Who Has Leverage over Whom?

I tried to make this point some time back on Twitter, but that was not the right place because you have to develop a somewhat more expansive argument. The question is about financial connections between different actors and what they mean. You can freely think of one side as Donald Trump and of the other as “Russians” in some sense, but my observation is quite general.

The reason I address this point is that I see many people get this wrong. If you have not thought about it, this is just an inadvertent mistake and innocuous. I have far less patience, though, or actually none, for journalists, pundits, or politicians who mess this up. They must know better, and it makes me cringe when they don’t.

Let’s assume X gives a loan to Y. A loan is a type of credit: X hands money over to Y as part of a contract. Y has obligations towards X: to pay the money back plus interest, at one point in the future or maybe staggered in smaller amounts, so-called amortization. Now the question is: Who has leverage over whom here? Who can use this transaction to put pressure on whom?

The answer with some caveats (see below) is that Y has leverage over X, not X over Y although I have seen a lot of people claim it is the other way around. Why do I say this? Y can default on the loan, ie. renege on his obligations, which means he will not repay the money, the principal, and will not pay the outstanding interest either.

X has no leverage here: He is on the hook and depends on the cooperation of Y. Surely in case of a default, there are remedies. X could sue Y and try to seize other property of his. But at best that makes X whole, which is no more a threat to Y than just having to honor the contract in the first place. And it only happens after Y defaults, something that Y can do, not X.

So if X is some “Russian” (an entity directly or indirectly connected with the Russian government or a private person that is unrelated), and Y is Donald Trump, then Donald Trump has leverage over the “Russian,” not the other way around. But I have seen the latter claim over and over again in the media.

Another example would be a bond, which is very similar to a loan. The only difference is that a bond is a rather standardized type of credit that can be traded on a market in small slices. Typical examples would be bonds issued by governments or by companies. Now if X owns a bond of some entity Y, then Y has at best leverage over X, not X over Y. In this case, it is rather improbable that Y would use this leverage. There might be very many X, and Y may not even know who holds their bonds. Since this is usually out in the open on some market, any attempt to put pressure on X would have wide repercussions.

But leverage is still conceivable if X is a major bondholder who could be pressured by Y with the threat of a default. That sometimes happens with a restructuring, a renegotiation of the debt, where Y extracts concessions from X: I offer you a deal where I only repay part of what I had to, but in exchange I will not default. That may be attractive for X if the threat of a default is real. For example, some governments have played hardball with bondholders. You could think of Greece or Argentina, the respective governments, not the people. They have had varying success with this. But again Y has leverage over X here, not the other way around

What was unfortunate, especially on 140-character Twitter, was that I made this general remark very loosely in the following context: It came out that Jared Kushner held a position in Israeli bonds. Now in principle, Israel would have leverage over Kushner, not Kushner over Israel. I had not even thought about it, but some people immediately assumed that I was insinuating some plot by Israel here and sensed underlying anti-Semitism. But my remark was in general, and I was unware of this interpretation until I got unexpected pushback.

It also makes no sense even if I assumed some sinister motive on the part of Israel, which I don’t. It is silly that Israel would play with their creditworthiness on the market to pressure one person who would not be scared even if there were a default on a few hundred thousand dollars in bonds. Israel would ruin their credit rating and cut themselves off from the market. And the threat is also not there because Israel is nowhere near a default. But in principle and here only in principle, there could be leverage only in this direction, not from Kushner on Israel. What could he do? Refuse to accept the coupons and the repayment of principal. Any borrower can shrug and laugh about such a “threat.”

Now back to the general case: I mentioned caveats where X could also have leverage over Y. Suppose Y has not yet received the loan and perhaps desperately needs it. Y can also get no credit from anybody else. In that case, X might have a lot of leverage over Y. However, as soon as the loan is on, this is over.

The same applies in the case that the loan is already on, but X perhaps needs to prolong it in the future. When the principal is due to be repaid, Y would perhaps want another loan to shift the maturity further out to the future. We would again have to assume that Y has no alternative ways to refinance his debt. In that case, X could have leverage over Y.

