Money & The EconomyOpinion

Ridiculous Trump Verdict Catastrophic for US Economy

Based on this verdict, nearly all Real Estate Developers may be guilty of fraud, especially if a politician says so.

Recently a New York state judge ordered Donald Trump to pay $364 million as part of a fraud trial against him and his companies. They say the verdict is a result of Trump over-valuing his properties to obtain more favorable terms from a lender. The charges were bogus, and the verdict is even more bogus. The verdict is intended to damage Trump. It could damage the entire economy.

The New York court concluded that Trump defrauded somebody by overstating property values. While the lender said that there was no fraud and the lender suffered no damages, the judge found Trump guilty anyway. The basis of these charges will mean that real estate developers must change their business practices.

The result will be less business expansion and damage to the New York and possibly the U.S. economies.

The full impact of the ridiculous Trump verdict may be even worse. Virtually every developer could be guilty of overvaluing existing properties.

When Trump sought loans for his properties, he estimated the market value. The lender does their own appraisal and then the terms of the loan are negotiated.

An example of what Trump and all developers do is easy to see. Let’s say a developer built an income-producing property. While there are a few different methods to appraise the value of a property, most will conclude that the value of an income-producing property is based on the income produced.

Regardless of the cost to build, if a property produces $200,000 in income annually, the value is set at a multiple of that. Let’s say the multiple is five. So, the property is valued at five times income or $1,000,000. The lender agrees with the value and offers to lend 70% of that value or $700,000.

Real estate developers need cash to invest in other projects that expand the economy. After several years, the developer can manage the property more efficiently and increase the annual income from $200,000 to $400,000. That means the value of the property has increased to $2,000,000, which is five times the annual income.

The developer then approaches the lender to grant a 70% loan on the property or $1,400,000. The original $700,000 loan is repaid, and the developer retains the $700,000 balance to invest in future projects that grow the economy.

Based on the recent Trump verdict, developers will be hesitant to refinance debt when they believe the value of the property has increased. A developer may say that if he submits a value of $2,000,000 and later some politically motivated court says that the property is still worth $1,000,000, the developer could face the same fate that Trump faced. That is massive fines and severe restrictions on their business activities.

That hesitancy will result in less capital available to developers and less economic growth.

The full impact of the ridiculous Trump verdict may be even worse. Virtually every developer could be guilty of overvaluing existing properties. Also, many homeowners may similarly be guilty of overvaluing their home to get more favorable rates when refinancing a mortgage or seeking a home equity loan.

Suppose a homeowner seeks a home equity loan. Currently, they have a $300,000 mortgage on a home they bought a few years ago for $400,000. Home prices have soared in recent years, so the homeowner says the house is now worth $500,000. The homeowner seeks a $100,000 home equity loan for whatever reason.

If the bank agrees that the home is now worth $500,000, they grant the $100,000 home equity loan. Suppose for some reason, the bank comes back a year later and says the home is not worth $500,000 but only worth $425,000. After granting the $100,000 home equity loan the total debt, including the $300,000 mortgage, is $400,000. Bank regulators will not allow $400,000 debt on a home worth only $425,000. Did the homeowner defraud the lender? Does the homeowner have to immediately pay back the home equity loan?

Of course not. If the borrower and the lender agree on a value, why should an elected official decide that the homeowner is guilty of fraud just because the elected official thinks the value was overstated?

Trump will likely appeal the verdict and even if the liberal appellate court in New York upholds the verdict, an objective higher court will reverse it. And they should. Any transaction where both parties agree to terms and no party is hurt should not be subject to a fraud conviction. Period.

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Michael Busler

Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years.

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