businesses continuing without disclosure and competition. In addition to subsidies, there would also be lots of appropriations support for new HUD mortgage financing on liberal terms so that the captive mortgage companies would generate more profits. They would then help owners refinance and pull out equity and help make top dollar public offerings such that future changes in value of the stock were entirely the expense of the taxpayer. The process was not unlike the way S&Ls were used during the 1980s to lock in inflated private real estate profits by leaving the taxpayer holding the bag. As an incentive to go along, the HUD Office of Inspector General, whose job it is to prevent all of this, would get special increases in funding for its law enforcement program Operation Safe Home. [It is my belief that “Operation Safe Home” is part of an unspoken HUD role that provides a hiding place for covert operations in what many would think is an out-of-the-way backwater.] Rumors flew that these Operation Safe Home funding increases were part of an agreement to target Hamilton and take other enforcement actions that would help position politically adept HUD landlords and real estate investors for gentrification during the remaining course of the deregulation process.

Cancellation of the loan sales would be a boon for the industry. Negotiated workouts with existing owners returning 35 cents on the dollar to HUD are more profitable to defaulting borrowers than purchase of the loans by third parties for 70 – 90 cents on the dollar. But this would hold true only so long as the White House Office of Management and Budget (OMB) would go along with pretending that HUD was getting 70-90 cents in the budget assumptions to fund new insurance. This is an important point to understand. In 1991, the Bush Administration had passed a law requiring that appropriations were necessary to issue new insurance — appropriations sufficient to pay for expected losses from that insurance. This was part of an effort to prevent the kind of back-door giveaways that had marked the Iran-Contra years at HUD. One of the reasons that HUD conducted the loan sales program was to ensure that it could lower insurance losses so that Congress could afford the appropriations necessary under the new rules to issue the significant volume of new insurance. New insurance would be popular with HUD developers because it meant more new projects could be developed. In other words, if HUD expects to recover 70 – 90 cents on each dollar of defaulted loans, new insurance is cheaper for the appropriators than if HUD expects to recover only 35 cents. That means HUD can issue far more insurance through companies like NHP’s mortgage subsidiary. It would be a fraud on the American taxpayers if new insurance were authorized based upon overly optimistic loss assumptions, because taxpayers will have to fund additional losses. Nevertheless, OMB has, in fact, agreed to this budget fiction of pretending HUD is doing loan sales when it is calculating the cost of new insurance while in fact HUD is not doing loan sales. Instead, old-style negotiated workouts that feed the Congressional fundraising coffers have returned. Everyone (except the taxpayer, whose interests are not represented) can profit, by pretending the color of the sky is different depending on which part of the budget is at issue. Needless to say, the HUD budget is full of these kinds of “multiple personality disorders.”

With these “Soviet” subsidy policies in place, designed to ensure federal political control of HUD multifamily investments in local neighborhoods, the opportunity to integrate on-line education and job opportunities on any significant scale disappeared. This is because the plan for Goldman Sachs, BlackRock Capital and other capital market and real estate investors to view information on the portfolio, to bid competitively on the remainder of the portfolio, or to bid on “place based” trusts was lost. If such investors were able to bid for all HUD assets in a place, including, for example, single family houses and apartment buildings, and the mortgages on them (what is referred to as a “place-based” sale), they would have a real opportunity, through introduction of employment and educational programs and other neighborhood-enhancing activities, to increase real estate values there. Hamilton believed that in such a place-based sale investors would be willing to bid significantly higher than others whose plans for the properties did not include neighborhood improvement, due to the huge profit potential. Instead, the portfolio now was to be managed so that owners couldn’t care less about education or jobs or neighborhoods and no broad range of investors have the information that will cause them to convert these neighborhoods to make economies other than through gentrification. Indeed, the big profit opportunities in HUD’s scheme would be in moving current residents out or into more expensive prisons or into assisted housing units for the elderly. They would also include bringing new, middle-income tenants in via a process known as “gentrification.” The gentrification phenomenon is happening all over the country today. While gentrification can be highly profitable for private industry, done in this matter, it is often extremely expensive for taxpayers.

For all of the enemies Hamilton and Edgewood made, there are approximately 250 Neighborhood Networks computer learning centers in service around the country today. If HUD had proceeded with a performance based plan, that number would probably have been closer to 2,500 and, more important, private equity would be replacing government subsidy and guarantee financing in many communities at a much higher speed than is happening today. Unfortunately, we have evolved a system in America where more people can make money from communities failing than from succeeding. This is perplexing, because, unless communities succeed in creating fundamental wealth, there will be no new money and wealth created at all. We are destroying the goose that lays the golden egg.

Learning Speed Heartburn:
“Oh, Senator, I Could Teach You How to Do This”

I have to say that of all the many challenges of prototyping outsourced data servicing with ETS, the problem that drained the most energy was dealing with the Hamilton employees and the management that Hamilton had recruited to grow and build ETS and other sites like it. The real estate, law enforcement and organized crime industries are not the only ones opposed to performance-based access to knowledge and capital. Pogo was right, “The enemy is us.” We experienced these problems close to home, too. Our first challenge was in learning how to learn how to outsource as well as how to teach investment bankers about the benefits of getting out of “expert” mode and into a “learning” model. This meant creating tools and databases as they learned. We were grappling with being a network company. The nature of ETS and the political risks attached to our project made that painful process even harder and more complicated.

