“Brazil in Drag”: Hyman Minsky on Donald Trump

Via Nathan Cedric Tankus, here is a recent JPKE article by Kevin Capehart on a 1990 lecture by Minsky that uses Trump as a case study of asset market bubbles in the 1980s. The lecture is fascinating, and not just as an odd historical artifact.

Here is what Minsky says about Trump:

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… 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 [discussed earlier in the lecture]; 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. … 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…

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. … 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.

….

The key question is why so many varied bubbles developed in the last several decades. The most general answer is that sharp changes in inflation rates and interest rates led to extremely volatile movement in asset prices. And once these price movements begin, then on occasion momentum may develop and feed on itself — at least for a while.

So in Minsky’s version of The Art of the Deal, there are three things you need to get rich like Trump. First, be an investor in NYC and New Jersey real estate in a period when land prices are rising rapidly there relative to the rest of the country. Second, be highly leveraged. And third — and this is critical — convert your equity to cash as quickly as possible to protect yourself from the post-bubble fall in prices. Picking the right individual properties doesn’t matter so much, and managing the properties well doesn’t matter at all.

In this analysis, the repeated bankruptcies of Trump-controlled properties don’t undermine his claims of business success, nor are they just an incidental footnote to it; they are an integral part of how he got so rich. Because the flipside of extracting cash from his properties through “what was in effect a home equity credit line” is that there was less equity left for the entity that actually owned them.

The trick to making money in an asset bubble is to cash out before it pops. Doing this by selling at the peak is hard; you have to time it just right. It’s easier and much more reliable to cash out the capital gains as they accrue; that just requires some way of moving them to a different legal entity. The precedent for Trump, in this reading, would be the utility holding companies that played such a big part in the stock market boom of the 1920s and were such a big target for regulation in the 1930s. Another parallel would be today’s private equity funds. To the extent that the funds cash out via so-called “dividend recapitalization” (special dividends paid by the acquired company to the PE fund) rather than eventual resale, an acquired company that doesn’t end in bankruptcy is money left on the table. It’s interesting, in this context, to think about Romney and Trump as successive Republican nominees: They may embody different cultural stereotypes (prissy Mormon patriarch vs womanizing New York vulgarian) but fundamentally they are in the same business of financial value extraction.