Citicorp May Have Set Debt Relief in Motion

By dramatically deciding last week to add $3 billion to its loan loss reserves, Citicorp, the nation’s largest bank, may have taken the first step toward a lasting solution to the Latin American debt crisis.

The bank will suffer a second-quarter loss of approximately $2.5 billion, but will strengthen its balance sheet in the long term.

More important, the move indicates growing awareness that the way the debt crisis has been dealt with since 1982--lending new money on better terms to recover interest due on old money--has run its course. Eventually, most other key lenders will be forced to follow Citicorp’s move: By building up their loan-loss reserves, they will in effect write down the value of their Third World, and particularly Latin, debts to near the value that the secondary market has been giving them--that is, 55 to 65 cents on the dollar.

Despite short-term complications, the consequences for the debtor nations probably are favorable. Some believe that in the immediate future, Citicorp’s action may make coming debt negotiations more difficult for Brazil. Similarly (although there are disagreements on this point) the already agonizing process of extending new credit to Latin debtors may become even more painful, particularly for medium-size banks, which have been pulled in opposite directions by reluctant regional and overpowering money-center banks.

The most important result to emerge from Citicorp’s decision lies in its opening the door to what until now were unmentionable words in the international financial community: debt forgiveness.

What Citicorp’s move amounts to is an equalization of its foreign debts’ book value with the market’s value. But in itself this write-down implies no concomitant reduction in the debtors’ obligations: They still owe 100 cents to the dollar. Hence they are obliged to continue making interest payments on the book value of their outstanding debts, not on the market value.

The yield generated by these loans is astronomical, and the entire situation is becoming politically unsustainable. Why should the debtors pay interest on more than what the banks say the loans are worth?

To say that they should do so simply because that was the agreement is no longer valid, precisely because Citicorp has now altered the original agreement.

The only solution is forgiveness--erasing from their books the portion of the debt that Citicorp and other banks make reserves against, passing on the reduction in value to the debtor.

For now, the savings for the debtors would be small and difficult to establish with precision, since Citicorp has not said which loans it is making provisions against. But once the principle of debt forgiveness is admitted, the limits to its application diminish rapidly, for it is the only real and lasting solution to the debt imbroglio, however unpleasant or unjust it may sound to some.

Many banks will resist following Citicorp. All banks undoubtedly will strive to avoid passing on to the debtor nations the reduction in their loans’ value. And everybody--the banks, the government of the United States and the multilateral lending agencies--will fight tooth and nail every extension of the principle of forgiveness. But in all three cases, the situation’s sheer inevitability, and the failure of present solutions, will drive matters forward.

Citicorp’s move has finally brought a sense of reality to the debt scene by giving loans their true worth and accepting that, in fact, they are less than fully performing assets. Forgiveness is the next step--and it is less remote than many believe--thanks, unexpectedly, to Citicorp.