If you watch Letterman's reaction, he didn't jump on the joke immediately. He seemed a bit uncomfortable which in turn seemed to make Sandler uncomfortable. But Sandler kept going with the bad joke and left the impression his idea of a transgender person is someone who is male born, dresses like a woman, has had no gender altering surgeries and is gay (interested in men).
Thanks Adam, for perpetuating the myth.
BTW, I don't believe he has a TG housekeeper. I think this was just a really bad joke.