Analysts Explain That Real Estate Gimmicks Don’t Work For The American Economy
During a lengthy phone interview with CNBC, presumptive Republican nominee Donald Trump outlined a plan to partially default on the United States’ outstanding sovereign debt obligations in hopes of eventually negotiating lower rates of repayment. The tactic is common in the types of commercial real estate dealings, but journalists and financial analysts stressed that employing such a strategy with American debt would undermine global financial stability and potentially drive the American economy into a deep recession.
Trump Floats Partially Defaulting On U.S. Sovereign Debt Obligations
Trump Suggests “Swashbuckling” Approach To Renegotiating U.S. Debt. During part of an hour-long CNBC interview ostensibly focused on the Federal Reserve’s domestic monetary policy decisions, Donald Trump concerns of runaway interest rate inflation for trillions of dollars of outstanding U.S. Treasury bonds while declaring himself “the king of debt.” Trump expressed concern that interest rates on the Treasury bond market might spike by two to five points at some point in the future. After being pressed by co-host Becky Quick and Andrew Ross Sorkin, Trump suggested that the “swashbuckling” approach he had used to renegotiate private debt deals could be employed to “refinance debt” owed by the United States Treasury. From the May 5 edition of CNBC’s Squawk Box:
DONALD TRUMP: We have $19 trillion of debt, right? We have — it’s going up to [$21 trillion]. I mean, we have numbers that are beyond belief. We are paying a very low interest rate, what happens if that interest rate goes two, three, four points up? We don’t have a country. I mean, if you look at the numbers, they’re staggering. I mean, we have a very low interest — we have tremendous debt, tremendous, and it’s at low interest rates, fortunately. If those rates went up two points, three points, five points — because you know, I was here during the Jimmy Carter days when the prime rate went up to like what 21 or 22 percent, Becky. Right?
So, I’ve seen what can happen. And its not — its not a good picture. But, what do we do with all of the money that we owe everybody when rates go up, and now all of a sudden we have to borrow at two points, or one point more even is devastating. But two, three, four, five points more. It’s a real dilemma, and we have to be very, very careful. And I am the king of debt, I do love debt, I love debt, I love playing with it. But of course now you’re talking about something that’s very, very fragile and it has to be handled very, very carefully.
ANDREW ROSS SORKIN (CO-HOST): Mr. Trump, you talk about debt. And you are to some degree the king of debt — I appreciate that point. You’ve also renegotiated debt agreements over the years. Do you believe that we, in terms of the United States, need to pay 100 cents on the dollar? Or do you think there are actually ways that we could renegotiate that debt?
TRUMP: I think — look, I’ve borrowed knowing that you can pay back with discounts. And I’ve done very well with debt. Now of course I was swashbuckling, and it did well for me, and it was good for me, and all that. And you know debt was sort of always interesting to me. Now, we are in a different situation with a country, but I would borrow knowing that if the economy crashed you could make a deal. And if the economy was good, it was good, so therefore you can’t lose. It’s like, you know, you make a deal before you go into a poker game.
BECKY QUICK (CO-HOST): But Mr. Trump are you suggesting that we would negotiate with the U.S. credit in such a way?
I understand that you’ve done this in business deals, but are you suggesting we would negotiate with the U.S. credit in such a way? Because —
TRUMP: No, I think this — I think there are times for us to refinance. We refinance debt with longer term[s], because you know we owe so much money. It’s so — nobody talks about it. Nobody talks about it until the bubble pops, and the bubble could pop, and it could pop, and it could be ugly. You’ve seen it a couple of times, but you haven’t seen it as bad as it could be. As bad as it was, you haven’t seen. And I could see long-term renegotiations, where we borrow long-term at very low rates and, frankly, we do need money to rebuild the infrastructure of our country.
QUICK: But let’s just be clear, you’re not talking about renegotiating sovereign bonds that the U.S. has already issued?
TRUMP: No, I don’t want to renegotiate the bonds, but I think you can do discounting. I think, depending on where interest rates are, I think you can buy back. I’m not talking about with a renegotiation, but you can buy back at discounts, you can do things at discounts. I’m not even suggesting that we don’t borrow money at very low rates long-term, so we don’t have to worry about when they come due.
