Economic human shields
By David A. Smith
5 min read
Up here in Boston, a fine old-school housing scandal is playing out.
Michael McLaughlin, who ran the Chelsea Housing Authority with an iron hand, has pled guilty to four felony counts of lying about his salary and is under investigation for diverting or misappropriating more than $7 million in public housing modernization funds. In response, HUD has threatened in writing to demand CHA repay this money, to which Mr. McLaughlin’s successor responded, in a Boston Globe interview “we don’t have it,” and went on to observe that “repayment would have a devastating impact upon the most vulnerable residents in the city of Chelsea.”
You will never hear such a story about a Low-Income Housing Tax Credit (LIHTC) property, because of a fundamental difference in program structure. In appropriated programs, an evil owner can use the residents as economic human shields; in LIHTC and similar investment tax credits, the owner cannot.
From the beginning of human civilization, evil people facing external threats have surrounded themselves with the innocent, for camouflage and as human shields. In this they have relied on “morality arbitrage” – they know that those chasing them care more for the innocent than they themselves do. In fact, the higher the enforcer’s morality, the more effectively the immoral can use human shields to prolong their tenure in power.
In affordable housing, the use of economic human shields is even easier, because a classical regulatory agreement is always a two-way street: while the owner is obligated to provide quality affordable housing, the regulator is obligated to give the owner enough resources (rents or subsidy) to maintain economic viability. The maestro of such malfeasance was the late A. Bruce Rozet, who at his peak controlled over 25,000 HUD apartments, and who wielded the regulatory agreement and economic human shield defense to frustrate several HUD secretaries’ campaigns to oust him. For more than a decade, Rozet stymied HUD because he knew that all of HUD’s enforcement remedies (like abating the Section 8) would punish the property and the residents long before they punished the owner, so he repeatedly thrust the residents forward as economic human shields.
By contrast, LIHTC and other investment tax credits are forms of soft equity – capital invested into a property – that eliminate the risk of economic human shields due to two critical factors:
- Private money, not government money. The equity that goes into a LIHTC property comes not from the government (HUD), but from private investors, so if the government is pursuing a claim, it is not pursuing against itself.
- Recapture goes against the investor, not the property. Money recaptured comes not from a cash extraction on the sponsor, but rather from a tax assessment against the corporate investor limited partners, who by self-selection are large financial institutions with enormous balance sheets, and hence are collectible.
Because LIHTC residents cannot be used as economic human shields the way HUD residents can be, LIHTC enforcement differs from and improves on appropriated enforcement in two ways:
- Enforcement is a valid threat. When an action cannot be taken, threatening it is a bluff; and when a threat is known to be a bluff, making it is actually an embarrassing admission of weakness. HUD has dozens of economic nuclear weapons, none of which it can practically deploy – and bad sponsors know this, so they positively delight when HUD starts to huff and puff.
- LIHTC investors enforce faster and sharper than government. Because the credit recapture hits the investors, and is enforceable, the bank investors are on tiptoe to prevent recapture, so they not only negotiate powerful remedies into the syndication documents, they will be quick to pull these triggers, and will be loaded for bear. If my anecdotal evidence is right, as many as 10% of all LIHTC properties have had their original local general partner expelled or substituted under investor pressure, a rate roughly ten times higher than in the HUD inventory.
Meanwhile, up here in Boston, enforcement – or the prospect of eventual future enforcement – drags along. Mr. McLaughlin, with creativity worthy of the late Rozet himself, has been pleading to the court that losing his giant pension (calculated on his fraudulently reported salary overpayment) should be considered a form of restitution. (Of course it’s not cash, hence no help even if accepted.) HUD’s spokeswoman also downplayed its threatened recapture claim, saying that HUD was “continuing discussions.” She avoided saying anything about enforcement; she knows, and cannot admit, that there is nothing to say, because HUD cannot enforce against Chelsea’s economic human shields.
David A. Smith is Chairman of Recap Real Estate Advisors, a Boston-based real estate services firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing. He also writes Recap’s free monthly essay State of the Market, available by emailing [email protected].
