Tuesday, September 29, 2020

Ponzi Finance II: quid pro quo

The real story revealed by the New York Times Trump tax returns bombshell is not that Donald Trump paid no taxes in 10 out of 15 years or that he paid $750 in 2016 and 2017. The real story is that he doesn't have net income to service his debt. There is nothing inherently illegal about that. He did it before in the 1980s and when real estate prices stopped rising in 1990, his creditors were left holding the bag.

Hyman Minsky wrote about Donald Trump's investment strategy in a 1990 talk, "The Bubble in the Price of Baseball Cards."

One of the puzzles of the 1980s was the rapid rise in the financial wealth of Donald Trump, author of The Art of the Deal, and what else. Trump’s fortune was made in real estate. Many large fortunes have been made in real estate, since real estate is highly leveraged. Two factors made Trump somewhat unique — one was the he developed a fortune in the period of high real interest rates, and the second was that the cash flows on most of Trump’s properties were negative.

Trump’s wealth surged because the market value of his properties — or at least the appraised value — was increasing faster than the interest rate. Trump obtained the funds to pay the interest on his outstanding loans by increasing the draw under what in effect was a home equity credit line. The efficiency with which Trump managed these properties was more or less irrelevant — hence Trump could acquire the Taj Mahal in Atlantic City without much concern about the impacts on the profits of the two casinos he already owned. Trump was golden — he had a magic touch — as long as property prices were increasing at a more rapid rate than the interest rate on the borrowed funds.

The puzzle is that the lenders failed to recognize that the arithmetic of his cash flows was virtually identical with that of the developing countries; in effect Trump was Brazil in drag. In the short run Trump could make his interest payments with funds from new loans — but when the increase in property prices declined to a value below the interest rate, Trump would become short of the cash necessary to pay the interest on the outstanding loans.

The increase in U.S. real estate prices in the 1980s was regional, and concentrated in the Northeast and in coastal California; for the country as a whole, real estate did not increase relative to the price level. The regional dispersion in the movement in real estate prices more or less paralleled the changes in personal income. Real estate prices dipped in the oil patch, climbed modestly in the rust belt, and surged in those areas that benefitted from the rapid increases in incomes in banking and financial services — sort of a derived demand from the financial success of Drexel Burnham. In effect, those individuals with high incomes in financial services — and with the prospect of sharp increase in incomes — set the pace for increases in real estate prices. 


Trump’s cousins were alive and well and flourishing in Tokyo, Taipei and Seoul especially in the second half of the 1980s. The prices of equities and real estate were increasing because they were increasing — the "greater fool theory" may have been relevant, in that the recent buyers believed there was a greater fool to whom they could sell these assets before the bubble imploded.

In any market economy the price of real estate will tend to reflect both its rental return and the rate of return on the riskless bond. Real estate is a riskier investment than bonds and even public utility stocks, so the anticipated return should be higher. But the real estate offers investors a more effective hedge against inflation. The cliché, "land is a good investment, the price of land always increases is right, wrong and irrelevant. The price of land rises and the price of land sometimes falls — the relevant question is whether the anticipated increase in the price of land is sufficiently higher than the interest rate on bonds to justify a riskier investment.

To make a long story short, when the interest rate on bonds rose above the rate of increase in real estate prices, Trump's real estate stopped being a "good investment." He could no longer pay off his old loans with the proceeds of new loans. Since his properties were money losers, there was no question of paying off his loans from his negative cash flow. That was Trump Ponzi Finance I.

The mystery of Ponzi Finance II is who would be "stupid" enough to loan hundreds of millions of dollars to a guy who had a track record of defaulting on hundreds of millions of dollars of loans and was recycling the same old racket? I'm sure you've all heard the expression quid pro quo? 




RW said...

Aye, and therein lies the fundamental problem Trump and his family face: retaining the presidency is not only critical to avoiding criminal and civil prosecution, it is critical to maintaining the profitability of the only 'assets' he has left to sell.

