It’s Time for the U.S. Banks to Write Down Latin Loans

The controversy over Nicaragua may turn out to be a sideshow. Mexico is the southern neighbor that really matters to America, and Mexico--shaken by collapsing oil prices and an earthquake--is in deep trouble. President Miguel de la Madrid wants relief on the country’s $97-billion overseas debt. It’s a reasonable demand that the United States should try to accommodate. Mexico is a reminder of how much our relations with Latin America hinge on defusing the region’s mammoth debt crisis.

Our porous borders and trade make Latin American prosperity and political stability vital U.S. interests. A sickly Mexican economy is already increasing illegal immigration into the United States. Since 1980, U.S. exports to Latin America have declined 31%; our annual trade deficit with the region has risen $18 billion. And the debt crisis may shape Latin America’s politics for decades. In Brazil and Argentina the survival of new democratic governments depends on their ability to overcome debt problems and raise living standards.

Actually, debt crisis is a misnomer; the real crisis is one of economic growth. In the 1970s cheap foreign loans and inflationary government spending kept Latin economies growing. The foreign loans were intended to finance productive new investments. In practice they often propped up high exchange rates, which promoted imports and discouraged exports. Without a new formula for growth, Latin economies will continue to stagnate.

At best, modest debt relief can play a secondary role in reviving Latin economies. Only Latin governments can make the basic changes needed to restore confidence. The three major debtors (Argentina, Brazil, Mexico) are moving to sell or close some state-owned companies. The eventual aim is for private investment to replace government as the main engine of economic growth.

A test of success will be whether debtor countries can reattract some of the funds held overseas by their own citizens. Latin American businesses and families have often voted no-confidence in their countries’ economic policies by buying dollars and investing overseas.

But excessive foreign debt now threatens reform. To service their loans, debtor countries have slowed their economies, cut imports and run massive trade surpluses (mostly in dollars). In 1985 Argentina’s surplus was 7.9% of its total output, Brazil’s 5.7% and Mexico’s 4.8%. (By contrast, the U.S. trade deficit equals 3% of our output.) Banks have squeezed as much from the debtors as possible, then covered unpaid amounts with new “loans.” The new loans avoid write-downs on old loans that would cut bank profits. It’s a bit of flimflam that’s dangerous for both creditors and debtors.

In part, the debt has served as a political pretext for unpopular but needed reforms. But austerity makes political sense only if it yields rewards. As De la Madrid said: “Permanent stagnation is unacceptablefor Mexico.” In 1986 Mexico may produce no more than it did in 1981, economist Abel Beltran Del Rio of Wharton Econometrics estimates; meanwhile, its population has grown 10%.

The United States should push banks for write-downs: reductions in loan amounts and an easing of interest rates. Our long-term national interest and the stability of the banking system lie in making the debt burden tolerable. Piling new loans atop old makes all the debt more risky. By raising the debt burden, it erodes debtors’ political will to pay at all. Yet the debt plan of Treasury Secretary James A. Baker III, intended to spur higher economic growth, calls for more loans and not write-downs.

No one denies that the major banks would temporarily suffer. But they would survive. A 20% write-down of all Latin loans would reduce the capital of the nine largest U.S. banks (holding more than half the loans) by about 25%. The bankers’ complaints that poor economic policies caused the current crisis are self-serving and hypocritical. If the policies were so obviously misguided, why did banks lend in the first place? In fact, the banks’ loans abetted these policies. Banks that make poor loans should not escape the consequences of their mistakes.

Mexico’s plight is crystallizing the issues. With oil as two-thirds of its exports, the oil-price collapse has crippled its ability to meet interest payments. But the problem applies to most Latin debtors, even though their immediate prospects have been improved by lower oil prices and declining U.S. interest rates. Debt relief is no panacea. Unless tied to reform, it would be worthless.

Politics is the stepchild of economics. The tendency to regard the debt crisis as a matter of arcane finance obscures the deeper reality. Latin America’s future and our relationship with the region are being forged in the crucible of the debt crisis. There are limits beyond which sovereign nations will not run their societies for the convenience of foreign bankers. That’s the message from Mexico, and we should heed it.