Banks Face Reality : Way Open to Solve Global Debt Crisis
In a matter of weeks, the whole shaky structure cobbled together since 1982 to deal with the Third World debt crisis came tumbling down.
The collapse began on May 19, when New York’s Citicorp, the nation’s largest banking company, announced that it was setting aside a staggering $3 billion in preparation for losses on its $15 billion in loans to ailing Third World borrowers. It continued through this week, when BankAmerica Corp., First Interstate Bancorp and Chemical New York Corp. joined a growing list of U.S. banks in following a similar course, adding reserves totaling $2.85 billion for future write-offs.
In just three weeks, American banks belatedly confronted the harsh truth that a substantial proportion of the Third World loans they so eagerly wrote in the 1970s and early 1980s is worthless today.
End to Wishful Thinking
So far, a half-dozen major banks have announced losses of more than $6.5 billion, and the tally is certain to climb as more banks admit that their profit reports for the last five years have been based on wishful thinking.
Citicorp’s action signaled its willingness to absorb a huge loss to clear its books for a more realistic approach to the debt-repayment problems of its Third World borrowers. Other banks were forced to follow suit because of market expectations and quiet regulatory pressure.
The return to reality in global banking, many bankers and outside analysts said, paves the way for creative new approaches to the developing nations’ crippling debt, which is now nearing $1 trillion worldwide.
Only Partial Solutions
But even the most optimistic observers expect the new efforts to provide only a partial solution to the Third World’s debt problems. The rest must come from the governments of industrial nations and renewed growth in the developing nations themselves, bankers and analysts said; and the prospects for dramatic progress on these fronts is doubtful.
A new structure for dealing with the debt crisis may arise from the rubble of the old, but its shape is not yet clear.
“These large increases in loan-loss reserves by major banks not only change the way developing country debt is viewed but potentially will affect the dynamics of how this problem will be dealt with,” said BankAmerica’s chief executive, A. W. Clausen, searching for a hopeful note in announcing the bank’s $1-billion reserve and resulting $1-billion loss on Monday.
“This addition to our reserve will allow us to address the new uncertainties introduced by the changes in market perception and will strengthen our ability to help develop constructive solutions to the developing country debt situation,” said Clausen, who oversaw the bank’s rush into Latin American lending during his earlier tenure as BankAmerica chief in the 1970s.
Indeed, the huge losses and the banks’ large cushion against future shocks have given fresh impetus to public and private efforts to forge workable answers to the so-far intractable problem of Third World debt. Innovative schemes such as debt-for-equity swaps, commodity trades and cut-rate lending programs, which so far have been tried only on a very limited scale, now have a far greater chance of success, analysts said.
Debt-for-equity swaps, in which a bank exchanges a loan for an ownership stake in a local business, are held out as a hope for relieving both the banks’ balance sheets and the borrowers’ interest burdens. But only about $5 billion in Third World swaps were done in all of 1986, and the market remains thin for trading debt in this way.
Los Angeles’ First Interstate is pioneering another innovation, payment of debts in commodities rather than dollars. First Interstate currently is arranging to buy agricultural produce, seafood and textiles from Peru and keep part of the proceeds as loan repayment.
Political Opposition Seen
These and other schemes to lessen the debt burdens of the developing countries are welcomed by bankers and officials in the debtor countries alike, although some predict that there will be political opposition to increased foreign bank ownership of local industries. But they are at best a partial solution to a huge problem, analysts said.
“The chances are slightly better because now we’re focusing on some real solutions,” said Peter Hakim, staff director of the Inter-American Dialogue, a Washington policy group concerned with Latin American issues. “But it’s clearly up to (industrial country) governments to change the rules or create additional funding”--loans from international agencies that carry lower terms and longer repayment periods.
What is surprising is how calmly the world has taken the news of the huge bank losses. Three years ago, the mere suggestion that America’s four top banks--Citicorp, BankAmerica, Chase Manhattan Corp. and Chemical--would lose $1 billion each because of their foolhardy lending to the Third World would have sent markets reeling. But investors have been prepared for this news for a long time and reacted positively to the move, applauding the bankers as “bold” and “farsighted” and bidding up the banks’ depressed stock prices.
In the developing countries, however, nothing has changed. At a time when the world’s poor nations are desperate for new money to repay old debts and build their societies for the future, their chief source of funds over the last decade--the banks--has essentially said, “ No mas. “
Cash-Starved Nations
No more will cash-starved developing nations sit down with a small group of international bankers and negotiate a $6-billion new money package, as Mexico did last fall. No more will hundreds of smaller banks fall in line behind the global giants and offer up their share of billions in new loans needed to pay interest on old loans.
And there is little hope that the governments of the rich countries will step in to fill the void left by the collapse of the system that was hastily slapped together in response to Mexico’s 1982 declaration that it could not pay the interest on its $100-billion debt. Proposals to commit taxpayers’ money to bail out the banks have never gotten very far in Congress.
The collapse of the old debt structure, although it offers some hope for the future, is not without costs. Bank shareholders have watched their investments shrink in value and, in the case of BankAmerica, seen their dividends evaporate. Cherished myths have been shattered, particularly the one espoused so fervently by former Citicorp Chairman Walter B. Wriston that “countries do not go bankrupt.”
Higher Interest Rates
The huge bank losses mean substantially less lendable funds for productive investments in the United States and abroad, and higher interest rates for money that is available. And the facade of bank cooperation, propped up so carefully during years of acrimonious loan restructuring talks with debtor nations, has been utterly demolished.
