BANKS ON THE BRINK BY JACK EGAN

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83M00914R001000030024-6
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 4
• Document Creation Date: December 19, 2016
• Document Release Date: February 20, 2007
• Sequence Number: 24
• Publication Date: October 25, 1982
• Content Type: OPEN SOURCE

Approved For Release 2007/02/20: CIA-R DP83M00914R001000030024-6
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By Jack Egan
Flirting With a Global Collapse
EM EMBER THE NEW YORK CITY the widening crisis. Instead, each case is
fiscal crisis of the mid- I970s? being dealt with on an ad hoc basis. The
It took one cliff-hanger after most troublesome case right now is Mex-
another to keep the city from ico, the world's most indebted nation,
going bankrupt. Multiply the with over $60 billion in loans outstand-
seriousness and complexity of that situ- ing to private banks.
ation by at least ten, and you'll get some-
idea of what lies ahead in the coming E'VE LEARNED FROM
year for the world's tightly interwoven 6 public policy that noth-
international financial system. ing gets done until there
It is no overstatement to say that the is a real crisis," says in-
governments of dozens of debt-ridden vestment banker Felix
nations, the International Monetary
Fund, the Federal Reserve Board, and
hundreds of American and foreign
banks together face the severest and
broadest financial crisis since the 1930s.
Private banks here and abroad have
lent over $300 billion to governments
of developing or Eastern European
countries and a. growing number of
those governments, led by Mexico, Ar-
gentina, and Poland, are unable to re-
pay. An outright default by any of these
countries could tip a number of major
banks into insolvency.
Unlike in the 1930s, American de-
positors are protected by government
insurance for up to $100,000 kept in any
one bank account. But internationally
there is no mechanism in place to ensure
that events don't get out of control.
Former I.M.F. managing director
Johannes Witteveen recently warned
that "a crisis in confidence in the inter-
national banking system could turn this
prolonged recession into a real depres-
sion." Unfortunately, last month's meet-
ing of the fund, an international bank
that keeps a monetary pool from which
nations can borrow, failed to produce
agreement on a global policy to stanch
28 NEW YORK/OCTOBER 25, 1982
Rohatyn, who was Instrumental in work-
ing out a solution to the New York City
mess. "But if you wait for crises to de-
velop, you're going to have to be very
lucky to get through all of them." -
Big American banks are having prob-
lems with their loans not only to coun-
tries but also to corporations. Bankrupt-
cies are running at a record rate, causing
many banks to take large write-offs
against earnings. And there have been
some bad accidents. Chase Manhattan
lost $285 million when Drysdale Gov-
ernment Securities went under in May.
The Continental Illinois National Bank
found itself holding $1.1 billion in ques-
tionable energy loans when the Penn
Square Bank, of Oklahoma City, became
insolvent in July.
Continental, the sixth-largest bank in
the country, has a portfolio filled with
loans to companies that either have filed
for bankruptcy or are in very bad shape.
As the main banker to International
Harvester, which for all intents and pur-
poses is technically insolvent, Con-
tinental has worked with a consortium
of 200-plus banks to restructure thecom-
pany while avoiding a formal bankruptcy
proceeding. By keeping International
Harvester from filing for bankruptcy,
Continental is able to evade another
large write-off.
The most promising development re-
cently has been the rapid decline of
interest rates in the United States, result-
ing from a decision by the Federal Re-
serve Board to stop fighting inflation by
limiting the amount of money available
for borrowing. The Fed is now trying to
induce a national economic recovery
and stem the mounting bankruptcies
and defaults both here and abroad.
Fed Chairman Paul Volcker, in a re-
cent speech to the Business Council,
insisted that the sharp decline in rates
"represents no change in the basic
thrust of policy," but the explosive rises
in stock and bond prices tell a different
story. The market gains clearly reflect a
belief that the Fed has given up on its
previously restrictive monetary policy
and will now do anything it can to bring
interest rates down.
In fact, Volcker told Business Council
members, the heads of the country's
largest corporations, that the step to
lower rates was "taken against a back-
ground of continued sluggishness in
business activity, the exceptional recent
strength of the dollar on the exchange
markets and indications of strong de-
mands for liquidity in some markets."
The question being asked by many is
whether lowering interest rates at this
point can do the trick-or whether the
Fed stuck with its restrictive policy too
long and is now acting in desperation to
pump money into a domestic and inter-
national economy that is already too
illiquid to respond. "It's very late in the
day for the Fed to be easing up," says
 41 QU1 QQA '2"t snap back vigor-
ously when a recovery finally begins, and
that recovery may still be many months
away. The global economy, meanwhile,
is expected to grow a tepid 1 percent in
1983, far from enough to generate the
cash for developing countries to repay
their debts.
