Bottom Line: No More Latin Loans : Baker Plan Was Hopelessly Off Target, as Citicorp Made Clear

When Citicorp decided last week to bolster its loan loss reserve by $3 billion, it acknowledged that its Latin American loans were not worth anywhere near their face value. In taking this initiative, Citicorp also made clear that, for the foreseeable future, it was not about to lend any more money to Latin American debtor nations, at least not willingly.

The Citicorp action, which is almost certain to be repeated by other money center banks, signals the end of the debt strategy of U.S. Treasury Secretary James A. Baker III, which depended for its success on a revival of commercial bank lending to debtor nations.

It is not surprising that Baker and so many others looked to commercial banks for the capital needed to get Latin America on the road to recovery. As notorious bank robber Willy Sutton said when asked why he robbed banks, “because that’s where the money is.” In the mid-1970s, when the dramatic rise in world oil prices produced a surplus of dollars to be recycled, commercial banks became the overwhelmingly largest source of financing for Latin American development--far outpacing official aid flows, bilateral and multilateral, and direct foreign investment.

In 1981, the year before the debt crisis broke, bank lending to Latin America rose to $56 billion--more than 10 times the amount of official lending and nearly seven times the amount of foreign investments. Just 10 years earlier, these latter sources had provided more than 70% of the region’s external funding.

In the aftermath of the debt crisis, commercial bank lending to Latin America essentially dried up. On average, only $3.2 billion per year became available in the three-year period from 1983 to 1985. The Baker Plan, announced in 1985, was intended to reverse the downward trend and mobilize greater bank lending--about $20 billion over the following three years. Even this amount, which most observers thought grossly inadequate to the region’s financial needs, was not forthcoming. In 1986 Latin American countries actually paid back more in principal than they received in new loans. New bank lending was available only in small amounts as part of broader financing packages designed to assist countries meet shortfalls in interest payments.

The prevailing assumption among policy officials in Washington had been that voluntary bank lending, albeit at somewhat reduced levels, would resume to Latin America once the immediate crisis had passed. They knew that the banks still had at stake the far larger amounts they had lent previously. The banks, it was presumed, would make the additional capital available so countries could invest for the future growth that would allow them to repay both old and new loans.

Moreover, many of the countries, particularly the large ones, were expected to regain their credit worthiness by paying interest on time despite economic difficulties.

Things turned out differently. The banks did not--and will not--lend money willingly to Latin America. Here’s why:

- Banks, as a rule, shun risk. Their profit margins are small, and they lend only when they are virtually certain that they will be paid back. The market in recession-battered Latin America is more appropriate for venture capitalists willing to take risks for greater gains.

- U.S. banks now consider domestic investments to be both more secure and more profitable than international loans. This is a tough combination to beat. Banks do not have the expertise to identify “good” investments in Latin America, and they are further dissuaded by the pessimistic projections of many corporate strategists.

- Interstate--not international--banking is the star to which U.S. banks now want to hitch their wagons. Stock swaps to acquire smaller banking institutions are the preferred way for large money-center banks to expand into new markets. Investor concern over weak Latin American loans have kept the prices of money-center bank stocks low--and this makes acquisitions more expensive. The more Latin American loans they have on their books, the more costly and difficult it is for banks vigorously to move into interstate operations.

- U.S. banks also want to enter the lucrative investment banking trade. Congress is concerned about the risks they may create for depositors, and has so far balked at approving the necessary legislation. Reducing Latin American exposure may bolster congressional confidence in the banks’ financial integrity.

The bottom line is that commercial banks are set against any new lending to Latin America. They want, as quickly as possible, to reduce their exposure in the region. The banks will be ready to lend again only when Latin America has recovered economically--when it enjoys sustained growth and a healthy business climate. They will not volunteer any of their funds to spur that recovery.

Where does this leave Latin America? No better or worse than it was before the Citicorp decision. That action, more than anything else, attested to the depth of the region’s economic and financial problems--and the enormous obstacles to recovery. It did not change the situation in any significant way.

Rebuilding the Latin American economies requires public resources and political leadership--most of all from the United States, but also from governments in Japan and Western Europe as well as in Latin America. If there if one lesson to be learned from the Citicorp action, it is that there are no private solutions to the debt crisis.