There are no heroes in this trillion-dollar saga, only villains and victims and the occasional small voice of reason crying out from the gloom. Money that could have been spent building productive enterprises or improving health care, education and public works in Africa, Asia and Latin America left the regions instead as flight capital spirited out by wealthy residents who were frightened or cynical or both.
Social scientists say that the burden of debt repayment and the resulting economic strains in Latin America alone will result in an additional 20 million people living in absolute poverty at the end of the century.
The cost will be paid in the United States, as well. Congress’ General Accounting Office estimates that the current recession in Latin America and the rest of the Third World has already cost the jobs of 400,000 Americans who produce agricultural and manufactured goods for export to customers in developing countries who can no longer afford them.
In the banking system, where so many seemed blind to reality, a few had at least one eye open. Charles L. Coltman III, chief of foreign lending at Philadelphia National Bank, has been a persistent critic of the system of lending new money to impoverished nations to pay interest on old loans.
Perpetuating a Fiction
“Piling debt upon debt only keeps bankers’ interest current,” Coltman said. It does nothing to address the underlying economic problems of the debtor countries and only perpetuates the fiction that the bank loans are, in industry parlance, “performing.”
Lending new money to pay old interest bills is called “round-tripping,” in which a bank essentially moves money from one account to another, while adding to the overall debt burden of the borrower.
The huge reserves by Citicorp and the other banks--which tacitly acknowledge that their loans to the Third World are worth at most 75 cents on the dollar--will bring that practice to an end. Banks cannot justify, and their auditors will not allow under prudent accounting practices, sending to the Third World a dollar that instantly is worth only 75 cents.
Coltman’s solution--which has so far been resisted by other bankers--is to lower the interest rates on existing loans to major Third World borrowers below current market rates, rather than lend new funds. The effect would be to lower the loan repayment burden on the debtor nations, without emptying the vaults of the banks. The losses caused by below-market lending could be subtracted from the newly bolstered reserves, Coltman said.
“The effect is the same as lending new money, except you don’t pile debt on debt. That’s important,” Coltman said.
New Lines of Credit
Coltman proposes also to reopen lines of credit to the Third World to help finance trade, which is needed to earn the foreign currency to pay old debts. But Coltman insists that the new trade credits will be provided only if they have seniority over older debt, meaning they will be paid before any others.
“That’s how you get them back to the market,” Coltman said. “You can’t do that unless that old debt is no longer a threat to servicing the new.”
John Reed, the brash 48-year-old chairman of Citicorp, was hailed as a genius for being the first major bank chairman to confess the obvious and take the long-delayed losses. He said the bank’s move was designed to strengthen, not weaken, the international financial system.
“We are totally dependent on the global banking system functioning, and we would not do anything that we felt was destructive to that,” he told Fortune magazine last week. “The judgment was that it made sense to do it and that it would not have a negative impact on the banking system and that it might indeed break the logjam in terms of flexibility.”
He said Treasury Secretary James A. Baker III and other U.S. officials had been consulted before the dramatic move and had concurred.
To Continue Lending
Reed said Citicorp would not drop out of the international lending game, although he said he intended to reduce the bank’s $15-billion Third World exposure by as much as $5 billion over the next few years by selling some loans and converting others to equity investments in foreign ventures. But new loans will be made only under much tighter conditions.
“We will definitely lend new money,” Reed said. “We have said consistently and constantly we will lend money anytime it makes sense. And making sense means there has to be some reasonable prospect that the money is going to get paid back.”
The Treasury secretary, whose so-called Baker Plan for addressing the debt problem never got off the ground, welcomed the banks’ increase in reserves.
“This action really puts United States banks on a par with Japanese and European banks, who are far ahead of our banks in this type of provisioning,” Baker said in a television interview from the economic summit meeting in Venice last Sunday. “I think, if you’re going to solve the Third World debt problem on the private side, as opposed to putting it on the backs of taxpayers in the creditor countries--which is something that we could not advocate or support--there are certain fundamental principles that are going to govern it.”
Government Reforms
Among those principles, Baker said, is that new lending should be in support of government reforms aimed at fostering freer trade and less public interference in the economy.
“The best way to encourage those reforms is to deal from a position of strength. This action will permit U.S. banks to deal more from a position of strength because heretofore they were concerned about a default and were sort of dealing from a position of weakness,” Baker said.
The banks’ increase in reserves was triggered in part by Brazil’s declaration in February that, because of a severe economic crisis, it was suspending interest payments on $68 billion in loans from foreign banks and governments. Brazil did not call its action a default, nor did the banks dare utter the word, but that’s what it was. Brazil said it would resume payments when the banks rescheduled the loans under more lenient terms.
In the interview, Baker offered no new policy initiatives and promised no new U.S. government support for the debtor nations. Until someone steps forward with a workable plan to restart the flow of resources to the Third World, the problem will remain unresolved.
Some in the developing world see opportunity in the current impasse. Either the banks or the rich nations will have to do something in the near term or face increasing political and economic instability in the Third World, according to Jorge Castaneda, a Mexican political scientist and social commentator.
“In the very short term, for whatever negotiations (that are) going on, like Argentina, it makes them obviously more difficult. It’s very complicated for the banks to write off loans on one hand and disburse new money on the other,” Castaneda said. “But, in the mid-term, it’s good news, because it creates an untenable situation . . . . From here, you must move forward.”
