Who Needs the Fed?. John Tamny

that informed his dealings with Trump a few years later, after his promotion to CEO. Having recently been burned by charisma, reputation, and track record, Robert Smith was a different man when Trump visited him than he was with Ueberroth a few years before. “When I first met with Trump he had already been heralded as a genius and seemed to be at the leading edge of everything,” Smith wrote. “Trump had a Clintonesque aura around him, the effervescent divinity of a studied deal-maker, and a categorical ability to communicate and inspire the belief of others in his personal vision. He no doubt could have been an evangelist.”⁷

      Trump sought a $50 million loan (Security Pacific’s “house limit”) for his Ambassador Hotel revitalization plan. Although Smith didn’t explicitly reject Trump’s request, he was skeptical. After the meeting he relayed his misgivings to bank executives who were perhaps understandably bowled over by this most charismatic of businessmen. They wanted to figure out a way to finance Trump, given the prestige that would result from being his banker. Smith didn’t budge.

      Smith said, “When a guy like Trump gets into trouble, he can no longer borrow, because no institution will lend to him.” He added, “As a lender, no matter how glamorous the person on the other side of the table is, you look to the borrower to have both primary and alternate sources of repayment. And, while Trump presented a financial statement with many million dollars of net worth, the ability of him to bail even this one project out was limited—because it was leveraged on an illiquid base of questionable value.”⁸ Smith ultimately lamented his failure to clearly communicate his skepticism about Trump’s creditworthiness. Remember, he didn’t explicitly turn him down. Apparently eager to do business with The Donald, other executives within the bank secured $10 million for Trump as part of “an initial study on the feasibility of restoring the Ambassador Hotel.” Smith “raised holy hell,” and with good reason. The property market swooned during the early 1990s, and as Smith predicted, Trump wasn’t able to make good on what he had borrowed. Smith went on to recall: “Two years later we wrote the whole thing off. It was a loss.”⁹

      Fast-forward two decades, and Trump is claiming he’s worth $10 billion.¹⁰ That is certainly possible, but as Smith makes plain, value is subjective. It’s also no major insight to point out that value is biased.

      In Trump’s defense, Trump understandably believes that the projects he’s involved with or has a stake in are winners. If he didn’t have an unshakeable belief in what he’s doing, then it’s probably safe to say he wouldn’t have the net worth (or outsize reputation) he has today.

      While observable and empirical logic dictates that Trump’s net worth is quite high (Forbes estimates $4.5 billion), the same logic should also cause us to question the $10 billion that Trump regularly cities. Naturally, Trump’s valuation of his various ventures is not going to resemble outside estimates. Again, if he lacked a powerful belief in his projects, then they wouldn’t be projects in the first place.

      It is not possible to know what’s on, or the value of, Trump’s balance sheet. Yet, Smith’s recall of Trump’s subpar creditworthiness is another reminder of the obnoxious conceit that drives economists at the Fed to presume to set the price of access to the economy’s resources. They can decree credit “easy,” but banks and other sources of credit don’t have to comply.

      Trump can claim a net worth that would make loaning to him an apparent no brainer, and the Fed can flood banks with dollars (more on this in Parts Two and Three of this book). But banks, like any other business, would not remain in business for long if they lent in the way the Fed blindly presumes to set rates: as though we are all the same in terms of our ability to pay loans back. Accessing credit shouldn’t be the same for everyone, nor is it. The cost of access is different for every individual and every business. It’s difficult to tell how easily Trump could get a loan today. Still, Smith’s memory of lending to him in the late 1980s is a reminder that even the banks, heavily regulated by the Fed, don’t always march to the beat of the Fed’s simplistic drum rhythms.

      Even better, new sources of credit constantly innovate around the Federal Reserve. While this will be discussed in greater detail in future sections of this book, for now it’s worth migrating to a form of finance that reached full flower around the same time that Trump rocketed to his early fame, high-yield finance. Readers may better know “high-yield bonds” as “junk bonds,” the latter being the pejorative members of the media attached to them long ago. Readers needn’t worry. There’s nothing complicated here.

      To understand “junk” or “high-yield” debt, let’s first imagine you have $10,000 lying around. Next, imagine that actress Jennifer Lawrence asked to borrow it. As the world’s highest-paid actress, with 2015 earnings of $52 million,¹¹ you would be willing to lend her the $10,000 at a pretty low rate of interest. With earnings like hers, there would be little to no risk involved. Lawrence could secure the $10,000 repayment almost by virtue of getting out of bed in the morning.

      But what if the high school son of a neighbor asked to borrow the $10,000 to buy lawnmowers for his new business venture? Eager to expand to several underserved neighborhoods quickly, he needs the credit for lawnmowers that he’ll then lend to contract workers who will pay him for their use.

      It may be a great idea, but it’s also possible that the borrower could lose interest or grow discouraged quickly. Figure the borrower has no credit to speak of other than his business idea, and odds are he lacks a track record of success, which Lawrence has in spades. The risk of lending the $10,000 to him is logically much greater. The loan may well be made (figure Lawrence would have all manner of credit sources lining up to lend to her), but only at a rate of interest that reflects the risk involved. That, in its most basic form, is high-yield finance.

      Enter Michael Milken. His name was needlessly sullied in the 1990s for having spent time in prison for alleged violations relating to “insider trading” (something the SEC, Congress, and the courts still can’t even define¹²). Yet Milken would be one of the faces on any Mount Rushmore meant to lionize the greatest capitalists ever.

      Without getting into too many details, it is worth quoting Payback, by Daniel Fischel, a professor of law at the University of Chicago: “There is no evidence that [Milken] did [commit any crimes], and certainly no evidence that he engaged in any conduct that had ever before been considered criminal.”¹³ Economic growth depends on information, and those who possess information that others don’t should be cheered on for making markets more informed by virtue of trading on it. But government officials, most notably future New York City Mayor Rudolph Giuliani, eventually secured a plea deal from Milken for acts that had never before been considered criminal. (He was worried about family members whom the feds were going after.) Yet, the government could never produce any notable evidence of wrongdoing in the first place. But I digress.

      Before the government forced Milken out of the investment industry altogether, and before he went to work for Drexel Burnham, a third-tier investment bank, Milken attended the University of Pennsylvania’s Wharton School of Business. While at Wharton, the performance of “low-rated” corporate bonds came to fascinate the MBA student. In particular, he discovered that Jennifer Lawrence–equivalent corporations with powerful track records were overrated in terms of creditworthiness relative to newer companies that lacked a long earnings history. Basically, he found that lawnmower start-up equivalents were less risky than was broadly assumed. And so a market was discovered.

      While top-tier banks and investment banks continued to secure finance for blue-chip companies like Exxon, AT&T, and GE, Milken went to work finding credit for newer, lower-rated companies. He also found investors willing to invest in their riskier debt in return for a higher interest rate of return. Basically, Milken found finance for the lawnmower concepts.

      His discovery that past performance wasn’t always a predictor of future performance (remember when Renée Zellweger and Cuba Gooding were A-list actors?) meant that he could bring investment banking services to the blue chips of tomorrow. As Fischel describes, “Whole industries—including gambling, telecommunications, and healthcare—were financed in significant part with high-yield bonds.”¹⁴ The list of companies that were the result of Milken securing them access