EconoMatters, Rethinking America

Trump’s Bankruptcies In Perspective

Trump’s business practices merely demonstrate a different set of rules for the rich.

Trump Hotel in Las Vegas. Credit: Wikimedia

Takeaways


  • Are Trump’s business bankruptcies really worse than other US corporate legal manipulations?
  • Short-termist management of so many big US firms today could soon put them in Trump’s situation.
  • Trump flew closer to the sun than other Icaruses have yet but singling him out would be mistaken.
  • Trump reflects a refined and purified vision of what America is in its re-expanding dark corners.

U.S. presidential candidate Donald Trump has publicly described his business empire’s four bankruptcies in the following terms: “I have used the laws of this country…the [bankruptcy] chapter laws, to do a great job for my company, for myself, for my employees, for my family.”

Because his businesses entered “Chapter 11” bankruptcies – named for the provision of the U.S. legal code that allows businesses to restructure without closing shop and liquidating – he sees the four episodes in utilitarian and strategic terms, not as failures.

While I am not defending Donald Trump’s view of his practices, one key question needs to be answered: Are Trump’s business bankruptcies really worse than other corporate legal manipulations and practices?

Gaming the system

True, Chapter 11 bankruptcy is uncommon by comparison to other maneuvers through American business and tax law. Certainly bankruptcy still carries a bit of a scarlet letter stigma even if the risk is somewhat controlled, and so it is generally avoided.

But is manipulating corporate bankruptcy law really worse than those other tactics? Major U.S. companies use and abuse legal provisions constantly to evade and avoid taxes to the government.

Trump, by contrast, used the law to avoid creditors at major investment banks and funds (and most of them came out the other side of his restructurings with lucrative deals).

Some U.S. companies do complicated maneuvers like “offshore reincorporation” and other tax-avoidance mergersa loophole Trump has actually criticized on the campaign trail.

The entertainment mogul used Chapter 11 for cashflow management purposes (and to slash hundreds of millions of dollars in company debts). If companies use the U.S. legal code to boost their profits and cashflow via tax avoidance, how is that less dubious than using Chapter 11 bankruptcy?

Donald Trump made business deals on the (correct) assumption that he could fall back on restructuring laws. Other firms make deals based on assumptions that they can fall back on tax loopholes.

Firm defenders of American business law might dismiss the existence of business law loopholes as irrelevant either way and might prefer to judge his record solely on what these bankruptcies says about his ability to run businesses responsibly.

Poor financial management

Well, what about comparing it to popular and trendy legal maneuvers that are questionable long-term business practices? Many U.S. companies have been borrowing heavily to reward their shareholders, instead of using it to invest in expansion.

This practice effectively means shareholders are profiting against the company’s future financial health, rather than from current (or future) returns on its previous (or current) investments. That means literally raiding the companies’ future earnings to generate payout cash now.

Such a company will eventually have to pay back the borrowed money with interest. In the meantime, it will not have gained anything from that borrowing because it was used to rain money down on shareholders instead of actually growing the company’s operations.

The vast majority of American stock is held by a very small number of people with a lot of money to throw around. This means companies are putting themselves deeper into a long-term hole, even as wealthy shareholders rake in money in the short-term.

Trump may be incorrect when he asserts that “virtually every person” at the top of the business world has made use of bankruptcy protections. But his claim might simply be a bit ahead of its time – given the short-termist (mis)management of so many major U.S. companies today.

Down the line, by borrowing to benefit shareholders, a lot of American companies could have very high debt burdens. They would also be very underdeveloped compared to foreign competitors who invested in keeping up with the times and growing their long-term potential earnings.

That will make them uncompetitive, as well as vulnerable to bankruptcy or Japanese-style zombification.

And even all of this is to say nothing of the Wall Street debacles in 2008 that would have forced massive bankruptcies were it not for backstop loans by the Federal government.

Trump, business law exploitation pioneer

Sure, Donald Trump flew closer to the sun (and did so sooner) than these other future Icaruses, but the effect may eventually be the same. Singling him out would be mistaken, if not hypocritical.

Once again, as with his xenophobic appeals, one finds that Trump is merely reflecting back a refined and purified vision of what America has become in its re-expanding dark corners – in this case corporate America and the wealthiest 1%.

Those corners of our society exercise financial and political power in a dangerous direction. But he did not make it that way, and he is not the exception.

There is a separate set of rules in the United States accessible only to the very wealthy and their mega-corporations that allows them to evade and avoid debts and taxes that are seemingly inescapable for average Americans.

That lack of fairness in the rules is undermining voter confidence in the political and economic governance system. Ironically (and worryingly), that mix of frustration and apathetic helplessness has created the opening for someone like Trump to step into the breach.

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About Bill Humphrey

Bill Humphrey is a senior editor at The Globalist. [United States] (@BillHumphreyMA)

Responses to “Trump’s Bankruptcies In Perspective”

Archived Comments.

  1. On September 7, 2015 at 11:22 pm Hank Rearden responded with... #

    I guess the advantage of being on the Web is that you can fill up a lot of space without knowing anything about the subject at hand.