The most important requirement for ETS to succeed was that a group of black women had to demonstrate high learning speeds about how money works using the Internet and advanced software technology. They had to make that information useful in their communities and provide services to small and large businesses in their area. There was no way that they were going to do the actual data servicing work without understanding the implications of what the data told them. Their comprehension of the substance of what we all were learning was part of what helped them see new opportunities and add value. It was also what made them a bigger threat. Their performance came at the price of access to and understanding of true knowledge.

Productivity at ETS was very much impacted by individual learning speeds within the ETS team itself. We had initially hired a random sample of people — we had not cherry-picked for performance indicators among applicants. As a result, building a high performance team became difficult and expensive, both for the top performers at ETS and for the investors. The lesson learned was that we needed to adhere to a strict discipline of hiring people who were committed to leaning and creating value on a sustainable basis. But this did teach us what we needed to know for the prototype. The cost of this approach was that sometimes ETS and Hamilton found it hard to get the day-to-day work done smoothly.

As time went by the top two or three members of the ETS team had skills and learning speeds about selected topics that started to surpass those some of the employees at Hamilton. Some Hamilton employees were from real estate or mortgage backgrounds and had trouble adapting to an Internet and software based learning environment. When an ETS employee earning $20,000 a year starts to function on a trajectory that means he or she can be as productive or more productive than someone earning $120,000 a year within a matter of years, tensions build. Such is the power of the Internet.

I really started to understand this when I went to China in 1997 to explore data servicing partnerships. What I discovered was that it was more economic to send some of our $120,000 jobs to China and keep the $20,000 workforce in the US, training them to perform up to a $30-60,000 level. The strictly “abstract” functions were much more mobile than was the “concrete” function. Hence, if I could find an intelligent, reliable workforce locally that could do the concrete task of raw data entry and document management while continuously adding software tools that continuously reengineered the abstract functions as well, we could improve profitability greatly.

This had all sorts of irritating implications for traditional executives. The relationship with clients had to be intimate and managed at the lowest day-to-day operations level possible. There was not time to send things back up a chain of command. That meant senior management could not earn large salaries for managing “process” and marketing to fellow executives who were equally divorced from day to day operations. Meantime, project managers at Hamilton had to have enough understanding of technology and data servicing to be effective at anticipating what tools and databases were needed and how to outsource this work. The learning network model was a shock to those used to chain of command and not having to anticipate or explain.

Bridget McClarin was a case in point. Bridget was living on D.C. unemployment payments before joining the ETS computer training class and learning the Microsoft Office Suite. After graduation she joined ETS and signed up to take classes at Catholic University, which is near Edgewood. In one of her first courses, she studied relational database design and a new technology called OLAP databases. Bridget was at Hamilton one day and was walking past a meeting in which our lead database developer and several technologists were discussing a problem in applying OLAP software. Bridget overheard them, walked in, helped them solve their debate and then walked out. The group was stunned. In 18 months Bridget had moved from a person with no computer skills to someone who was reasonably literate on advanced database design issues.

The person whom Bridget probably surprised the most during those two years was Senator Kit Bond of Missouri. Senator Bond chaired the Senate Small Business Committee. His counsel, who had been in the property management business and involved with training programs in that capacity, was interested in what ETS was doing. Senator Bond had sponsored a bill that, if passed, would have encouraged federal agencies to outsource work to businesses that located and generated new employment in areas with high welfare and unemployment rates. The idea was that corporations did not have demand for this work force, but there was plenty of outsourced work like data servicing that could be available. In addition, it was much cheaper for the federal government to pay for data servicing work than to pay $35-55,000 per family for a woman with children not to work. The goal was to improve skills and private income in a way that would save the government money in an integrated federal budget.

Senator Bond invited a team of people from ETS to the Senate to testify.

Bridget’s testimony included her description of how she became computer literate and walked the Senator by a large monitor through a “money map” (these are maps that show how money works in a place) that we had posted on the Internet. Bridget was now producing money maps for us at about 50-75% of the cost of what we had been paying for them before we invested in ETS. She explained to the Senators her use and understanding of Geographic Information Systems (GIS) and geocoding databases. Senator Bond asked her how she had learned GIS programming. Bridget explained that a GIS trainer had come over to ETS, but that he was not competent, so she and her co-workers had gotten the training manual and taught themselves. Senator Bond, with his mouth wide open, then said that he hoped Bridget understood that there were people like him who found computers and technology intimidating. Bridget looked at him and said in the warmest and most feminine of ways “Oh Senator, don’t worry, you could do this, I could teach you.” Senator Bond was speechless. He had just realized the speed at which the presumed not-so-skilled could become skilled, and even more so.

Senator Bond’s legislative efforts did not meet with success. Firms that benefit from minority set asides, 8A firms, saw this effort as a threat. So a group of minority business leaders soon joined with prison companies, real estate investors and construction interests seeking to profit on government subsidy and gentrification during the period of deregulation. The number of private businesses that wanted to maintain lower learning speeds and preferred to survive by “gaming” the process seemed endless. Worse still, it was clear that the leadership of the nation would do anything to permit themselves and the status quo to survive the compelling pressures for change. During the summer of 1996, the elites made a substantial commitment to grow “stupider and stupider.” But it was far from just the elites. In 1996, it looked like each group wanted a rigged deal for itself, and no one wanted to do what it would take to ensure that the whole worked or grew.