Another more general case would be that X and Y are in an ongoing business relationship. This is perhaps not the only loan that Y could get from X. And Y would like to keep that option in the future. In that case again, if it is very important for Y and he has no alternatives, then X can have leverage over Y. That’s why many borrowers have a long-term interest in honoring their commitments although it might seem attractive in the short run to just walk away and default.

However, in all these cases, it is the prospect of further loans or other business that creates the leverage, not a loan that is on. And it is also necessary that Y has to do business with X and cannot work around him in some way. So in a strict sense, an existing loan might be a symptom of possible leverage, but is not proof in and of itself. As I have said: I have seen lots of people, and people who should know better, draw the conclusion that if you discover a loan from X to Y, that shows that X has leverage over Y. But that would need a special and much better argument than just pointing to the loan.

The case of an investment is similar, if it does not lead to control over Y. Suppose X invests in Y’s business. You could view this as a loan that need not be repaid and has maybe variable “interest payments,” ie. dividends for a stock or a share in the profits in other cases. If you view it as kind of a loan (technically, it is not debt, but equity), X is even more so on the hook than with a loan. Y could simply not pay dividends or distribute a share in the profits. There is usually no obligation to do this and no breach of contract. So Y has leverage over X, and X is pretty helpless in return. Hence if again X is a “Russian” and Y is Donald Trump, the “Russian” is on the hook, and not Donald Trump. I have seen even more people get this wrong than with a loan, though.

The same caveats apply: X could have leverage over Y as long as the investment has not yet been made. Also the prospect of further business might create leverage. But the investment itself does not. And the leverage in this case is weaker than with a loan. If you are obligated to repay the loan at some point in time and also to pay interest, X can enforce that. But with an investment, Y has control over the money, and X cannot ask the money back.

A still different case is a deal between X and Y. X buys something from Y. That means X has the money first, and Y has some good. After the deal, Y has the money and X the good. In that case, neither X nor Y have leverage over the other side, apart perhaps from a period of time where the money has not yet been transfered, but the good, or the other way around.

So if we again set X to a “Russian,” Y to Donald Trump and the good is a condo in a Trump Tower or whatever, then neither the “Russian” nor Trump have leverage over each other. Perhaps this is the most frequent mistake I have seen. People point out that many “Russians” have bought condos from Trump and jump to the conclusion that that proves leverage over him. But it does not. If you buy a car from Volkswagen, the company cannot come to you and tell you to do anything. And neither can you tell the company to do anything.

Once more, the caveats apply: the prospect of imminent business or the expectation of business in the future, ongoing business relationships, and so forth, can create leverage of X over Y. However, that is even weaker than for an investment and weaker still than for a loan. Once the transaction is through, there is no relationship between the two sides. For a condo, there might be other contractual obligations, eg. because Trump manages the whole condo complex. But that is a different question.

So, to list deals where Trump has sold condos to “Russians,” and even where he has received investments or loans does not establish in and of itself that the “Russians” have leverage over him. This is a standard argument you can see all over the media, but it shows nothing per se. To prove leverage you would have to at least explain something like why Trump needs these transactions and has no way to get around them or that he expects further deals soon or later in the future. However, that is much harder to do because it turns around things that have not happened yet or where you have only circumstantial clues. So there may be little hard evidence.

If Donald Trump expects to sell something in five years or to get investments and loans, this may only be in his mind. If he desperately needs it, there might be strong leverage over him, and my hunch is that that is the case. However, the usual way of proving it is just sloppy and does not establish anything. And it may be very hard to show it as a matter of principle both by the media and before a court of law.

There may be other aspects that are relevant, eg. if Trump knowingly participated in criminal schemes, eg. money laundering, or courted mobsters and dubious foreign actors. Fraud could play a role if he duped others with false claims, or so could tax evasion. However, those are independent matters that would have to be established in other ways than with a list of loans, investments or business deals. Yet, you can see this very often, and I find the level of expertise in the media often appallingly low.

Bottom line: Be careful with such arguments. Think through what they really show. It is easy to jump to conclusions because you want to have something against Donald Trump. I do, too. But it does not help to go for a “guilt by association” argument that has no merit. A false claim could even play into Trump’s hands because it is easy to refute it. I hope everybody in the media reads my post!