The bankers can only hope that the
mutual interest of all the parties in-
volved will keep the system from break-
ing apart. "There are going to be some
major strains for some time to come, but
I don't think the bubble is going to
burst," says Norman Klath, a Morgan
Guaranty Bank vice-president who spe-
cializes in international economic anal-
ysis. "Everyone has too much at stake,
from the borrowers to the lenders to the
governments. The biggest problem right
now isworking throughone or two troub-
led countries, demonstrating that all the
parties involved realize the conse-
quences of failure."
Volcker: His effort to pump money into the system won't help if the banks refuse to lend.
Rohatyn. He is especially concerned
about the several hundred banks that
operate in the Eurodollar market-
banks that borrow and lend dollars
outside the United States. They have no
government to back them as a lender of
last resort in case of failure. While the
Fed has indicated that it will prevent any
large U.S. bank or its direct subsidiary
from going under, and other industri-
alized countries are expected similarly
to prop up their own private banks, these
Eurodollar banks could start tumbling
like dominoes. "What we need right now
is some coordinated thinking among the
industrialized countries on how to pre-
vent such a situation from occurring,"
Rohatyn says.
"We have a race between the Fed's
attempt to re-liquefy the financial system
and the continuing deterioration of the
economy," says Raymond Dalio, presi-
dent of Bridgewater Associates, an eco-
nomic-consulting firm. "And it's a race
that will go right down to the wire."
Dalio is doubtful that the Fed will suc-
ceed. If it does, he believes, it could, by
making borrowing easier and less ex-
pensive, set off a new round of serious
inflation by 1983 or 1984.
Optimists are hoping that a financial
crisis can be avoided if the U.S. economy
starts to turn around. A rebound here
could begin to pull the world out of its
economic doldrums, providing the
growth that would permit the develop-
ing countries to repay their debts. How-
ever, current projections suggest that
T HE BIGGEST PROBLEM RIGHT
now to work through is Mex-
ico. Although a rescue pack-
age has been put together for
that country, the terms of a
final agreement are still unclear, and
difficult negotiations lie ahead. As a
condition for more than $4 billion in
new loans, the I.M.F. is trying to impose
severe austerity measures on Mexico.
But if Mexico is forced to slow down its
economy, it is hard to see how it can
begin to pay back its debts. Only a re-
sumption of strong economic growth
can reverse the situation, and the
I.M.F.'s conditions for a bailout will
probably put Mexico deeper into the
red. Even if an agreement is reached,
growing internal unrest and political
turmoil may make any promise to de-
flate the Mexican economy impossible
to carry out for very long.
Argentina is in even worse shape. Hy-
perinflation has turned it into a basket
case. With more than $25 billion in out-
standing bank loans, Argentina is mak-
ing minimal interest payments on these
debts and has stopped repaying any
principal. It is not even making any ef-
fort to reschedule its -debts. There has
recently been talk that Argentina may
repudiate its loans, a thought that sends
shudders through the banking com-
munity. However, the banks have looked
the other way, fearing to take write-offs
that could. wipe out their capital. An
approach to the I.M.F. for assistance has
been made by Argentina, but no an-
nouncement of any bailout package has
been made.
The repayment difficulties of Mexico
and Argentina, which together account
for one-quarter of the loans to all de-
veloping countries, have caused the
banks virtually to freeze lending to all
countries in Latin America. U.S. banks
hold about a third of this total
 4R001000030024-6
"...The bankers can only hope that the mutual interest
debt. Eastern-bloc countries have also
been cut off from new loans, as a result
of Poland's financial problems.
The growing reluctance of banks to
extend new loans, reversing the lending
binge of the last ten years, has created
problems for all countries. Brazil, for
example, which owes $53 billion to the
banks, is finding it more and more dif-
ficult to get new financing. As a result, it
may soon find itself in the same position
as Mexico. Brazilian officials have been
meeting with lenders in New York, Lon-
don, and Tokyo to try to convince them
that Brazil's economy is in much better
shape than Mexico's. So far, Brazil has
raised about three-fourths of the $18-
billion in total borrowing it needs this
year to remain solvent. But if it fails to
get all it needs, a crisis of major
dimensions could follow.
HERE'S AN ESSENTIAL CON-
tradiction in the policy the
I.M.F. is pursuing to deal
with the problems of the
growing list of debtor nations
that are in jeopardy. While one country
after another finds that it can't repay its
debts, the I.M.F.'s conditions for fresh
The External Bank Debt
300 Of Non-Oil, Developing Countries
aid include cutting back on imports and
clamping down on economic growth as
a way to subdue inflation. But while such
measures may be effective for a specific
country, they serve to depress overall
world economic activity even more. One
nation's imports are another's exports.
The effort by any one country to reduce
its inflation by curbing imports only
drives the global economy into a deeper
recession. And the pressure for protec-
tion against imports also increases as
domestic unemployment rises.