If interest rates go up one percent, one percent, it’s devastating. If they go up two, or three, or four percent. … But I would refinance debt, I think we should refinance longer term debt. [CNBC, Squawk Box, 5/5/16]
Media Blast Trump’s “Astounding” And “Insane” Idea, Which “Would Destroy The Economy”
Business Insider: Trump’s Proposed Debt Restructuring Is “An Insane Idea That Would Tank The American Economy.” Business Insider senior editor Josh Barro slammed the presumptive GOP nominee for promising to “approach financing the US government as if it’s one of his failing casinos.” Barro noted that Trump’s plan to renegotiate American debt obligations would not function like the “corporate finance deals” Trump alluded to. Rather than shedding some debt obligations, Trump’s plan would immediately undermine investor confidence, “spark a crisis in the Treasury markets,” and drive interest rates even higher. From Business Insider:
Some corporate finance deals really do work like this: You issue risky debt, and the lenders know you might not be able to pay them back in full if something really bad happens. But that kind of debt bears a high interest rate, because the lenders know you might not be able to pay them back in full if something really bad happens.
US Treasury bonds have very low interest rates because investors are extremely confident they will be paid in full, even in poor economic conditions. Trump — by openly saying that he would keep partial payment on the table as an option — could spark a crisis in the Treasury markets if he became president. Investors would cease to see Treasurys as a safe asset, and they would demand higher interest rates in exchange for risk.
It has been common for years for some Republicans to talk about America’s debts as unpayable. Starting from that incorrect premise, Trump is only adding the insight that if you’re going to default anyway, you might as well borrow what you can while you still have access to the credit markets. [Business Insider, 5/6/16]
Bloomberg: Bond Expert Calls Trump’s Idea “Stupid And Ridiculous.” Bloomberg reported that U.S. bond traders dismissed Donald Trump’s idea to renegotiate debt, something no Treasury secretary in the history of the country has ever done, because as David Adler, head of government-bond strategy for CRT Capital Group said, the idea is “stupid,” “ridiculous” and “never going to happen.” From the May 6 Bloomberg article:
Since the founding of the country Treasury secretaries have been unwavering in their commitment to always make good on government obligations, an assurance that’s helped make U.S. debt a haven from risk around the world. A default would put that status in jeopardy, sinking the value of the dollar and sending yields surging, according to David Ader, head of government-bond strategy at CRT Capital Group LLC. Growth could stall as borrowing costs for holders of mortgages and other consumer loans — which are tied to government debt yields, spiked.
“This is stupid and ridiculous and never going to happen,” Ader said from Stamford, Connecticut. “But it’s not impossible that he could be president, and could try all the seemingly ludicrous and impossible things he’s talked about. You can’t just dismiss it when the guys got his finger on the button, so to speak.”
Treasury market participants aren’t immune to concern about the national debt, even as they remain unshaken by Trump’s comments. When partisan gridlock brought the government to the brink of default in August 2011, one-month Treasury bill rates climbed to a 29-month high and stocks fell as S&P Global Ratings cut the nation’s credit rating.
“This is irresponsible talk,” says Patrick Chovanec, New York-based chief strategist for Silvercrest Asset Management Group. “If there was a belief that he would actually do it, I don’t know how markets would react. Clearly, they’re dismissing it at the moment as simply rhetoric, and not particularly well thought-out rhetoric.”
The U.S. has never defaulted on its obligations in modern history. [Bloomberg, 5/6/16]
The Economist: Treasury Bonds Are What “Underpins The Entire Global System.” The Economistreported that Donald Trump compared negotiating United States government bonds to how a company negotiates its debt in bankruptcy, something that would not make sense because U.S. bonds are “the heart of the financial system.” U.S. bonds are collateral for banks, insurance, pension funds, and mutual funds, and default would result in “cataclysmic consequences for the economy that would far outweigh any gains in refinancing costs.” From the May 6 edition of The Economist:
The idea, it seems, would be to get creditors to accept less than 100 cents on the dollar. This happens with corporate bankruptcies; if the market price has fallen to 60 cents on the dollar, and been snapped up by specialist hedge funds, then redeeming the debt at 70 cents on the dollar may be a good deal. Emerging economies have done the same in the past when they have fallen on hard times; it happened in Greece.
But with Treasury bonds, investors expect to get 100 cents on the dollar. It is the risk-free asset that underpins the entire global financial system.
A forced deal, of course, would count as a default. Treasury bonds are at the heart of the financial system. Banks use them as collateral for loans; insurance companies hold them as reserves; pension funds own then to fund retirement benefits; mutual funds own them as well. Any default within the system would have cataclysmic consequences for the economy that would far outweigh any gains in refinancing costs. To cap it all, the Federal Reserve owns almost $2.5 trillion of Treasury bonds and the Social Security Fund some $2.8 trillion. So the government would, in part, be defaulting to itself. [The Economist, 5/6/16]
NY Times: “Such Remarks By A Major Presidential Candidate Have No Modern Precedent” And Show “The Limits Of Translating [Trump’s] Business Acumen Into The World Of Government Finance.” The New York Times reported on Trump’s plan by noting that there is “no modern precedent” for “a major presidential candidate” to suggest only partially paying back debts owed by the federal government. The Times explained that Trump’s proposal might end up “costing American taxpayers a lot of money” and noted that the reason the U.S. government can borrow at such low rates is that “Treasury securities are regarded as a safe investment” and are expected to repaid on time and in full. From the May 6 New York Times article:
After assuring Americans he is not running for president “to make things unstable for the country,” the presumptive Republican nominee, Donald J. Trump, suggested that he might reduce the national debt by persuading creditors to accept something less than full payment.