    Bankruptcy law is built into our economic system and has been from colonial times. The reason for that is to encourage risk-taking and permitting the risk-taker to survive economically if a venture fails.

    Real estate is unique in the very high amount of leverage – debt – that is used to finance it. This is because in most cases, in most markets, in most times, it is fairly stable as to value of the property and the cash flow it generates.

    When Donald Trump – the Trump Organization – undertakes a project, it puts in a relatively small amount of equity and borrows the rest. Let’s say Trump puts up 20% of the value of the project and borrows 80%. In a normal business, particularly a startup, this would not be an acceptable balance sheet – there would have to be much more equity and much less debt. In a Silicon Valley startup, virtually all of the investment is equity because the company does not have the ability either to service debt or to pay it back.

    But the situation in real estate is very different. At each stage in the project, there is value that could be sold to repay the debt.

    Where does the debt come from? From banks and insurance companies. Real estate lending is the business of those parts of the banks and insurance companies that Trump deals with. They have their own evaluation departments. Analyzing the deal is part of their value-added to the transaction. Being able to do proper independent evaluations is part of their ricebowl.

    Once they have evaluated the project, most certainly including the credibility of the owner and manager of the property – i.e,. of Trump – they then PRICE FOR THE RISK THEY HAVE IDENTIFIED. Let me say that again – THEY PRICE FOR THE RISK.

    Life is uncertain. Economic forces can move against a project. The perceived market for the property – say the Trump Taj Mahal – can either not materialize, or it can weaken. The property becomes unviable in terms of cash flow and/or its market value drops.

    The first person to be wiped out is the equity holder – Trump. The lenders are now the holders of the devalued property. The property is not worth zero. It is worth less than it was at the time of the transaction. The debt holders can either sell it in distress, or hold it in the expectation that it will increase in value. They may or may not take a loss.

    This is the way real estate is done. All parties evaluate the transaction and the lenders price for the risk.

    What you think you are describing is FRAUD. You are thinking that Trump has tricked his business associates in some way and they are left with an empty bag. That is not the case. Trump (a) would not have a good reputation and (b) would not be able to do deals if the lenders felt ill-used and certainly if they had been defrauded.

  2. On September 8, 2015 at 12:00 am bhumphreyTG responded with... #

    I’m really not sure where your disagreement with what I wrote comes in. I’m not suggesting at all that Trump tricked or defrauded investors and business associates, and I’m not even attacking his use of bankruptcy laws or his explanation of how he used them. He is using the longstanding rules to his advantage (although I think Chapter 11 is not exactly the colonial version of bankruptcy) as the rules allow him to do.

    This essay actually suggested that there are much worse offenses, contrary to the media portrayal of Trump’s bankruptcies as some terrible thing that reflects poorly on him.

  3. On September 8, 2015 at 12:34 am Hank Rearden responded with... #

    You are painting a bleak picture of American business practices and associating Trump with them.

    Gaming the system”

    “But is manipulating corporate bankruptcy law really worse than those other tactics?”

    “If companies use the U.S. legal code to boost their profits and cashflow via tax avoidance, how is that less dubious than using Chapter 11 bankruptcy?”

    “Poor financial management”

    “Trump, business law exploitation pioneer”

    “Once again, as with his xenophobic appeals, one finds that Trump is merely reflecting back a refined and purified vision of what America has become in its re-expanding dark corners…” God only knows what that means, but I intuit you do not mean it as a compliment.

    You are saying Trump is a bad guy. You do a riff on stock buybacks which is irrelevant to Trump’s business since it is not public.

  4. On September 8, 2015 at 12:43 am bhumphreyTG responded with... #

    First, he himself is the one suggesting he gamed the system (because he believes that makes him sound like a business genius). Second, these other critiques/claims — that he is bad at business because of these bankruptcies, which I’m not affirming or denying — are widely made against him in the media, and I am saying they are lesser sins than other business loopholes and business practices. I’m saying other businesses are doing far worse things and are being run much more poorly.

    Yes, I do think Trump is a bad guy. But the entire point of this essay is that he’s not a bad guy *because* of his bankruptcies, unlike what many, many articles have implied. He is comparable at worst to his fellow businessmen in this arena, i.e. “merely reflecting back”

  5. On September 8, 2015 at 1:08 am Hank Rearden responded with... #

    “But the entire point of this essay is that he’s not a bad guy *because* of his bankruptcies, unlike what many, many articles have implied.”

    I don’t agree that you have really made this point, but even if you have, it is a distinction without a difference. And you are missing the point that bankruptcy in as broad-based a real estate business as Trump’s is by way of being a cost of doing business which all parties are well aware of. It does not bespeak (a) a character weakness; (b) a moral weakness; or (c) bad conduct in business.

  6. On September 8, 2015 at 1:11 am bhumphreyTG responded with... #

    Right, I didn’t criticize him for that. I just didn’t defend him on it either. I have no strong objections to his bankruptcies. I’m well aware that everyone in the business knows that’s how it works in real estate.