Deflation was the economic disease of
the Great Depression. But memories
seem to be short. As John Kenneth
Galbraith points out in Money, "the fear
of inflation which inflation leaves in its
wake can be as damaging as the inflation
itself."
The accelerating inflation of the
1970s, aggravated by two oil shocks, is
probably the main reason for the current
banking and liquidity crisis. As inflation
advanced faster than interest rates, bor-
rowing became more desirable, since
loans could be repaid in cheaper dollars.
This fueled more inflation and more bor-
rowing. The banks were only too glad to
go along. The best way to keep earnings
growing as inflation heated up was to
increase loan volume. The big surpluses
that built up in the petroleum-producing
countries were deposited in the multi-
national banks, which in turn recycled
the money to the developing countries
to help them pay their mounting energy
bills. The booming international loan
market meanwhile encouraged many
new banks to enter the business, and
competition for market share became
fierce.
The propensity to borrow was not lim-
ited to developing countries. The U.S.
government also ran a perpetual deficit,
and corporations and consumers took
on mountains of debt. The rationale was
the same: With prices going up faster
than interest rates, it was, best to buy
something today that would only cost
more tomorrow, when repayment could
be made in a depreciated currency. As a
result, an enormous debt bubble was
created. Money was socked into real
estate, gold, collectibles, and other
"hard" assets. Corporate and govern-
ment bonds, representing the claims of
creditors, took a dive.
. The rules of the game suddenly
changed in October 1979, when the Fed-
eral Reserve Board, under Chairman
Volcker, announced that it would no
longer try to control interest rates but
would stick to a predetermined level of
growth in the country's money supply.
This drastic shift in policy was in direct
response to monetarist economic the-
ory, which contends that the rate of
inflation is determined by how fast the
central bank ladles out money. By the
spring of 1980, the bank prime rate had
hit 20 percent as a result of the change
in emphasis.
In March 1980, under prodding from
President Carter, the Fed imposed regu-
lations limiting borrowing. The result
was an unexpectedly sharp contraction
in the economy. The Fed let interest
rates plunge, and the prime dropped to
NEW YORK I, iff J3 . Mf Release 2007/02/20: CIA-RDP83M00914R001000030024-6
 Approved For Release 2007/02/20: CIA-RDP83M00914R001000030024-6
of all the parties will keep the system together..*"
10 percent only two months later. When
the controls were lifted, interest rates
surged again, and in December 1980 the
prime rate hit 21.5 percent.
Inflation was slow to respond to the
new policy. But in the last twelve
months, it has dropped drastically, from
an annual rate of about 13 percent to
less than 6 percent. Interest rates, how-
ever, have come down more slowly. As
recently as January, the prime rate stood
at 18 percent. Rates began- falling in
August, and their descent has ac-
celerated in the'last month. Last week, a
number of major banks cut the prime to
12 percent, the lowest level in more than
two years. A 12 percent rate, however, is
far higher than the average bank lending
rate over the last hundred years.
Just as borrowing worked to the ad-
vantage of consumers when prices were
climbing faster than inflation, the
persistence of double-digit interest rates
when inflation is declining rapidly has
strained borrowers. Leverage, after all,
works both ways. The current recession,
the most serious since the 1930s, has
reduced corporate cash flow and made it
extremely difficult for businesses to re-
pay their high levels of accumulated
debt.
The Fed's latest policy shift, despite
disclaimers from Volcker, is clearly an
attempt to ameliorate the situation by
abandoning the pure monetarist ap-
proach. However, the belated effort to
re-liquefy corporations and stimulate the
economy may not work if the banks
don't cooperate. Having gone overboard
in extending credit during the last ten
years, the banks have become reluctant
to make new loans. And no matter how
much money the Fed pumps into the
financial system, it won't help if the
banks refuse to lend.
In Canada, the government has been
forced to bail out Dome Petroleum in
order to prevent a bankruptcy that
would have annihilated a number of the
country's largest banks. Germany is
helping to save AEG-Telefunken, the
electronics giant. The reluctance of the
How MuehThey Owe
Banks' claims on selected countries, as reported to the
Bank for International Settlements.
1981 TOTAL
U.S. BANKS' SHARE
(BILLIONS OF
ALL NINE
COUNTRIES
DOLLARS)
BANKS LARGEST
DEVELOPING
3313
?"35% 23%
Non-OPEC Countries
258.5
3623
Brazil
52.7
32 20
Korea
19.9
45 23
Philippines
10.2
53 36
Colombia
5.4
51 36
Thaan"
Malaysia
4.4
22 19
FgYI?t.. y y .. _
;
Peru
4.4
45 24
fur ey
_R
4
opEc Countries
72.8
32 22
Ve nei~t a
Algeria
8.4
16 11
I n1a 7
Ni
Nigeria
6.0
19 15
Ecuaad01' A