Such remarks by a major presidential candidate have no modern precedent. The United States government is able to borrow money at very low interest rates because Treasury securities are regarded as a safe investment, and any cracks in investor confidence have a long history of costing American taxpayers a lot of money.
Experts also described Mr. Trump’s vaguely sketched proposal as fanciful, saying there was no reason to think America’s creditors would accept anything less than 100 cents on the dollar, regardless of Mr. Trump’s deal-making prowess.
Repurchasing debt is a fairly common tactic in the corporate world, but it only works if the debt is trading at a discount. If creditors think they are going to get 80 cents for every dollar they are owed, they may be overjoyed to get 90 cents. Mr. Trump’s companies had sometimes been able to retire debt at a discount because creditors feared they might default.
But Mr. Trump’s statement might show the limits of translating his business acumen into the world of government finance. The United States simply cannot pursue a similar strategy. The government runs an annual deficit, so it must borrow to retire existing debt. Any measures that would reduce the value of the existing debt, making it cheaper to repurchase, would increase the cost of issuing new debt. Such a threat also could undermine the stability of global financial markets. [The New York Times, 5/6/16]
Vox: Trump Is Proposing “A Bankruptcy Of The United States Federal Government That Would Incinerate The World Economy.” Vox editor Matthew Yglesias noted that Trump’s plan to renegotiate debt obligations toward only partial repayments would amount to “a bankruptcy of the United States federal government that would incinerate the world economy.” Yglesias slammed Trump’s “dangerous ignorance” about monetary policy while highlighting the inherent problem of approaching the day-to-day functions of government as if it were a private business. Yglesias concluded his argument by pointing out that Trump’s debt default proposal would not be necessary in any “conceivable circumstance” because the United States Treasury can produce “instantly and in infinite quantities” all of the American dollars it needs to repay any amount of debt. From the May 6 Vox article:
With his statement, Trump not only revealed a dangerous ignorance about the operation of the national monetary system and the global economic order, but also offered a brilliant case study in the profound risks of attempting to apply the logic of a private business enterprise to the task of running the United States of America.
Remember 2008, when the markets went from thinking housing debt was low-risk to thinking it was high-risk, and a global financial crisis was the result? This would be like that, but much worse — US government debt is the very foundation of low-risk investments.
What’s especially troubling about Trump’s proposal is that there is genuinely no conceivable circumstance under which this kind of default would be necessary. The debt of the federal government consists entirely of obligations to pay US dollars to various individuals and institutions. US dollars are, conveniently, something the US government can create instantly and in infinite quantities at any time. [Vox, 5/6/16]
Wash. Post: Conservative Economists Criticize Trump’s Idea As “Outrageous.” Max Ehrenfreund wrote on The Washington Post’s Wonkblog that “doubts have arisen before” that the U.S. government would not default on its debt because of Republican members of congress refusing to raise the debt ceiling in 2011, which led to Standard & Poor’s rating agency downgrading the U.S.’s credit rating. Ehrenfreund also quoted two conservative economists who were critical of Trump’s idea for the national debt. From the May 6 Wonkblog post:
The comments were striking because, historically, U.S. government debt has been treated as sacrosanct, the safest investment in the world, and a pillar of global financial stability.
While Trump’s precise plans were unclear from the interview, if the U.S. government did not pay some of its debts in full, creditors would come to see the country as an unreliable borrower, said Douglas Holtz-Eakin, an economist who heads the conservative American Action Forum think tank.
“You’re Puerto Rico,” he said, referring to the fact that the U.S. territory is on the verge of defaulting on its debt. “That’s not a good thing.”
“The Treasury Department could go to people who hold the debt and say, look, we’re not going to be able to pay you back,” said Michael Strain, an economist at the right-leaning American Enterprise Institute. “That would be an outrageous thing to do. … It could introduce chaos.”
U.S. government debt has remained crucial to the global financial system over the past few years, especially as the global economy has weakened. Still, doubts have arisen before, particularly when Republican congressional leaders threatened not to raise the federal limit on borrowing without policy concessions from the Obama administration in 2011. Ultimately, the cap was raised, though not before the Standard & Poor’s rating agency reduced the rating of the debt from the firm’s highest grade. [The Washington Post, WonkBlog, 5/6/16]