Fred C. Dobbs said...

Only losers don't get to deduct 'depreciation'?

OTOH, many know that real estate developers
get a bunch of yoooge income tax breaks.

Bonanza for Rich Real Estate Investors, Tucked Into Stimulus Package

NY Times - March 26, 2020

... “It’s a pretty big deal,” said Peter Buell, who runs tax services for the real estate practice of the accounting firm Marcum. A separate provision in the stimulus bill, which removes restrictions on losses that people can carry over from previous years, would make the tax break even more lucrative.

A spokesman for the Real Estate Roundtable, a lobbying group, played down the importance of the provision. He said that under the 2017 law, some real estate developers simply spread their losses over multiple years, potentially avoiding the $500,000 ceiling.

Among the possible beneficiaries of the change are real estate investors in President Trump’s inner circle.

In 2018, The New York Times reported that Jared Kushner, Mr. Trump’s son-in-law and adviser, likely didn’t pay federal income taxes for several years because of paper losses generated by depreciating his companies’ properties, despite his significant wealth and earnings from other sources, according to confidential financial documents.

Mr. Trump has also reported significant losses on his tax return. Portions of a 1995 tax return published by The Times showed nearly $916 million in losses, which could have permitted him to avoid paying any federal income taxes for almost two decades.

The 2017 law restricted both men’s abilities to reap tax savings through only-on-paper losses; now, with those limits likely to be lifted, Mr. Trump and Mr. Kushner, as well as other wealthy real estate developers, have the potential to score big tax savings.

The Senate unanimously approved the $2 trillion aid package late Wednesday night. The House is expected to vote on the measure on Friday to deal with the economic damage wrought by the coronavirus pandemic; it would be the largest fiscal stimulus package in modern American history. It would then be sent to Mr. Trump for his signature.

Fred C. Dobbs said...

I don't claim to understand real
estate investing, but it seems
that 'buildings decline in real
value' over time. Basically, they
fall apart. Therefore, a landlord
is entitled to claim depreciation
on their properties. Even if the
market value on such properties
goes up & up.

How is such a mogul to make enough
moolah to support himself? By taking
out loans against the market value of
their holdings, of course. Pay the
interest, keep rolling over the debt.

If you work it right, you can build
an empire this way, but if you are
momentarily unlucky, though wealthy,
you might find yourself stuck in a
yooogely tough job like US President.

JDM said...

It's not that often we actually learn the identity of the greater fool.

Unknown said...

So in other words Trump is an extreme miniature version of GOVERNMENT aka Social Security Medicare & Medicaid Ponzi Schemes.... he learned from the Best.... no wonder liberals have the Trump Derangement Syndrome... he does their Ponzi Scheme 11 Times better than them....

Sandwichman said...

I hate to admit it, unknown, but there is a grain of truth in what you say. Forget about social insurance, though, that's not where the REAL Ponzis are to be found. Mainstream Ponzi finance has a history going back to the South Seas Bubble of 1720. Trump doesn't "do the Ponzi better than liberals." In fact he's rather inept at it. What he is good at is convincing morons that he is some kind of superman.

Fred C. Dobbs said...

According to Wikipedia,
the Trump Organization has
22,450 employees (as of 2015),
so that means - presumably -
TrumpCo pays a lot of 'payroll
taxes', as the employer's share.

In that sense, though many
- including me - would argue this
doesn't really count, Trump must
surely pay a lot of taxes.

However, payroll taxes are deductible
business expenses, according to the IRS.

Business Expenses to Deduct Now via @Entrepreneur http://entm.ag/1zKBE1q

Fred C. Dobbs said...

Basically, the Real Mystery is
that if 'buildings decline in real
value' over time because they
fall apart, how is it that the
market value on such properties
goes up & up?

Maybe not unlike 'great art', like
Andy Warhol's soup cans, whose
values also go up & up, as one
wealthy owner sells such pieces
to another wealthy person.