Why Trump really could push the U.S. to default on its debt

Why Trump really could push the U.S. to default on its debt

Donald Trump knows a thing or two about defaulting on debt. His businesses have filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code at least four times to overcome excessive indebtedness: first with Trump Taj Mahal in 1991, then Trump Plaza Hotel in 1992, Trump Hotels and Casino Resorts 12 years later, and Trump Entertainment Resorts in 2009.

Moreover, Trump openly boasts about this strategy. “I have used the laws of this country just like the greatest people that you read about every day in business have used the laws of this country, the chapter laws, to do a great job for my company, for myself, for my employees, for my family,” he said in 2015. No wonder there has been speculation that he may choose bankruptcy over paying the $450 million penalty owed to New York State following his civil conviction for fraud.

While personal bankruptcy would be a matter between Trump and New York, his fondness for “the chapter laws” ought to concern us all. If Trump is elected president in November, he will face a similar but far larger credit problem: the U.S. government’s growing debt burden. Trump might try to resolve the issue by defaulting, just as he has done for his businesses. This is a low-probability event, but one that would have catastrophic consequences, which could help explain the rise of the price of gold to all-time highs this year as Trump’s presidential prospects have grown.

To be sure, there is no provision in the current bankruptcy code for the federal government to seek protection the way a business or an individual can. Even state governments cannot declare bankruptcy (though municipalities can). But as president, Trump could order the Secretary of the Treasury to abstain from paying interest or repaying the principal on the federal debt. Missing a payment would put the United States in default. But since bond holders could do little more than sue the U.S. Treasury to get their money, Trump may believe that he can negotiate a deal with America’s major creditors.

Of course, a default would destroy the image of U.S. debt as the safest investment available — the keystone of the contemporary financial world. But why should that stop Trump? He likes to take risks with other people’s money, especially when his own exposure is limited. As he said in “The Art of the Deal,” “Protect the downside and the upside will take care of itself.” Moreover, second-term presidents tend to become more reckless because they are no longer restrained by the ballot box. Their limited downside encourages risk-taking.

For example, Republican Presidents Richard Nixon and Ronald Reagan, and Democratic President Bill Clinton, all found trouble in their second terms. Nixon covered up the Watergate burglary, Reagan admitted to trading arms for hostages in the Iran-Contra scandal, and Clinton was impeached for perjury and obstruction of justice.

But these are just selective anecdotes. To demonstrate convincingly that the “downside protection” of lame ducks encourages risky undertakings would require a rigorous experiment. If only we could put the chief executive on a reality-TV show, manufacture similar dangers during both terms, and compare the outcomes.

In fact, two natural experiments in the 20th century come quite close to this. President Woodrow Wilson was elected in 1912, re-elected in 1916, and faced the problem of World War I during both terms. He avoided entering the Great War during his first term, despite pressure from his closest advisers and Germany’s sinking of the Lusitania in May 1915 (which cost 128 American lives). But less than a month after his second inauguration, he scrapped his campaign slogan, “He kept us out of war,” and urged Congress to enter the war.

The second experiment involves Franklin D. Roosevelt, a presumptive lame duck when re-elected to a second term in 1936. Roosevelt had discussed with his cabinet an aggressive move to pack the Supreme Court in 1935 to curb its power, after the Court had struck down key parts of his New Deal legislation. But his advisers considered the upcoming 1936 election too close to call, so Roosevelt delayed his plans. Then, on Feb. 5, 1937, three months after his landslide victory, he proposed legislation to increase the number of Supreme Court justices from nine to 15.

Downside protection encourages risk-taking. If elected to a second term, Trump could join the list of reckless lame-duck presidents by putting the U.S. into default on its bonds. U.S. debt would lose its exalted position and all the privileges that come with it, and Trump would just blame the Democrats for their excessive spending.

William L. Silber is a former professor of finance and economics at New York University’s Stern School of Business

This commentary was published with the permission of Project Syndicate